By FPA member Eric Toya, CFP®
Last Updated: December 20, 2010
The much anticipated resolution to our tax laws for 2011 and 2012 has finally been reached, with not a moment to spare. On Friday, December 17, President Obama signed into law a bill extending the Bush-era tax cuts for two more years. The details of the tax law are still forthcoming, but there are some implications that you should consider for the remaining two weeks of 2010 and for the start of 2011.
If you completed a Roth conversion in 2010, you have the option of reporting all of the conversion income on your 2010 taxes or splitting it up between 2011 and 2012. Prior to the passage of the tax bill, it was unclear whether or not the additional time to pay the taxes may be outweighed by the potentially higher tax rates in 2011 and 2012. However, we now know that your tax rates will remain the same for two more years. This means that unless you anticipate a substantial increase in your income in 2011 and 2012, you should split and defer the income from your Roth conversion to 2011 and 2012.
Additionally, barring an expected increase in income, you likely don’t need to rush to complete a Roth conversion in 2010. By waiting until January to do a Roth conversion, you will have an entire additional year to undo the conversion if there is a compelling reason to do so, such as a major market crash.
End of Year Income
If you have the option to receive income in 2010 or defer to 2011, the passage of the tax bill means that it may be preferable to defer to 2011. Previously, many were being advised to accelerate income into 2010 in anticipation of tax rates going up in 2011. Now that we know that tax rates will remain the same, deferring income from December 2010 to January 2011 gives you an extra year to pay the taxes.
If the income that you are deferring is employment income (including self-employment income) that is subject to FICA taxes (Social Security taxes), this makes deferral to 2011 even more compelling. The employee share of FICA is reduced from 6.2 percent to 4.2 percent in 2011. This means that you get to keep an additional two percent of all income that is subject to FICA and received in 2011.
Of course, each situation is unique, and if you are anticipating an increase in income in 2011, you may still be better off accelerating income into 2010.
Realizing Capital Gains
Similar to the receipt of income, some investors were realizing capital gains in 2010, expecting long-term capital gains rates to increase in 2011. The rate has been kept the same for 2011 and 2012, including the hard to believe zero percent capital gains rate for taxpayers in the 10 percent and 15 percent income brackets. Again, it would generally make sense to defer the realizing of gains until 2011 to buy more time to pay the taxes.
Charitable Gifting from Individual Retirement Accounts (IRAs)
If you are age 70½ or older, the new law allows you to make a donation of up to $100,000 to a charity directly from your IRA. A donation can be made in lieu of your Required Minimum Distribution (RMD) for 2010. Individuals have until the end of January 2011 to make a charitable donation and have it count for your 2010 RMD. If you have already taken your RMD for 2010, and wish to take advantage of this provision, please contact your IRA custodian to determine how to return the funds and make a charitable donation directly from the IRA before the end of January.
Numerous other details in the new law may affect your present planning opportunities. In particular, there are provisions for business owners, students, and families potentially facing the Alternative Minimum Tax. Also, a significant inclusion is the reinstatement of the Estate Tax with the individual exemption amount set at $5 million. Please consult a financial planner or tax adviser to discuss your specific situation.
FPA member Eric S. Toya, CFP®, is Vice President of Wealth Management for Trovena, LLC in Redondo Beach, Calif. Eric graduated from the University of Southern California with a BS in Finance and Accounting and is a current member of the FPA Los Angeles Chapter Board of Directors. Eric has been quoted in national publications, including the Wall Street Journal, Money Magazine and the Los Angeles Times.