Tax Planning 2012: Last Chance!

Taxes are the biggest debate this election year. Will there be a change passed for next year? Looks doubtful, eh? And if there's no change, we go back to the tax rates of 2002. That means the top rate goes to 39.5% from today's 35%, and other changes reappear which will increase income taxes across the board. Even if a tax bill passes, it will likely include a tax increase.

For those who want to position themselves financially for a higher-tax world in the future, there are two items to consider:

1) The tax deduction for charitable contributions is likely to be reduced or restricted after 2012. This could affect the advantages of using a Donor Advised Fund (DAF) for philanthropy.

2) 2012 will be the best year to convert IRA's to Roth IRA's for many taxpayers who are likely to be in a lower tax bracket now than future years.

The tax planning strategy consists of contributing highly appreciated stock to a DAF before December 31st of 2012. Under current rules, this will avoid the tax on all the appreciation and provide the taxpayer with a charitable deduction for the full market value of the stock. For example, suppose that a taxpayer purchased stock years ago for a low price of $2 per share and it is worth $42 per share today. There is an unrealized capital gain of $40/share. If you hold 1,000 shares, the capital gains tax on the $40, 000 based on current legislation (15% federal) will be $6,000. This tax is avoided by making the donation.

In addition to this savings, the taxpayer will also receive a charitable deduction for the full $42,000 market value of the stock. This will save a taxpayer in the top bracket (35%) $14,700 in 2012 income tax.

The taxpayer can simply save these tax dollars, or they can be applied against the cost of a Roth IRA conversion. If the taxpayer chooses to convert $42,000 of an IRA to a Roth IRA they can do so for no additional tax cost because the additional taxable income of $42,000 for the Roth conversion will be offset by the $42,000 charitable contribution deduction.

Our analysis shows that the taxes saved by having your retirement money grow tax-free in a Roth would fully offset the taxes paid now to convert the funds in seven years. So by paying taxes on the IRA money now, you could increase your after-tax retirement income by 13% to 28% for the rest of you and your spouse's lifetimes!
There are still six months left to implement this strategy, and it is somewhat complex.

I appreciate the editorial review contributed by Chip Simon, CFP®, an ACA colleague in Poughkeepsie, NY.

About the author

Bert Whitehead

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