We've all heard the German proverb (when translated), "throw out the baby with the bathwater," and some may see this as an appropriate idiom for their tax planning in 2013 in the wake of proposed changes. It may seem crazy, but with the pending "fiscal cliff" and all the uncertainty surrounding the change in the tax laws, economy and deficit, now might be a good time to "throw out the baby." Depending on your personal situation (i.e. years until retirement, amount of money saved, and risk tolerance to name a few), now may be a good time to take some risk off the table and save some of the value generated with the decent year-to-date market performance. Keep in mind that your personal circumstances will dictate what to do with "the baby," but with the changes that are proposed, now is a good time to start thinking about how those proposed changes might affect your financial portfolio.
This is not a directive to "sell sell sell" (quoting "Mad Money's" Jim Cramer on CNBC) but an opportunity to reflect on the upcoming changes and to prevent the temptation to sell everything. Since the election, we've been receiving calls from clients asking us if they should sell stocks due to the pending changes regarding gains, dividends and income tax rates. Consider the following tips before making adjustments, and remember to relax as you prepare for what's to come, as it is truly anyone's guess.
Tax increases in 2013 are by no means a certainty, but our federal income tax rates remain at historic lows, ranging from 10 percent to 35 percent. Due to our nation's record deficit, we feel it is a good bet that taxpayers will see a combination of higher tax rates and a number of popular deductions and credits eliminated. With the proposed changes, some individuals may get hit harder than others, but no one is immune.
What should you do with only one month before the NewYear? First of all, don't panic. Tax law changes happen more often than you think. Although a major tax law change hasn't happened since 1986, "patches" take place all the time and with usually little or no fanfare.
Second, it is important not to let your emotions take over before analyzing and breaking down the facts about the tax laws. Get advice from professionals you trust and not your friend, neighbor, co-worker or boss. Chances are their situation is different than yours, and their advice or course of action may not apply to you.
Third, know that not all changes will affect you. It is important to know what changes will affect you and your personal situation and how to minimize the impact of those changes. For example, if you have children in college and you are paying their tuition and utilizing the American Opportunity Tax Credit, knowing how the expiration of this credit will change your tax liability and having some strategies to minimize the impact will save you money by graduation.
The tax increase that could have the most wide spread impact is the proposed expiration of the estate and gift tax exclusion amounts and 35 percent tax rate on all transfers. Currently the lifetime exclusion amount for an individual is $5.12 million or $10.24 million for married couples. Right now that covers the vast majority of the American population, so it's almost a non-issue. But if all goes according to plan, the exclusion amount will reset to $ million per individual and the excess taxed at a whopping 55 percent. I know $1 million seems like a lot, but when you consider any life insurance, personal residence, and retirement assets, that $1 million gets eaten up quickly. This will have an immediate impact on those with larger estates, and gifting strategies for those individuals will become an essential part of the overall planning process.
It is helpful to keep in mind what we know about current legislation and possible future legislation when determining what impact it may have on estate and tax planning. Also, we all know that what is proposed and what is passed are almost always two completely different things. The key is to get ahead of any changes and be prepared. This may mean simply adjusting your asset allocation within your different taxable and tax-deferred accounts or beginning to gift assets to love ones. Whatever the case, changes are coming, and the time to prepare is decreasing. Now more than ever it is going to be important to sit down with your financial planner, tax accountant, and estate planning attorney in order to understand and navigate the proposed changes.
Tom Prutzman and Kyle McCann are principals in Reno-based Prutzman Wealth Management. Contact them at 775-996-5672 or through www.prutzmanwm.com.
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