What Not To Do In 2012 As Tax Rates Creep Up -

As December 31 creeps closer, we keep hearing stories about how the combination of increased taxes and sequestration is literally the end of the world. It has a whole zombie apocalypse feel to it. But should we ready our bunkers and stock up on canned goods just now? Not quite. Outside of taking note of Preparedness 101 as explained by the CDC (truly the most fun thing you’ll read all day), here are ten more things not to do as 2012 wraps up:

1.     Delay putting your house on the market. I know, I've heard it, too. House prices are going up. That’s good, right? So if you hold onto that house just a little bit longer, you could make out like a bandit – or not. Beginning in 2013, a new Medicare tax of 3.8% will be imposed on unearned income for high income taxpayers (individuals reporting income over $200,000 and married taxpayers reporting income over $250,000). That includes capital gain on the sale of a home which is otherwise not excluded: remember, homeowners who meet the criteria may exempt up to $250,000 gain (or $500,000 for married taxpayers) from income. That exclusion still applies. But if your income is above the threshold and if the gain from the sale of your home is more than the exclusion, you will be subject to the Medicare tax on the non-exempt portion.

2.      Hoard your cash. When the calendar flips on January 1, it’s not just the federal income tax that will be affected: there are changes happening in the federal estate and gift tax world, too. Gift tax is a tax on the transfer of property for less than fair market value from one person to another and is imposed on the person making the gift if it’s over the annual exclusion amount for gifts – currently $13,000. That means that every person can gift $13,000 to any number of donors (meaning that you could give $13,000 to one person or $13,000 each to more than a million people) without gift tax consequences. If you give more than the annual exclusion amount, it chips away at your lifetime applicable exclusion amount -  a complicated way of saying the amount of taxable gifts you can make in your lifetime. For 2012, that amount is $5,120,000, but for 2013, it’s slated to drop to $1,000,000, a significant difference. If you’re in a position to make gifts, now is the time.

3.     Offload underperforming stocks. At year end, investment advisers often tell you to get rid of stocks that are losing value in order to balance capital gains with losses. However, with capital gains rates on the way up in 2013, it may make sense to wait and balance capital gains at a higher rate with losses. But what if you've jumped the gun already and ditched the losers? It’s not the end of the word. To the extent that you have excess capital losses in 2012, you may be able to carry those forward.

4.      Put off medical expenses. Traditional wisdom would say that if rates are going up in January, it would make more sense to postpone deductions, if possible, to offset higher rates. That would work if all things remained equal. But they’re not. Currently, medical expenses reported on Schedule A of your 1040 are deductible to the extent that they exceed 7.5% of your adjusted gross income (AGI). Beginning in 2013, taxpayers will only be able deduct those medical expenses which exceed 10% of AGI (though those 65 and older keep the 7.5% floor until 2016). That means that you will have to spend more in order to take the first dollar of medical deduction. For example, if you have an AGI of $100,000 – and are under the age of 65 – for 2012, you could begin deducting medical expenses that exceed $7,500; in 2013, you won’t be able to deduct medical expenses until you spend $10,000. For more on what’s changing with respect to medical expenses in 2013, check out this post.

5.      Make plans to support your favorite charity… next year. Again, as rates go up, it’s tempting to wait and make charitable gifts next year so that you can claim a charitable deduction at the highest tax rate. However, the reinstated Pease limitations may stand in your way. The Pease limitations, named after former Rep. Don Pease (D-OH), limit itemized deductions for high income taxpayers (generally, beginning at $261,650 for married taxpayers). Those limitations were eliminated for a number of years, including 2012, but are on tap to return in 2013. What this means is that certain deductions – including charitable deductions – will be limited for high income taxpayers, effectively increasing the top marginal tax rates.

6.      Load up on stocks that pay dividends. For 2012, stocks that paid dividends (if you can find such elusive creatures) are something of a bargain since they are taxed with capital gains treatment or ordinary income. Capital gains rates were extremely low for 2012 and ordinary income tax rates weren’t all that bad. In 2013, however, all dividends will be taxed as ordinary income. And income tax rates are going up. You do the math.

7.      Keep your rich uncle on life support. I know it sounds morbid – and tacky – but folks start asking the tough questions when millions of dollars are at stake. And in a year where the federal estate tax exemption amount is scheduled to decrease from the current $5,120,000 to a mere $1,000,000, hours literally count. Your doctors and your priest may tell you different but from a tax perspective, if you have a taxable estate, it’s better to die in 2012 than in 2013.

8.     Discount bonds. I’m not sure why people don’t like bonds. Maybe they don’t sound as sexy as stocks. But bonds can be a great investment on the tax side – especially in a volatile economic climate. Interest paid from Treasury bills, notes and bonds is taxable at the federal level only and the interest from municipal bonds may escape federal, state and local tax, depending on your circumstances. Interest paid out by other kinds of bonds is taxed as ordinary income but may be pro-rated or deferred in some instances. Bonds can result in a lower overall tax bill than income from stocks alone (just ask Warren Buffett). Of course, I’m not encouraging a rush on bonds; bonds do tend to be outperformed by blue chips so consult with a financial adviser to see what works for you.

9.      Make your tax appointment for 2013. All of these changes can make your head spin. And it’s easy to put off dealing with them until you actually get those tax forms in front of you. By then, however, it might be too late. If you are concerned about your tax bill for 2013, now is the time to take action. Consult with your tax and financial investors before year end to discuss a strategy for next year. Otherwise, it’s like jumping on a plane and then asking what to pack.

10. Panic. Paying more in taxes will suck but it won’t be the end of the world. We’ve had higher rates and more dire circumstances before and we’ve muddled through. Tax consequences aren't contagious – in contrast to Ataxic Neurodegenerative Satiety Deficiency Syndrome – and you can ward most of them off with a little thoughtfulness and preparation. We’ll all get through this.

Of course, all of this is based on the premise that the Tax Code isn't going to change at all between now and the beginning of next year. I think we’ll all know that even this Congress is capable of doing something. I don’t, however, have great expectations for significant tax reform over the next four weeks. So be smart, stay informed and consult with your tax advisor now. And oh yeah, look out for zombies.