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Monthly Client Newsletter | May 2012

T he 2012 Tax filing season is now behind us. What's next? How about tremendous changes in the tax code with "automatic" triggers at the end of the year? This month's newsletter reviews some of the largest pre-scheduled tax rate changes with suggestions to start planning now for what will likely be a wild ride leading up to the November elections.

Contents

Big Year, Big Rate Changes

Tax Rates WILL Change in 2013

401K fee disclosures delayed

Throughout the history of the tax code, virtually all tax laws passed and signed into law have had certainty applied to them. And unless Congress decided to permanently change the law, taxpayers could "count on" and plan according to the laws in the books. This all changed a little over a decade ago when, as part of congressional negotiations, significant tax law changes were made on a temporary basis with "sunset" provisions. The "sunset" basically meant that tax laws automatically reverted to old versions of the tax code on pre-determined dates. Since then, taxpayers have been put into a quandary as to what the laws will be for next year...and often for the current tax year.

What's Happening This Year
Because of this "sunsetting" tax law phenomena, a unique situation will occur at the end of 2012; tax laws will change UNLESS Congress acts. This blend of tax laws terminating, in addition to a presidential election year, substantial deficit spending, and "automatic" spending reductions because of the inability of Congress to agree on budget cuts creates a "perfect storm" for tax law uncertainty. While this uncertainty does not help any of us, three things are certain:

1.  We know what the current tax laws are

2.  We know tax laws will change in 2013

3.  We know what the laws WILL BE if no action is taken

So how do you prepare for a manageable household tax bill? The first step is to become aware of the major tax provisions that are automatically scheduled to change. Outlined here are major, scheduled tax rate changes.

1. Tax Rates are scheduled to increase
Tax rates are scheduled to increase in 2013. This alone, can have a tremendous impact on your tax bill next year. Outlined here are the current rates, their current income thresholds, and what they may become in 2013.

2012
Tax
Rate
2013
Tax

Rate
Income Tax Rate Change (using 2012 income tax brackets)
Single
Married Filing Joint/Widow
Head of Household
Married Filing Separate
10%
15%
$1
 
8,700
$1
 
17,400
Under
 
12,400
Under
 
8,700
15%
8,701
-
35,350
$17,401
-
70,700
12,401
-
47,350
8,701
-
35,350
25%
28%
35,351
-
85,650
70,701
-
142,700
47,351
-
122,300
35,351
-
71,350
28%
31%
85,651
-
178,650
142,701
-
217,450
122,301
-
198,050
71,351
-
108,725
33%
36%
178,651
-
388,350
217,451
-
388,350
198,051
-
388,350
108,726
-
194,175
35%
39.6%
over 388,350
over 388,350
over 388,350
over 194,175

Note: Income is your taxable income. Actual income brackets for 2013 will be slightly higher than those noted here for 2012.

Action to take now

Check Use the chart above, find your filing status, and look for your taxable income. Using the marginal tax rate you can see what the impact of the new rates might be on your income in 2013. Plan now to ensure you will not be surprised by the drop in your after-tax income with the increased rates.
CheckIf you have the ability to shift income into 2012, you may wish to do so. The one-year savings could be tremendous.

2. Dividend Tax Rates are also scheduled to increase....a lot
Currently, ordinary dividends are taxed at a maximum rate of 15%. Unless Congress acts, starting in 2013 dividends will once again be taxed as ordinary income, or as much as 39.6%. So what should you think about throughout 2012?

CircleIndividuals.Holding dividend-bearing stocks outside of retirement accounts makes more sense when there is a preferential tax rate. This may no longer be the case. In 2013 the total projected return on dividend bearing investments will be lower and should be reviewed as part of your portfolio analysis. In fact, under a worse case scenario, the demand for dividend paying stock may go down enough to impact the value of the stock.
CircleSmall C-corporations. Many small businesses organized as C-Corporations may have retained earnings that will require their owners to pay dividend taxes upon distribution. Consider distributing those earnings now to save as much as 24.6% in federal taxes! This is also true for S-Corporations that have residual retained earnings from prior C-Corporations.

3. Itemized Deduction and Personal Exemption Phase-outs Re-appear
Itemized deductions and tax exemptions are common benefits within the tax code that reduce your taxable income. Prior to 2010, there were provisions to phase-out these tax reduction benefits for those whose income surpassed certain thresholds. After 2012, unless Congress acts, your itemized deductions and tax exemptions may once again be phased-out.

Action to take now

Check Review your most recent tax return and see if you may be impacted by the itemized deduction and tax exemption phase-out. The phase-outs were triggered in 2009 when:
Filing Status: Personal ExemptionItemized Deductions
SingleAGI exceeds:
$166,800
$166,800
Head of Household
208,500
166,800
Married Joint/Widow
250,200
166,800
Married Filing Separate
125,100
83,400

4. Long-Term Capital Gains Tax Rate increase
Through 2012, most Long Term Capital Gains enjoy preferential tax rate treatment versus ordinary income tax rates. If you have a qualified investment you have owned for more than 12 months, the minimum capital gains tax rate remains at 0% for those in the 10 and 15% income tax brackets, while the maximum capital gains tax rate is 15% through 2012. After this date, the 0% rate could revert to 10% with the maximum capital gains tax rate going from 15% to 20%.

Action to Take Now

Check Review your investments and consider selling to capitalize on the lower long-term capital gains tax rate.
CheckConsider waiting until later in the year to make any moves in case Congress acts to extend the lower tax rate beyond 2012.
CheckRemember to review capital losses in conjunction with gains. Up to $3,000 in capital losses can offset ordinary income each year, but only after netting against capital gains.

5. The Alternative Minimum Tax will Hit Millions More
Today approximately 3 to 5 million middle and upper-middle class taxpayers find themselves paying an Alternative Minimum Tax. Starting in 2013, this number could exceed 20 million taxpayers without an extension of the AMT "patch".



New 401(k) Fee Disclosures Delayed

What you need to know

401K fee disclosures delayedFor years employees participating in their employer-provided 401(k) program were blissfully unaware of the fees and added costs that were quietly reducing the long-term returns on their retirement income. In most cases, employers were using plans that had reasonable costs. But in others, especially within small employer groups, this was not always the case. Because of this, laws were passed requiring full fee disclosures by June 1, 2012. A recent announcement by the Labor Department granted a disclosure delay until late August, 2012.

What to expect

Even though the Labor Department has granted this disclosure delay, in all likelihood you will already start to see the fees disclosed within your 401(k) program. This is because many large plan managers needed time to implement the change and have already done so in anticipation of the original June disclosure requirement. When the disclosures are in place, your 401(k) program must disclose to you on a quarterly basis:

Circle The dollar amount of any fees and expenses deducted from your account with a description of the fee and/or expense.
CircleThe disclosure requirements include both direct and indirect fees charged by administrators and mutual fund firms. The indirect fees are often the ones that have been silently folded within fund performance metrics.
CircleFund performance must be disclosed for one, five and ten years and compared against standard performance benchmarks.

Why the change?

CircleMost employees and retirees were unaware their retirement accounts were even being charged fees. A recent survey by AARP found that 71% of people interviewed thought they paid nothing to participate in their retirement savings plan.
CircleThe ever-rising cost of these hidden fees was becoming substantial. It is estimated that a 1% expense charge in a plan could result in a loss of more than 10 years of retirement income (versus a 1/2% fee ) for someone making $45,000 a year throughout their working years.

What this means to you

When you receive your first quarterly 401(k) statement with fee and expense disclosures here are some things to review and consider:

CircleLook for expenses to be no more than 1/2% of your fund balances per year.
CircleIf sponsor fees exist, make sure you are getting something for your money. The higher the sponsor fee, the more services you should expect.
CircleIf no longer employed at the company, consider rolling your 401(k) program into an IRA that can lower your costs.
CircleTake special care to review expenses and fees related to target-date funds. These age-based investment alternatives tend to be very fee and expense heavy.
CircleConsider switching from high expense funds to lower expense funds with similar investment philosophies and returns.

Remember a 401 (k) plan with high expenses and fees is taking money from your retirement income. Is there good news? Yes, fund fees have been getting lower ever since this disclosure law was passed. It seems that by putting a spotlight on the problem, employers are now actively working to reduce these once hidden expenses.



Time for an Estate Review?

Health care reform heats up

In 2010 there was a one-year tax holiday for most estates. Now when you die your heirs could potentially pay a tax on assets passed on to beneficiaries. However, the Federal Government excludes from tax an initial value of the estate through a devise called the Unified Credit Exclusion.

In 2012 the Unified Credit Exclusion amount equates to $5,120,000 in assets with a maximum Federal Estate Tax Rate of 35%. In 2013 the exclusion amount drops dramatically to $1,000,000 while the maximum tax rate goes up to 55%. While many think Congress will take action to exclude higher estate values from tax, there is no certainty that it will occur.

Action to Take Now

If you have an estate that approaches the lower exemption amount in 2013 you should put an estate plan in place to minimize the tax impact should you or your spouse pass away. Already have a plan? Given the substantial changes in this area of the tax code over the past three years, you should probably review your plan. Preparation in this area of the tax code could save you significant money in lower taxes and help minimize hardships for your beneficiaries.



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