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Year End Tax Planning, More Now Than Ever

By Harry S. Margolis

You probably get letters from your accountant and financial planner every year telling you about the opportunities available for year-end tax planning. While we don’t usually send out such missives, this year is a different from most with Bush-era tax reductions slated to go into effect on January 1st — unless Congress and the President agree on a way to avoid the “Fiscal Cliff” before then.

The usual advice is to put off paying taxes as long as possible, but with tax rates likely to rise, especially for those earning more than $250,000 a year, it may make sense in some cases to reverse this strategy this year. Here are some specific tactics to consider:

  • Realize capital gains this year. Usually, investors postpone selling stock and taking capital gains as long as possible consistent with their investment strategies. However, with taxes on long-term capital gains at the historically low rate of 15 percent this year, you may be able to save at least 5 percent by selling stock this year rather than next. (I wonder if we will see a big sell off in stock between now and the end of the year if a lot of investors follow this strategy — perhaps that will be a buying opportunity.)

  • Postpone deductions and charitable contributions until next year. Many taxpayers pay deductible expenses, such as local and state taxes, and make charitable deductions at the end of the calendar year in order reduce their taxes for that year. This is especially true for owners of small businesses (including law firms) who often pay off all of their business obligations before the end of the year. However, this year they may be better off postponing payments until 2013 if doing so could mean that the deductions are worth more next year than they are in 2012.

  • Making a large taxable gift. There’s been a lot of discussion about taking advantage of the ability to give away up to $5.12 million tax free this year, which could drop to $1 million on January 1st if Congress doesn’t intervene. For those with estates of more than $1 million ($2 million for a couple), it’s certainly worth considering making gifts this year, though this is probably more relevant for individuals with estates exceeding $3.5 million for individuals and $7 million for couples since President Obama has proposed setting the federal estate tax threshold at this level. Of course, there’s no guarantee where it will end up and with the Massachusetts estate tax threshold set at $1 million, gifts will reduce the Massachusetts tax if not the federal one as well.

All of this tax planning is more complicated than ever this year because it involves the interplay of estate, gift, capital gain and income tax rules, and we don’t know for sure what the tax code will look like next year — just that tax rates are likely to rise. We strongly recommend tax planning steps only with the assistance of a professional in the field, whether an accountant or attorney. And we recommend consulting with your advisors as soon as possible given the short time left between now and the end of the year.

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