Many tax cuts that were passed during the Bush era are scheduled to expire at the end of 2010. The Obama administration, however, has indicated its intention to extend some of those tax cuts, and it seems likely that Congress will see fit to make such extensions.
As far as I can tell, the consensus appears to be that the following scheduled changes are likely to occur:
- Long-term capital gains will go back to being taxed at a maximum rate of 20% rather than 15%.
- The top tax bracket (currently 35%) will go back up to 39.6%.
- The second-to-top tax bracket (currently 33%) will go back up to 36%, though the lower end of the bracket will be bumped up.
… and the following scheduled changes are not likely to occur:
- The 10% tax bracket will not be eliminated as scheduled.
- Dividends will not go back to being taxed as ordinary income as scheduled, though they will — like LTCGs — be taxed at a max rate of 20% instead of 15%.
- The standard deduction for married couples filing jointly will not be reduced as scheduled.
- The top end of the 15% tax bracket for married couples filing jointly will not be reduced as scheduled.
- The middle two tax brackets (currently 25% and 28%) will not rise back to 28% and 31% as scheduled.
Taken together, the above changes would leave us with the following projected 2011 tax brackets (courtesy of the Tax Policy Center):
Single 2011 Tax Brackets (Projected)
Taxable Income
|
Marginal Tax Rate: |
| $0-$8,425 |
10% |
| $8,425-$34,200 |
15% |
| $34,200-$82,850 |
25% |
| $82,850-$192,000 |
28% |
| $192,000-$375,700 |
36% |
| $375,700+ |
39.6% |
Married Filing Jointly 2011 Tax Brackets (Projected)
Taxable Income
|
Marginal Tax Rate: |
| $0-$16,850 |
10% |
| $16,850-$68,400 |
15% |
| $68,400-$138,050 |
25% |
| $138,050-$232,950 |
28% |
| $232,950-$375,700 |
36% |
| $375,700+ |
39.6% |
Head of Household 2011 Tax Brackets (Projected)
Taxable Income
|
Marginal Tax Rate: |
| $0-$12,000 |
10% |
| $12,000-$45,800 |
15% |
| $45,800-$118,300 |
25% |
| $118,300-$189,350 |
28% |
| $189,350-$375,700 |
36% |
| $375,700+ |
39.6% |
Married Filing Separately 2011 Tax Brackets (Projected)
Taxable Income
|
Marginal Tax Rate: |
| $0-$8,425 |
10% |
| $8,425-$34,200 |
15% |
| $34,200-$69,025 |
25% |
| $69,025-$116,475 |
28% |
| $116,475-$187,850 |
36% |
| $187,850+ |
39.6% |
Planning for Tax Changes
So what should we do to minimize our own taxes in the face of such changes? A few things come to mind.
First, if you’re planning to sell any of your holdings (in a taxable account) that have appreciated in value, you may want to consider doing so before the end of the year.
Second, if you expect to find yourself in a higher marginal tax bracket starting next year:
- It may make sense to accelerate your income to the extent possible so that it occurs in 2010 rather than 2011.
- Conversely, if possible, you may want to delay some of your deductions so that they apply to 2011 rather than 2010.
- You may want to consider using tax-free bonds, bond funds, and money market funds instead of their taxable counterparts, if you’re not already doing so.
Lastly, if it begins to look like the special tax treatment of dividends is not going to be extended (that is, if it looks like dividends will begin to be taxed as ordinary income), the following changes may be wise:
- For those of you who pay attention to asset location, it would make sense to tax-shelter high-dividend stocks/funds before tax-sheltering low-dividend stocks/funds.
- For anyone looking to generate income from a taxable portfolio, high-dividend stocks and funds will become meaningfully less attractive compared to alternatives (such as CDs and bond funds).
What are your thoughts? How are you planning to minimize your taxes in light of upcoming changes?
One quick note: Please keep any comments to the topic of how to plan for tax changes. Like all of you, I have my opinions on whether tax burdens should be increased, decreased, or redistributed, but this is not the place for such discussion. I won’t hesitate to delete any comments of a political nature.
For More Information, See My Related Book:
A testimonial from a reader on Amazon:
"Very easy to read and is a perfect introduction for learning how to do your own taxes. Mike Piper does an excellent job of demystifying complex tax sections and he presents them in an enjoyable and easy to understand way. Highly recommended!"
I’ve recently gotten a few questions about the deadline for a Roth IRA conversion. The answer is that it depends on what, exactly, you want to know the deadline for.
The shortest answer is that, for any given year, the deadline for a Roth IRA conversion is December 31 of that year. (Note: This is different from IRA contributions, which can be made up until April 15 of the following year.)
There are a few other Roth conversion-related deadlines you may want to know about, though.
Income Limits Are Gone for Good
As of 2010, the income limits for Roth IRA conversions disappeared. They are not scheduled to come back. In other words, no matter your income level, Roth conversions are not “do it in 2010 or miss your chance.”
Why 2010 Is Special
December 31, 2010 is the deadline, however, for the special option to delay payment of the tax on a Roth conversion. That is, for 2010 Roth conversions, if you choose to do so, you can claim 50% of the converted amount as income in 2011 and the other 50% in 2012.
Beginning in 2011, Roth conversions will go back to working like normal — if you convert in a given year, you’ll have to claim the converted amount as income in that same year.
Roth Conversion Recharacterization Deadline
In case you’ve never run across the term before: A “Roth conversion recharacterization” is basically a do-over. If you convert an amount from a traditional IRA to a Roth IRA, you’re allowed to undo the whole thing as long as you don’t wait too long.
To do so, you’ll have to:
- Notify the custodian(s) of your traditional IRA and your Roth IRA of your intention to recharacterize the conversion,
- Transfer the amount in question from the Roth IRA back to the traditional IRA, and
- If you’ve already filed your tax return for the year of the conversion, you’ll have to amend that return.
The deadline for recharacterizing a Roth IRA conversion is October 15 of the year following the conversion.
Just Because You Can…
One last point: Just because you can convert your IRA to a Roth IRA doesn’t mean you should convert it.
Happy Friday, dear readers. 
Roth conversions have gotten a lot of press over the last year (and I suspect that won’t change any time soon). Personally, I’m of the opinion that they’re being recommended in many cases where they don’t really make sense.
So I particularly enjoyed two articles this week — the first two below — one covering a good example of a Roth conversion, the other covering a bad example of a Roth conversion.
And for our weekly reminder: If you’re a blogger, you’re welcome to submit a post here for consideration in next week’s roundup.
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For many tax breaks, a taxpayer is ineligible if he or she is claimed as a dependent on somebody else’s return. In other words, there are numerous tax breaks for which most students are ineligible.
Fortunately, IRAs and Roth IRAs don’t work that way.
As long as you have earned income, and your modified adjusted gross income is below a certain level (It changes every year, but most students needn’t worry — see here for Roth IRA rules.), you’re eligible to make contributions to an IRA.
Roth IRA or Traditional IRA?
The primary difference between a traditional IRA and a Roth IRA is that a traditional IRA gives you a tax break now (in the form of a deduction), while a Roth IRA gives you a tax break later (in the form of tax-free withdrawals from the account).
For the most part, students aren’t overly burdened with taxes. In fact, if your income is below the standard deduction amount, you’re not paying income taxes at all. As such, the deduction you could get from making traditional IRA contributions probably has little or no value.
Takeaway: A Roth IRA is the better choice for most students.
Where to Open an IRA?
People often ask which brokerage firm offers the best investment selection. In my opinion, investment selection isn’t all that important when choosing a brokerage firm.
It’s true that certain mutual funds are only available via specific brokerage firms. But every single brokerage firm will give you access to exchange traded funds (ETFs), which you can use to build a low-maintenance, diversified portfolio.
As a result, rather than focusing on investment selection, I’d suggest looking for a brokerage firm with low costs and good customer service. Fortunately, there are several such choices.
For example, each of the following brokerage firms are super low-cost:
- OptionsHouse: $2.95 per stock or ETF trade, with free trades for 60 days.
- TradeKing: $4.95 per stock or ETF trade.
- Vanguard: $7.00 per stock or ETF trade, with free trades of Vanguard ETFs.
- Fidelity: $7.95 per stock or ETF trade, with free trades of several iShares ETFs.
- Schwab: $8.95 per stock or ETF trade, with free trades of Schwab ETFs.
Get Started!
When you’re first beginning to invest, how much you invest will have a far larger impact than how you invest. Rather than getting hung up on choosing the absolute best investments with the absolute best brokerage firm, I’d suggest just getting started:
- Open an IRA,
- Put together a low-cost, low-maintenance, diversified portfolio (see here for examples), and
- Work on contributing to that portfolio as much as you can, as often as you can.
Health Savings Accounts (HSAs) are a pretty nifty way to save money. In short, if you’re eligible, they allow you to use pre-tax money to pay for medical expenses. This is done in either of two ways:
- Through making (pre-tax) payroll deductions directly through your employer, or
- Through claiming an “above the line” deduction for the amount you contribute to your HSA.
HSA Contribution Limits
For 2010, HSA contribution limits are as follows:
- $3,050 for a person with self-only coverage, or
- $6,150 for family coverage.
- Also, if you’re 55 or older, you’re allowed to make a catch-up contribution of $1,000.
Note: Any contributions made by your employer count toward the annual contribution limit, thereby reducing the contribution that you can make.
Contributions for each year can be made up until April 15 of the following year.
HSA Eligibility
In order to be eligible to make contributions to an HSA, you must be covered by a high-deductible health plan (HDHP) with an annual deductible of at least $1,200 ($2,400 if it’s family coverage). The plan must also have maximum out-of-pocket expenses of less than $5,950 ($11,900 if it’s family coverage).
Also, you must:
- Not be enrolled in Medicare,
- Not be claimed as a dependent on somebody else’s return, and
- Not have other health care coverage (with a few exceptions).
HSA vs. FSA
Health Savings Accounts (HSAs) are often confused with Flexible Spending Accounts (FSAs). The primary difference between the two is that money contributed to an HSA rolls over to the following year if unused. In contrast, FSAs are “use it or lose it.” Any money left unspent in an FSA disappears at the end of the year.
The takeaway is that with an HSA you don’t have to play the game of guessing how much you’re going to face in medical expenses each year. For example, if your 2010 HSA contributions exceed your medical costs, that’s no problem. You’ll be able to use the remaining money from your 2010 contributions to pay medical costs in 2011 — or 2012, 2013, etc.
HSA Withdrawals
Money can be withdrawn from an HSA at any time, for any reason. However, unless the money is either a) spent on qualified medical expenses or b) used to reimburse you for qualified medical expenses, it will be subject to income taxes and a 10% penalty.
- Exception: If you’re age 65 or over, or have become disabled, the 10% penalty is waived, though regular income taxes will still apply.
Qualified medical expenses include those that would qualify for the Medical and Dental Expenses deduction, as well as non-prescription medicines.
Investing within an HSA
Funds within and HSA can be invested in much the same way as within an IRA (though your investment options will be limited to whatever the HSA administrator chooses to offer). Of course, at any given point, it’s likely you’ll be spending the money within your HSA in the near future, so it’s usually a good idea to keep it invested in something very low-risk.
Earnings and growth within an HSA are not taxable — though again, if you take money out for something other than qualifying medical expenses, the entire distribution is taxable and potentially subject to a 10% penalty.
For More Information, See My Related Book:
A testimonial from a reader on Amazon:
"Very easy to read and is a perfect introduction for learning how to do your own taxes. Mike Piper does an excellent job of demystifying complex tax sections and he presents them in an enjoyable and easy to understand way. Highly recommended!"
Happy Friday, everyone. We have a relatively brief collection of articles this week. Enjoy.
Remember, if you’re a blogger, you’re welcome to submit a post here for consideration in next week’s roundup.
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Thanks for reading!
