Important New Tax Issues and Wealth Management

With 2010 more than halfway behind us, it is a good time to consider the potential for tax-planning opportunities regarding wealth management. Unfortunately, in addition to opportunities, there are a number of uncertainties and changes that will impact many taxpayers. Here are a few things to keep in mind.

Roth IRA Conversions

This year is important for Roth conversions for several reasons. Starting in 2010, income limits have been eliminated on eligibility to make a conversion to a Roth IRA. There are a variety of reasons to consider a Roth conversion, including the ability to avoid mandatory distributions from your retirement account during your lifetime as well as pass a portion of your assets tax-free to your beneficiaries. This year taxpayers also have a onetime opportunity to choose to pay taxes on the converted amount in 2010 or spread the tax payments over 2011 and 2012. An important consideration for spreading out the tax payments over 2011 and 2012, as well as for determining if a Roth conversion is right for you at all, is whether you expect your marginal tax rate will be lower in 2010, in the next two years or in the future when you would begin to take taxable distributions if you don’t convert. One thing looks likely at this time – tax rates going up next year for taxpayers in the higher tax brackets … which leads us to the next topic.

Marginal Tax Rates

Today there are six marginal federal income tax rates. Without additional legislation these will expire at the end of 2010. The lowest 10% bracket will disappear, and the remaining brackets will return to pre-2001 levels, as shown below:

Other Key Tax Rate Changes

The tax rates that apply to long-term capital gains are changing as well. This year if you sell a capital asset (like a share of stock) that you’ve held for more than one year, the gain will generally be treated as a long-term capital gain, taxed at 15% if you are in one of the top four marginal tax brackets or 0% if you are in the 10% or 15% tax brackets.

These rates are also scheduled to expire at the end of 2010. In 2011, a 20% rate will apply, except for taxpayers in the lowest marginal tax bracket who will pay a 10% rate on long-term capital gains.

Qualifying dividends are treated similarly to long-term capital gains in 2010, taxed at 15% for the top four brackets and at 0% for taxpayers in the 10% and 15% tax brackets. In 2011, they will be taxed as ordinary income.

FIM Group will continue to manage all of your accounts (taxable accounts, IRAs, etc.) to take advantage of the unique structure that each account offers in order to maximize tax efficiencies.

Looking ahead, new taxes related to the recent health care legislation will take effect in 2013. A new Medicare payroll tax of 0.9% will be assessed on wages exceeding $200,000 for individual taxpayers and on combined wages exceeding $250,000 for married couples filing jointly.

Also beginning in 2013 is a new Medicare surtax of 3.8%. Single filers with income exceeding $200,000 and joint filers with income more than $250,000 will be assessed the surtax on the lesser of: 1) net investment income, or 2) modified adjusted gross income (MAGI) in excess of the income thresholds. If either 1 or 2 is zero, there is no surtax. Net investment income includes taxable interest, dividends, capital gains, distributions from annuities, rent and royalty income, and passive-activity income. It should be noted that distributions from a traditional IRA are counted in MAGI and could trigger the surtax, whereas Roth withdrawals will not.

Estate Tax

This year we saw the temporary repeal of the federal estate tax. Many expected Congress to move quickly to reinstate the tax, but to date we are still waiting. The chart below shows a summary of the changes, and as you can see the estate tax returns in 2011 to the pre-2001 level of $1 million with a top tax rate of 55% unless additional legislation is passed.

All of this uncertainty makes it especially important to review your estate plan to ensure that it effectively carries out your wishes.

This summary covers some of the more significant federal tax opportunities, changes and uncertainties for your tax planning consideration. This is by no means an exhaustive list but rather highlights some of the changes that may affect many of our clients. The impact and applicability in individual circumstances needs to be reviewed on a case-by-case basis. Please contact an FIM Group adviser if you would like to discuss any of these matters further.

We can’t predict what Congress will do, but as in recent years it is likely we will see additional legislation between now and the end of the year making it important to stay informed.