No matter how hard President Obama works with Congress to strike a deal on the budget deficit and economic stability, one thing is very likely: tax rates are going up next year.
The 2012 temporary payroll tax holiday is scheduled to end, and there appears to be little appetite to extend it. Without this tax break, proposed as a boost to the economy, middle class Coloradans will pay about $1,000 per family more next year.
What’s more, a number of deductions are becoming more difficult. For example, in 2013, unreimbursed medical expenses will be deductible to the extent they exceed 10 percent of your adjusted gross income. In 2012, the threshold is 7.5 percent.
More dramatically, if Congress and the President fail to agree on steps to avert the fiscal cliff, taxes could rise three times more than increases due to restored payroll taxes.
Proposed as a measure to reduce the federal deficit, the fiscal cliff calls for huge tax increases and across-the-board spending cuts in January 2013. The fiscal cliff allows Bush era tax cuts to expire and increases the number of families facing the alternative minimum tax. These automatic tax increases would hit nearly all Americans to the tune of about $3,500 per family, on average.
Given the certainty that taxes are now the lowest that they’ll be in years, and that a number of deductions will be harder to achieve next year, here are four tax planning steps to take now:
1. Consider making contributions to a Roth IRA, rather than a traditional IRA. While contributing to a Roth does not reduce your taxable income (unlike other retirement account contributions), Roth payouts are tax-free. That makes them immune from the threat of higher tax rates, as long as you take payouts on a certain schedule.
2. Likewise, consider converting traditional IRAs to Roth IRAs this year. Again, if tax rates are the lowest they’ll likely be in a while, you will pay income tax on the converted fund, but you’ll be doing so on the assumption that future taxes will be much higher.
3. If you are planning a medical procedure for 2013, consider prepaying some expenses with a credit card. Also, consider accelerating any discretionary medical purchases such as prescription eyeglasses. This year, unreimbursed medical expenses are deductible to the extent they exceed 7.5 percent of your adjusted gross income, but in 2013, for individuals under age 65, those expenses will need to exceed 10 percent of AGI in order to count as a tax deduction.
4. Make gifts sheltered by the annual gift tax exclusion before the end of the year. You can give $13,000 in 2012 to each of an unlimited number of individuals but you can’t carry over unused exclusions from one year to the next.