As of this writing, there’s a great deal of political wrangling occurring in regard to the so-called fiscal cliff. There’s a lot being said about how to fix the problem, which includes both tax increases and huge spending cuts. It’s going to be an interesting tax season — are you ready for it?
In order to avoid a situation in which everyone is unhappy, the compromise is likely to include some budget cuts — but not huge cuts — and some tax increases — but not on everybody. Any scenario, though, is likely to include higher taxes on investments.
Higher taxes on investments are one of the easiest things to get through, since they don’t affect much of the income for what is considered the middle class. In 2013, taxes on dividends are scheduled to revert from being taxed favorably (at the same rate as long-term capital gains) to being taxed at your marginal rate. Additionally, the long-term capital gains tax rates are slated to head higher. And few people are suggesting that these tax increases on investments be put off.
On top of that, the Medicare surtax on investment income (part of the Patient Protection and Affordable Care Act) for high earners is going into effect in 2013. That isn’t likely to be put off, either.
How to get ready for higher taxes on investment income
Now is the time to prepare for the potential of higher taxes on your investment income. First of all, you can work on managing your AGI by shifting more of your earnings to this year. If you’re concerned about hitting the income threshold for the Medicare surtax, this will allow you to reduce your income in the coming year, and thereby avoid some of the tax hit.
Some companies are actually paying their dividends a little early this year (like Ethan Allen) in order to avoid paying them in the coming year. That way, at least one dividend payment will avoid the higher taxes on dividend income. With dividend income being taxed as regular income starting in 2013 — unless Congress does something about it — that’s something you need to plan for. Instead of being taxed at a top rate of 15%, you could see higher taxes if your marginal rate is higher. And, if some tax rates end up higher, that could also mean an even bigger tax bill on your dividend income.
Finally, some investors are choosing to harvest gains. Many people choose to harvest tax losses this time of year, selling losing stocks and deducting the losses to lower their tax bills. This year, though, some are choosing to sell winners as well, taking advantage of the fact that long-term capital gains top out at a 15% rate; next year it could be 20% or even 25%. Selling losers could help offset some of those gains for tax purposes.
In the end, though, you will likely need to pay a higher tax bill in 2013 if you rely on investment income. At the very least, make sure to prepare yourself by adjusting your thinking and maybe even running some scenarios by your accountant.
Are you worried about higher taxes on investment income?