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Timothy Middleton Taking Advantage of a Tax Reprieve W

ITH the approach of April 15, all of us are forced to come to

grips with taxes, even if all we do is dump a carton of receipts and W-2 forms on our accountant’s desk and write out whatever check is due.

This year we’re breathing a sigh of relief because last year’s Congress agreed, with some re- luctance, not to allow the present tax cuts to expire. As a result, the top tax rate on dividends and long-term capital gains will re- main 15 percent for couples with a total taxable income over $69,000. For couples with a total taxable income of

less than

$69,000, there is no tax on divi- dends or long-term capital gains. Short-term gains—that is, those captured from the sale of a secu- rity within twelve months of buy- ing it—continue to be taxed like ordinary income, but income tax rates also did not go up as had been anticipated.

But this last-minute reprieve has meant that a lot of advice given last year on handling the tax cuts’ expiration is no longer valid. Here’s a quick guide to a few issues that savers and in- vestors need to keep in mind to minimize the tax bite.

Redeeming Prior-Year Losses If you took capital losses dur- ing the bear market of 2008 to 2010, you probably had few gains


against which to apply them. But with stocks solidly back in the win column, capital gains are rain- ing down on canny investors. Un- used capital losses can be car- ried forward, and now is a good time to start redeeming them. Losses on long-term positions (held more than a year) can off- set taxes on long-term gains dol- lar for dollar, and they can also be applied against $3,000 of other income. Many investors deferred taking advantage of this rule last year, when it seemed likely tax rates would rise in 2011, and thus the tax exemption would be particularly welcome. But with tax rates locked in through 2012, now is as good a time as any to take advantage of this deduction.

Roth IRA Conversions Another benefit that has been carried forward is an extension of the period in which the tax hit for converting a regular IRA into a Roth IRA will be softened. In 2011, just as in 2010, any tax- payer—and not just those with incomes below $107,000 for in- dividuals or $169,000 for married couples filing jointly—can convert a traditional IRA to a Roth IRA and spread any taxes due over two years, this year and the next. Traditional IRAs are tax-de- ductible. This means that you pay less tax during the years when you contribute. But the money is locked away, with penalties for

withdrawals by people younger than 59½, and Uncle Sam gets his share back by taxing all with- drawals from your IRA as ordi- nary income. For a substantial retirement account that has been growing for a long time, this can mean you will pay a lot more in total

IRA, which can be substantial, are immune from later taxation.

taxes at the far end than you saved at the beginning. Roth IRAs, on the other hand, are not deductible. But to com- pensate for that, 100 percent of their proceeds, including the in- terest, dividends, and capital gains accumulated over the years before they are needed, are shielded from income tax. Money saved over the years can grow into a substantial nest egg that Uncle Sam can’t touch.

Under the current rules, any- one who converts a traditional IRA into a Roth IRA will have half of the value converted added to their income for tax purposes in each of the years 2011 and 2012, so that if you converted a $100,000 IRA, you would report an additional $50,000 in income each year. Because of this im- mediate tax hit, there’s no rea- son for retirees to convert their IRAs; they’ll probably be taxed at a lower rate taking out smaller sums over longer periods. The big advantages accrue to tax- payers who are still in their peak earning years and whose IRAs still have many years to grow. Long-term earnings in a Roth

Unified Gift-Tax Deduction This year, for the first time, individuals can give away up to a lifetime maximum of $5 million to others, such as heirs, whether in the form of gifts or inheritances, including generation-skipping be- quests. Aside from increasing the exemption from death duties to this level, the practical effect of the change is to allow younger wealthy taxpayers to pass sub- stantial amounts of money to their children and other heirs. Thus a couple could give as much as $10 million between them, basically eliminating fed- eral estate taxes for all but the very rich. And they can give it when their children are buying their first homes, or paying big tuition bills for their own children. But please be aware that this exemption is per taxpayer, not per recipient. A couple can give $10 million in total before taxes kick in, regardless of how many children, grandchildren, nieces, nephews, and others they might want to help.

Always keep in mind the fact that it’s against the law to cheat on your taxes, but it’s perfectly legal (and smart) to take full ad- vantage of all the exceptions, limitations, and other loopholes that tax law allows. ■

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