Greg Rosica, CPA, CFP
Greg Rosica, CPA, CFP, a partner with the accounting firm Ernst & Young who specializes in private client services and tax consulting, New York City. EY.com
Congressional gridlock has had one slightly beneficial impact on federal income tax filers this year—there weren’t many big changes in the tax rules to further confuse you when you filed your 2011 return. But that is likely to change later this year—Congress will need to grapple with the fact that Bush-era tax cuts from a decade ago are scheduled to disappear in 2013. And new rules that are being phased in require brokerage firms to report more details of your investment purchases and sales.
Don’t get caught unprepared. Among the key changes and potential changes that could affect how much you pay for tax year 2012, 2013 and beyond…
In an effort to detect inaccuracies on investment gains and losses reported on tax returns, the IRS is requiring brokerage firms to report additional information directly to the IRS.
When you sell certain investments, the brokerages will issue 1099-B forms that show the amount you paid for the investments (known as the cost basis)…any capital gains or losses (calculated by subtracting the cost basis from the sale price)…and some “wash sales,” which occur when an investor buys the same investment within 30 days before or after a sale. In the event of a wash sale, you cannot declare a capital loss on that investment for tax purposes.
Last year, the IRS started requiring brokerage firms to report the new details to the IRS on individual stocks bought on or after January 1, 2011.
Starting this year, the new brokerage reporting rules apply to shares of mutual funds and exchange-traded funds (ETFs) held in taxable accounts, but only those you purchased on or after January 1, 2012.
Next year, brokerage firms will be required to start reporting the same information on bonds, options and private placements bought on or after January 1, 2013.
What to do: Keep detailed records of all transactions because the IRS could challenge you if your reported capital gains or losses differ from what the brokerage firm reported. Remember that any dividends and capital gains that you reinvest can alter the cost basis.
If you buy shares at various times and eventually sell a portion of your stake rather than all of it at once, you will need to tell your brokerage firm which cost-basis method you want to apply to any sales.
If you don’t pick a method for sales of shares in a fund, the brokerage firm may use the average-cost basis in its report to the IRS—that is, the average price you paid for all the shares you own in the fund. It might be of greater advantage for you, however, to use one of several other methods that identify how much you paid for individual shares. Once you choose a method, it must be used for all future sales of shares in a particular investment.
For stocks, if you don’t pick a method, the brokerage firm will use the first-in, first-out (FIFO) method, which assumes that the first shares you sell are the first shares you bought.
If you are still working on your 2011 taxes: Anytime you spot an incorrect cost basis on a stock sale on Form 1099-B, you can adjust and correct it on Form 8949, new this year. However, the discrepancy and correction are likely to draw the IRS’s attention. Instead, ask your brokerage firm to issue a corrected 1099-B form before you file your taxes.
For more information, speak with your accountant or see IRS Publication 550, Investment Income and Expenses, at www.IRS.gov.
This year, IRA owners who are 70½ or older no longer have the option of donating up to $100,000 in withdrawals from an IRA directly to a qualified tax-exempt charity to avoid federal and/or state taxes on the withdrawals. That’s because a provision allowing this tax-free withdrawal expired at the end of 2011 and has not yet been reinstated by Congress, although it still is possible that Congress will reinstate the provision retroactive to the beginning of the year, as it did in 2010.
What to do: Consider waiting until it is clear what Congress will do before you make your IRA withdrawal and charitable contribution. However, even if Congress does not reinstate the tax-free provision and you are taxed on your IRA withdrawal, you will be able to take a deduction for the charitable gift, offsetting part or all of the tax on the withdrawn amount.
If Congress does not act this year on the expiration of the Bush tax cuts, the top rate on ordinary income in 2013 will rise to 39.6% from 35% and rates for other brackets also will jump…all dividends will be subject to ordinary income tax rates…and the highest capital-gains tax rates will rise from 15% to 20%. Also, there will be a new Medicare surtax for singles with income of more than $200,000 and joint filers with income of more than $250,000—it is 3.8% on investment income and 0.9% on earned income. In addition, the lifetime limit on an individual’s exemption from the federal estate tax would drop from $5.12 million this year to $1 million, while the tax rate on estate assets over the limit would rise from the current 35% to 55%.
It is widely believed that Congress will come up with some kind of compromise to avoid at least some of the tax increases, but it is unlikely to happen until very late in 2012.
What to do: Have your accountant and investment adviser run projections based on various scenarios—one under much higher taxes in 2013…the other keeping taxes at current rates. Then be ready to execute money-saving tax strategies as soon as we get more clarity. If tax rates do go higher next year, you may want to…
Identify long-term stock and mutual fund holdings that might make sense to sell this year. For instance, you might want to sell investments that have had big long-term gains to avoid a higher capital-gains tax in the future.
If possible, shift some ordinary income from 2013 to 2012. This might include payments for contract work, bonuses or nonqualified stock options that you can exercise this year.
Push deductions such as charitable contributions into 2013, because they are more valuable when tax rates are higher.
Consider municipal bonds. Munis may become more attractive because they are exempt from federal taxes and, in some cases, state and local taxes. That exemption becomes more valuable when tax rates rise.
Consider switching to tax-managed mutual funds. These funds use specific strategies, such as limiting turnover of stocks and deferring gains, to enhance the after-tax returns that they produce.
