Much could change in the last few months of 2010. One uncertainty facing many Americans is what will happen regarding the tax cuts that are ready to expire at the turn of the year. Because of their income potential, many physicians across the country are asking themselves not only what will happen in the next four plus months if the cuts are allowed to expire but what can be done about it now. First let’s take a look at the potential changes.
What’s on the Horizon
The tax cuts that were implemented in 2001 and 2003, most commonly known as the “Bush Tax Cuts”, lowered taxes for every American across the country. These are set to expire at the end of this year. There is currently much speculation as to what Congress and the Obama administration will try to change in the tax code prior to November, but that is obviously yet to be determined. Since the changes that have been discussed and proposed thus far by Congress include allowing only the top brackets to expire, we can, however, rest assured that most every physician will be looking at higher brackets in 2011. However, if nothing changes, here is what is planned at the end of the year:
- Federal Income Taxes – This is the most discussed topic throughout the country. If the cuts are allowed to expire the current six brackets, which are: 10%, 15%, 25%, 28%, 33% and 35% will be replaced by five brackets, those being: 15%, 28%, 31%, 36% and 39.6%. For most physicians this obviously means about 4%+ in take home every year.
- Capital Gains Rates – But wait, there’s more. A whole lot more. Currently those who have assets that are non-qualified (not in an IRA, 401K, 403B, etc.) such as second homes, investment real estate, stocks, bonds or mutual funds pay a maximum capital gains and dividends rate of 15%. Again, should the cuts be allowed to expire at the end of the year, those rates will go to 20% for capital gains and skyrocket to 39.6% maximum for dividends. This obviously makes tax efficient investing a top priority for physicians in the years ahead.
- Phase-outs Coming Back – Prior to the tax cuts, two phase out rules made it much more difficult for high income earners to take advantage of write-offs on their income. These two main phase outs will come back into effect unless changes are made. The first is a phase out for itemized deductions. This phase out rule could eliminate up to 80% of a high-income physician’s itemized deductions. If you are married filing jointly and make over $170,000 per year this will certainly affect you. The second phase out coming back into full effect next year is for personal exemptions. So again, if you are married filing jointly and your income exceeds $252,000 that will mean yet another tax hike.
While there isn’t a bright side to having more of your hard earned income going to the government, there are things that can be done before the end of the year that might be advantageous for you and your practice. Let’s take a look at a few. (Please remember that you should always consult with your tax and/or financial professional prior to following through on any of these ideas.)
- Non-Qualified Assets – If the tax cuts are indeed allowed to expire, moving forward in 2011 and beyond the tax efficiency of managing your non-qualified assets will be of much greater importance. Having a financial advisor who understands these issues, specifically how they relate to the physicians world, will be key. As far as what can be done now, take a look at what gains you have in your accounts thus far. It might make sense to sell off those gains and reallocate them to a different section of your portfolio. In the future, you might also look to broader diversify your investment allocation throughout your entire asset base. This might mean holding dividend producing or higher turnover funds in your qualified accounts and getting your small cap and/or emerging market exposure in non-qualified accounts as they historically do not pay as high of dividends.
- Higher Pay – If you own your practice and/or can control your pay and have the ability to increase your income this year or give yourself a healthy bonus, you might want to think about doing so prior to the end of the calendar year.
- Charitable and Itemized Deductions – If one has a goal of making a sizeable charitable gift this might be the year to do so. In addition, any large itemized deductions that could be made in 2010 rather than 2011 should be a topic of conversation with your tax professional.
- Roth Conversion – Some reading this hopefully have already taken advantage of the Roth IRA conversion that was made available to all Americans, regardless of income, at the beginning of 2010. In case you are unaware of this rule change, for the first time ever the government is allowing individuals to convert Rollover IRA’s or past 401K’s to Roth IRA’s this year. While the amount that you choose to convert is added on to your taxable income this year, the Roth will be tax-free upon distribution in retirement. This is the only year that individuals can choose to defer the taxes owed and pay 50% on one’s 2011 return (due April 15th, 2012) and the remaining 50% on the 2012 return (due 4/15/2013). However, as mentioned above, it might make sense to pay the taxes due on this year’s return as most likely most physicians will be staring much higher taxes straight in the eye when we sign Auld Lang Syne as the ball drops in Times Square.
Kasey Gahler, CFP, is owner and financial advisor at Gahler Financial (www.gahlerfinancial.com). He can be reached at email@example.com. These are the opinions of Kasey Gahler and not necessarily those of Cambridge Investment Research. This article is for informational purposes only and should not be construed or acted upon as individualized investment advice.