Political goings-on may influence the decision, too. A revised outlook for future tax rates, coupled with a distasteful $450,000 tax bill for converting, led one of Sue Clark's clients to call off his 2010 conversion several weeks ago. "Last year, we were convinced tax rates were going up. Now we're not so sure they are, at least not in the near future, so he decided to continue to defer the tax rather than pay it now," says Clark, a CPA and tax principal with Larson Allen in Minneapolis.
On the other hand, if you expect tax rates to climb, "that's a reason, even if the account has gone down, to hold on to the Roth," counters Benjamin Tobias, a CPA/planner and president of Tobias Financial Advisors in Plantation, Fla. You decide.
Finally, tell your clients who are prone to vacillating that if they recharacterize their 2010 conversion and subsequently change their minds (i.e., wish to reconvert), they must wait more than 30 days after recharacterizing to put the money back into a Roth, says Michael J. Jones, a partner in the Monterey, Calif., CPA firm Thompson Jones LLP. With the markets in chaos, a lot can happen in that span.
Gains For Nothing, And Basis Reset For Free
As Tobias projects clients' 2011 tax situations, especially his retirees with emaciated interest income, he's keeping an eye out for couples with taxable incomes below $69,000 and for single clients under $34,500. They pay no tax on long-term capital gains that bring their incomes up to these amounts. "When gains aren't going to be taxed, we do tax-gain harvesting," Tobias says.
After taking a gain, sometimes he will buy the fund right back. This re-establishes the holding's basis at a higher value, which lowers the tax when it is later sold. This isn't a wash-sale because it involves a gain, not a loss, Tobias notes.
Get While The Getting's Good
To help clients optimally time deductions, look for breaks scheduled to expire after this year. Included here are the above-the-line deduction for college tuition and fees, as well as the option to itemize state and local sales taxes instead of income taxes. Giving to charity directly from an IRA without counting the withdrawal as income is also in its final year (again), according to Mark Luscombe, the principal federal tax analyst at CCH Inc.
Beginning January 1, 2013, a Medicare surtax of 3.8% can apply to couples with joint incomes greater than $250,000 and to single filers above $200,000. (For details, see "Coming Down The Pike," in the June 2010 issue of Financial Advisor.) Consider realizing gains before the surtax kicks in, Raymond James' Hartman suggests.
Similar thinking has CPA/planner Michael Tedone focused on his executive clients' stock options and restricted stock. Blackout periods could keep these clients from acting as 2013 nears, he fears. "So we're talking to them about accelerating exercises over the next 15 months," says Tedone, the chief compliance officer at Filomeno Wealth Management LLC, in West Hartford, Conn.
Regarding transfer taxes, the gift tax exemption increased to $5 million this year, unifying it with the estate tax, and the rate for both levies is now 35%. These attractive parameters expire at the end of 2012, but don't let clients wait until the last minute to gift, recommends estate planner Katie Colombo. "We're telling clients to act now because Congress could close this window at any time," says Colombo, an attorney at Oshins & Associates LLC, in Las Vegas.
"But there is a potential for clawback, or recapture," warns Clark, the Minneapolis CPA. Suppose a client gifts $5 million tax-free under current rules. Further suppose that after 2012 the estate tax returns to a $1 million exemption, which will happen without any new legislation, and the client dies then. In that case, many observers interpret current law to say that the estate would owe tax on $4 million-the amount gifted tax-free during life ($5 million) minus the exemption allowed at death ($1 million).