Now that the “fiscal cliff” has been averted, new laws mean taxes will be going up on almost everybody. Here are some planning tips to consider:
Look at your investment mix
In recent years, many financial advisors advocated owning stocks that produced dividends. Not only did the dividend create an earnings stream, dividends also enjoyed a preferential tax rate of 15 percent, which made after-tax rates of returns attractive. The dividend rate will jump to 23.8 percent for single taxpayers making $400,000 and households making more than $450,000. The 3.8 percent Affordable Care Act tax will also be imposed at lower income thresholds ($200,000 single and $250,000 household) increasing their rate to 18.8 percent. This will reduce many investors’ after-tax rate of return and other investment options may be more appealing.
It’s also possible that corporations may be more reluctant to pay out dividends in the future with the tax rates being higher. So if you rely on dividends as a revenue stream you may need to diversify into other vehicles to keep generating a similar stream.
Under the new law the “payroll tax holiday” has ended. This means the employee’s share of FICA is now 6.2 percent instead of 4.2 percent. If you own your own business, you may want to review what you take in salary and what you take in profit distribution. Remember, the salary must be reasonable.
Roth versus traditional IRA
The Roth IRA option has become very popular and part of that has been due to the lower tax rates we’ve been under. With some of the tax increases set to hit those making $200,000, it may be more beneficial to look at making a deductible tax contribution if it can keep your income low enough to avoid the tax increases and surcharges.
Rental income is subject to the 3.8 percent Affordable Care Act tax. If your business also owns its building in a separate LLC, it may be time to look at the amount of rent you are paying and reduce it if that’s feasible.