- Days left

5 things you can do now to get ready for huge tax hikes in 2011

In less than six months, taxes for many Americans are going up. Tax cuts originally signed into law by former President Bush are set to expire at the end of 2010 unless Congress makes a change in the Tax Code. Unfortunately for taxpayers, 2010 is also a significant election year, which, if history has taught us anything, means that Congress is unlikely to do much at all. If the law stays the same, on January 1, 2011, you can expect that the highest federal income tax rate for individuals will increase to 39.6% from 35%; capital gains tax rates will rise to 20% and dividends will lose their tax favorable status and retreat back to ordinary income status.

Even worse, state and local governments are struggling to make budgets balance. A whopping 45 states reported receiving less revenue in 2009 than in 2008, a trend that states can't sustain in 2010. Last year, at least 10 states considered major tax increases and others sought to increase or expand the tax base by hiking sales taxes or imposing excise taxes on such items as cigarettes and soda.

How can you avoid extra hits to your wallet in 2011? Here are five tips to consider:

  • Move. While a number of states are increasing taxes in order to recover lost tax revenue, a handful are considering lowering taxes, at least for those taxpayers at the top. While states like California, Hawaii and Wisconsin are looking to boost taxes for millionaires, others such as New Jersey and Rhode Island are shaving taxes for those at the top. If you're not in the top tax bracket, you may still benefit from a move, since seven states impose no income tax at the state level: Alaska, Florida, Nevada, South Dakota, Texas, Washington and Wyoming. No-income-tax states have lured the likes of Tiger Woods, who reportedly moved to Florida simply to avoid additional tax. While a move may seem like a huge commitment, studies suggest that seeking out a more tax-favored state is becoming more popular for those of us who aren't sports professionals or rock stars. A move across the border from Oregon to Washington, for example, could mean more than 10% of your pay stays in your wallet.
  • Convert to a Roth IRA. In 2010, a taxpayer with an existing traditional IRA can convert it to a Roth IRA regardless of income and without any prepayment penalty. Taxpayers can opt to pay federal income tax associated with the conversion over two years, but that might not be the best idea if rates are going up. Paying up in 2010 likely means a lower tax rate. And if rates continue to go up, you can breathe a sigh of relief, since future distributions from a Roth IRA will be paid out income tax free.
  • Retire early. An early retirement these days generally means a lump sum payment as opposed to a long term pension. If you could take a lump sum now and pay tax at 35% rather than wait and pay tax at 39.6%, wouldn't you? The marginal tax savings on a $200,000 retirement package could net you $9,200 more if you take it in 2010 than waiting until 2011. Even if you're not retiring, consider cashing in those stock options. High income tax rates plus a dramatically low AMT exemption (not to mention a less than robust market) may make waiting less advantageous.
  • Don't get married (or better yet, get a divorce). In 2001, Congress sought to end the so-called marriage penalty with changes to the standard deduction and income tax brackets. That means for 2010, the standard deduction for married couples is twice that for singles; married couples also have a wider tax bracket. In 2011, those provisions will expire so the standard deduction for married couples will fall to less than double what it is for single filers; and the ceiling of the 15% bracket for married couples will be reduced so that it is no longer double what it is for single filers. The result? Less tax savings for some married couples. Married couples who will lose out the most are those with disparate incomes, meaning couples who benefited by getting twice the tax benefits from one large income; working couples with similar incomes did not see as much benefit. While the penalty (or benefit, depending on where you fall on the tax scale) isn't necessarily a deal-breaker, its existence has given more than one couple pause to consider whether nuptials make financial sense.
  • Die. Sure, it sounds dramatic. But if you're wealthy, it could save your heirs tons of money. As part of the Economic Growth and Tax Reconciliation Act of 2001, the federal estate tax is repealed for 2010 -- but only for 2010. In 2011, it is reinstated with a personal exemption of a mere $1 million and a flat tax rate of 55%. That can add up fairly quickly. Just ask Dan Duncan's family. The 77-year-old Texas tycoon died earlier this year with a fortune estimated by Forbes magazine to be worth $9 billion, the 74th wealthiest person in the world. His heirs will walk away with all $9 billion this year. Had he lived just nine months longer, Uncle Sam could have claimed $4.95 billion in federal estate tax.
Of course, let's put this into perspective: The laws are written by Congress. The same Congress that wrote these increases in today could write them out tomorrow. I certainly wouldn't recommend that you plan major life (or death) events around the Tax Code, but there is a nugget of truth in many of these recommendations: moving, retiring, getting married -- and even dying -- can result in significant tax consequences. It's important to be informed. Sometimes, timing is everything.

Increase your money and finance knowledge from home

How to Buy a Car

How to get the best deal and buy a car with confidence.

View Course »

Banking Services 101

Understand your bank's services, and how to get the most from them

View Course »

TurboTax Articles

What is IRS Form 8824: Like-Kind Exchange

Ordinarily, when you sell something for more than what you paid to get it, you have a capital gain; when you sell it for less than what you paid, you have a capital loss. Both can affect your taxes. But if you immediately buy a similar property to replace the one you sold, the tax code calls that a "like-kind exchange," and it lets you delay some or all of the tax effects. The Internal Revenue Service (IRS) uses Form 8824 for like-kind exchanges.

What are ABLE Accounts? Tax Benefits Explained

Achieving a Better Life Experience (ABLE) accounts allow the families of disabled young people to set aside money for their care in a way that earns special tax benefits. ABLE accounts work much like the so-called 529 accounts that families can use to save money for education; in fact, an ABLE account is really a special kind of 529.

What is IRS Form 8829: Expenses for Business Use of Your Home

One of the many benefits of working at home is that you can deduct legitimate expenses from your taxes. The downside is that since home office tax deductions are so easily abused, the Internal Revenue Service (IRS) tends to scrutinize them more closely than other parts of your tax return. However, if you are able to substantiate your home office deductions, you shouldn't be afraid to claim them. IRS Form 8829 helps you determine what you can and cannot claim.

What is IRS Form 8859: Carryforward of D.C. First-Time Homebuyer Credit

Form 8859 is a tax form that will never be used by the majority of taxpayers. However, if you live in the District of Columbia (D.C.), it could be the key to saving thousands of dollars on your taxes. While many first-time home purchasers in D.C. are entitled to a federal tax credit, Form 8859 calculates the amount of carry-forward credit you can use in future years, not the amount of your initial tax credit.

What is IRS Form 8379: Injured Spouse Allocation

The Internal Revenue Service (IRS) has the power to seize income tax refunds when a taxpayer owes certain debts, such as unpaid taxes or overdue child support. Sometimes, a married couple's joint tax refund will be seized because of a debt for which only one spouse is responsible. When that happens, the other spouse is said to be "injured" and can file Form 8379 to get at least some of the refund.

Add a Comment

*0 / 3000 Character Maximum