Business and Financial Year-End Tax Planning Tips

With only a few weeks left in the year, now is an ideal time to review your investment portfolio and take advantage of any potential tax breaks by December 31. It's a good idea to sit down with your financial advisor before the holiday season gets into full swing and look for ways to help reduce your 2012 income taxes.

That tax-planning strategy is particularly important this year, since it's possible that some rates may go up on Jan. 1, 2013. That's when the so-called Bush tax cuts are scheduled to expire, unless the President and Congress agree to extend those lower rates before year end.

Regardless of what happens in Washington, there are steps you can take to help improve your financial situation. Here are some strategies to consider.

1. Maximize your contributions to a retirement plan. Whether you have a 401(k) plan at work, a traditional individual retirement account (IRA) or a SEP-IRA for the self-employed, add up your 2012 contributions to date. Then, see whether you can add to that total before year-end. Also, check to see if your employer will match those contributions, putting even more money into your account.

Remember that every dollar you put into these types of retirement plans can potentially reduce your current income by the same amount.  If you contribute $10,000 this year, you may be able to subtract that from your adjusted gross income on your 2012 return.  Your tax advisor can help you determine the deductibility of any contribution. . In addition, that money can be invested for years, earning interest or dividends with no income taxes due until you withdraw the money later in life.

2. Consider municipal bonds. Unlike most types of bonds, the income you receive from municipal bonds is typically not subject to federal income taxes and may be generally free from state and local taxes. That means you may be able to buy high-quality bonds issued by states, counties, cities or other government agencies without impacting your 2013 tax return. If taxes go up next year, it's possible that those municipal bonds may rise in value, providing an even bigger potential boost to your investment portfolio.

However, be aware that local governments have differing credit ratings, so some municipal bonds may be a bit more risky than others.  Also, municipal bonds generally have lower rates than corporate bonds, reflecting those tax advantages. Therefore, you should review the after-tax returns on both types of bonds for a true "apples to apples" comparison.

3. Review your capital gains situation. One of the biggest tax questions facing investors is whether capital gains taxes will rise from the current 15 percent rate to 20 percent next year. That could mean a substantial increase in the taxes you pay on the appreciated value of your stocks, bonds and other assets when it's time to sell.

Talk with your financial and legal advisors about whether it makes sense to sell some of those assets before year-end, in order to take advantage of the potentially lower capital gains rate. You may also want to consider selling assets that have lost value in the past year to help offset any realized capital gains you may have.

4. Reduce dividend income. If the Bush-era tax cuts do expire, dividend income could be taxed at a much higher rate – possibly more than twice the current level for high-income earners. Therefore, you may want to review your portfolio and consider shifting money away from assets that pay dividends, such as many blue-chip stocks, and into other sectors.

However, it's still very important to retain a diversified investment portfolio, with assets that can potentially grow in value and help protect against inflation risk.  So, don't let tax considerations be the only driver in your investment strategy. For example, you may want to hold onto some dividend-paying stocks in order to help stay diversified or help meet your income needs.

5. Review your estate plans. Next year, estate and gift taxes are scheduled to go up significantly. Therefore, you may want to consider transferring some of your assets to your heirs before year end in order to lock in those lower rates. Again, talk with your financial or tax advisor, since everyone's situation is different.

So, take the time to review your investment portfolio with a close look at your tax situation. After all, cutting your 2012 tax bill might be the best holiday present you could give to your family.


Andrew Menachem, CIMA®, is a Wealth Adviser at The Menachem Group at Morgan Stanley in Miami and teaches at the University of Miami. Views expressed are those of the author, not necessarily Morgan Stanley Smith Barney LLC, member SIPC, and are not a solicitation to buy or sell any security.  The investments and/or strategies referenced herein may be speculative in nature, illiquid, subject to significant risks, including the loss of principal, and are not suitable for all investors. Diversification and asset allocation do not guarantee a profit or protect against a loss. Companies paying dividends can reduce or cut payouts at any time. Morgan Stanley Smith Barney LLC and its Wealth Advisors do not provide tax or legal advice.

Interest in municipal bonds is generally exempt from federal income tax. However, some bonds may be subject to the alternative minimum tax (AMT). Typically, state tax-exemption applies if securities are issued within one’s state of residence and local tax-exemption typically applies if securities are issued within one’s city of residence. The tax-exempt status of municipal securities may be changed by legislative process, which could affect their value and marketability. The value of fixed income securities will fluctuate and, upon a sale, may be worth more or less than their original cost or maturity value.