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PERSPECTIVES

How you might cope with rising taxes.

February 01, 2011
Jonathan Clements, Director of Financial Education, Citi Personal Wealth Management

In December 2010, Congress extended the Bush-era tax cuts. Problem is, most of the new tax law's provisions expire at the end of 2012, raising the prospect of higher federal tax rates in 2013.

In fact, upper-income Americans are already looking at higher taxes in 2013, thanks to a special Medicare tax increase that was included in last year's health-care law and that can also ding investment gains. The 3.8% Medicare tax will hit couples with modified adjusted gross income of more than $250,000 and individuals above $200,000.

What to do? Here are five strategies you may want to discuss with your Financial Advisor and tax professional:

  • If income-tax rates rise, municipal bonds may become more appealing. For example, a 3% municipal bond has a tax-equivalent yield of some 4.6% at today's top federal rate of 35%. But if the top rate rises to, say, 40%, the tax-equivalent yield climbs to 5%.
  • You might rethink the wisdom of holding dividend-paying stocks in your taxable account. High-income earners may pay the new Medicare tax on their dividends starting in 2013. In addition, while qualifying dividends are currently taxed at a 15% maximum federal rate, they could once again be taxed as ordinary income if Congress doesn't extend the special tax treatment for qualifying dividends beyond 2012.
  • Without a new tax law, the long-term capital-gains rate will rise from 15% in 2011 and 2012 to 20% in 2013. And even if the 15% rate is extended, high-income families may be hit by the Medicare tax. One implication: If you have appreciated stock in your taxable account that you're contemplating selling, you may want to sell before year-end 2012.
  • Consider converting your regular Individual Retirement Account to a Roth IRA, so you can pay the conversion tax at today's lower income-tax rates. Converting may make sense if you expect to be in the same or a higher tax bracket at retirement--and you have funds outside your IRA to pay the tax bill on the taxable sum converted.
  • Look into increasing retirement-account contributions so you can shelter your ongoing gains from any future tax increases, including the Medicare tax. In 2011, you can contribute as much a $16,500 to a 401(k) plan, or $22,000 if you are age 50 or older. Meanwhile, this year's maximum IRA contribution is $5,000, or $6,000 for those 50 and above.

One piece of good news: As you wrestle with the continuing tax uncertainty, you may find there's a little extra money in your paycheck in 2011. For this year only, the employee share of the Social Security payroll tax has been trimmed from 6.2% to 4.2%. If you make $100,000 a year, you could take home an additional $2,000 in 2011.

INVESTMENT PRODUCTS: NOT FDIC INSURED • NO BANK GUARANTEE • MAY LOSE VALUE

The information set forth was obtained from sources believed to be reliable, but we do not guarantee its accuracy or completeness.

These strategies do not necessarily represent the experience of other clients, nor do they indicate future performance or success. Investment results may vary. The investment strategies presented are not appropriate for every investor. Past performance is not a guarantee of future results.

Citigroup Inc., and its affiliates do not provide tax or legal advice. To the extent that this material or any attachment concerns tax matters, it is not intended to be used and cannot be used by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Any such taxpayer should seek advice based on the taxpayer's particular circumstances from an independent tax advisor.

Bonds are affected by a number of risks, including fluctuations in interest rates, credit risk and prepayment risk. This material does not constitute an offer to sell or the solicitation of an offer to buy these securities. All rates are subject to change and availability. Municipal Bonds may be subject to state and local taxes and you may also be subject to Alternative Minimum Tax (AMT). Official offerings may be made only by the final Official Statement. If sold prior to maturity you may receive more or less than your original investment. Past performance is not a guarantee of future results.

© 2011 Citigroup Inc. Citi Personal Wealth Management is a business of Citigroup Inc., which offers investment products through Citigroup Global Markets Inc. ("CGMI"), member SIPC. Citibank, N.A. and CGMI are affiliated companies under the common control of Citigroup Inc. Citi and Citi with Arc Design are registered service marks of Citigroup Inc. or its affiliates, and are used and registered throughout the world.

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