What you need to be doing now

1. Catch the early bird special. In anticipation of higher tax rates, if your portfolio includes appreciated assets, this year might be a good time to take some gains off the table at the maximum capital gains rate of 15 percent, rather than the 20 percent currently slated for 2011. Investors in the 15 percent tax bracket or lower have no gains due on appreciated assets in 2010, but will face a 10 percent tax in 2011.


2. Diversify retirement savings from a tax standpoint. Having taxable and non-taxable pots to draw from makes sense in an uncertain tax environment. The good news is that the lifting of the $100,000 income limit for converting a traditional IRA to a Roth IRA makes diversifying possible for all taxpayers.

Today, anyone - regardless of their income -can convert retirement assets from a traditional IRA to a Roth. A Roth offers three major benefits: Tax-free growth that is especially attractive considering income tax rates are likely to go up in the future; tax diversification that provides flexibility in retirement income distribution planning; and no required distribution at age 70-1/2 that helps transform your retirement savings into a financial legacy.

Obviously, converting retirement assets to a Roth would result in reportable income and trigger additional income tax - and it may be difficult to consider paying income tax on a large IRA. However, it's important to realize that you don't need to convert the entire account. While investors who converted in 2010 can spread taxes due over 2011 and 2012, those in the higher tax brackets may be better off having paid all those taxes in 2010. In promoting the extra time to pay, Uncle Sam fails to mention that the top tax bracket will increase to 39.6 percent from 35 percent in 2011. Either way, if the nation is indeed entering a long period of rising income tax rates, paying a conversion tax bill may seem like a bargain in retrospect.


3. Use fraud losses. Because the Roth conversion is an ordinary income taxable event, taxes due can be offset by major losses due to fraud which are booked as an ordinary income loss as opposed to a capital loss. If you have the misfortune to take a straight fraud and theft deduction, you can convert the same amount from a traditional IRA into a Roth IRA conversion and end up with zero tax on that conversion - the strategy is a way of making lemonade out of a very sour lemon.
   
   It's also possible to go back a few years for loss carry forwards to add to write-offs of ordinary income. When you go back and zero-out tax liability, you save that 10-15 percent on a good proportion of the dollars. Plus, when you do a Roth IRA conversion, you convert taxable dollars into a future non-taxable income stream, so the effective tax savings is even more impactful than just zeroing out your tax liability.


4. Rethink some standard tax planning advice. While typically we evaluate the benefits of deferring some salary we are advising high wage-earners who have the flexibility to receive ordinary income this year instead of in a later year when tax rates may be higher - and possibly to exercise non-qualified stock options. Typically we accelerate deductions like charitable contributions and prepaying state and property taxes - but this year that strategy too may be reversed.
   
   In another departure, if future income tax rates truly skyrocket tax-qualified plans may lose some of their appeal. You still want to contribute to your workplace plan, certainly enough to qualify for any available company match, but with the question of whether you truly will be in a lower tax bracket in retirement, you might also consider funding accounts outside the tax-deferred arena for some diversity.


5. Understand that dividends will be taxed more highly. Currently, the maximum tax rate on qualified dividends is 15 percent, but that will revert to regular income tax rates in 2011. Although President Obama has proposed a tax of 20 percent for both capital gains and dividends in 2011, if the reclassification of dividends lapses at the end of 2010, next year the top dividend rate could revert to 39.6 percent. Still others talk about a tripling of the current 15 percent rate. Whatever happens, the increase in tax on qualified dividends obviously makes dividend paying stocks less attractive in a retirement income stream.
   
   In addition, starting in 2013, the Healthcare and Education Reconciliation Act of 2010 will levy a new 3.8 percent Medicare tax on investment income for individuals earning more than $200,000 or couples earning $250,000. Notably, the 3.8 percent surtax does not apply to distributions from IRAs and other qualified retirement plans like 401(k)s, 403(b)s and 457 plans, or Roth IRAs.
   
   Because income from tax exempt and tax deferred vehicles like municipal bonds, tax deferred non-qualified annuities, life insurance, and non-qualified deferred compensation do not count as investment income, investments in these vehicles should become more favorable relative to investments producing income subject to the tax.
   
   The net effect of the capital gain tax increase and Medicare tax will be a 23.8 percent tax rate for higher earners--the highest rate for long-term capital gains since 1997. Once these higher rates kick in, high wage-earners may try to defer income in an effort to stay below the highest tax thresholds.