As we approach the end of 2013, we wanted to make you aware of some of the year-end planning opportunities available to individual taxpayers, especially as the result of provisions that are new for 2013 and those that at the moment are scheduled to expire this year.
Early in 2013, the 2012 Taxpayer Relief Act was enacted and the “Bush-era” tax cuts, which were scheduled to sunset at the end of 2012, were permanently extended and modified. Here is a recap of some of the Act’s main provisions that affect taxes for 2013 and beyond.
- Income tax rates. The lower income tax rates of 10, 15, 25, 28, 33, and 35 percent were made permanent, and a new tax rate of 39.6 percent is imposed on taxable income over a threshold amount. For 2013, these threshold amounts are: $450,000 for married taxpayers filing jointly and surviving spouses, $225,000 for married taxpayers filing separately, $425,000 for heads of households, and $400,000 for single taxpayers.
- Capital gains tax. The favorable rate of zero percent for taxpayers in the 10 and 15 percent brackets remains unchanged. The 15 percent rate for taxpayers is now applicable to those in the 25, 28, 33, and 35 percent brackets. However, a new 20 percent rate applies to higher-income taxpayers that are subject to the 39.6 percent income tax rate.
- Tax on dividends. Qualified dividends received from domestic corporations and qualified foreign corporations continue to be taxed at the same rates that apply to long-term capital gains.
- Itemized deduction phaseout. Returning in 2013, itemized deductions are once again reduced by 3% of the amount by which adjusted gross income exceeds the applicable threshold. However, the amount of itemized deductions cannot be reduced by more than 80%. The income thresholds are as follows: $300,000 for married taxpayers filing jointly and surviving spouses; $275,000 for heads of households; $250,000 for unmarried taxpayers who are not surviving spouses or heads of households; and $150,000 for married taxpayers filing separately (equal to one-half of the amount for a joint return or surviving spouse, after any adjustment for inflation). The thresholds will be adjusted for inflation beginning in 2014.
- Personal exemption phaseout. The revival of the personal exemption phaseout rules reduces or eliminates the deduction for personal exemptions for higher income taxpayers. Under the personal exemption phaseout, the total amount of exemptions that may be claimed by a taxpayer is reduced by two percent for each $2,500, or portion thereof (two percent for each $1,250 for married couples filing separate returns) by which the taxpayer’s AGI exceeds the applicable threshold. The same income threshold limits used in the itemized deduction phaseout above apply to the personal exemption phaseout. Unlike the itemized deduction phaseout, however, personal exemptions can be reduced to zero by these phaseouts.
New Tax Provisions for 2013
There are also new provisions with which you should become familiar, as they may affect your overall tax strategy:
Health Care Reform
Beginning in 2014, some of the most far reaching provisions of this legislation will become effective: the individual mandate to carry minimum essential health coverage for taxpayers and their dependents; the ability to obtain coverage through an insurance exchange; and a special tax credit to help offset the cost of insurance. The following revenue-raising health care reform provisions became effective in 2013:
Net Investment Income Tax (NIIT). Taking effect on January 1, 2013, a Medicare surtax of 3.8 percent is imposed on the lesser of net investment income (NII) or modified adjusted gross income (MAGI) above a specified threshold. However, the Medicare surtax is not imposed on income derived from a trade or business in which the taxpayer is an active participant, nor from the sale of property used in a trade or business in which the taxpayer is an active participant.
NII includes the following investment income reduced by certain investment-related expenses, such as investment interest expense, investment brokerage fees, royalty-related expenses, and state and local taxes allocable to items included in net investment income:
- Gross income from interest, dividends, annuities, royalties, and rents, provided this income is not derived in the ordinary course of an active trade or business;
- Gross income from a trade or business that is a passive activity;
- Gross income from a trade or business of trading in financial instruments or commodities; and
- Gain from the disposition of property, other than property held in an active trade or business.
Individuals are subject to the 3.8 percent NIIT if their MAGI exceeds the following thresholds (which are not adjusted for inflation): $250,000 for married taxpayers filing jointly or a qualifying widower with a dependent child; $125,000 for married taxpayers filing separately; and $200,000 for single and head of household taxpayers. Thus, if you are close to these income thresholds for 2013 and also have income subject to the NIIT, consider deferring income into 2014.
Additional HI (Medicare) Tax. Beginning in 2013, higher income individuals are subject to an additional 0.9 percent HI (Medicare) tax, not to be confused with the 3.8 percent Medicare surtax on NII. The additional Medicare tax means that the portion of wages received in connection with employment in excess of $200,000 ($250,000 for married couples filing jointly and $125,000 for married couples filing separately) is subject to an additional 0.9% Medicare surtax. The additional Medicare surtax also applies to self-employed individuals. To avoid an underpayment penalty related to this tax or the NIIT, you can instruct your employer to withhold an additional amount of federal income tax from your wages before year end.
Increased medical expense threshold. In 2013, the threshold for the itemized deduction for unreimbursed medical expenses increases from 7.5 percent of AGI to 10 percent of AGI for regular income tax purposes. For AMT purposes, medical expenses remain deductible only to the extent they exceed 10 percent of AGI. However, taxpayers (or their spouses) who are age 65 and older before the close of the tax year are exempt from the increased threshold of 10 percent for the 2013 through 2016 tax years. These taxpayers can continue to deduct qualified medical expenses that exceed 7.5 percent of AGI.
Tax Incentives Set to Expire
The following are popular tax incentives that are set to expire on December 31, 2013 unless Congress acts to extend them so you may want to consider taking advantage of them while they’re still in effect: 1) State and local sales tax deduction 2) Teachers’ classroom expense deduction 3) Exclusion from income of debt forgiveness on one’s principal residence 4) Deduction for mortgage insurance premiums 5) IRA distributions given directly to charity 6) Tuition and fees deduction
Traditional Tax Planning
Traditional year-end planning techniques remain very important for 2013. In considering steps to take in year-end planning, please keep in mind that the goal is to minimize taxes overall for 2013 and 2014 which may mean taking into account expectations for next year as well. In considering income deferral and deduction/credit acceleration techniques, it is important to maximize each of the lower tax brackets in both 2013 and 2014. Here is a list of some actions to consider before year-end if they make economic sense for your particular situation.
If you expect your income in 2014 to be the same or lower as your income in 2013, please consider the following income deferral and deduction acceleration techniques: 1) Sell appreciated assets in 2014 rather than 2013 2) Delay Roth conversions to 2014 3) Minimize retirement distributions 4) Execute like-kind exchange transactions rather than recognizing the gain and paying tax upon sale 5) Minimize the effect of AGI limitations on deductions/credits 6) Maximize net investment interest deductions 7) Match passive activity income and losses.
Here are some additional strategies to consider:
- If you have a high-deductible health insurance plan and are eligible to make health savings account (HSA) contributions by December of this year, you can make a full year’s worth of deductible HSA contributions for 2013.
- If you expect to be in the 10% or 15% tax brackets in 2013 and have long-term capital gains or dividend income, you may be able to take advantage of a 0% tax rate on both of those types of income. To take advantage of this provision, a single taxpayer must have taxable income of less than $36,250, and married couples must have taxable income of less than $72,500, including the capital gains.
- Realize losses on securities while substantially preserving your investment position. For taxpayers to whom the 20% long-term capital gains rate and/or the 3.8% Medicare surtax may apply, this may help to reduce the effect of those provisions. There are several ways this can be done. For example, you can sell the original holding, and then buy back the same securities at least 31 days later. Please be sure not to sell solely for tax reasons, but rather with your overall investment plan in mind.
- Take required minimum distributions (RMDs) from your IRA or 401(k) plan (or other employer-sponsored retired plan) if you have reached age 70 1/2. Failure to take a required withdrawal can result in a penalty of 50% of the amount not withdrawn. If you turned age 70 1/2 in 2013, there are special rules regarding the timing of your distribution.
- Postpone income until 2014 and accelerate deductions into 2013 to lower your 2013 tax bill. This may enable to you to claim larger deductions, credits, and other tax breaks for 2013. Postponing income may be desirable for taxpayers who anticipate being in the same or lower tax bracket next year.
- It may be advantageous to arrange with your employer to defer a bonus until 2014.
- If you are self-employed and haven’t done so yet, consider setting up a self-employed retirement plan.
- If you own an interest in a partnership or S-corporation, you may need to increase your basis in the entity so you can deduct a loss from it for this year.
- Consider using a credit card to prepay expenses that generate deductions for this year.
- If you expect to owe state and local income taxes next year, increase withholding or pay estimated tax payments before year-end to pull the deduction into 2013 if doing so won’t create an AMT problem.
- Accelerate personal big ticket purchases (such as the purchase of a vehicle or boat) into 2013 for a deduction of sales taxes. This deduction is scheduled to sunset on December 31, 2013 unless extended by Congress.
- Consider extending your subscriptions to professional journals, paying professional dues, enrolling in and paying for job-related courses, purchasing a new vehicle when used for business purposes, etc., to bunch into 2013 if doing so will help them to exceed the floor amounts based on income.
- Donate appreciated stock. If you’ve owned the shares over a year, you can deduct the full value and not pay tax on the appreciation.
- If you’re thinking of donating a used auto to charity, you may want to inquire whether the charity plans to sell the car or use it in its charitable activities; the latter may yield a bigger deduction for you.
- If you are facing a penalty for underpayment of federal estimated tax, you may be able to eliminate or reduce it by increasing your withholding.
- Keep in mind the effect of any year-end planning moves on the alternative minimum tax (AMT) for 2013.
- Make annual exclusion gifts before year-end to save both estate and gift taxes. In 2013, you can give $14,000 in cash or property to any one individual free of gift tax and this applies to an unlimited number of individuals. However, you can’t carry over unused exclusions from one year to the next. The transfers also may save family income taxes where income-earning property is given to family members in lower income tax brackets who are not subject to the kiddie tax. Also, amounts paid directly to educational institutions or health care providers on behalf of others are not considered gifts.
Please call our office at (239)433-5554 if you have any questions or would like to schedule an appointment to discuss your specific year-end tax planning strategies. You may also visit our website at www.markham-norton.com.