Year end tax planning could be especially productive this year, because timely action could nail down a host of tax breaks that won’t be around next year unless Congress acts to extend them which, at the present time, is uncertain at best.
Additionally, a significant new tax provision which will impact high-income
earners starting in 2013 (and which carries with it significant planning considerations) will be the application of the 3.8% surtax on unearned income and the additional 0.9% Medicare (hospital insurance, or HI) tax that applies to individuals receiving wages in excess of $200,000 ($250,000 for married couples filing jointly and $125,000 for married couples filing separately).
The surtax is 3.8% of the lesser of (1) net investment income (NII), or (2) the excess of modified adjusted gross income (MAGI) over an unindexed threshold amount ($250,000 for joint filers or surviving spouses, $125,000 for a married individual filing a separate return, and $200,000 in any other case). As year end nears, a taxpayer’s approach to minimizing or eliminating the 3.8% surtax will depend on his estimated MAGI and NII. Some taxpayers should consider ways to minimize (e.g. – through deferral) additional NII and/or MAGI for the balance of the year.
The additional Medicare tax may require year end actions. Employers must withhold the additional Medicare tax from wages in excess of $200,000 regardless of filing status or other income. Self-employed persons must take it into account in figuring their estimated tax payments. There could be situations in which an employee may need to have more withheld to cover the tax. For example, an individual earns $200,000 from one employer during the first half of the year and a like amount from another employer during the balance of the year. He would owe the additional Medicare tax, but there would be no withholding by either employer, since wages from each don’t exceed $200,000. Also, in determining whether they may need to make adjustments to avoid a penalty for underpayment of estimated tax, individuals also should be mindful that the additional Medicare tax may be overwitheld. This could occur, for example, where only one of two married spouses works and reaches the threshold requiring the employer to withhold, but the couple’s income won’t be high enough to actually cause the tax to be owed.
We have compiled the following list of additional actions, based on current tax rules, which may help you save tax dollars if you act before year end. Not all actions will apply to every individual situation, but many may apply to yours.
Considerations applicable to individuals
· Increase the amount you set aside for next year in your employer’s health flexible spending account if you set aside too little for this year.
· If you become eligible to make health savings account contributions in December of this year, you can make a full year’s worth of deductible HSA contributions for 2013.
· Realize losses in your investment portfolio while substantially preserving your investment position. For example, you can sell a particular holding, then buy back the same or similar securities at least 31 days later.
· Postpone income until 2014 and accelerate deductions into 2013. This strategy may enable you to claim larger deductions and credits in 2013 which might otherwise be phased out due to the level of your adjusted gross income. These include child tax credits, higher education tax credits, the above the line deduction for higher education expenses, and deductions for student loan interest. Postponing income is also desirable for those taxpayers who anticipate being in a lower tax bracket next year due to changed financial circumstances.
· If you believe a Roth IRA is more appropriate in your circumstances than a traditional IRA, consider converting traditional IRA funds which may be invested in depressed stocks or mutual funds into a Roth IRA if you are eligible to do so. Keep in mind, however, that such a conversion will increase your adjusted gross income for 2013, thus possibly exacerbating the 3.8% Medicare surtax mentioned above.
· If you converted assets in a traditional IRA to a Roth IRA earlier in this year, and the assets in the Roth have declined in value, unless you take action you may wind up paying more tax than is necessary. You can back out of the transaction by recharacterizing the conversion – that is, by transferring the converted amount (plus earnings) from the Roth IRA back to a traditional IRA. If the circumstances are right, you can later reconvert to a Roth IRA.
· It may be advantageous to arrange with your employer to defer a bonus to which you are entitled to 2014.
· Consider using a credit card to prepay expenses that can generate deductions for this year.
· If you expect to owe state and local income taxes when you file your 2013 return next year, consider asking your employer to increase withholding of state and local taxes (or make estimated payments) before year end to pull the deduction of those taxes into 2013 (but only if so doing won’t create an alternative minimum tax (AMT) problem – see further comment below).
· Take an eligible rollover distribution from a qualified retirement plan before the end of 2013 as a possible means minimizing or perhaps avoiding altogether a penalty for underpayment of estimated taxes. Income tax will be withheld from the distribution and will be applied toward your 2013 tax obligation. You can then timely roll over the gross amount of the distribution (increased by the amount of the withheld tax) to a traditional IRA. No part of the distribution will be includible in income for 2013, but the withheld tax will be applied pro rata over the full 2013 tax year.
· Estimate the effect of any year end planning moves on the AMT for 2013, keeping in mind that many tax breaks allowed for purposes of calculating your “regular” tax liability are disallowed for AMT purposes. These include the deduction for state and local property taxes on your residence, state income taxes (or state sales taxes if you elect this deduction option), miscellaneous itemized deductions, and personal exemption deductions. Other deductions, such as those for medical expenses, are calculated in a more restrictive way for AMT purposes than for regular tax purposes in the case of a taxpayer who is over age 65 or whose spouse is over age 65 as of the close of the tax year.
· Accelerate “big ticket” purchases into 2013 in order to assure a deduction for sales taxes on the purchases (unless your state and local income taxes would total a larger amount).
· Homeowners should consider making energy saving improvements to their residence, such as installing extra insulation or energy-saving windows, or an energy efficient heater or air conditioner. If such assets are installed before 2014, special tax credits may be available.
· If you have the opportunity, consider purchasing “qualified small business stock” (QSBS) before the end of this year. Under current law, there is no tax on gain from the sale of such stock if it is (1) purchased after September 27, 2010 and before January 1, 2014, and (2) held for more than five years. In addition, such sales won’t cause AMT preference problems. To qualify for these breaks, the stock must be issued by a regular (C) corporation with total gross assets of $50 million or less, and a number of other technical requirements must be met. Let us know if you need more of these details.
· If you reached age 70-1/2 in 2013, you must consider the implications of taking annual required minimum distributions (RMDs) from your IRA or 401(k) plan. Failure to take a required withdrawal can result in a penalty of 50% of the amount of the RMD not withdrawn. If you turned age 70-1/2 in 2013, you are allowed to delay the first required distribution until early 2014. If it makes sense to take advantage of this first year deferral, however, remember that you will have to take a double distribution in 2014, which might push you into a higher tax bracket in 2014 and/or have a detrimental impact on various other tax provisions which are adjusted gross income sensitive.
· Make gifts sheltered by the annual gift tax exclusion before the end of the year. You can give $14,000 in 2013 to each of an unlimited number of individuals, but you cannot carry over unused exclusions from one year to the next.
Considerations applicable to businesses and owners
· For tax years beginning in 2013, up to $500,000 in business property acquisitions can be expensed (rather than capitalized and depreciated over several years). Unless Congress changes the rules, for tax years beginning in 2014, the dollar limit will drop to $25,000, and expensing won’t be available for qualified real property.
· Businesses should also consider making expenditures that qualify for 50% bonus first year depreciation. Again – this provision won’t be available next year without Congressional action.
· If you are self-employed and haven’t yet done so, set up some form of retirement plan. There are many options in this area, and in the right circumstances, significant tax dollars can be saved by funding retirement plan contributions.
· If you own an interest in a partnership or S corporation, determine your income tax basis, and consider increasing your basis if necessary to enable you to deduct a loss which may pass through to you in 2013.