2013 Year End Tax Planning Considerations
Dear BNN Clients and Friends:
As the holidays approach, we are reminded that it also time to consider year-end individual tax planning strategies. Projecting your current year tax liability allows us to seek opportunities to reduce that burden. Planning for that liability also allows us to identify your cash flow needs well in advance of April 2014.
Year-end tax planning may involve any number of matters: being aware of changes in the tax laws, taking advantage of expiring tax provisions, and deferring or accelerating income or deductions depending upon your specific situation. A significant swing in your income or expenses from year to year may make such strategies worth considering.
The following includes information on tax law changes that took effect this year, as well as planning opportunities that may make sense for you.
Baker Newman Noyes
NEW TAX PROVISIONS
Same-Sex Marriage Ruling
As a result of this ruling, same-sex couples who legally marry in a state that recognizes their marriage are considered married for federal tax purposes, regardless of whether the couple’s home state recognizes same-sex marriage. For 2013 and all future years, legally married same-sex couples must file their federal income tax returns as married filing jointly or married filing separately.
Same-sex married couples may enjoy all of the federal tax-related benefits previously available only to opposite-sex married couples. Any same-sex marriage legally entered into in one of the 50 states, the District of Columbia, a U.S. territory or a foreign country is covered by the ruling. These benefits include:
- Income tax benefits
- Estate and gift tax benefits
- Claiming personal and dependency exemptions
- Claiming child-related credits
- Pre-tax employee benefits
- Spousal IRAs
Top Tax Rate Increase
Beginning in 2013, a top marginal tax rate of 39.6% takes effect, increased from 35%. This rate applies to taxable income in excess of $450,000 (joint filers), $400,000 (single filers), and $225,000 (married filing separately).
Capital Gains and Qualified Dividends Tax Rate
Although favorable tax rates for long-term capital gains and qualified dividends, generally, were made permanent by the American Taxpayer Relief Act of 2012 (ATRA), the top rate is now 20% rather than 15%. Therefore, 0%, 15%, and 20% rates apply to long-term capital gain and qualified dividend income, depending on your tax bracket. These rates are also applicable for the alternative minimum tax computation.
Affordable Care Act Tax Provisions
Two new taxes take effect in 2013: the 3.8% Net Investment Income Tax and the 0.9% Additional Medicare Tax. Both taxes apply to income above the threshold amount of $200,000 ($250,000 if married filing jointly or $125,000 for married filing separately).
In addition to investment income, the calculation of the Net Investment Income Tax includes most rental income and net gain attributable to the disposition of property other than property held in a trade or business. The Additional Medicare Tax applies to an individual’s wages and self-employment income.
Increased Medical Expense Deduction Threshold
For years before 2013, unreimbursed medical expenses that exceeded 7.5% of adjusted gross income (AGI) for the year were deductible. For 2013 and later years, the deduction floor is increased to 10%. However, for 2013 through 2016, the floor remains 7.5% if you or your spouse has reached age 65 before the close of the applicable tax year.
Reinstated Phaseouts of Personal Exemptions and Itemized Deductions
For taxpayers with adjusted gross income over $250,000 (unmarried other than head of household and surviving spouse), $300,000 (joint filers), $275,000 (head of household), and $150,000 (married filing separately), there is a reduction in personal exemptions and itemized deductions, which will effectively increase taxes on high-income taxpayers.
Maine Tax Law Changes
For taxpayers filing in Maine, income tax rates have changed. Prior to 2013, graduated rates ranged from 2% to 8.5%. For 2013 and future years, the rates will range from 0% to 7.95%.
Perhaps more significantly for some, for tax year 2013 and future years, a Maine taxpayer who itemizes deductions will be limited to an overall cap of $27,500 (to be indexed for inflation after 2013). If you are considering making additional charitable contributions before year end or will incur other deductible expenses that you may be able to defer payment of until 2014, please contact us.
Given your overall income and expense situation, it may make sense to continue to make such contributions or pay such expenses given the overall higher federal tax burden applicable in 2013. However, we can help you determine the best approach to timing payment of such contributions and deductible expenses.
Transfers to Roth Accounts
In 2013, an expanded option is available to taxpayers with a 401(k) plan that includes a qualified Roth contribution program. The taxpayer may transfer an amount from the pre¬tax elective deferral account into a designated Roth account in the same plan (subject to plan rules). In 2012, this was allowed only for participants who were at least age 59 ½; that age limitation does not apply in 2013. Although the transfer is subject to regular income tax, no early distribution penalty will apply. Subsequent distributions from the Roth account will be free of income tax assuming certain timing requirements are met.
EXPIRING TAX PROVISIONS
A number of tax benefits were extended under ATRA – most only through 2013. The American Opportunity Tax Credit (AOTC), however, is one benefit that was extended through 2017. The AOTC allows for several taxpayer friendly opportunities including a maximum $2,500 credit per eligible student, higher income phaseouts for filers, the extension of credit eligibility to the first four years of post-secondary education, the inclusion of textbooks and course materials as eligible expenses, and the ability to claim 40% of the credit as refundable.
The following benefits are scheduled to end December 31, 2013:
- Higher education tuition deduction
- $250 deduction for eligible teacher expenses
- Exclusion from gross income for discharges of principal residence debt
- Mortgage insurance premium itemized deduction
- The election to claim an itemized deduction for sales tax paid in lieu of State income taxes
- Qualified Charitable Distributions from IRAs for taxpayers aged 70 ½ or older
- Residential energy property credit
TRADITIONAL TAX PLANNING
Thoughtful planning will consider tax savings within the context of your entire financial picture. The following are some of the actions we would review before year end to see if they make sense in your situation.
Accelerate Income into 2013
It may be beneficial to accelerate income into 2013, especially if your 2014 income is projected to be significantly greater. Besides realizing gains in your investment portfolio, other options for accelerating income include:
- convert a Traditional IRA or SEP IRA into a Roth IRA and recognizing the conversion income this year;
- take IRA distributions (non-RMD) this year rather than next year;
- realize gains from selling stocks or other assets this year;
- if you own a business that uses cash-basis accounting, encourage customers to pay your accounts receivable before year end; and
- finalize legal matters or insurance claims that will generate taxable income this year.
Defer Income into 2014
Alternatively, it may make sense to defer income into 2014 – in particular, if you think that your income will decrease considerably next year.
Income deferral options include:
- time the receipt of a year-end bonus in January 2014 rather than December;
- postpone the sale of assets at a gain until 2014;
- harvest losses to offset gains already realized;
- delay the exercise of any stock options;
- if you intend to sell property, consider an installment sale to spread out the receipts over time;
- consider tax advantageous investment options;
- fund an IRA, if you are within certain income requirements; and
- maximize salary deferrals to a qualified retirement plan.
Defer Deductions into 2014
If you anticipate a significant increase in taxable income in 2014, you may want to consider deferring deductions into 2014:
- defer the payment of year-end charitable contributions, property tax payments, and medical expenses, to the extent you might get a deduction for such payments then; and
- delay the sale of any property that will produce a loss.
Accelerate Deductions into 2013
If you expect your income to decrease next year, an acceleration of deductions into the current year may offset the higher income this year. For example:
- prepay property taxes in December;
- make your January mortgage payment in December;
- prepay any remaining 2013 state income tax liability rather than waiting until April (although AMT is an important factor in determining if prepaying that liability is beneficial – taxes are not deductible in computing AMT);
- bunch medical expenses into one year to help meet the 10% threshold;
- make any large charitable contributions in 2013, rather than 2014;
- sell property such as stocks at a loss; and
- fund a health savings account (HSA) to the extent allowable.
Alternative Minimum Tax
If you are subject to the alternative minimum tax (AMT), certain deductions are limited. Thus, if we anticipate that you will be subject to the AMT, we need to consider the timing of expenses that are limited under AMT. If not beneficial this year, perhaps the expenditures should be deferred to 2014.
Under certain circumstances, a taxpayer aged 70 ½ or older, who is charitably inclined can save some tax by making a direct (one step) contribution to a charity from the IRA (as distinguished from receiving the distribution and then writing a check to charity). Generally, an individual receives the distribution and then transfers payment to a charity (two steps). This two-step process increases income, which can trigger some phase-outs and other adverse consequences, only to be neutralized by an itemized deduction that may be subject to federal and state limitations (discussed earlier). The direct contribution instead prevents the distribution from being included in income or creating a deduction – thereby maximizing the benefit.
Direct (one step) donations of appreciated securities to charity can also be beneficial. If a security is sold and the proceeds are donated to charity (two steps), any gain on the sale (generally the increase in value over its cost) is taxable. However, in many circumstances a one step donation of the security to charity allows the taxpayer to deduct the market value, without the need to report gain on the increased value.
Many of life’s events may impact your tax situation. Marriage, divorce, birth or death in a family, lost or new jobs, and retirement all have important tax implications that should be analyzed in advance of the 2013 tax filing season.
The planning tips above represent just a few general considerations related to year-end planning for individuals. If you have any questions or you would like to discuss whether a projection of your 2013 tax liability is warranted before year-end, please call your BNN advisor.
IRS Circular 230 Disclosure:
Pursuant to requirements imposed by the Internal Revenue Service, any tax advice contained in this communication (including any attachments) is not intended to be used, and cannot be used, for purposes of avoiding penalties imposed under the United States Internal Revenue Code or promoting, marketing or recommending to another party any transaction or tax-related matter addressed herein.