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Lewitz, Balosie, Wollack, Rayner & Giroux, LLC
Certified Public Accountants
Newsletter
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Last Chance?
Some of the tax breaks discussed in this newsletter are identified as expiring in 2013. However, the government has extended many expiring benefits in the past. Will some of these get extended? We don't know, but it is best to take advantage of them while you can. |
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Quick Link To Our Website
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YEAR-END TAX PLANNING ISSUE
The year is quickly coming to a close, but there is still time to take action to reduce your taxes. Tax rates have increased for 2013 and many taxpayers will see an increase in their tax bill. When tax rates go up, the value of planning also increases. In spite of talk of tax simplification, the tax code keeps getting more complex and what may be a good strategy for one taxpayer may not work for another. Therefore, when you review these tips, keep your own individual situation in mind.
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Taxpayers with taxable income above $450,000 on a joint return and $400,000 for a single filer will be paying at a new 39.6% tax rate. This higher tax rate makes tax deductions more valuable. As this rate applies to taxable income increasing either adjustments to income (above the line deductions) or itemized deductions (below the line deductions) will help reduce taxes.
The Affordable Care Act introduces a new 3.8% tax on net investment income. This applies to taxpayers with modified adjusted gross income (MAGI) above $250,000 on a joint return and $200,000 for a single filer. Only modifications to income can be used to reduce the measurement threshold used to determine when this tax applies. Once the threshold is met, the surtax applies to the lesser of the taxpayers' net investment income or the amount that their MAGI exceeds the applicable threshold. While itemized deductions will not reduce the threshold, investment expenses are deductible against taxable investment income. Therefore expenses like investment management fees will reduce the surtax even if they are below the limits to apply to itemized deductions.
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Planning With Retirement Plans
And IRAs
With increased rates and a surtax, maximizing retirement plan contributions becomes more important. A deductible contribution may directly reduce regular income tax, but may also indirectly reduce the investment income surtax by bringing a taxpayer's MAGI closer to or below the applicable threshold. Taxpayers who are in the maximum bracket and paying the surtax could have a combined tax savings of 43.4%. If you have been contributing to a Roth IRA, you should consider the impact the new higher rates will have and whether it is better to make a deductible contribution.
Self-employed taxpayers should consider whether they are maximizing their retirement contributions. Rather than contributing to an IRA, you may wish to adopt a retirement plan with higher contribution limits. If you have employees, higher tax rates mean that it costs less to contribute to a plan for their benefit.
A retirement plan needs to be established before the end of the year, although contributions can be made up until the due date of your return.
Taking a retirement plan distribution could increase a taxpayer's income above the new thresholds and result in higher taxes. It may be prudent to start withdrawing smaller amounts sooner if you anticipate a need for the funds, rather than waiting and taking a large amount later on in one year.
Owners of traditional IRAs who reach age 70 1/2 during 2013 have until April 1, 2014 to take their 2013 required minimum distribution (RMD). The 2014 RMD must be taken by December 31, 2014. Rather than taking two distributions in 2014, it may be best to take the first RMD in 2013.
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Long-Term Capital Gains
and Qualified Dividends
The maximum tax rate on long-term capital gains and qualified dividends has increased to 20% for taxpayers with taxable income above $450,000 on a joint return and $400,000 for single filers. However, since these individuals are also subject to the investment income surtax, the effective rate will be 23.8%. The tax rate for taxpayers below these income levels will stay at 15%. Joint filers with taxable income below $72,500 and single filers with taxable income below $36,250 for 2013 will be at the 0% tax rate for long-term capital gains and qualified dividends.
Taxpayers should consider the impact of recognizing long-term capital gains in light of these thresholds. It may be wise to recognize the gains over a number of years to stay below the thresholds, such as by selling small numbers of securities each year, balancing losses against gains, or, for other investments, selling on the installment method.
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Charitable Giving Can Save Taxes,
Smart Giving Can Save More
The itemized deduction phase-out has been reinstated beginning in 2013. Taxpayers with adjusted gross income above $300,000 on a joint return and $250,000 on a single return will be subject to the phase-out. The phase-out provisions do not apply to deductions for medical expenses, investment interest, gambling losses, and casualty and theft losses. The phase-out does, however, apply to charitable contributions. Taxpayers with fluctuating income should consider the impact of the phase-out and whether it is best to "bunch-up" contributions in years when the phase-out doesn't apply.
While being beneficial before, donating appreciated assets (such as securities or land) becomes an even smarter move under the new tax structure. Selling an asset and donating the cash proceeds could increase income into higher brackets and subject the gain to the net investment income surtax. When taxpayers donate appreciated assets, they don't recognize the appreciation as income, but can still claim the market value as a deduction, subject to certain limitations.
Taxpayers who are at least 70 1/2 can make a qualified transfer directly from their IRA of up to $100,000 to a charity and not need to recognize the distribution as income. Not only that, but this will reduce the amount of your required minimum distribution for the year. In some situations this could have the benefit of reducing income below the new thresholds since effectively it reduces "above-the-line" income. As this benefit expires after 2013 taxpayers should consider "front loading" planned future giving to take advantage of this before it is too late. Contact your IRA administrator early to allow ample time to make the transfer.
Part of smart giving is being sure that you keep the proper documentation to support your donations. This may require obtaining a qualified appraisal for large donations in some circumstances. The IRS has become more aggressive in auditing charitable contributions and disallowing otherwise valid deductions because proper supporting documents were not obtained. IRS Publication 526 has more information on the documents you need.
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Is a Roth Conversion Right For You?
While the normal "rule-of-thumb" is to defer income to postpone paying taxes until later, there are situations when it makes sense to accelerate income by converting a traditional IRA to a Roth IRA and paying the tax now. Taxpayers who find themselves in an unusually low income year may wish to accelerate income to take advantage of lower tax rates. This may be due to being between jobs or having a low investment income year. Some taxpayers prefer the advantages of a Roth IRA, such as not having a required minimum distribution and being able to pass the tax-free benefits on to their heirs, and are willing to pay the income taxes now.
Once in a Roth, income from the converted funds can accumulate without being subject to taxes in the future. If the converted funds are withdrawn from the Roth within 5 years, they will be subject to the 10% penalty, unless one of the exceptions applies.
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Tax Breaks For Education Costs
There is a deduction against income (above-the-line) for qualified higher education tuition and fees of up to $4,000. This deduction expires after 2013 and starts to phase-out for joint filers with adjusted gross income above $130,000 and single filers above $65,000.
The American Opportunity Education Tax Credit provides a credit of up to $2,500 for qualified tuition, fees, and course materials. This credit begins to phase-out when income is above $160,000 for joint filers and $80,000 for single filers.
The Lifetime Learning Credit equals 20% of the first $10,000 of qualified education tuition and fees. This credit begins to phase-out when adjusted gross income is above $107,000 on a joint return and $53,000 on a single return.
Taxpayers can also withdraw up to $10,000 from an IRA to pay for qualified education expenses and avoid the 10% early distribution penalty, although the amount will still be subject to income taxes. The education expenses must be paid in the same year that the IRA funds are withdrawn to qualify.
To benefit from these tax breaks in 2013 the expenses must be paid in 2013. To maximize the benefits, it may be wise to prepay spring 2014 expenses in 2013. Because of the phase-out limits, it may be beneficial for the parent to waive claiming a dependency deduction for the student and allowing the student to benefit from the education costs. IRS Publication 970 has more details on tax breaks for students and their families.
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State And Local Taxes
A temporary rule allowing taxpayers to deduct either state and local income taxes or sales taxes is set to expire after 2013. After this year, only state and local income taxes will be deductible. If you are planning to purchase a big-ticket item, such as a car, boat, or motor home, that is subject to sales tax, consider closing the deal before the end of the year to get the deduction.
State and local taxes are not deductible for the alternative minimum tax and are one of the deductions that is reduced under the itemized deduction phase-out, so the tax benefit for higher income taxpayers may be limited.
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Tax Breaks For Businesses
Businesses have a special tax election they can make to expense the cost of certain capital purchases, called Code Sec. 179 Expensing. For 2013, this election can be made for qualified acquisitions up to $500,000. Starting in 2014, this amount is reduced to $25,000. Businesses can also elect a special 50% bonus depreciation for qualified property, however this election expires for property placed in service after 2013.
Businesses that are considering buying large qualified assets should evaluate whether it is beneficial to buy these items and place them in service before the end of the year. Taxpayers who own "flow-through" entities such as S-Corporations, partnerships and sole proprietorships could benefit by reducing the income on their individual tax returns and possibly staying below some of the new thresholds discussed above.
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Higher Taxes For Estates And Trusts
Beginning in 2013, the new higher tax rates also apply to estates and trusts, but the threshold is significantly lower than for individuals. Not only does the 39.6% tax rate apply to estates and trusts with taxable income over $11,950, but the 3.8% investment income surtax also applies. As the effective tax rate quickly reaches 43.4%, it may be best to distribute income during the year to the beneficiary if possible. Trustees can elect to treat distributions made during the first 65 days of the year as if they were made in the prior year.
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A word of caution: this is a brief summary and does not include all of the details that may impact your individual situation. Please contact us if you would like more information.
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About Lewitz, Balosie, Wollack,
Rayner & Giroux, LLC
Our five partners have over 160 years of combined professional experience. We provide accounting, tax, and financial services to individuals, businesses, nonprofit organizations, estates, and trusts. Our services include tax return preparation, software consulting, and compilations, reviews, and audits of financial statements. We have been located in the shoreline community of Old Saybrook, Connecticut for over 50 years. Feel free to contact us if we can be of service. We can be reached at 860-388-4451.
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IRS Circular 230 Disclosure
To ensure compliance with requirements imposed by the Internal Revenue Service, we inform you that any tax advice contained in this communication, unless expressly stated otherwise, was not intended or written to be used, and cannot be used, for the purpose of (i) avoiding tax-related penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any tax-related matters addressed herein.
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