As 2013 comes to a close, individual tax planning is more important than ever due to increasing tax rates, the new Net Investment Income tax, the additional Medicare tax, and a few other changes that came about with the American Taxpayer Relief Act that was passed in January 2013. For higher income taxpayers, such as professional service providers, 2013 will represent a year of increased tax burden compared to previous years. In addition to the graduated rates of 10, 15, 25, 28, 33, and 35 percent, a new 39.6 percent rate will kick in as follows:
|Married filing jointly||$450,000||$457,600|
The Net Investment Income tax (NIIT), effective on January 1, 2013, imposes a 3.8 percent Medicare surtax on the lesser of a higher-income individual’s net investment income or adjusted gross income that exceeds $200,000 for single filers or $250,000 for married filing joint filers. This surtax applies to traditional investment income as well as passive income, including capital gains from selling investments. Therefore, it is imperative that higher income taxpayers know if their income is active or passive. Taxpayers should also consider keeping their income below the $200,000/250,000 NIIT threshold levels by deferring income to 2014 if possible.
Also new for 2013 is the additional 0.9 percent Medicare tax. This tax is imposed when an individual’s wages exceed $200,000 for single filers and $250,000 for married filing joint filers. The employer should automatically withhold this extra tax when income surpasses the above thresholds. The tax will be calculated as a separate line item on your income tax return. Although there is not a lot of planning to do to avoid this additional tax, one strategy would be to defer a year-end bonus into 2014, if you have that option, which would defer paying this tax for one year.
Shifting income or deductible expenses to minimize the increasing tax rates may be desirable for 2013. This can be accomplished by accelerating deductibles into 2013 and deferring income into 2014. If 2013 itemized deductions are likely to be just under, or just over, the standard deduction amount, you might want to consider the strategy of bunching together expenditures for itemized deductions every other year, while claiming the standard deduction in the intervening years. The 2013 standard deduction is $12,200 for married joint filers, $6,100 for single and married filing separate filers, and $8,950 for heads of households. For example, you could move charitable donations that would normally be made in early 2014 to the end of 2013. You can also pay your real estate taxes and state tax estimates in 2013 instead of January 2014. However, watch out for the Alternative Minimum Tax (AMT), as state and real estate taxes are not deductible for AMT purposes. Similarly, if you expect to pay a higher tax rate next year, you may want to claim the standard deduction this year and bunch itemized deductions into 2014 when they can offset the higher taxed income, and are thereby utilized at a higher marginal tax rate.
Starting in 2013, the top rate for capital gains increases from 15% to 20%. This top rate applies to individuals in the higher ordinary income tax bracket of 39.6%. If you have unused capital losses from tax year 2012, these losses will offset any gains if you sell appreciated stock in 2013. If you have appreciated stock or mutual fund shares that have been held for longer than one year and you plan to make significant charitable contributions before year-end, consider keeping your cash and donating the stock instead. You will avoid the higher tax rate on capital gains and still be able to deduct the donated property’s basis.
If you happen to be selling investment property in 2013, contemplate installment sale reporting due to an increase in capital gain rates for 2013. An installment sale allows you to defer gains by spreading them over several years as you receive the proceeds. Although depreciation recapture will still occur in the year of sale, depending on the sale price, installment reporting could save you significant tax dollars.
If you are self-employed and have children, consider employing your child to work in the business. This would shift income from you to your child, who will most likely be in a lower tax bracket and may avoid tax altogether due to their standard deduction. There can also be payroll tax savings since wages paid by sole proprietors to their children 17 and younger are exempt from both social security and unemployment taxes. Another benefit to employing your child is that with earned income, they can then contribute to an IRA. You are not only saving taxes, but your child is getting a great start on their retirement savings.
If you expect to owe income taxes for 2013, consider bumping up your federal withholding from wages now through the end of the year. When filing your 2013 tax return, even if you owe, your underpayment penalty will be minimized or eliminated all together with federal withholding, even if the majority was withheld in December. Federal withholding is considered taken out evenly throughout the year, as opposed to quarterly with estimated tax payments, which are considered paid when submitted to the Internal Revenue Service.
Expiring Tax Breaks
Certain tax breaks that have been around for many years are set to expire at the end of 2013, but it is not too late to consider the following ideas for tax year 2013:
Remodeling your home for energy efficiency improvements. A $500 tax credit is still available for making energy efficient improvements to your home, like installing new doors or windows that meet energy efficiency requirements or adding installation to your home. Note that these improvements must be made to your principal residence. Additionally, the $500 credit applies to cumulative claims for the credit dating back to 2006. Thus, if you have taken an energy credit in the past, you might be limited, so consult your tax advisor if you have any questions.
Charitable contributions from your IRA. If you are 70 and a half or older, you can transfer up to $100,000 out of your individual retirement account directly to charity. For some of our taxpayers, this is more tax efficient than taking the required minimum distribution and paying income tax on that distribution. Note that the fund must be transferred directly from the IRA to the charity.
Teacher’s classroom expense deductions. This popular deduction, set to expire this year, allows teachers an above-the-line tax deduction of up to $250 for unreimbursed school expenses. It might be a good idea to stock up on classroom supplies for the whole school year before year-end.
Looking ahead to 2014
If you are an employee, consider making the maximum 401(k) contribution, which would be $17,500 for tax year 2014 and an additional $5,500 if you are age 50. This is pre-tax money, assuming not a Roth 401(k), and a great way to save on both federal and state taxes. If your employer has a matching program, consider at least contributing the minimum amount to get the matching benefit.
And don’t forget to consider your company’s health care flexible spending account. For 2014, you can set aside $2,500, pre-tax, to spend on dependent care assistance and out of pocket medical expenses. The Internal Revenue Service recently announced updated guidance permitting carryover of up to $500 of unused health flexible spending account balances at the end of the plan year. The IRS has modified the rule requiring unused amounts to be forfeited, commonly referred to as the “use-or-lose” rule, by allowing some carryover. For a plan year beginning in 2013, an amendment including the carryover provision may be adopted on or before the last day of the plan year that begins in 2014.
We hope that you can use some of the planning ideas highlighted above. As always, if you have any questions, do not hesitate to contact your Clark Schaefer Hackett professional service provider.