As we approach year-end, tax planning considerations should be starting to take shape. New tax legislation has brought greater certainty to year-end planning, but has also created new challenges. The number of changes made to the Tax Code and the opportunities these changes bring may seem overwhelming. However, early planning will help you to maximize your potential tax savings and minimize your tax liability. Here is some key high level year-end tax planning strategies.
Changes for 2013 and beyond
In 2012, year-end planning was complicated by the great uncertainty over the fate of the Bush-era tax cuts. For more than 10 years, individuals had enjoyed lower income tax rates, but these rates were scheduled to expire after 2012. Moreover, many tax credits and deductions that had been made more generous were also set to expire after 2012. In January 2013, Congress passed the American Taxpayer Relief Act of 2012 (ATRA), which made permanent many, but not all, of the Bush-era tax cuts and also some tax benefits enacted during the Obama administration. Congress also permanently “patched” the alternative minimum tax (AMT) to prevent its encroachment on middle income taxpayers. The result is much greater certainty in year-end tax planning for 2013 because we know what the individual tax rates are in 2014, how many tax credits and deductions are structured, and much more.
Of course, there are always complexities in the Tax Code. In 2013, two new Medicare taxes kicked-in (a 3.8-percent net investment income (NII) surtax and a 0.9-percent Additional Medicare Tax). In addition, the U.S. Supreme Court ruled that the federal government’s denial of recognition of same-sex marriage was unconstitutional, opening the door to allowing married same-sex couples to file joint federal tax returns and take advantage of other tax benefits available to married couples. Beginning in 2014, some of the most far reaching provisions of the Affordable Care Act will become effective: the individual mandate, the start of Marketplaces to obtain insurance and a special tax credit to help offset the cost of insurance.
Planning for expiring tax incentives
First, do not lose the benefit of some generous, but temporary tax incentives that are available in 2013 but may not be in 2014. Are you planning to purchase a big-ticket item such as a new car or boat? The state and local sales tax deduction (available in lieu of the deduction for state and local income taxes) is scheduled to expire after 2013, and you may want to accelerate that purchase to take advantage of the tax break. A valuable tax credit for making certain energy efficient home improvements, including windows and heating and cooling systems, and a deduction for teachers’ classroom expenses are also scheduled to expire after 2013. These are just some of many incentives that will sunset after 2013 unless extended by Congress.
Planning for new taxes and rates
Some individuals may be surprised that they owe additional taxes in 2013, even with the extension of the Bush-era tax cuts. Three new taxes are in effect for 2013: the NII surtax, the Additional Medicare Tax and a revived 39.6 percent tax bracket for higher income individuals. The 3.8-percent NII surtax very broadly applies to individuals, estates and trusts that have certain investment income above set threshold amounts. These amounts include a $250,000 threshold for married couples filing jointly; $200,000 for single filers. One strategy to consider is to keep, if possible, income below the threshold levels for the NII surtax by spreading income out over a number of years or finding offsetting above-the-line deductions.
The Additional Medicare Tax applies to wages and self-employment income above threshold amounts including $250,000 for married couples filing joint returns and $200,000 for single individuals. If you have not already reviewed your income tax withholding for 2013, now is the time to do it. One way to reduce the sting of any Additional Medicare Tax liability is to withhold an additional amount of income tax.
As discussed, ATRA extended the Bush-era tax rates for middle and lower income individuals. ATRA also revived the 39.6 percent top tax rate. For 2013, the starting points for the 39.6 percent bracket, for 2013 are $450,000 for married couples filing jointly and surviving spouses, $425,000 for heads of households, $400,000 for single filers, and $225,000 for married couples filing separately. ATRA also revived the personal exemption phaseout and the limitation on itemized deductions for higher income individuals.
Starting in 2013, ATRA also sets the top rate for capital gains and dividends to 20 percent for those taxpayers at the highest marginal tax bracket.
Planning for health care changes
Before year-end, individuals need to review how the Affordable Care Act will impact them. The Affordable Care Act brings a sea-change to our traditional image of health insurance. The law requires individuals, unless exempt, to either carry minimum essential health care coverage or make a shared responsibility payment (also known as a penalty). Most employer-sponsored health insurance is deemed to be minimum essential coverage, as is coverage provided by Medicare, Medicaid, and other government programs. Self-employed individuals and small business owners should revisit their health insurance coverage, if they have coverage, before year-end and weigh the benefits and costs of obtaining coverage in a public Marketplace (or a private insurance exchange) for themselves and their employees. Small businesses may be eligible for a tax credit to help pay for health insurance. Individuals may qualify for a premium assistance tax credit, which is refundable and payable in advance, to offset the cost of coverage.
Individuals with health flexible spending accounts (FSAs) and similar arrangements should take a look at their spending habits for 2013 and predict how they will use these tax-favored funds in the future. In 2013, the maximum salary-reduction contribution to a health FSA is $2,500. Remember that health FSAs have strict “use it or lose it” rules, and the cost of over-the-counter drugs cannot be reimbursed with health FSA dollars unless you obtain a prescription (there are some exceptions).
Individuals who itemize their deductions also need to keep in mind the 10 percent floor for qualified medical expenses. This change took effect at the beginning of 2013. It means that you can only claim deductions for medical expenses when they reach 10 percent of adjusted gross income (for regular tax purposes and for alternative minimum tax purposes). There is a temporary exception for individuals over age 65 for regular tax purposes.
Planning for gifts
Gift-giving is often overlooked as a year-end planning strategy. For 2013, individuals can make tax-free gifts (no tax consequences for the giver or the recipient) of up to $14,000 to any individual. Married couples may “split” their gifts to each recipient, which effectively raises the tax-free gift to $28,000. Gifts between spouses are always tax-free unless one spouse is not a U.S. citizen. In that case, the first $143,000 in gifts made in 2013 is tax-free.
There are special rules for gifts made for medical care and education that can be a valuable component of a year-end tax strategy, especially for individuals who want to help a family member of friend. Monetary gifts given directly to a college to pay tuition or to a medical service provider are tax-free to the person making the gift and the person benefitting from education or medical care.
Gifts to charity also are frequently made at year-end. Through the end of 2013, taxpayers age 70 ½ and older can make a tax-free distribution from individual retirement accounts to a charity. The maximum distribution is $100,000. Individuals taking this option cannot claim a deduction for the charitable gift.
Planning for retirement savings
Year-end is a good time to review if your retirement savings plans and tax strategies complement each other. For 2013, the maximum amount of contributions that can be made to an IRA is $5,500, with a $1,000 catch-up amount allowed for individuals over age 50. Keep in mind that the maximum amount that can be contributed to a Roth IRA begins to decrease once a taxpayer’s adjusted gross income crosses a certain threshold. Please note that 2013 contributions, for tax purposes, may be made until April 15, 2014.
We have reviewed only some of the many year-end tax planning strategies that could help you minimize your 2013 tax bill and maximize savings. Please contact your Coldstream Relationship Manager with how these strategies may impact you.
Year End Tax Planning Checklist for Individuals
Not all actions will apply in your particular situation but can help narrow the decisions that are appropriate for you.
□ A new 3.8% surtax may apply to investment income if your adjusted gross income exceeds $250,000 (married filing jointly) or $200,000 (single filers). One way to mitigate the 3.8% surtax is to get your income under the threshold levels by spreading the income out over a number of years.
□ Also new is a .9% Medicare tax on wages and self-employment income above $250,000 (married filing jointly) or $200,000 (single filers). Your income tax withholding should be reviewed to ensure sufficient withholdings are made.
□ If you elect to claim a state and local general sales deduction instead of a state and local income tax deduction, you may want to accelerate the purchase of big-ticket items such as a new car or boat as it expires at the end of this year.
□ A valuable tax credit for making certain energy efficient home improvements, including window and heating and cooling systems also expire at the end of this year.
□ Planning for health care changes. Self-employed individuals and small business owners should revisit their health insurance coverage, if they have coverage, before year-end and weigh the benefits and costs of obtaining coverage in a public Marketplace for themselves and their employees.
□ Individuals with health flexible spending accounts (FSAs) should review their balances and decide how they will use these tax-favored funds. In 2013, the maximum salary-reduction contribution to a health FSA is $2,500 and Health FSAs have a strict “use it or lose it” rules.
□ Starting in 2013, individuals who itemize their deductions need to keep in mind the 10 percent floor for qualified medical expenses. It means that you can only claim deductions for medical expenses when they reach 10 percent of adjusted gross income. There is a temporary exception for individuals over age 65.
□ For 2013, individuals can make tax-free gifts of up to $14,000 to any individuals. Married couples may “split” their gifts to each recipient, which effectively raises the tax-free gift to $28,000.