Tim’s Midyear Tax Planning Tips
While Tax Day 2014 may seem like the distant future in July, there are steps that you and your Daszkal Bolton Account Manager can take now to save money on your 2013 taxes. Timothy Devlin, CPA, Tax Partner, has some tax-saving tips that individuals and businesses should consider this summer to be on track with new tax code regulations and avoid missing out on exemptions, deductions and credits.
KEY POINT: Shelving your taxes until spring 2014 could cost you money. The tax law passed as part of the deal to avert the fiscal cliff imposes a new 39.6% marginal rate on taxable income over $400,000 ($450,000 for married couples). Taxpayers in this bracket will pay 23.8% on dividends and long-term capital gains — not the 15% rate that applies to most investors.
Other changes reach down the income chain. Taxpayers with adjusted gross income of $250,000 or more ($300,000 for married couples) will effectively pay higher marginal rates because Congress resurrected phase-out’s of itemized deductions and personal exemptions. And taxpayers with modified adjusted gross income of $200,000 or more ($250,000 for married couples) face a new 3.8% surtax on net investment income.
There are ways to mitigate these tax hikes, especially if you act now! Some are obvious like being bold when timing investment gains and losses and not overlooking estate planning, but read on for some additional ideas that could save you money.
Tip 1: File for Exemptions Correctly
Taxpayers should strive to take full advantage of every eligible exemption. For instance, a married couple filing jointly would have an exemption for each spouse as well as one for each dependent. Declaring personal exemptions can get complex due to the change in tax law. If a person is not subject to alternative minimum tax, the new law for 2013 phases out personal exemptions. Depending on a person’s income, for each $2,500 over a threshold–for joint filers that’s $300,000 and for single filers that’s $250,000–your personal exemptions are reduced by 2%.
W-2 employees should pay close attention to ensure they have the right exemptions in place. Having too much money withheld can be a misstep, but having too little withheld may cause a person to have to write a check to the IRS at the end of the year.
Double-check your withholding. Starting this year, taxpayers will owe an additional 0.9% Medicare tax on earned income of more than $200,000 for single filers or $250,000 for married couples who file jointly.
If you’re single and earn $225,000 this year, your employer will be required to withhold 1.45% on the first $200,000 and 2.35% on the next $25,000. But if you’re married and you and your spouse each earn $150,000, your employers won’t withhold the extra 0.9% payroll tax because your individual earnings are under the threshold, yet you’ll still owe the additional levy on $50,000 of your joint income and trigger an underpayment penalty.
You could also run into problems if you have investment income that’s subject to the 3.8% surtax. To avoid penalties, you may need to adjust your withholding. If you’re self-employed, you may need to adjust your quarterly estimated tax payments to cover the new tax.
Tip 2: Keep Track of Deductions
Deductions reduce taxable income and the value of those deductions are based on one’s marginal tax bracket, so it’s important to make sure they are being claimed on the right form and for the accurate amount.
Making contributions to a 401(k) or other retirement vehicle will reduce adjusted gross income, and help you avoid exceeding the threshold that will throw you into a higher tax bracket or subject your income to the healthcare bill surcharge. Keeping accurate records for deductions such as charitable donations or medical expenses is essential.
Deducting medical expenses will be more difficult this year. To qualify for a write-off, your unreimbursed medical expenses must exceed 10% of your adjusted gross income (AGI), up from 7.5% in the past. For taxpayers 65 and older, the threshold remains at 7.5% through 2016. And remember, you can deduct only expenses that exceed the 7.5% or 10% threshold. Make sure you keep track of all qualifying expenses. You can deduct a portion of premiums for long-term-care insurance and travel costs for medical services!
To determine the best filing status, Daszkal Bolton recommends taxpayers add up all itemized deductions and compare it to the standard deduction to see which number is larger. The standard deduction is $12,200 for married couples and $6,100 for individuals. Generally taxpayers who own a house are going to be better off with the itemized deductions because of the mortgage interest deduction and real estate tax deduction.
Tip 3: Take Advantage of All Applicable Credits
Tax credits are extremely valuable to reduce tax liability dollar for dollar and with several common credits, there are many opportunities to reduce tax burden. The child tax credit may apply if you have a qualifying child under age 17, which may help reduce your federal income tax by up to $1,000 for each qualifying child you claim on your return. In 2013, the American Opportunity tax credit gives a $2,500 credit for undergraduate education for an eligible student and is calculated per student, not per tax return!
Tip 4: Make Your Investment Portfolio More Tax-Efficient
Summer is a good time to review your portfolio for potential losses you could use to offset capital gains. If you were planning to sell appreciated investments this year, dumping some of your losers will help you lower or eliminate taxes on the gains.
Higher tax rates make it even more important to pay attention to the types of investments in taxable accounts and the types in tax-deferred accounts, such as your 401(k) plan. Keep investments that generate a lot of taxes, such as taxable bonds, real estate investment trusts and high-turnover mutual funds, in tax-deferred accounts. Consider keeping index funds and other tax-efficient investments in taxable accounts.
If you need income from your taxable account, consider municipal bonds. Interest on muni bonds is exempt from federal taxes and, in most cases, from income taxes of the state in which the bonds were issued. In addition, munis are exempt from the 3.8% investment surtax, which makes them even more attractive. Keep in mind, though, that interest from some types of muni bonds is subject to the alternative minimum tax (AMT).
Tip 5:Take Advantage of Tax-Deferred Accounts
The new tax rates and phase-out’s are tied either to adjusted gross income or to taxable income. (AGI is the amount before subtracting the value of exemptions and deductions; taxable income is the amount that’s actually taxed.) So it’s more important than ever to look for ways to hold down both figures.
Contributing to a health savings account will reduce both AGI and taxable income; the money grows tax-deferred, and it can be withdrawn tax-free for qualified medical expenses. To be eligible for an HSA, you must be covered by a high-deductible health insurance policy with a deductible of at least $1,250 for individual coverage or $2,500 for a family.
You may contribute $3,250 to an HSA this year for individual coverage or $6,450 for a family; if you’re 55 or older, you can kick in an additional $1,000. That’s considerably more than the $2,500 maximum you can put in a medical flexible spending account, another tax-favored way to pay health care expenses. And unlike flex plans, which come with a use-it-or-lose-it provison, HSAs let you roll over unused funds for future years.
Another effective strategy is to max out your contributions to tax-deferred retirement plans. In 2013, employees younger than age 50 may contribute up to $17,500 to a 401(k) plan; workers 50 and older may contribute an additional $5,500.
Tip 6: Give Appreciated Assets to Your Adult Children or to Charity
If your children are struggling to pay off student loans, give them appreciated stocks or mutual funds instead of cash. When they sell, they may pay lower taxes on the gain than you would owe. The long-term capital gains rate for taxpayers in the 10% or 15% tax bracket (with taxable income up to $36,250 for singles or $72,500 for married couples) is 0%.
Shifting income and future appreciation from investments to family members by means of gifting can be a great tax-planning opportunity. For gift tax purposes, the annual exclusion in 2013 has been increased from $13,000 to $14,000. You can also give securities valued at $14,000 per person in 2013 without filing a gift tax return; if you are married, you and your spouse can give away $28,000.
Each year, these amount may be given to each of any number of recipients with no tax consequences. In addition, the estate, gift and generation skipping transfer tax has been permanently set at a top rate of 40 percent with a $5.25 million exemption for total lifetime gifts or for estates of decedents dying in 2013.
To qualify for the special rate for long-term gains, the securities must have been held for more than 12 months. For gift securities, however, the holding period includes the time that you owned the assets, so your children don’t have to wait a year to sell their stocks or funds. But be careful if your dependent children are younger than age 19, or full-time students younger than age 24, as they will be subject to the “kiddie tax,” meaning investment income exceeding $2,000 will be taxed at your tax rate.
Now that the top long-term capital gains rate is 23.8%, donating appreciated stocks or mutual funds to charity is a smart strategy for high-income taxpayers. By giving appreciated assets, you avoid taxes on the gains and still get to deduct the full value of the securities. The charity doesn’t have to pay taxes on the profits when it sells the securities.
Tip 7: Convert Traditional IRA into Roth IRA
In a typical qualified retirement plan, a tax deduction is allowed when contributions are made to the plan, and future distributions are taxable. For a Roth IRA, no deduction is allowed for contributions, but distributions of original contributions and income are tax-free. Last year, a qualified retirement plan could allow participants to contribute to a Roth account. Plans also could allow participants to convert pretax accounts to Roth accounts, but only for amounts participants had a right to withdraw, usually because they were at least 59½. Starting in 2013, any amount in a non-Roth account can be rolled over to a Roth account in the same employer plan, whether or not the participant is 59½. The conversion is subject to regular income tax but not an early distribution penalty
Tip 8: Make Charitable Gifts from Your IRA.
Congress extended through 2013 a provision that allows taxpayers age 70½ and older to transfer up to $100,000 from traditional IRAs directly to charity. Such contributions can count toward required minimum distributions for the year.
Your contribution won’t be deductible, but it will lower your AGI. That could qualify you for tax breaks and reduce or even eliminate taxes on Social Security benefits. It could also help you avoid new tax hits, such as the phase-out of other deductions.
Additional Tax Tips for Business Income
Several business provisions in the tax law are available only through 2013, so it might be smart to plan using them by the end of the year. They include:
• Section 179 expensing of up to $500,000 of new or used equipment when total fixed asset additions do not exceed $2 million for the year;
• Lesser expensing is available when fixed-asset additions exceed $2 million but are less than $2.5 million;
• No deduction is available when fixed asset additions equal or exceed $2.5 million;
• A 50% bonus depreciation on new equipment;
• A 15-year rather than a 39-year cost recovery on qualified leasehold improvements and restaurant and retail assets;
• Some Research and Development credits; and
• The Work Opportunity Tax Credit.
Midyear and year-end planning may be especially important for Section 179 expensing, which is scheduled to drop from $500,000 in 2013 to $25,000 in 2014, and for bonus depreciation, which is scheduled to expire totally after year end.
And Don’t Forget to Consider Accelerating Income to 2013!
It is often recommended that businesses defer taxable income to the following year, which can be done by sending out invoices later in the year or postponing some deductible expenses. But this approach is only useful if you expect to pay a lower tax rate next year. If businesses and individuals find themselves paying higher rates in 2014, then it may be more beneficial to accelerate some taxable income into this year so that it can be taxed at the lower rate.
CONTACT US: The American Taxpayer Relief Act signed on January 2, 2013, created significant tax increases for high-earners. The thresholds identifying “high-earners” differ from one tax provision to the next, leaving many who don’t consider themselves wealthy exposed to these tax increases. Make it a midyear priority to size up your tax situation while you still have enough time to adjust strategies for 2013. If you wait, you limit your options and very likely will pay higher taxes than necessary. Contact Tim Devlin at 561-367-1040, or [email protected] for more information on the midyear tax planning opportunities that are best suited to your individual circumstances. He and his tax team can make sure the planning strategies you pursue don’t leave you with tax surprises down the road.
