As we near the end of 2013, high-income taxpayers should note several changes to the tax code that will affect this year’s returns. A variety of strategies can be utilized to effectively plan before the end of the year.
Specifically, higher income individuals should consider the effects of the following new laws.
Medicare contribution taxes // A 3.8 percent Medicare contribution tax will be assessed on net investment income for taxpayers whose modified adjusted gross income is over the specified threshold of $250,000 on a joint return, or $200,000 on a single return. Net investment income is unearned income (income not earned from a trade or business and income subject to the passive activity rules) such as interest, dividends, capital gains, annuities, royalties, rents, and income from businesses in which the taxpayer is not an active participant. Note that interest income from municipal bonds is not subject to the additional tax.
Medicare tax // There will be an additional Medicare tax of 0.9 percent on earned income for individuals whose wages or net self-employment income is above $200,000 for a single return, or $250,000 for a joint return.
Increase in tax rates // Taxpayers with adjusted gross income of $450,000 on a joint return, or $400,000 on a single return, will be subject to a 39.6 percent tax rate.
Increase in capital gains and qualified dividend rates // For the same high-income earners, a 20 percent tax rate (instead of 15 percent) will be required on long-term capital gains and qualified dividends. The 3.8 percent Medicare tax on net investment income may apply as well based on the $450,000 joint/$400,000 single thresholds.
Adjusted Gross Income (AGI) based phaseouts // Itemized deductions and personal exemptions are being phased out when AGI is above $300,000 on a joint return, and $250,000 on a single return.
Strategies for Dealing with New Tax Laws
Manage deductions and income // High-income earners who will be in the highest income tax bracket in 2014 but not 2013 should consider deferring deductions and accelerating income for 2013. Likewise, they could defer income and accelerate deductions for 2013 if they anticipate 2014 being lower than 2013.
For example, a cash method taxpayer can accelerate income by speeding up the billing and collection process. Another example is a taxpayer who sells capital gain property on an installment basis in 2013 and realizes a long-term capital gain could accelerate income by electing out of the installment method.
Consider also the level of income for each year the potential 3.8 percent Medicare tax may apply.
Before a deferred or accelerated income or deduction strategy is implemented, consider the potential alternative minimum tax effect.
If the situation is right, it could prove to be a smart tax move. Talk to an adviser about potential obstacles to implementing this strategy.
Make retirement account moves now // Consider converting your traditional IRAs to Roth IRAs or re-characterizing an earlier conversion. Distributions from Roth IRAs are tax-free and may keep a taxpayer from being taxed in a higher tax bracket that would otherwise apply if taxable distributions are taken. Taxable distributions would be included in income to determine if the threshold is exceeded that triggers the 3.8 percent Medicare surcharge.
Allow deductible expenditures for future needs // Plan for the future and make your deductible expenditures before the end of the year. For example, take advantage of the energy efficiency property tax incentives. If you are self-employed, make your business purchases of machinery and equipment now to ensure they will be deductible on your 2013 return. For tax years beginning after 2013, the maximum expensing limit is scheduled to drop to $25,000, down from the $500,000 limit for 2013.
Contribute to charities // Individual taxpayers who are at least 70 years old may contribute to charities directly from their IRAs without their contribution amounts appearing in their gross income. By making this move, some may be able to reduce their tax liability more than they would if they were to receive the distribution from their IRA and then contribute the amount to charity. This could potentially eliminate issues on AGI phaseouts.
Visit with Your Trusted Tax Adviser
Lack of year-end tax planning might prove harmful. Meet with your trusted tax adviser to determine which year-end strategies will benefit you. If you don’t have an adviser who will give you a customized plan, find a CPA who will take your particular situation and planning goals into account. Minimizing taxes can be done despite the new tax rules for high-income earners.