As we approach year-end, it’s again time to focus on
last-minute moves you can make to save taxes—both on your 2013 return and in
future years.
For most individuals, the ordinary federal income tax rates
for 2013 will be the same as last year: 10%, 15%, 25%, 28%, 33%, and 35%.
However, the fiscal cliff legislation, passed early this year, increased the
maximum rate for higher-income individuals to 39.6% (up from 35%). This change
affects taxpayers with taxable income above $400,000 for singles, $450,000 for
married joint-filing couples, and $425,000 for heads of households. In addition,
the new 0.9% Medicare tax and 3.8% Net Investment Income Tax (NIIT) potentially
kick in when modified adjusted gross income (or earned income in the case of the
Medicare tax) goes over $200,000 for unmarried, $250,000 for married
joint-filing couples, which can result in a higher-than-advertised federal tax
rate for 2013.
Despite these tax increases, the current federal income tax
environment remains relatively favorable by historical standards. This letter
presents a few tax-saving ideas to get you started. As always, you can call on
us to help you sort through the options and implement strategies that make sense
for you.
Ideas for Your Business
Take Advantage of Tax Breaks for Purchasing
Equipment, Software, and Certain Real Property. If you have plans to
buy a business computer, office furniture, equipment, vehicle, or other tangible
business property or to make certain improvements to real property, you might
consider doing so before year-end to capitalize on the following generous, but
temporary tax breaks:
·
Bigger Section 179 Deduction. Your business may be able to take
advantage of the temporarily increased Section 179 deduction. Under the Section
179 deduction privilege, an eligible business can often claim first-year
depreciation write-offs for the entire cost of new and used equipment and
software additions. (However, limits apply to the amount that can be deducted
for most vehicles.) For tax years beginning in 2013, the maximum Section 179
deduction is $500,000. For tax years beginning in 2014, however, the maximum
deduction is scheduled to drop to $25,000.
·
Section 179 Deduction for Real Estate. Real property costs are
generally ineligible for the Section 179 deduction privilege. However, an
exception applies to tax years beginning in 2013. Under the exception, your
business can immediately deduct up to $250,000 of qualified costs for restaurant
buildings and improvements to interiors of retail and leased nonresidential
buildings. The $250,000 Section 179 allowance for these real estate expenditures
is part of the overall $500,000 allowance. This temporary real estate break will
not be available for tax years beginning after 2013 unless Congress extends
it.
Note: Watch out if your business is already expected
to have a tax loss for the year (or be close) before considering any Section 179
deduction, as you cannot claim a Section 179 write-off that would create or
increase an overall business tax loss. Please contact us if you think this might
be an issue for your operation.
·
50% First-year Bonus Depreciation. Above and beyond the bumped-up
Section 179 deduction, your business can also claim first-year bonus
depreciation equal to 50% of the cost of most new (not used) equipment and
software placed in service by December 31 of this year. For a new passenger auto
or light truck that’s used for business and is subject to the luxury auto
depreciation limitations, the 50% bonus depreciation break increases the maximum
first-year depreciation deduction by $8,000 for vehicles placed in service this
year. The 50% bonus depreciation break will expire at year-end unless Congress
extends it.
Note: First-year bonus depreciation deductions can
create or increase a Net Operating Loss (NOL) for your business’s 2013 tax year.
You can then carry back a 2013 NOL to 2011 and 2012 and collect a refund of
taxes paid in those years. Please contact us for details on the interaction
between asset additions and NOLs.
Evaluate Inventory for Damaged or Obsolete Items.
Inventory is normally valued for tax purposes at cost or the lower of cost or
market value. Regardless of which of these methods is used, the end-of-the-year
inventory should be reviewed to detect obsolete or damaged items. The carrying
cost of any such items may be written down to their probable selling price (net
of selling expenses). [This rule does not apply to businesses that use the Last
in, First out (LIFO) method because LIFO does not distinguish between goods that
have been written down and those that have not].
To claim a deduction for a write-down of obsolete inventory,
you are not required to scrap the item. However, in a period ending not later
than 30 days after the inventory date, the item must be actually offered for
sale at the price to which the inventory is reduced.
Employ Your Child. If you are self-employed, don’t
miss one last opportunity to employ your child before the end of the year. Doing
so has tax benefits in that it shifts income (which is not subject to the Kiddie
tax) from you to your child, who normally is in a lower tax bracket or may avoid
tax entirely due to the standard deduction. There can also be payroll tax
savings since wages paid by sole proprietors to their children age 17 and
younger are exempt from both social security and unemployment taxes. Employing
your children has the added benefit of providing them with earned income, which
enables them to contribute to an IRA. Children with IRAs, particularly Roth
IRAs, have a great start on retirement savings since the compounded growth of
the funds can be significant.
Remember a couple of things when employing your child. First,
the wages paid must be reasonable given the child’s age and work skills. Second,
if the child is in college, or is entering soon, having too much earned income
can have a detrimental impact on the student’s need-based financial aid
eligibility.
Ideas for Maximizing Nonbusiness
Deductions
One way to reduce your 2013 tax liability is to look
for additional deductions. Here’s a list of suggestions to get you started:
Make Charitable Gifts of Appreciated Stock. If you
have appreciated stock that you’ve held more than a year and you plan to make
significant charitable contributions before year-end, keep your cash and donate
the stock (or mutual fund shares) instead. You’ll avoid paying tax on the
appreciation, but will still be able to deduct the donated property’s full
value. If you want to maintain a position in the donated securities, you can
immediately buy back a like number of shares. (This idea works especially well
with no load mutual funds because there are no transaction fees involved.)
However, if the stock is now worth less than when you
acquired it, sell the stock, take the loss, and then give the cash to the
charity. If you give the stock to the charity, your charitable deduction will
equal the stock’s current depressed value and no capital loss will be available.
Also, if you sell the stock at a loss, you can’t immediately buy it back as this
will trigger the wash sale rules. This means your loss won’t be deductible, but
instead will be added to the basis in the new shares.
Don’t Lose a Charitable Deduction for Lack of
Paperwork. Charitable contributions are only deductible if you have proper
documentation. For cash contributions of less than $250, this means you must
have either a bank record that supports the donation (such as a cancelled check
or credit card receipt) or a written statement from the charity that meets
tax-law requirements. For cash donations of $250 or more, a bank record is not
enough. You must obtain, by the time your tax return is filed, a
charity-provided statement that shows the amount of the donation and lists any
significant goods or services received in return for the donation (other than
intangible religious benefits) or specifically states that you received no goods
or services from the charity.
Maximize the Benefit of the Standard Deduction. For
2013, the standard deduction is $12,200 for married taxpayers filing joint
returns. For single taxpayers, the amount is $6,100. Currently, it looks like
these amounts will be about the same for 2014. If your total itemized deductions
are normally close to these amounts, you may be able to leverage the benefit
of your deductions by bunching deductions in every other year. This allows you
to time your itemized deductions so that they are high in one year and low in
the next. You claim actual expenses in the year they are bunched and take the
standard deduction in the intervening years.
For instance, you might consider moving charitable donations
you normally would make in early 2014 to the end of 2013. If you’re temporarily
short on cash, charge the contribution to a credit card—it is deductible in the
year charged, not when payment is made on the card. You can also accelerate
payments of your real estate taxes or state income taxes otherwise due in early
2014. But, watch out for the AMT, as these taxes are not deductible for AMT
purposes.
Manage Your Adjusted Gross Income (AGI). Many tax
breaks are only available to taxpayers with AGI below certain levels. Some
common AGI-based tax breaks include the child tax credit (phase-out begins at
$110,000 for married couples and $75,000 for heads-of-households), the $25,000
rental real estate passive loss allowance (phase-out range of $100,000–$150,000
for most taxpayers), and the exclusion of social security benefits ($32,000
threshold for married filers; $25,000 for other filers). In addition, for 2013
taxpayers with AGI over $300,000 for married filers, $250,000 for singles, and
$275,000 for heads-of-households begin losing part of their personal exemptions
and itemized deductions. Accordingly, strategies that lower your income or
increase certain deductions might not only reduce your taxable income, but also
help increase some of your other tax deductions and credits.
Making the Most of Year-end Securities
Transactions
For most individuals, the 2013 federal tax rates on long-term
capital gains from sales of investments held over a year are the same as last
year: either 0% or 15%. However, the maximum rate for higher-income individuals
is now 20% (up from 15% last year). This change affects taxpayers with taxable
income above $400,000 for singles, $450,000 for married joint-filing couples,
$425,000 for heads-of-households, and $225,000 for married individuals who file
separate returns. Higher-income individuals can also get hit by the new 3.8%
NIIT on net investment income, which can result in a maximum 23.8% federal
income tax rate on 2013 long-term gains.
As you evaluate investments held in your taxable brokerage
firm accounts, consider the tax impact of selling appreciated securities
(currently worth more than you paid for them). For most taxpayers, the federal
tax rate on long-term capital gains is still much lower than the rate on
short-term gains. Therefore, it often makes sense to hold appreciated securities
for at least a year and a day before selling to qualify for the lower long-term
gain tax rate.
Biting the bullet and selling some loser securities
(currently worth less than you paid for them) before year-end can also be a
tax-smart idea. The resulting capital losses will offset capital gains from
other sales this year, including high-taxed short-term gains from securities
owned for one year or less. For 2013, the maximum rate on short-term gains is
39.6%, and the 3.8% NIIT may apply too, which can result in an effective rate of
up to 43.4%. However, you don’t need to worry about paying a high rate on
short-term gains that can be sheltered with capital losses (you will pay 0% on
gains that can be sheltered).
If capital losses for this year exceed capital gains, you
will have a net capital loss for 2013. You can use that net capital loss to
shelter up to $3,000 of this year’s high-taxed ordinary income ($1,500 if you’re
married and file separately). Any excess net capital loss is carried forward to
next year.
Selling enough loser securities to create a bigger net
capital loss that exceeds what you can use this year might also make sense. You
can carry forward the excess capital loss to 2014 and beyond and use it to
shelter both short-term gains and long-term gains recognized in those
years.
Identify the Securities You Sell. When selling stock
or mutual fund shares, the general rule is that the shares you acquired first
are the ones you sell first. However, if you choose, you can specifically
identify the shares you’re selling when you sell less than your entire holding
of a stock or mutual fund. By notifying your broker of the shares you want sold at the time of the sale, your gain or loss
from the sale is based on the identified shares. This sales strategy gives you
better control over the amount of your gain or loss and whether it’s long-term
or short-term.
Secure a Deduction for Nearly Worthless Securities. If
you own any securities that are all but worthless with little hope of recovery,
you might consider selling them before the end of the year so you can capitalize
on the loss this year. You can deduct a loss on worthless securities only if you
can prove the investment is completely worthless. Thus, a deduction is not
available, as long as you own the security and it has any value at all. Total
worthlessness can be very difficult to establish with any certainty. To avoid
the issue, it may be easier just to sell the security if it has any marketable
value. As long as the sale is not to a family member, this allows you to claim a
loss for the difference between your tax basis and the proceeds (subject to the
normal rules for capital losses and the wash sale rules restricting the
recognition of loss if the security is repurchased within 30 days before or
after the sale).
Ideas for Seniors Age
701/2 Plus
Make Charitable Donations from Your IRA. IRA
owners and beneficiaries who have reached age 701/2 are permitted to make
cash donations totaling up to $100,000 to IRS-approved public charities directly
out of their IRAs. These so-called Qualified Charitable Distributions, or
QCDs, are federal-income-tax-free to you, but you get no itemized charitable
write-off on your Form 1040. That’s okay because the tax-free treatment of QCDs
equates to an immediate 100% federal income tax deduction without having to
worry about restrictions that can delay itemized charitable write-offs. QCDs
have other tax advantages, too. Contact us if you want to hear about them.
Be careful—to qualify for this special tax break, the funds
must be transferred directly from your IRA to the charity. Also, this
favorable provision will expire at the end of this year unless Congress extends
it. So, this could be your last chance.
Take Your Required Retirement Distributions. The tax
laws generally require individuals with retirement accounts to take withdrawals
based on the size of their account and their age every year after they reach age
701/2. Failure
to take a required withdrawal can result in a penalty of 50% of the amount not
withdrawn. There’s good news for 2013 though—QCDs discussed above count as
payouts for purposes of the required distribution rules. This means, you can
donate all or part of your 2013 required distribution amount (up to the $100,000
limit on QCDs) and convert taxable required distributions into tax-free
QCDs.
Also, if you turned age 701/2 in 2013, you can
delay your 2013 required distribution to 2014, if you choose. However, waiting
until 2014 will result in two distributions in 2014—the amount required for 2013
plus the amount required for 2014. While deferring income is normally a sound
tax strategy, here it results in bunching income into 2014. Thus, think twice
before delaying your 2013 distribution to 2014—bunching income into 2014 might
throw you into a higher tax bracket or have a detrimental impact on your other
tax deductions in 2014.
Ideas for the Office
Maximize Contributions to 401(k) Plans. If
you have a 401(k) plan at work, it’s just about time to tell your company how
much you want to set aside on a tax-free basis for next year. Contribute as much
as you can stand, especially if your employer makes matching contributions. You
give up “free money” when you fail to participate to the max for the match.
Take Advantage of Flexible Spending Accounts (FSAs).
If your company has a healthcare and/or dependent care FSA, before year-end you
must specify how much of your 2014 salary to convert into tax-free contributions
to the plan. You can then take tax-free withdrawals next year to reimburse
yourself for out-of-pocket medical and dental expenses and qualifying dependent
care costs. Watch out, though, FSAs are “use-it-or-lose-it” accounts—you don’t
want to set aside more than what you’ll likely have in qualifying expenses for
the year.
Married couples who both have access to FSAs will also need
to decide whose FSA to use. If one spouse’s salary is likely to be higher than
what’s known as the FICA wage limit (which is $113,700 for this year and will
likely be somewhat higher next year) and the other spouse’s will be less, the
one with the smaller salary should fund as much of the couple’s FSA needs as
possible. The reason is the 6.2% social security tax levy for 2014 is set to
stop at the FICA wage limit (and doesn’t apply at all to money put into an FSA).
Thus, for example, if one spouse earns $120,000 and the other $40,000 and they
want to collectively set aside $5,000 in their FSAs, they can save $310 (6.2% of
$5,000) by having the full amount taken from the lower-paid spouse’s salary
versus having 100% taken from the other one’s wages. Of course, either way, the
couple will also save approximately $1,400 in income and Medicare taxes because
of the FSAs.
If you currently have a healthcare FSA, make sure you drain
it by incurring eligible expenses before the deadline for this year. Otherwise,
you’ll lose the remaining balance. It’s not that hard to drum some things up:
new glasses or contacts, dental work you’ve been putting off, or prescriptions
that can be filled early.
Adjust Your Federal Income Tax Withholding. As stated
at the beginning of this letter, higher-income individuals will likely see their
taxes go up this year. This makes it more important than ever to do the
calculations to see where you stand before the end of the year. If it looks like
you are going to owe income taxes for 2013, consider bumping up the federal
income taxes withheld from your paychecks now through the end of the
year. When you file your return, you will still have to pay any taxes due less
the amount paid in. However, as long as your total tax payments (estimated
payments plus withholdings) equal at least 90% of your 2013 liability or, if
smaller, 100% of your 2012 liability (110% if your 2012 adjusted gross income
exceeded $150,000; $75,000 for married individuals who filed separate returns),
penalties will be minimized, if not eliminated.
Watch Out for Alternative Minimum
Tax
Recent legislation slightly reduced the odds that you’ll owe
the alternative minimum tax (AMT). Even so, it’s still critical to evaluate all
tax planning strategies in light of the AMT rules before actually making any
moves. Because the AMT rules are complicated, you may want our assistance.
Don’t Overlook Estate Planning
For 2013, the unified federal gift and estate tax exemption
is a historically generous $5.25 million, and the federal estate tax rate is a
historically reasonable 40%. Even if you already have an estate plan, it may
need updating to reflect the current estate and gift tax rules. Also, you may
need to make some changes for reasons that have nothing to do with taxes.
Conclusion
Through careful planning, it’s possible your 2013 tax
liability can still be significantly reduced, but don’t delay. The longer you
wait, the less likely it is that you’ll be able to achieve a meaningful
reduction.
last-minute moves you can make to save taxes—both on your 2013 return and in
future years.
For most individuals, the ordinary federal income tax rates
for 2013 will be the same as last year: 10%, 15%, 25%, 28%, 33%, and 35%.
However, the fiscal cliff legislation, passed early this year, increased the
maximum rate for higher-income individuals to 39.6% (up from 35%). This change
affects taxpayers with taxable income above $400,000 for singles, $450,000 for
married joint-filing couples, and $425,000 for heads of households. In addition,
the new 0.9% Medicare tax and 3.8% Net Investment Income Tax (NIIT) potentially
kick in when modified adjusted gross income (or earned income in the case of the
Medicare tax) goes over $200,000 for unmarried, $250,000 for married
joint-filing couples, which can result in a higher-than-advertised federal tax
rate for 2013.
Despite these tax increases, the current federal income tax
environment remains relatively favorable by historical standards. This letter
presents a few tax-saving ideas to get you started. As always, you can call on
us to help you sort through the options and implement strategies that make sense
for you.
Ideas for Your Business
Take Advantage of Tax Breaks for Purchasing
Equipment, Software, and Certain Real Property. If you have plans to
buy a business computer, office furniture, equipment, vehicle, or other tangible
business property or to make certain improvements to real property, you might
consider doing so before year-end to capitalize on the following generous, but
temporary tax breaks:
·
Bigger Section 179 Deduction. Your business may be able to take
advantage of the temporarily increased Section 179 deduction. Under the Section
179 deduction privilege, an eligible business can often claim first-year
depreciation write-offs for the entire cost of new and used equipment and
software additions. (However, limits apply to the amount that can be deducted
for most vehicles.) For tax years beginning in 2013, the maximum Section 179
deduction is $500,000. For tax years beginning in 2014, however, the maximum
deduction is scheduled to drop to $25,000.
·
Section 179 Deduction for Real Estate. Real property costs are
generally ineligible for the Section 179 deduction privilege. However, an
exception applies to tax years beginning in 2013. Under the exception, your
business can immediately deduct up to $250,000 of qualified costs for restaurant
buildings and improvements to interiors of retail and leased nonresidential
buildings. The $250,000 Section 179 allowance for these real estate expenditures
is part of the overall $500,000 allowance. This temporary real estate break will
not be available for tax years beginning after 2013 unless Congress extends
it.
Note: Watch out if your business is already expected
to have a tax loss for the year (or be close) before considering any Section 179
deduction, as you cannot claim a Section 179 write-off that would create or
increase an overall business tax loss. Please contact us if you think this might
be an issue for your operation.
·
50% First-year Bonus Depreciation. Above and beyond the bumped-up
Section 179 deduction, your business can also claim first-year bonus
depreciation equal to 50% of the cost of most new (not used) equipment and
software placed in service by December 31 of this year. For a new passenger auto
or light truck that’s used for business and is subject to the luxury auto
depreciation limitations, the 50% bonus depreciation break increases the maximum
first-year depreciation deduction by $8,000 for vehicles placed in service this
year. The 50% bonus depreciation break will expire at year-end unless Congress
extends it.
Note: First-year bonus depreciation deductions can
create or increase a Net Operating Loss (NOL) for your business’s 2013 tax year.
You can then carry back a 2013 NOL to 2011 and 2012 and collect a refund of
taxes paid in those years. Please contact us for details on the interaction
between asset additions and NOLs.
Evaluate Inventory for Damaged or Obsolete Items.
Inventory is normally valued for tax purposes at cost or the lower of cost or
market value. Regardless of which of these methods is used, the end-of-the-year
inventory should be reviewed to detect obsolete or damaged items. The carrying
cost of any such items may be written down to their probable selling price (net
of selling expenses). [This rule does not apply to businesses that use the Last
in, First out (LIFO) method because LIFO does not distinguish between goods that
have been written down and those that have not].
To claim a deduction for a write-down of obsolete inventory,
you are not required to scrap the item. However, in a period ending not later
than 30 days after the inventory date, the item must be actually offered for
sale at the price to which the inventory is reduced.
Employ Your Child. If you are self-employed, don’t
miss one last opportunity to employ your child before the end of the year. Doing
so has tax benefits in that it shifts income (which is not subject to the Kiddie
tax) from you to your child, who normally is in a lower tax bracket or may avoid
tax entirely due to the standard deduction. There can also be payroll tax
savings since wages paid by sole proprietors to their children age 17 and
younger are exempt from both social security and unemployment taxes. Employing
your children has the added benefit of providing them with earned income, which
enables them to contribute to an IRA. Children with IRAs, particularly Roth
IRAs, have a great start on retirement savings since the compounded growth of
the funds can be significant.
Remember a couple of things when employing your child. First,
the wages paid must be reasonable given the child’s age and work skills. Second,
if the child is in college, or is entering soon, having too much earned income
can have a detrimental impact on the student’s need-based financial aid
eligibility.
Ideas for Maximizing Nonbusiness
Deductions
One way to reduce your 2013 tax liability is to look
for additional deductions. Here’s a list of suggestions to get you started:
Make Charitable Gifts of Appreciated Stock. If you
have appreciated stock that you’ve held more than a year and you plan to make
significant charitable contributions before year-end, keep your cash and donate
the stock (or mutual fund shares) instead. You’ll avoid paying tax on the
appreciation, but will still be able to deduct the donated property’s full
value. If you want to maintain a position in the donated securities, you can
immediately buy back a like number of shares. (This idea works especially well
with no load mutual funds because there are no transaction fees involved.)
However, if the stock is now worth less than when you
acquired it, sell the stock, take the loss, and then give the cash to the
charity. If you give the stock to the charity, your charitable deduction will
equal the stock’s current depressed value and no capital loss will be available.
Also, if you sell the stock at a loss, you can’t immediately buy it back as this
will trigger the wash sale rules. This means your loss won’t be deductible, but
instead will be added to the basis in the new shares.
Don’t Lose a Charitable Deduction for Lack of
Paperwork. Charitable contributions are only deductible if you have proper
documentation. For cash contributions of less than $250, this means you must
have either a bank record that supports the donation (such as a cancelled check
or credit card receipt) or a written statement from the charity that meets
tax-law requirements. For cash donations of $250 or more, a bank record is not
enough. You must obtain, by the time your tax return is filed, a
charity-provided statement that shows the amount of the donation and lists any
significant goods or services received in return for the donation (other than
intangible religious benefits) or specifically states that you received no goods
or services from the charity.
Maximize the Benefit of the Standard Deduction. For
2013, the standard deduction is $12,200 for married taxpayers filing joint
returns. For single taxpayers, the amount is $6,100. Currently, it looks like
these amounts will be about the same for 2014. If your total itemized deductions
are normally close to these amounts, you may be able to leverage the benefit
of your deductions by bunching deductions in every other year. This allows you
to time your itemized deductions so that they are high in one year and low in
the next. You claim actual expenses in the year they are bunched and take the
standard deduction in the intervening years.
For instance, you might consider moving charitable donations
you normally would make in early 2014 to the end of 2013. If you’re temporarily
short on cash, charge the contribution to a credit card—it is deductible in the
year charged, not when payment is made on the card. You can also accelerate
payments of your real estate taxes or state income taxes otherwise due in early
2014. But, watch out for the AMT, as these taxes are not deductible for AMT
purposes.
Manage Your Adjusted Gross Income (AGI). Many tax
breaks are only available to taxpayers with AGI below certain levels. Some
common AGI-based tax breaks include the child tax credit (phase-out begins at
$110,000 for married couples and $75,000 for heads-of-households), the $25,000
rental real estate passive loss allowance (phase-out range of $100,000–$150,000
for most taxpayers), and the exclusion of social security benefits ($32,000
threshold for married filers; $25,000 for other filers). In addition, for 2013
taxpayers with AGI over $300,000 for married filers, $250,000 for singles, and
$275,000 for heads-of-households begin losing part of their personal exemptions
and itemized deductions. Accordingly, strategies that lower your income or
increase certain deductions might not only reduce your taxable income, but also
help increase some of your other tax deductions and credits.
Making the Most of Year-end Securities
Transactions
For most individuals, the 2013 federal tax rates on long-term
capital gains from sales of investments held over a year are the same as last
year: either 0% or 15%. However, the maximum rate for higher-income individuals
is now 20% (up from 15% last year). This change affects taxpayers with taxable
income above $400,000 for singles, $450,000 for married joint-filing couples,
$425,000 for heads-of-households, and $225,000 for married individuals who file
separate returns. Higher-income individuals can also get hit by the new 3.8%
NIIT on net investment income, which can result in a maximum 23.8% federal
income tax rate on 2013 long-term gains.
As you evaluate investments held in your taxable brokerage
firm accounts, consider the tax impact of selling appreciated securities
(currently worth more than you paid for them). For most taxpayers, the federal
tax rate on long-term capital gains is still much lower than the rate on
short-term gains. Therefore, it often makes sense to hold appreciated securities
for at least a year and a day before selling to qualify for the lower long-term
gain tax rate.
Biting the bullet and selling some loser securities
(currently worth less than you paid for them) before year-end can also be a
tax-smart idea. The resulting capital losses will offset capital gains from
other sales this year, including high-taxed short-term gains from securities
owned for one year or less. For 2013, the maximum rate on short-term gains is
39.6%, and the 3.8% NIIT may apply too, which can result in an effective rate of
up to 43.4%. However, you don’t need to worry about paying a high rate on
short-term gains that can be sheltered with capital losses (you will pay 0% on
gains that can be sheltered).
If capital losses for this year exceed capital gains, you
will have a net capital loss for 2013. You can use that net capital loss to
shelter up to $3,000 of this year’s high-taxed ordinary income ($1,500 if you’re
married and file separately). Any excess net capital loss is carried forward to
next year.
Selling enough loser securities to create a bigger net
capital loss that exceeds what you can use this year might also make sense. You
can carry forward the excess capital loss to 2014 and beyond and use it to
shelter both short-term gains and long-term gains recognized in those
years.
Identify the Securities You Sell. When selling stock
or mutual fund shares, the general rule is that the shares you acquired first
are the ones you sell first. However, if you choose, you can specifically
identify the shares you’re selling when you sell less than your entire holding
of a stock or mutual fund. By notifying your broker of the shares you want sold at the time of the sale, your gain or loss
from the sale is based on the identified shares. This sales strategy gives you
better control over the amount of your gain or loss and whether it’s long-term
or short-term.
Secure a Deduction for Nearly Worthless Securities. If
you own any securities that are all but worthless with little hope of recovery,
you might consider selling them before the end of the year so you can capitalize
on the loss this year. You can deduct a loss on worthless securities only if you
can prove the investment is completely worthless. Thus, a deduction is not
available, as long as you own the security and it has any value at all. Total
worthlessness can be very difficult to establish with any certainty. To avoid
the issue, it may be easier just to sell the security if it has any marketable
value. As long as the sale is not to a family member, this allows you to claim a
loss for the difference between your tax basis and the proceeds (subject to the
normal rules for capital losses and the wash sale rules restricting the
recognition of loss if the security is repurchased within 30 days before or
after the sale).
Ideas for Seniors Age
701/2 Plus
Make Charitable Donations from Your IRA. IRA
owners and beneficiaries who have reached age 701/2 are permitted to make
cash donations totaling up to $100,000 to IRS-approved public charities directly
out of their IRAs. These so-called Qualified Charitable Distributions, or
QCDs, are federal-income-tax-free to you, but you get no itemized charitable
write-off on your Form 1040. That’s okay because the tax-free treatment of QCDs
equates to an immediate 100% federal income tax deduction without having to
worry about restrictions that can delay itemized charitable write-offs. QCDs
have other tax advantages, too. Contact us if you want to hear about them.
Be careful—to qualify for this special tax break, the funds
must be transferred directly from your IRA to the charity. Also, this
favorable provision will expire at the end of this year unless Congress extends
it. So, this could be your last chance.
Take Your Required Retirement Distributions. The tax
laws generally require individuals with retirement accounts to take withdrawals
based on the size of their account and their age every year after they reach age
701/2. Failure
to take a required withdrawal can result in a penalty of 50% of the amount not
withdrawn. There’s good news for 2013 though—QCDs discussed above count as
payouts for purposes of the required distribution rules. This means, you can
donate all or part of your 2013 required distribution amount (up to the $100,000
limit on QCDs) and convert taxable required distributions into tax-free
QCDs.
Also, if you turned age 701/2 in 2013, you can
delay your 2013 required distribution to 2014, if you choose. However, waiting
until 2014 will result in two distributions in 2014—the amount required for 2013
plus the amount required for 2014. While deferring income is normally a sound
tax strategy, here it results in bunching income into 2014. Thus, think twice
before delaying your 2013 distribution to 2014—bunching income into 2014 might
throw you into a higher tax bracket or have a detrimental impact on your other
tax deductions in 2014.
Ideas for the Office
Maximize Contributions to 401(k) Plans. If
you have a 401(k) plan at work, it’s just about time to tell your company how
much you want to set aside on a tax-free basis for next year. Contribute as much
as you can stand, especially if your employer makes matching contributions. You
give up “free money” when you fail to participate to the max for the match.
Take Advantage of Flexible Spending Accounts (FSAs).
If your company has a healthcare and/or dependent care FSA, before year-end you
must specify how much of your 2014 salary to convert into tax-free contributions
to the plan. You can then take tax-free withdrawals next year to reimburse
yourself for out-of-pocket medical and dental expenses and qualifying dependent
care costs. Watch out, though, FSAs are “use-it-or-lose-it” accounts—you don’t
want to set aside more than what you’ll likely have in qualifying expenses for
the year.
Married couples who both have access to FSAs will also need
to decide whose FSA to use. If one spouse’s salary is likely to be higher than
what’s known as the FICA wage limit (which is $113,700 for this year and will
likely be somewhat higher next year) and the other spouse’s will be less, the
one with the smaller salary should fund as much of the couple’s FSA needs as
possible. The reason is the 6.2% social security tax levy for 2014 is set to
stop at the FICA wage limit (and doesn’t apply at all to money put into an FSA).
Thus, for example, if one spouse earns $120,000 and the other $40,000 and they
want to collectively set aside $5,000 in their FSAs, they can save $310 (6.2% of
$5,000) by having the full amount taken from the lower-paid spouse’s salary
versus having 100% taken from the other one’s wages. Of course, either way, the
couple will also save approximately $1,400 in income and Medicare taxes because
of the FSAs.
If you currently have a healthcare FSA, make sure you drain
it by incurring eligible expenses before the deadline for this year. Otherwise,
you’ll lose the remaining balance. It’s not that hard to drum some things up:
new glasses or contacts, dental work you’ve been putting off, or prescriptions
that can be filled early.
Adjust Your Federal Income Tax Withholding. As stated
at the beginning of this letter, higher-income individuals will likely see their
taxes go up this year. This makes it more important than ever to do the
calculations to see where you stand before the end of the year. If it looks like
you are going to owe income taxes for 2013, consider bumping up the federal
income taxes withheld from your paychecks now through the end of the
year. When you file your return, you will still have to pay any taxes due less
the amount paid in. However, as long as your total tax payments (estimated
payments plus withholdings) equal at least 90% of your 2013 liability or, if
smaller, 100% of your 2012 liability (110% if your 2012 adjusted gross income
exceeded $150,000; $75,000 for married individuals who filed separate returns),
penalties will be minimized, if not eliminated.
Watch Out for Alternative Minimum
Tax
Recent legislation slightly reduced the odds that you’ll owe
the alternative minimum tax (AMT). Even so, it’s still critical to evaluate all
tax planning strategies in light of the AMT rules before actually making any
moves. Because the AMT rules are complicated, you may want our assistance.
Don’t Overlook Estate Planning
For 2013, the unified federal gift and estate tax exemption
is a historically generous $5.25 million, and the federal estate tax rate is a
historically reasonable 40%. Even if you already have an estate plan, it may
need updating to reflect the current estate and gift tax rules. Also, you may
need to make some changes for reasons that have nothing to do with taxes.
Conclusion
Through careful planning, it’s possible your 2013 tax
liability can still be significantly reduced, but don’t delay. The longer you
wait, the less likely it is that you’ll be able to achieve a meaningful
reduction.