Year-end tax planning could be especially productive this year because timely action could nail down a host of tax breaks that won't be around next year unless Congress acts to extend them, which, at the present time, looks doubtful. These include, for individuals: the option to deduct state and local sales and use taxes instead of state and local income taxes; the above-the-line deduction for qualified higher education expenses; and tax-free distributions by those age 70-— or older from IRAs for charitable purposes. For businesses, tax breaks that are available through the end of this year but won't be around next year unless Congress acts include: 50% bonus first-year depreciation for most new machinery, equipment and software; an extraordinarily high $500,000 expensing limitation; the research tax credit; and the 15-year write-off for qualified leasehold improvements, qualified restaurant buildings and improvements and qualified retail improvements.
High-income-earners have other factors to keep in mind when mapping out year-end plans. For the first time, they have to take into account the 3.8% tax surtax on unearned income and the additional 0.9% Medicare (hospital insurance, or HI) tax that applies to individuals receiving wages with respect to employment in excess of $200,000 ($250,000 for married couples filing jointly and $125,000 for married couples filing separately).
The surtax is 3.8% of the lesser of: (1) net investment income (NII), or (2) the excess of modified adjusted gross income (MAGI) over an unindexed threshold amount ($250,000 for joint filers or surviving spouses, $125,000 for a married individual filing a separate return, and $200,000 in any other case). As year-end nears, a taxpayer's approach to minimizing or eliminating the 3.8% surtax will depend on his estimated MAGI and NII for the year. Some taxpayers should consider ways to minimize (e.g., through deferral) additional NII for the balance of the year, others should try to see if they can reduce MAGI other than unearned income, and others should consider ways to minimize both NII and other types of MAGI.
The additional Medicare tax may require year-end actions. Employers must withhold the additional Medicare tax from wages in excess of $200,000 regardless of filing status or other income. Self-employed persons must take it into account in figuring estimate tax. There could be situations where an employee may need to have more withheld toward year end to cover the tax. For example, consider an individual who earns $200,000 from one employer during the first half of the year and a like amount from another employer during the balance of the year. He would owe the additional Medicare tax, but there would be no withholding by either employer for the additional Medicare tax since wages from each employer don't exceed $200,000. Also, in determining whether they may need to make adjustments to avoid a penalty for underpayment of estimated tax, individuals also should be mindful that the additional Medicare tax may be over withheld. This could occur, for example, where only one of two married spouses works and reaches the threshold for the employer to withhold, but the couple's income won't be high enough to actually cause the tax to be owed.
American Taxpayer Relief Act of 2012 (ATRA) was signed into law on January 2, 2013. ATRA 2012 was a significant tax package that extended several deductions through 2013, made permanent AMT relief and many Bush-era tax cuts, reinstated personal exemption and itemized deduction limitations for 2013 forward, and raised the top tax rates for individual income and capital gains and dividends.
The Act also included a one-year extension, through 2013, of the election to take an itemized deduction for state and local general sales taxes in lieu of the itemized deduction for state and local income taxes, the deduction for mortgage insurance premiums paid on the purchase of a qualified residence; the above-the-line higher education tuition deduction; the $250 above-the-line deduction for certain expenses of elementary and secondary school teachers; and the research credit. Absent any additional legislation, these one-year tax extender items will expire on December 31, 2013, and will not be available for 2014.
The temporary payroll tax holiday, which reduced the social security tax by 2% in 2011 and 2012, was not renewed for 2013, therefore, the social security tax reverts back to 6.2%. This change will result in a decrease in take home pay for employees, as well as a larger SE tax for self-employed taxpayers in 2013.
TRA 2010 extended the zero capital gain tax rate through 2012. The zero tax-rate is applied to long-term capital gain and/or qualified dividend income that would otherwise be subject to the 10/15% tax rates. ATRA made permanent the 0% and 15% rates. High income taxpayers will generally be taxed at a maximum rate of 20% beginning in 2013. Additionally, the 3.8% surtax on net investment income also may apply.
With the passage of the American Taxpayer Relief Act of 2012, the limitation on personal exemptions and itemized deductions was reestablished for tax year 2013. The phase-out for personal exemptions and itemized deductions applies for taxpayers whose adjusted gross income exceeds the following inflation-adjusted amount: $300,000 for married filing joint and qualifying widow(er) filers, $250,000 for single filers, $275,000 for head of household filers and $150,000 for married individuals filing separately.
As in the prior three tax years, in 2013, debts which are forgiven on a mortgage secured by qualified principal residence may be excluded from gross income. Only mortgage debt used to acquire or improve the principal residence qualifies for the exclusion. No tax relief is allowed for home equity loans, business properties, rental properties or second mortgages not used to acquire, build, or substantially improve a principal residence. The amount that may be excluded is limited to $2 million for married individuals filing jointly ($1 million for married individuals filing separately).
Contribution limits for IRAs have increased to a higher maximum contribution amount from the initial $2,000 to $5,500 indexed for inflation for future years. Individuals at least 50 years old in 2012 will be allowed an additional "catch-up" contribution of $1,000 (same as 2011) to their regular IRA contributions. The "catch-up" contributions can be made any time during the year in which the taxpayer turns 50.
Employer-sponsored salary reduction contribution limitations to IRC 401(k) type plans increases from $17,000 to $17,500 in 2013. Employers may allow those age 50 or over to contribute an additional $5,500 in 2013. The salary deferral limitation for SIMPLE plan participants increases from $11,500 to $12,000 for 2013. SIMPLE plan catch-up contributions for participants age 50 and over remain unchanged at $2,500 in 2013.
Under the Patient Protection and Affordable Care Act of 2010, the AGI floor used to calculate the 2013 allowable itemized deduction for medical expenses is increased from 7.5% to 10% for taxpayers who are under age 65 at the end of 2013. Taxpayers who are 65 and older at the end of 2013 will continue to use the AGI floor of 7.5% to figure deductible medical expenses. As a result of this change, the 2013 AMT adjustment for medical expenses will only calculate for taxpayers age 65 or older.
Under the Patient Protection and Affordable Care Act of 2010, new taxes will take effect in 2013. There is an additional Medicare tax of 0.9% on wages or self-employment income over $250,000 if you file a joint return, $125,000 if you are married but file separately, or $200,000 for any other filing status. The Tax on Net Investment Income is 3.8% on the lesser of net investment income or any excess of modified adjusted gross income over $250,000 if you file a joint return, $125,000 if you are married but file separately, or $200,000 for another filing status.
Health Savings Accounts are a pre-tax savings tool, which enable individuals with high deductible health insurance to make pre-tax contributions to cover health care costs. For 2013, individuals may contribute up to $3,250 for self-only coverage and $6,450 for family coverage. The additional tax on distributions from an HSA or an Archer MSA that are not used for qualified medical expenses remains at 20%.
Effective tax planning requires a year-round effort each year, especially as your overall financial position changes. If you wish to discuss the provisions affecting you as well as the available tax strategies that would be appropriate to minimize your tax liability and maximize your tax savings, please give us a call to set up an appointment.