Year-end tax planning is a bigger challenge this year than in past years because, unless Congress acts, individuals could face higher tax rates next year on their income, capital gains and dividends, as well as higher estate taxes.
These adverse tax consequences are by no means a certainty. Congress could extend the Bush-era tax cuts for some or all taxpayers, even retroactively in 2013, revive some favorable tax rules that have expired and extend those that are slated to expire at the end of this year. While these uncertainties create year-end tax planning challenges, they should not be an excuse for inaction.
Regardless of Washington’s action, there are some changes in 2013 that result from other tax measures that recently passed. One of the most notable is the new Medicare Surtax (surtax) of 3.8 percent on unearned income for single taxpayers with modified adjusted gross income greater than $200,000 and $250,000 for married couples. Simply being above these limits does not guarantee that you will be subject to this additional tax. Instead, a “lesser of” formula determines whether you are affected.
If you are thinking of selling assets that are likely to produce large gains, consider making the sale before year-end. This year, long-term capital gains are taxed at a maximum rate of 15 percent, but the rate may increase next year depending upon Congress’ action. In addition, any sale made this year is not subject to the surtax.
Consider making contributions to Roth IRAs instead of traditional IRAs. Roth IRA payouts are tax-free and thus immune from the threat of higher tax rates under certain qualifications. This tax-free distribution in future years will not be subject to taxation nor the surtax.
Consider taking any needed money from your IRAs and 401ks for 2013 living expenses in 2012. This could help you avoid higher taxes in 2013 while living off of the excess 2012 distributions. However, this must be coordinated with your minimum required distributions if over the age of 70½.
Taxpayers should also consider when to make their charitable contributions. Charities would prefer to receive the funds in 2012 but, depending upon Congress’ action, deductions could be more valuable in 2013 to some taxpayers.
This year, unreimbursed medical expenses are deductible if they exceed 7.5 percent of your adjusted gross income. However, in 2013, for individuals under age 65, these expenses will be deductible only to the extent they exceed 10 percent of the adjusted gross income. If you have a shot at exceeding the 7.5 percent floor this year, accelerate discretionary medical expenses – such as prescription glasses, contacts or elective procedures not covered by insurance – into this year that you were planning on making next year.
If your business is incorporated, consider taking money out of the business via a stock buyback or a dividend. Either way, you will be taxed at a maximum rate of only 15 percent in 2012 versus a potential 43.4 percent in 2013. Business owners should also put new business equipment and machinery in service before year-end to qualify for the 50 percent bonus first-year depreciation allowance and higher expensing elections.
While there are many uncertainties in the tax law, there are many things that we know will happen next year and planning around these can be a wiser investment of your time than worrying about what Congress might change for 2013.
Life is a journey, plan for it.
Neil A. Brown is a CPA and CFP with Burkett Financial Services in West Columbia. Reach him at www.uscneil.com or (803) 200-2272.