& Company, P.C.
Certified Public Accountants and Financial Advisors
Tax Planning Guide
2016 - 2017
Tax planning for the 2012 tax year was a major challenge because of the uncertainty as to whether significant tax increases scheduled for 2013 would go into effect. On Jan. 1, 2013, Congress passed the American Taxpayer Relief Act of 2012 (ATRA), which prevented income tax rate increases for most taxpayers and addressed many expired tax breaks. However, ATRA did not provide as much relief to higher-income taxpayers. Many will see rate hikes on income exceeding certain thresholds. Expanded Medicare taxes will also affect higher-income taxpayers this year. Even though many of ATRA’s provisions are suppose to be permanent, this simply means that the provisions do not have expiration dates. Congress can still pass additional changes affecting your tax liability this year or in future years. For this, and many other reasons, tax planning continues to be a complicated and critical task. The following information is intended to help you familiarize yourself with key tax law changes and to make the most of the tax-savings opportunities available to you. Feel free to contact us regarding clarification or to obtain additional strategies for 2014 and beyond.
DEDUCTIONS AND ALTERNATIVE MINIMUM TAX (AMT)
Should tax law changes affect your planning this year? ATRA made lower ordinary-income tax rates permanent for most taxpayers, but some, previously in the 35% bracket, now face the 39.6% rate’s return. ATRA also brought back a reduction on many deductions. It kicks in when adjusted gross income (AGI) exceeds $250,000 (singles), $275,000 (heads of households) or $300,000 (joint filers). Whether or not you’re affected by these tax increases, you may want to implement the traditional timing strategies of deferring income and accelerating deductible expenses to reduce, or at least defer, tax.
The Alternative Minimum Tax (AMT) - When planning for deductions, the first step is to consider the AMT — a separate tax system that limits some deductions and doesn’t permit others, such as state and local income tax deductions, property tax deductions, and miscellaneous itemized deductions subject to the 2% of AGI floor (for example, investment expenses and unreimbursed employee business expenses). You must pay the AMT if your AMT liability exceeds your regular tax liability. You may be able to time income and deductions to avoid the AMT, reduce its impact or even take advantage of its lower maximum rate. ATRA has made planning a little easier because it includes long-term AMT relief. Before the act, unlike the regular tax system, the AMT system wasn’t regularly adjusted for inflation. Instead, Congress had to legislate any adjustments. Typically, it did so via an increase in the AMT exemptions. ATRA has set higher exemptions permanently, indexing them — as well as the AMT brackets — for inflation going forward.
Home-related breaks - Consider both deductions and exclusions:
Property tax deduction. Before paying your bill early to accelerate the itemized deduction into 2013, review your AMT situation. If you’re subject to the AMT, you’ll lose the benefit of the deduction for the prepayment.
Mortgage interest deduction. You generally can deduct interest on up to a combined total of $1 million of mortgage debt incurred to purchase, build or improve your principal residence and a second residence. Points paid related to your residence also may be deductible.
Home equity debt interest deduction. Interest on home equity debt used for any purpose (debt limit of $100,000) may be deductible. So consider using a home equity loan or line of credit to pay off credit cards or auto loans, for which interest isn’t deductible and rates may be higher. Warning: Beware of the AMT — if the home equity debt isn’t used for home improvements, the interest isn’t deductible for AMT purposes.
Home office deduction. If your use of a home office is for your employer’s benefit and it’s the only use of the space, you generally can deduct a portion of your mortgage interest, property taxes, insurance, utilities and certain other expenses, as well as the depreciation allocable to the office space. Or you may be able to take the new, simpler, “safe harbor” deduction. (Contact your tax advisor for details.) Home office expenses are a miscellaneous itemized deduction, which means you’ll enjoy a tax benefit only if these expenses plus your other miscellaneous itemized expenses exceed 2% of your AGI.
SOMETHING NEW! Additional Medicare tax now applies to higher earners. Who’s affected? Taxpayers with earned income exceeding certain thresholds.
Key changes: Under the health care act, starting in 2013, taxpayers must pay an additional 0.9% Medicare tax on FICA wages and self-employment income exceeding $200,000 per year ($250,000 for joint filers and $125,000 for married filing separately). Employers are obligated to withhold the additional tax beginning in the pay period when wages exceed $200,000 for the calendar year — without regard to an employee’s filing status or income from other sources. So your employer might withhold the tax even if you aren’t liable for it — or it might not withhold the tax even though you are liable for it.
Planning tips: You may be able to implement timing strategies to avoid or minimize the additional tax. If you don’t owe the tax but your employer is withholding it, you can claim a credit on your 2013 income tax return. If you do owe the tax but your employer isn’t withholding it, consider filing a W-4 to request additional income tax withholding, which can be used to cover the shortfall and avoid interest and penalties.
Home sale gain exclusion. When you sell your principal residence, you can exclude up to $250,000 ($500,000 for joint filers) of gain if you meet certain tests. Warning: Gain that’s allocable to a period of “nonqualified” use generally isn’t excludable.
Home sale loss deduction. Losses on the sale of a principal residence aren’t deductible. But if part of your home is rented or used exclusively for your business, the loss attributable to that portion will be deductible, subject to various limitations.
Debt forgiveness exclusion. Homeowners who receive debt forgiveness in a foreclosure, short sale or mortgage workout for a principal residence generally don’t have to pay federal income taxes on that forgiveness. Warning: As of this writing, this break is scheduled to expire after 2013.
Rental income exclusion. If you rent out all or a portion of your principal residence or second home for less than 15 days, you don’t have to report the income. But expenses directly associated with the rental, such as advertising and cleaning, won’t be deductible.
Health-care-related breaks - If your medical expenses exceed 10% of your AGI, you can deduct the excess amount. Eligible expenses include health insurance premiums, long-term care insurance premiums (limits apply), medical and dental services, and prescription drugs. Consider “bunching” non-urgent medical procedures and other controllable expenses into one year to exceed the 10% floor.
Warning: Before 2013, the floor was only 7.5% for regular tax purposes, making it easier to exceed. Taxpayers age 65 and older can still enjoy that 7.5% floor through 2016. The floor for AMT purposes, however, is 10% for all taxpayers (the same as it was before 2013). Also remember that expenses that are reimbursed (or reimbursable) by insurance or paid through one of the following accounts aren’t deductible:
1. HSA. If you’re covered by qualified high-deductible health insurance, a Health Savings Account
allows contributions of pretax income (or deductible after-tax contributions) up to $3,250 for self-
only coverage and $6,450 for family coverage (for 2013), plus an additional $1,000 if you’re age 55 or
older. HSAs bear interest or are invested and can grow tax-deferred similar to an IRA. Withdrawals
for qualified medical expenses are tax-free, and you can carry over a balance from year to year.
2. FSA. You can redirect pretax income to an employer-sponsored Flexible Spending Account up to
an employer-determined limit — not to exceed $2,500 for plan years beginning in 2013. The plan
pays or reimburses you for qualified medical expenses. What you don’t use by the end of the plan
year, you generally lose. If you have an HSA, your FSA is limited to funding certain “permitted”
Charitable donations - Donations to qualified charities are generally fully deductible for both regular tax and AMT purposes, and they may be the easiest deductible expense to time to your tax advantage. For large donations, discuss with your tax advisor which assets to give and the best ways to give them. For example:
Appreciated assets. Publicly traded stock and other securities you’ve held more than one year can make one of the best charitable gifts. Why? Because you can deduct the current fair market value and avoid the capital gains tax you’d pay if you sold the property. Warning: Donations of such property are subject to tighter deduction limits. Excess contributions can be carried forward for up to five years.
Charitable Remainder Trust's (CRT). For a given term, a charitable remainder trust pays an amount to you annually (some of which generally is taxable). At the term’s end, the CRT’s remaining assets pass to one or more charities. When you fund the CRT, you receive an income tax deduction. If you contribute appreciated assets, you also can minimize and defer capital gains tax. You can name someone other than yourself as income beneficiary or fund the CRT at your death, but the tax consequences will be different.
FAMILY AND EDUCATION:
If you’re a parent, a student or even a grandparent, valuable deductions, credits and tax-advantaged savings opportunities may be available to you or to your family members. Some child- and education-related breaks had been scheduled to become less beneficial in 2013, but the tax-saving outlook is now brighter because ATRA extended most enhancements — in many cases, making them permanent.
Child and adoption credits - Tax credits reduce your tax bill dollar-for-dollar, so make sure you’re taking every credit you’re entitled to. For each child under age 17 at the end of the year, you may be able to claim a $1,000 child credit.
2013 family and education tax breaks: Are you eligible?
Tax Break Single Filer Joint Filer
$110,000 - $130,000
Child or Dependent Care Credit (2) $15,000 - $43,000 $194,580 - $234,580
ESA Contribution $95,000 - $110,000 $190,000 - $220,000
American Opportunity Credit $80,000 - $90,000 $160,000 - $180,000
Lifetime Learning Credit $53,000 - $63,000 $107,000 - $127,000
Student Loan Interest Deduction $75,000 - $125,000 $125,000 - $155,000
(1) Assumes one child. The phase-out end is higher for families with more than one eligible child.
(2) The phase-out is based on AGI rather than
MAGI. The credit does not phase out altogether, but
the minimum credit percentage of 20% applies to AGIs above $43,000.
If you adopt in 2013, you may qualify for an adoption credit or an employer adoption assistance program income exclusion; both are $12,970 per eligible child. Some enhancements to these credits had been scheduled to expire after 2012, but ATRA made them permanent. (Contact your tax advisor for details.)
Warning: These credits phase out for higher-income taxpayers.
Child care expenses - A couple of
tax breaks can help you offset these costs:
Tax credit. For children under age 13 or other qualifying dependents, you may be eligible for a credit for a portion of your dependent care expenses. Eligible expenses are limited to $3,000 for one dependent and $6,000 for two or more. Income-based limits reduce the credit but don’t phase it out altogether. The credit’s value had been scheduled to drop in 2013, but ATRA made higher limits permanent.
FSA. You can contribute up to $5,000 pretax to an employer-sponsored child and dependent care Flexible Spending Account. The plan pays or reimburses you for these expenses. You can’t use those same expenses to claim a tax credit.
Individual Retirement Accounts (IRAs) for teens - IRAs can be perfect for teenagers because they likely will have many years to let their accounts grow tax-deferred or tax-free. The 2013 contribution limit is the lesser of $5,500 (up from $5,000 in 2012) or 100% of earned income. Traditional IRA contributions generally are deductible, but distributions will be taxed. On the other hand, Roth IRA contributions aren’t deductible, but qualified distributions will be tax-free. Choosing a Roth IRA is typically a no-brainer if a teen doesn’t earn income that exceeds the standard deduction ($6,100 for 2013 for single taxpayers), because he or she will likely gain no benefit from the ability to deduct a traditional IRA contribution. If your children or grandchildren do not want to invest their hard-earned money, consider giving them the amount they’re eligible to contribute — but keep the gift tax in mind. If they don’t have earned income and you own a business, consider hiring them. As the business owner, you can deduct their pay, and other tax benefits may apply. Warning: The children must be paid in line with what you’d pay nonfamily employees for the same work.
Kiddie Tax - The “kiddie tax” applies to children under age 19 as well as to full-time students under age 24 (unless the students provide more than half of their own support from earned income). For children subject to the tax, any unearned income beyond $2,000 (for 2013) is taxed at their parents’ marginal rate rather than their own, likely lower, rate. Keep this in mind before transferring income-generating assets to them.
529 plans - If you’re saving for college, consider a Section 529 plan. You can choose a prepaid tuition program to secure current tuition rates or a tax-advantaged savings plan to fund college expenses:
--Contributions aren’t deductible for federal purposes, but plan assets can grow tax-deferred.
--Distributions used to pay qualified expenses (such as tuition, mandatory fees, books, equipment,
supplies and, generally, room and board) are income-tax-free for federal purposes and typically
for state purposes as well.
--The plans typically offer high contribution limits, and there are no income limits for contributing.
--There’s generally no beneficiary age limit for contributions or distributions.
--You remain in control of the account, even after the child is of legal age.
--You can make tax-free rollovers to another qualifying family member.
--The plans provide estate planning benefits: A special break for 529 plans allows you to front-load
five years’ worth of annual gift tax exclusions and make a $70,000 contribution (or $140,000 if you
split the gift with your spouse).
The biggest downsides may be that your investment options — and when you can change them — are limited.
Education credits and deductions - If you have children in college now, are currently in school yourself or are paying off student loans, you may be eligible for a credit or deduction:
American Opportunity credit. This tax break covers 100% of the first $2,000 of tuition and related expenses and 25% of the next $2,000 of expenses. The maximum credit, per student, is $2,500 per year for the first four years of postsecondary education. The credit had been scheduled to revert to the less beneficial Hope credit after 2012, but ATRA extended the enhanced credit through 2017.
Lifetime Learning credit. If you’re paying postsecondary education expenses beyond the first four years, you may be eligible for the Lifetime Learning credit (up to $2,000 per tax return).
Tuition and fees deduction. If you don’t qualify for one of the credits because your income is too high, you might be eligible to deduct up to $4,000 of qualified higher education tuition and fees. Warning: ATRA extended this break only through 2013.
Student loan interest deduction. If you’re paying off student loans, you may be able to deduct up to $2,500 of interest (per tax return). ATRA made certain enhancements to the deduction permanent; contact your tax advisor for details.
Warning: Income-based phase outs apply to these breaks, and expenses paid with distributions from 529 plans or ESAs (see “What’s new!” above) can’t be used to claim them.
Tax planning for investments gets even more complicated this year 30 days before or after you sell the security that created the loss. You can recognize the loss only when you sell the replacement security.
Fortunately, there are ways to avoid triggering the wash sale rule and still achieve your goals. For example, you can immediately buy securities of a different company in the same industry or shares in a mutual fund that holds securities much like the ones you sold. Or, you may wait 31 days to repurchase the same security. Alternatively, before selling the security, you can purchase additional shares of that security equal to the number you want to sell at a loss, and then wait 31 days to sell the original portion.
Swap your bonds. With a bond swap, you sell a bond, take a loss and then immediately buy another bond of similar quality and duration from a different issuer. Generally, the wash sale rule doesn’t apply because the bonds aren’t considered substantially identical. Thus, you achieve a tax loss with virtually no change in economic position.
Mind your mutual funds. Mutual funds with high turnover rates can create income that’s taxed at ordinary-income rates. Choosing funds that provide primarily long-term gains can save you more tax dollars because of the lower long-term rates.
See if a loved one qualifies for the 0% rate. ATRA made permanent the 0% rate for long-term gain that would be taxed at 10% or 15% based on the taxpayer's ordinary-income rate. If you have adult children in one of these tax brackets, consider transferring strategy can be even more powerful if you would be subject to the 3.8% Medicare contribution tax or the 20% long-term capital gains rate if you sold the assets.
Warning: If the child will be under age 24 on Dec. 31, first make sure he or she won’t be subject to the “kiddie tax.” Also, consider any gift tax consequences.
SOMETING NEW! - Will you owe the 3.8% Medicare tax on investment income? Who’s affected? Investors with income exceeding certain thresholds.
Key changes: Under the health care act, starting in 2013, taxpayers with modified adjusted gross income (MAGI) over $200,000 per year ($250,000 for joint filers and $125,000 for married filing separately) may owe a new Medicare contribution tax, also referred to as the “net investment income tax” (NIIT). The tax equals 3.8% of the lesser of your net investment income or the amount by which your MAGI exceeds the applicable threshold. The rules on what is and isn’t included in net investment income are somewhat complex, so consult your tax advisor for more information.
Planning tips: Many of the strategies that can help you save or defer income tax on your investments can also help you avoid or defer NIIT liability. And because the threshold for the NIIT is based on MAGI, strategies that reduce your MAGI — such as making retirement plan contributions — can also help you avoid or reduce NIIT liability.
Loss carryovers - If net losses exceed net gains, you can deduct only $3,000 ($1,500 for married taxpayers filing separately) of the net losses per year against ordinary income (such as wages, self-employment and business income, and interest). You can carry forward excess losses indefinitely. Loss carryovers can be a powerful tax-saving tool in future years if you have a large investment portfolio, real estate holdings or a closely held business that might generate substantial future capital gains. But if you don’t expect substantial future gains, it could take a long time to fully absorb a large loss carryover. So, from a tax perspective, you may not want to sell an investment at a loss if you won’t have enough gains to absorb most of it. (Remember, however, that capital gains distributions from mutual funds can also absorb capital losses.) Plus, if you hold on to the investment, it may recover the lost value. Nevertheless, if you’re ready to divest yourself of a poorly performing investment because you think it will continue to lose value — or because your investment objective or risk tolerance has changed — don’t hesitate solely for tax reasons.
Beyond gains and losses - With some types of investments, you’ll have more tax consequences to consider than just gains and losses:
Dividend-producing investments. ATRA made permanent the favorable long-term capital gains tax treatment of qualified dividends. Such dividends had been scheduled to return to being taxed at higher, ordinary-income tax rates in 2013.
Warning: Higher-income taxpayers will still see a tax increase on qualified dividends if they’re subject to the new 3.8% Medicare contribution tax (see “What’s new!” on page 11) or the return of the 20% long-term capital gains rate.
Interest-producing investments. Interest income generally is taxed at ordinary-income rates. So, in terms of income investments, stocks that pay qualified dividends may be more attractive tax-wise than, for example, CDs or money market accounts. But nontax issues must be considered as well, such as investment risk and diversification.
Bonds. These also produce interest income, but the tax treatment varies:
--Interest on U.S. government bonds is taxable on federal returns but generally exempt on state and
--Interest on state and local government bonds is excludable on federal returns. If the bonds were
issued in your home state, interest also may be excludable on your state return.
--Tax-exempt interest from certain private-activity municipal bonds can trigger or increase the
alternative minimum tax (AMT — see page 2) in some situations.
--Corporate bond interest is fully taxable for federal and state purposes.
--Bonds (except U.S. savings bonds) with original issue discount (OID) build up “interest” as they rise
toward maturity. You’re generally considered to earn a portion of that interest annually — even
though the bonds don’t pay this interest annually — and you must pay tax on it.
Stock options. Before exercising (or postponing exercise of) options or selling stock purchased via an exercise, consult your tax advisor about the complicated rules that may trigger regular tax or AMT liability. He or she can help you plan accordingly.
What’s the maximum capital gains tax rate?
12 months or less (short term) 35% 39.6% 2 (2)
More than 12 months (long term) 15% 20% 2 (2)
Some key exceptions:
Long-term gain on collectibles, such as artwork and antiques 28% 28%
Long-term gain attributable to certain recapture of
prior depreciation on real property 25% 25%
Long-term gain that would be taxed at 15% or less based on
the taxpayer’s ordinary-income rate 0% 0%
(1) In addition, under the 2010 health care act, a new 3.8% Medicare contribution tax applies to net
investment income to the extent that modified adjusted gross income (MAGI) exceeds $200,000
(singles and heads of households) or $250,000 (married couples filing jointly).
(2) Rate increase over 2012 applies only to those with taxable income exceeding $400,000 (singles),
$425,000 (heads of households) or $450,000 (married couples filing jointly).
RETIREMENT - Retirement planning is one area that was only minimally affected by ATRA. However
that does not mean it should not be an important element in your tax planning this year. Tax
advantaged retirement plans can help you build and preserve your nest egg - but only if you
contribute as much as possible, carefully consider your traditional vs. Roth options, and are tax-smart when making withdrawals. Maximizing your contributions to a traditional plan could even keep you from being pushed into a higher tax bracket or becoming subject to the new 3.8% Medicare contribution tax on net investment income.
401(k)s and other employer plans - Contributing to a traditional employer-sponsored defined contribution plan is usually a good first step:
--Contributions are typically pretax, reducing your taxable income.
--Plan assets can grow tax-deferred — meaning you pay no income tax until you take distributions.
--Your employer may match some or all of your contributions pretax. The 2013 employee contribution
Because of tax-deferred compounding, increasing your contributions sooner rather than later can have a significant impact on the size of your nest egg at retirement. If, however, you’re age 50 or older and
didn’t contribute much when you were younger,
you may be able to partially make up for lost time with
“catch-up” contributions. If your employer offers
a match, at minimum contribute the amount necessary to get
the maximum match so you don’t miss out on that
Retirement Plan Contribution Limits for 2013 Chart - Build and preserve your nest egg with tax-smart planning:
Contribution Contribution (1)
Traditional and Roth IRAs $ 5,500 $ 1,000
401(k)s, 403(b)s, 457s and SARSEPs (2) $ 17,500 $ 5,500
SIMPLEs $ 12,000 $ 2,500
(1) For taxpayers age 50 or older by the end of the tax year.
(2) Includes Roth versions where applicable.
Note: Other factors may further limit your maximum contribution.
More tax-deferred options - In certain situations, other tax-deferred savings options may
You’re a business owner or
self-employed. You may be able to set up a
plan that allows you to make much larger contributions.
You might not have to make 2013 contributions, or even
set up the plan, before year end. Your employer
doesn’t offer a retirement plan. Consider a traditional
IRA. You can likely deduct your contributions, though
your deduction may be limited if your spouse participates in
an employer-sponsored plan. You can make 2013 contributions
as late as April 15, 2014.
Roth options - A potential downside of tax-deferred saving is that you’ll have to pay taxes when you make withdrawals at retirement. Roth plans, however, allow tax-free distributions; the tradeoff is that contributions to these plans don’t reduce your current-year taxable income:
1. Roth IRAs. Your annual contribution limit is reduced by any traditional IRA contributions you make
for the year. An income-based phase-out may also reduce or eliminate your ability to contribute.
Estate planning advantages are an added benefit: Unlike other retirement plans, Roth IRAs don’t
require you to take distributions during your life, so you can let the entire balance grow tax-free over
your lifetime for the benefit of your heirs.
2. Roth conversions. If you have a traditional IRA, consider whether you might benefit
from converting some or all of it to a Roth IRA. A conversion can allow you to turn tax-deferred
future growth into tax-free growth and take advantage of a Roth IRA’s estate planning benefits.
There’s no income-based limit on who can convert to a Roth IRA. But the converted amount is
taxable in the year of the conversion. Whether a conversion makes sense for you depends on factors
such as your age, whether the conversion would push you into a higher income tax bracket or trigger
the Medicare contribution tax on your net investment, whether you can afford to pay the tax on the
conversion, your tax bracket now and expected tax bracket in retirement, and whether you’ll need the
IRA funds in retirement.
3. “Back door” Roth IRAs. If the income-based phase-out prevents you from making Roth IRA
contributions and you don’t have a traditional IRA, consider setting up a traditional account and
making a nondeductible contribution to it. You can then wait until the transaction clears and convert
the traditional account to a Roth account. The only tax due will be on any growth in the account
between the time you made the contribution and the date of conversion.
4. Roth 401(k), Roth 403(b), and Roth 457 plans. If the plan allows it, you may designate some
or all of your contributions as Roth contributions. (Any employer match will be made to a traditional
plan.) No income-based phase-out applies, so even high-income taxpayers can contribute. Under
ATRA, plans can now more broadly permit employees to convert some or all of their existing
traditional plan to a Roth plan.
Early withdrawals - Early withdrawals from retirement plans generally should be a last resort. With a few exceptions, distributions before age 59½ are subject to a 10% penalty on top of any income tax that ordinarily would be due on a withdrawal. This means that you can lose a substantial amount to taxes and penalties. Additionally, you’ll lose the potential tax-deferred future growth on the withdrawn amount. If you must make an early withdrawal and you have a Roth account, consider withdrawing from that. You can withdraw up to your contribution amount free of tax and penalty. Another option, if your employer-sponsored plan allows it, is to take a plan loan. You’ll have to pay it back with interest and make regular principal payments, but you won’t be subject to current taxes or penalties.
Early distribution rules are also important to be aware of if you change jobs or retire and receive a lump-sum retirement plan distribution. To avoid the early-withdrawal penalty and other negative tax consequences, request a direct rollover from your old plan to your new plan or IRA. Otherwise, you’ll need to make an indirect rollover within 60 days to avoid tax and potential penalties. Warning: The check you receive from your old plan may be net of 20% federal income tax withholding. If you don’t roll over the gross amount (making up for the withheld amount with other funds), you’ll be subject to income tax — and potentially the 10% penalty — on the difference.
Required minimum distributions - After you reach age 70½, you must take annual required minimum distributions (RMDs) from your IRAs (except Roth IRAs) and, generally, from your defined contribution plans. If you don’t comply, you can owe a penalty equal to 50% of the amount you should have withdrawn but didn’t. You can avoid the RMD rule for a non-IRA Roth plan by rolling the funds into a Roth IRA. So, should you take distributions between ages 59½ and 70½, or take more than the RMD after age 70½? Distributions in any year your tax bracket is low may be beneficial. But also consider the lost future tax-deferred growth and, if applicable, whether the distribution could:
1. Cause your Social Security payments to become taxable
2. Increase income-based Medicare premiums and prescription drug charges, or
3. Affect other deductions or credits with income-based limits.
Warning: While retirement plan distributions aren’t subject to the health care act’s new 0.9% or 3.8% Medicare taxes, they are included in your modified adjusted gross income (MAGI) and thus could trigger or increase the 3.8% tax on net investment income, because the thresholds for that tax are based on MAGI.
If you’ve inherited a retirement plan, consult your tax advisor regarding the applicable distribution rules.
Estate planning may be a little less challenging now
that we have more certainty about the future of estate, gift
and generation-skipping transfer (GST) taxes. ATRA makes
exemptions and rates for these taxes, as well as certain
related breaks, permanent. Estate taxes will increase
somewhat, but not as much as they would have without the
legislation. And the permanence will make it easier to
determine how to make the most of your exemptions and keep
taxes to a minimum while achieving your other estate planning
goals. However, it’s important to keep in mind that
“permanent” is a relative term — it simply
means there are no expiration dates. Congress could still
pass legislation making estate tax law changes.
Estate tax - Under ATRA, for 2013 and future years, the top estate tax rate will be 40%. This is a five percentage point increase over the 2012 rate. But it’s significantly less than the 55% rate that was scheduled to return for 2013, and it’s still quite low historically. The estate tax exemption will continue to be an annually inflation-adjusted $5 million, so for 2013 it’s $5.25 million. This will provide significant tax savings over the $1 million exemption that had been scheduled to return for 2013. It’s important to review your estate plan in light of these changes. It’s possible the exemption and rate changes could have unintended consequences on your plan. A review will allow you to make the most of available exemptions and ensure your assets will be distributed according to your wishes.
Gift tax - The gift tax continues to follow the estate tax exemption and rates. Any gift tax exemption used during life reduces the estate tax exemption available at death. You can exclude certain gifts of up to $14,000 per recipient each year ($28,000 per recipient if your spouse elects to split the gift with you or you’re giving community property) without using up any of your gift tax exemption. This reflects an inflation adjustment over the $13,000 annual exclusion that had applied for the last few years. (The exclusion increases only in $1,000 increments, so it typically goes up only every few years.)
GST Tax - The GST tax generally applies to transfers (both during life and at death) made to people more than one generation below you, such as your grandchildren. This is in addition to any gift or estate tax due. The GST tax continues to follow the estate tax exemption and top rate. ATRA also preserved certain GST tax protections, including deemed and retroactive allocation of GST tax exemptions, relief for late allocations, and the ability to sever trusts for GST tax purposes.
State taxes - ATRA makes permanent the federal estate tax deduction (rather than a credit) for state estate taxes paid. Keep in mind that many states impose estate tax at a lower threshold than the federal
government does. To avoid unexpected tax
liability or other unintended consequences, it’s
critical to consider state law. Consult a tax advisor with
expertise on your particular state.
Tax-smart giving - Giving away assets now will help reduce the size of your taxable estate. Here are some strategies for tax-smart giving:
Choose gifts wisely. Consider both estate and income tax consequences and the economic aspects of any gifts you’d like to make:
To minimize estate tax, gift property with the greatest future appreciation potential.
To minimize your beneficiary’s income tax, gift property that hasn’t already appreciated significantly since you’ve owned it.
To minimize your own income tax, don’t gift property that’s declined in value. Instead, consider selling the property so you can take the tax loss and then gift the sale proceeds. Plan gifts to grandchildren carefully. Annual exclusion gifts are generally exempt from the GST tax, so they also help you preserve your GST tax exemption for other transfers. For gifts that don’t qualify for the exclusion to be tax-free, you generally must apply both your GST tax exemption and your gift tax exemption.
Gift interests in your business. If you own a business, you can leverage your gift tax exclusions and exemption by gifting ownership interests, which may be eligible for valuation discounts. So, for example, if the discounts total 30%, in 2013 you can gift an ownership interest equal to as much as $20,000 tax-free because the discounted value doesn’t exceed the $14,000 annual exclusion. Warning: The IRS may challenge the calculation; a professional, independent valuation is recommended.
Gift FLP interests. Another way to potentially benefit from valuation discounts is to set up a family limited partnership. You fund the FLP and then gift limited partnership interests.
Warning: The IRS scrutinizes FLPs, so be sure to set up and operate yours properly. Pay tuition and medical expenses. You may pay these expenses without the payment being treated as a taxable gift to the student or patient, as long as the payment is made directly to the provider.
SOMETHING NEW! - Exemption portability for married couples now permanent. Who’s affected? Married couples and their loved ones. Key changes: If one spouse dies and part (or all) of his or her estate tax exemption is unused at his or her death, the estate can elect to permit the surviving spouse to use the deceased spouse’s remaining estate tax exemption. Before ATRA, this “portability” had been available only if a spouse died in 2011 or 2012. And even this relief was somewhat hollow, because it provided a benefit only if the surviving spouse made gifts using the exemption, or died, by the end of 2012. ATRA makes portability permanent. Be aware, however, that portability is available only for the most recently deceased spouse, doesn’t apply to the GST tax exemption, isn’t recognized by some states, and must be elected on an estate tax return for the deceased spouse — even if no tax is due.
Planning tips: The portability election is simple and will provide flexibility if proper planning hasn’t been done before the first spouse’s death. But portability doesn’t protect future growth on assets from estate tax like applying the exemption to a credit shelter trust does. Trusts offer other benefits as well, such as creditor protection, remarriage protection, GST tax planning and state estate tax benefits. So married couples should still consider setting up marital trusts — and transferring assets to each other to the extent necessary to fully fund them. Transfers to a spouse (during life or at death) are tax-free under the marital deduction, assuming he or she is a U.S. citizen.
Make gifts to charity. Donations to qualified charities aren’t subject to gift taxes and may provide an income tax deduction.
Trusts can provide significant tax savings while
preserving some control over what happens to the transferred
assets. You may want to consider these:
A credit shelter (or bypass) trust can help minimize estate tax by taking advantage of both spouses’ estate tax exemptions.
A qualified terminable interest property (QTIP) trust can benefit first a surviving spouse and then children from a prior marriage.
A qualified personal residence trust (QPRT) allows you to give your home to your children today — removing it from your taxable estate at a reduced tax cost (provided you survive the trust’s term) — while you retain the right to live in it for a certain period.
A grantor-retained annuity trust (GRAT) works similarly to a QPRT but allows you to transfer other assets; you receive payments from the trust for a certain period. Finally, a GST — or “dynasty” — trust can help you leverage both your gift and GST tax exemptions, and it can be an excellent way to potentially lock in the currently high exemptions.
Insurance - Along with protecting your family’s financial future, life insurance can be used to pay estate taxes, equalize assets passing to children who aren’t involved in a family business, or pass leveraged funds to heirs free of estate tax. Proceeds are generally income-tax-free to the beneficiary. And with proper planning, you can ensure proceeds aren’t included in your taxable estate.