2013 Year-End Tax Planning for Individuals

As we near the end of 2013, now is an excellent time of year to review the opportunities for reducing your tax burden. In this article, we will look at strategies to assist individuals with their year-end planning. We will not be able to cover all of the items you should consider, so please contact your tax advisor to learn the best ways to minimize your tax liability for 2013 and beyond.

Starting with 2013, taxpayers will experience an increase in tax rates. The top marginal rate increases to 39.6%. Many taxpayers will have 3% of their itemized deductions shaved off, and many will pay capital gains tax at 20% instead of 15%. Therefore, the traditional timing strategies of deferring income and accelerating deductions can reduce — tax. Beware of the alternative minimum tax (AMT), however. If the AMT applies to you, the opposite timing strategy would be used. Planning which involves a two-year period should be done to determine how to minimize the alternative minimum tax and achieve the lowest overall tax for the two-year period.

In addition to the rise in existing tax rates, the Patient Protection and Affordable Care Act enacted two new taxes. Beginning in 2013, those with earned income more than $200,000 ($250,000 for joint filers) will pay an additional 0.9% Medicare surtax on earned income in excess of the threshold. Employers are obligated to withhold this tax beginning in the pay period in which wages exceed $200,000. This is without regard to your filing status, spouse’s wages or income from other sources. So your employer might withhold the tax even if you aren’t liable for it, or they might not withhold the tax even though you are liable for it. If you do not owe the tax, but your employer is withholding it, you can claim a credit on your 2013 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 underpayment interest and penalty.

The other new tax is a 3.8% Medicare surtax on net investment income such as interest, dividends, rents, royalties and certain capital gains. This surtax applies to taxpayers with adjusted gross income (AGI) over $200,000 ($250,000 for joint filers). Strategies that reduce AGI can mitigate this surtax. Some of the strategies for reducing AGI are:

Invest in municipal bonds to generate tax-free income. Look for unrealized losses in your investment portfolio and consider selling them to offset your gains. Also consider moving investments from high-yielding dividend paying stocks to growth stocks that do not pay dividends or that pay lower dividends. Be sure to balance the tax consequences with sound investment decisions.

Consider making a distribution from your retirement plan directly to a qualified charity. For 2013, a maximum of $100,000 can be transferred. This can satisfy the required minimum distribution requirement yet won’t be included in income. However, it will not provide a charitable deduction.

Wealth transfer planning may help mitigate the cost of the surtax to wealthy individuals, as the gift of primary income or net income producing property will transfer the asset from the donor, thereby reducing overall net income. A similar strategy can be used to give to charity—gifting income or property to a charity can reduce the donor’s net income.

For asset sales, consider installment sales or like-kind exchanges. Members in businesses organized as flow-through entities can explore reorganizing as an S corporation. It is easier for a shareholder of an S Corporation to avoid classification of their income as investment income subject to the additional tax. This idea is explored more in the next article on business tax planning.

The preceding ideas are certainly not all-inclusive. To achieve the best tax outcome, please start your planning now. At minimum, a projection should be prepared so you know how the new taxes are going to impact you. Bartlett, Pringle & Wolf will assist you with ideas that work for your situation. Should you have any questions, please contact me at (805) 963-7811 or eboscacci@bpw.com.