There is a little more certainty in year-end tax planning than we had last year. Tax rates in 2014 are expected to remain comparable to 2013 and Congress is not currently in heavy debate over significant changes like we saw at the end of last year when the legislation spilled into the beginning of this year. While we have had time to lament over the new 2013 rules involving phase-outs of itemized deductions and personal exemptions, increased income tax rates and new Medicare surtaxes, we expect surprised taxpayers when the numbers hit the tax returns this upcoming filing season. WBL is always happy to “run the numbers” as part of year-end planning for our clients, so please contact us. In the meantime, here are some thoughts that you might find useful.
Ordinary Income Tax Rates
In 2013, for those individuals with taxable income of over $400,000, or joint filers over $450,000, or heads of households over $425,000, the tax rate for ordinary income over those thresholds will be taxed at 39.6% rather than 35%. For taxable income under those thresholds, 2013 tax rates will be comparable to 2012. Clearly if one can manage taxable income to stay under the thresholds in 2013 and 2014, the impact of this additional tax can be avoided. Please let us know if you believe you will be close to these thresholds and we can discuss strategies.
Capital Gains/Qualified Dividends
For taxpayers above the same $400,000/$425,000/$450,000 thresholds noted above, the top federal rate for long-term capital gains and qualified dividends will be 20% in 2013 versus 15% in 2012. For those under these thresholds, the same 2012 tax rates apply. Again, managing income to stay under the thresholds if possible might be beneficial. Also, selling investment assets to realize capital losses before year-end and managing holding periods to avoid short-term gains remain good strategies for many. Both these ideas might be challenging given the run-up in the stock markets this year.
As a reminder, dividends are generally eligible for the lower tax rates as “qualified dividends” if they are received from a domestic corporation or a qualified foreign corporation, on which the underlying stock is held for at least 61 days within a specified 121-day period.
The 25% tax rate for certain real estate gains and the 28% tax rate for sales of collectibles remain unchanged.
Medicare Surtax on Investment Income
New this year from the Affordable Care Act (ACA) is the 3.8% Medicare surtax on net investment income (NII) for those with AGI of $200,000 ($250,000 joint filers). The tax equals 3.8% of the lesser of NII or the excess of modified AGI over the $200,000/$250,000 thresholds.
NII generally includes most capital gains, interest, dividends and income from passive activities (including real estate income for those not considered “real estate professionals”). Gains from a trade or business are generally excluded from NII as is tax-free income such as interest income on municipal bonds. Taxpayers with multiple businesses/activities who are subject to the Medicare surtax should consider whether to take advantage of recently-finalized regulations that allow taxpayers to make an election in 2013 to regroup certain businesses/activities in order to aggregate the hours spent on such businesses/activities and convert potential passive activities to non-passive. The passive activity rules are complicated and such an election must be made with caution given its possible impact on future dispositions.
Limitation on Itemized Deductions and Exemptions
High income taxpayers have to reduce certain otherwise allowable itemized deductions by 3% of the amount by which their adjusted gross income (AGI) exceeds an applicable threshold. They also have their personal exemptions phased out by 2% for each $2,500 of AGI in excess of the applicable threshold. The applicable AGI thresholds for 2013 are: $300,000 for joint filers, $275,000 for heads of households and $250,000 for singles. For those affected, this is a hidden tax increase. The prior law capping the reduction of itemized deductions to 80% was retained in the law.
The Section 179 expensing deduction for certain fixed asset acquisitions is $500,000 for 2013, subject to a $2 million investment limit, and there remains the 50% bonus depreciation for many other fixed asset acquisitions placed in service in (calendar year) 2013. Unless Congress acts, Section 179 is scheduled to drop to $25,000 in 2014, subject to a $200,000 investment limit, and the 50% bonus depreciation is set to expire. While we hope that favorable changes in this area are forthcoming for 2014, there is no guarantee this will happen and therefore the race is on to place fixed assets into service by year-end.
Final Repair/Capitalization Regulations
The IRS recently issued final regulations that explain when taxpayers must capitalize costs and when they can deduct expenses for acquiring, maintaining, repairing and replacing tangible property. While the regulations are effective January 1, 2014, there is an election available to apply them retroactive to 2012. Also, it is important to note that in order to apply the de minimis expensing alternative discussed in the regulations, a written policy must be in place before January 1, 2014. See our summary of these regulations with other important information at on our blog.
2013 “Extenders” That May Expire
More than 50 temporary tax provisions were extended through 2013 but are currently set to expire in 2014. And there is little sign that we will get any relief from Congress for 2014 until 2014, if ever. So take advantage of them while you can. On the individual side, these include (among others): Child tax credit, dependent care credit, certain tuition credits and deductions, exclusion of income from cancellation of mortgage debt, IRA distributions for charity for those older than 70-1/2 years old, state and local sales tax deductions, and certain energy credits. On the business side, the extenders that are scheduled to expire at the end of 2013 (among others) include: research tax credit, work opportunity tax credit, 100% exclusion for gain on sale of qualified small business stock and the reduced recognition period to five years for S Corporation built-in gains tax.
To reduce your estate, you can give up to $14,000 tax-free in 2013 to as many donees as you want without reducing your estate and lifetime gift tax exclusion amount. In addition, because spouses may combine their exemptions in a single gift from either spouse, married givers may double the amount of the exclusion to $28,000 per donee. Qualifying tuition payments and medical payments do not count against this limit. The annual exclusion will be $14,000 in 2014 as well. Plus, the lifetime exclusion will increase to $5.34 million in 2014 from $5.25 million, enabling those who had previously gifted the lifetime maximum to gift another $90,000 in addition to the annual exclusion amounts.
Other “Typical” Tax Savings Strategies
Given that income tax rates for 2014 will be comparable to 2013, most taxpayers will generally benefit from the typical tax strategies we have discussed in previous years. For example, consider strategies for deferring income and accelerating expenses for cash basis businesses, taking advantage of one or more of the many retirement vehicles available and “bunching” certain expenses such as medical expenses into one year if doing so will put you over the limits and enable a tax benefit. For taxpayers who plan to make charitable contributions before year end, consider donating appreciated securities rather than cash. You reap the benefit of the same charitable contribution deduction, subject to certain limitations, without recognizing the gain on securities for tax purposes. Also, it continues to be important to monitor the impact of the alternative minimum tax (AMT) with its parallel tax system that disallows certain expenses such as real estate taxes while taxing certain otherwise tax-free income such as interest from municipal private activity bonds. Your WBL professionals are available to explain these in more detail and run the numbers.
A Race For Georgia Incentives:
Because Georgia has capped the total amount of certain tax credits that it will provide, taxpayers are encouraged to get applications filed as soon as possible before the credits get used up in 2014. For example, Georgia has set aside $58 million for tax credits for contributions made to Student Scholarship Organizations (SSO). Now that owners of S corporations, LLCs and partnerships can contribute up to $10,000 in a year, while other individuals can contribute up to $2,500 (joint filers) or $1,000 (singles), it is widely expected that the cap will be reached in early January and SSOs are encouraging that applications be completed before year-end. A similar race is expected for Georgia companies in the gaming industry who are vying for the $25 million in credits available with tax returns filed in early 2014. Contact WBL for more information about these and other tax incentives.
There are other year-end strategies that might be more specific to your situation. If you have any questions or if we can help in any way, please contact us. In the meantime, we will continue to monitor the tax impact of what goes on in Washington with respect to any changes to the ACA, the budget talks underway to avoid another government shutdown and other legislation.