Year-End Planning: Take Advantage of Expiring Tax Breaks

Year-end tax planning in 2013 presents some new challenges and opportunities for high-net-worth individuals.  Taxpayers need to be aware of various changes to the tax laws that took effect on January 1, 2013, as a well as certain tax breaks that are set to expire on December 31, 2013.

The top income tax bracket is now 39.6% (up from 35%), beginning at taxable income of $400,00 for unmarried individuals or $450,000 for married couples filing jointly. The to prate for capital gains and qualified dividends is now 20% (up from 15%).

The pre-Bush era phase outs of itemized deductions and personal exemptions have been revived, beginning at adjusted gross income (AGI) of $250,000 for unmarried individuals or $300,000 for joint filers.  Furthermore, the deduction of unreimbursed medical expenses is now subject to a “floor” of 10 percent of AGI; however, through 2016, individuals age 65 and older may still deduct expenses in excess of the old 7.5% floor.

There is a new 3.8% surtax on the lesser of “net investment income,” such as interest, individuals or $250,000 for joint filers.  There is also a new .9% Medicare tax for individuals receiving wages or self-employment income in excess of those thresholds.

Year-End Strategies

• Estimated Tax Payments: Many taxpayers did not take the new rates, taxes, limitations and phaseouts into account when making estimated payments earlier this year and may be subject to underpayment penalties.  The penalties can be reduced (although usually not eliminated entirely) by increasing the final 2013 estimated payment, which is due by January 15, 2014.
• Timing income and expenses: If you can control the timing of income and expenses, you may have an opportunity to reduce the tax bite.  The typical strategy is to defer taxes by pushing income into future years and accelerating expenses into future years and accelerating expenses into the current year.  However, that strategy is not ideal for everyone.  You should project income and expenses and assess the impact of recognizing them in 2013 versus 2014.  The analysis should consider the extent to which you will be subject to the new taxes and limitations, as well as the Alternative Minimum Tax.
• Charitable contributions: If you expect an unusual amount of income in 2013, and you are charitably inclined, you should consider making charitable contributions to offset the income.  The charitable deduction is limited to 50%, 30% or 20% of AGI, depending on the type of organization (public charity, private foundation, etc.) you donate to and the type of property you contribute (cash or appreciated property). You may carry the non-deductible portion forward for up to five years.
• Tax-free gifts:  Each taxpayer may gift up to $14,000 annually per donee ($28,000 if the taxpayer’s spouse elects to “split” the gift).  In addition, you may make an unlimited amount of gifts for another individual’s health or education, provided the gift is made directly to the educational institution or healthcare provider.  These gifts are an easy way to transfer wealth to family members without using the estate and lifetime gift tax exemption, which is currently $5.25 million and will be increasing to $5.34 million per person starting in 2014.
• Retirement contributions: It is not too late to create a retirement plan for 2013 and contribute. Doing so can reduce your overall taxable income.