Opportunities and Pitfalls for Your 2013 Return

As we approach the end of 2013, it is in your best interest to be aware of the many opportunities and pitfalls that could affect your 2013 income tax return! At the same time, it may be advantageous to also look ahead to what we know about 2014 to aid in your year-end tax strategies. Contact us to set up a year-end planning session and review of your status to aid in effective planning. In this letter we will provide you with some areas that may affect you or your business in 2013 and 2014.

We began 2013 with the passage of “The American Tax Relief Act of 2012”, which provided after-the-fact relief for 2012, as well as notice of provisions of the “Bush-era tax cuts” which had been extended to 2013, and in some cases, beyond. The effects of the 2010 “Affordable Care Act” are also beginning to affect many taxpayers. The purpose of this newsletter is to alert you to potential opportunities and hazards as 2013 comes to an end.

Individuals

Persons with earned incomes over $200,000 will experience several increases to their tax bite. Married couples with incomes in excess of $250,000 ($200,000 for singles) will be assessed a “Hospital Insurance” tax (Medicare) of .009 on their earned income in excess of the threshold. This increased Medicare tax does not affect the Employer portion of the Medicare Tax. Employers will have already been withholding some of this increased tax.

In addition, the investment income of these individuals will be subject to an additional “Hospital Insurance” net investment income tax of 3.8%. Investment income includes capital gains, dividends, rental income, and the income from a business if you are a passive participant, and even the gain on sale of a personal residence which exceeds the excludable amount!

For married couples with taxable incomes of $450,000 ($400,000 for singles) there is a new tax bracket of 39.6%. Faced with these higher taxes you may need to increase tax withholding or pay additional estimated taxes at year-end. We can help with these calculations. The favorable capital gains rate increases from 15% to 20% for these taxpayers, as well.

In addition to higher taxes and tax rates, married couples with adjusted gross incomes over $300,000 (even less for other filing statuses) will begin to lose the deduction for exemptions. Coupled with this is the reduction of itemized deductions at these levels of adjusted gross income. It is most imperative that critical attention be given to the amount of Adjusted Gross Income. Most tax benefits and credits have limits or phase-outs based on Adjusted Gross Income. In most cases, Adjusted Gross Income coupled with your filing status is the starting point for effective tax planning. (See accompanying charts)

Let’s take a look at some tax saving ideas that relate to lowering your total income:

  • Wages – Is it possible to delay year-end bonuses?For the closely held corporation (especially if thefiscal year differs from a calendar year) theauthority to defer a year-end bonus is alreadythere. However, in the case of a “Personal ServiceCorporation”, this is not advisable.
  • Interest – In those cases where you control thetiming of the annual payment of interest; is adeferral possible? Perhaps those loans to theclosely held corporation, requiring annual interestpayments could schedule the annual payment tobe made in 2014.
  • Dividends – If annual dividends haven’t beendeclared, consider donating the stock or giving itto a charity, if the new “Net Investment Income”surtax is a consideration. Otherwise, the lowertax rates on qualified dividends may work to youradvantage.
  • Self-employment considerations – We will discussunder the “Business” headline
  • Capital Gains – Since capital gains continue to betaxed at more favorable rates, it may behoove youto recognize built-in gains at year-end to takeadvantage of these rates. If you are carryingforward capital losses from prior years, there iseven more reason to use current year capitalgains to utilize these losses. Keep in mind torecognize short-term capital gains first, since theyare taxed at ordinary income tax rates. Capital gains are considered investment income and ALL investment income should be monitored to stay below the thresholds for the “Net Investment Income” surtax.
  • Rental Income – Accelerate repairs andreplacements into the current year.
  • Social Security Income – If part of your SocialSecurity is taxable and you are required to takeminimum distributions, consider donating yourminimum distribution to your favorite charity.This move eliminates the inclusion of the amountin income, but also removes the contribution fromItemized Deductions.

The next step would be to address those items deducted from Total Income to arrive at Adjusted Gross Income. Here we have several options:

Teachers – There is a special deduction which has been extended and available for elementary and secondary education school teachers. The deduction on the front of Form 1040 is limited to $250, but it reduces Adjusted Gross Income, which is important for many other tax provisions which may be available to you. Amounts in excess of $250 can be deducted as Itemized Deductions on Schedule A, if you itemize deductions.

Retirement Savings Options – Depending upon you (or your spouse’s) participation in an employer’s qualified plan, the IRA contribution can provide a maximum deduction of $5,500 ($6,500, if over 50 years of age) per spouse. If you are self-employed, a Simplified Employee Pension (SEP) or Individual 401(k) plan can be established by year-end (return due date for SEP) which would allow larger contributions/deductions.

After considering the above strategies, we can estimate your Adjusted Gross Income. As we mentioned earlier, this is probably the most important figure on your tax return, because it is the measurement point for so many of the tax provisions and benefits available to you as a taxpayer.

The next step is the Standard Deduction, or if you qualify, the Itemized Deductions. The Standard Deduction amounts for 2013 are:

Married Filing Jointly, or a Qualified Widow(er) $12,200
Single 6,100
Head of Household 8,950
Married Filing Separately 6,100
Additional for Elderly/Blind – Married 1,200
Additional for Elderly/Blind – Single 1,500
Taxpayer who is claimed as a dependent on another return 1,000

The amount allowed for each exemption (dependent) is $3,900. Keep in mind; the amounts for Exemptions (Dependents) as well as Itemized Deductions are phased out when Adjusted Gross Income exceeds the following thresholds:

Married Filing Jointly, or a Qualified Widow(er) $300,000
Head of Household $275,000
$150,000
Married Filing Separately Single $250,000

Itemized Deductions –

  • The threshold for deducting medical expenses hasbeen raised from 7 ½ % of adjusted gross income to 10% of adjusted gross income for taxpayers under age 65. For those taxpayers (or their spouses) who are 65 and older the floor remains at 7 ½ % through 2016.

    The age-old strategy of marshaling these expenses by grouping in the current year or deferring to next year remains in effect.
  • The deduction for state and local sales tax has notbeen extended beyond 2013. While it is politically popular, its continued existence is not guaranteed. Consider a major purchase in 2013 (auto, boat, motor home) to assure the availability.
  • The deduction of mortgage insurance premiumsas qualified residence interest is also expiring at the end of 2013.
  • Miscellaneous Itemized Deductions. Here thereare the possibilities of several deductions, mostly subject to amounts in excess of 2% of adjusted gross income. Consider deductions such as unreimbursed employee business expenses, Investment expenses, job hunting costs, legal fees (where appropriate) and use of home or auto for business purposes. Based on your individual situation, we should explore any that may apply to your situation.
  • To further emphasize the importance of Adjusted Gross Income, the following are all affected by Adjusted Gross Income:

Adjusted Gross Income Threshold Begins At:

Adjusted Gross Income Thresholds

Same-Sex Marriage – On June 26, 2013, the U.S. Supreme Court struck down Section 3 of the Defense of Marriage Act (also known as DOMA), which had defined marriage for federal purposes as the union of one man and one woman as unconstitutional. For 2013 and beyond, all same-sex marriages are recognized for all federal tax purposes, regardless of whether or not a couple resides in a jurisdiction that recognizes same-sex marriage. Thus, all legally married same-sex couples will be treated as married for all federal tax purposes.

The above only addresses the regular income tax. Always hiding in the bushes is the Alternative Minimum Tax which each year reaches more and more taxpayers. Congress originally set up the Alternative Minimum Tax so that “wealthy” taxpayers could not escape taxation. However, due to inflation along with other factors, which had not been considered by Congress, the Alternative Minimum Tax has reached “down” to many middle class income taxpayers. While there are exemptions of $80,000 for married filing jointly and $51,900 for unmarried, the calculations prior to these exemptions are very technical. We can, as part of a year-end tax planning session, address these concerns.


In addition to changes in the tax law, year-end tax planning should also address any changes in personal circumstances that have occurred during 2013, or are that may change during 2014, such as:

  • Change in filing status: marriage, divorce, death,or head of household.
  • Birth or adoption of a child
  • Child no longer young enough for child credit
  • Child who no longer is subject to “kiddie” tax
  • Casualty losses
  • Changes in health conditions or medical expenses
  • Moving or relocation
  • College and other education expenses
  • Employment changes
  • Retirement
  • Personal bankruptcy
  • Large inheritance
  • Business success or failure

Expiring Tax Provisions

The following list includes some of the more popular individual tax provisions which are scheduled to expire December 31, 2013:

  • Educator’s Expenses – Up to $250 for grade K-12teachers, instructors, counselors, principals andaides.
  • Cancellation of Home Mortgage Debt – Up to $2million of cancellation of debt income on qualifiedpersonal residence mortgages.
  • Qualified mortgage insurance premiums treatedas mortgage interest.
  • Up to $500 tax credit (lifetime limit) forinvestment in qualified energy efficiencyexpenditures for a taxpayer’s principal residence.
  • Election to deduct state and local sales taxes asitemized deductions instead of state and localincome taxes paid.
  • Deduction of up to $4,000 for tuition and fees forqualified higher education expenses.
  • Charitable transfers of up to $100,000 from an IRAdirectly to a charity.

Business

Year-end planning for your business (whether incorporated or not) should involve all the traditional ways to time normal expenditures to fit your particular situation. Expenditures which can either be accelerated or deferred should be addressed. Keep in mind that several “extenders” will end at December 31, 2013, or be modified.

  • Section 179 Expensing – The expanded annualdollar limitation for 2013 is $500,000, beforebeing phased-out. This enhanced provision couldcreate a problem if the income limitation (itcannot create a loss) forces a carry-forward of theunused portion. Beginning after 2013 the dollarlimit will drop drastically to $25,000. The current$2 million ceiling drops to $200,000. Unusedcarry-forward could take years to absorb. A closelook at the profit situation of your business, alongwith its needs for Section 179 qualified propertyshould be discussed. One advantage of Section179 election is that it applies to pre-owned as wellas new property.
  • Bonus Depreciation – New property (with arecovery period of 20 years or less) is subject to50% deduction in 2013, unless it is elected to NOTbe taken. Unlike Section 179, there is no dollarlimitation and the move can create a netoperating loss. A net operating loss may not be toyour advantage, depending on the form ofownership of your business.
  • Expensing versus Capitalization of Repairs – IRShas just recently released the final regulationsregarding when and how taxpayers must treatcosts incurred for acquiring, maintaining,replacing, or repairing tangible property. Thesesweeping applications can challenge virtuallyevery business endeavor. We are prepared todiscuss how they apply to your business.
  • Work Opportunity Credit – This provision forhiring members of certain targeted groups expireson December 31, 2013 and the persons employedmust begin work before January 1, 2014.

There are many more opportunities and pitfalls awaiting the American Taxpayer. Why not contact us today and set up an appointment to review your specific situation?