Although there is more tax certainty in 2013 than in recent years, there are still many new challenges when it comes to thinking about year-end tax planning. The American Taxpayer Relief Act of 2012 (ATRA) and many tax provisions of the Patient Protection and Affordable Care Act of 2010 (PPACA) take effect this year. Since many of the provisions go into effect when adjusted gross income (AGI), modified adjusted gross income (MAGI), or taxable income are over certain thresholds, much of the focus on planning for this year revolves around managing those thresholds, or finding ways to reduce your tax bite if you are over the threshold.
Some of the more important provisions taking effect in 2013 are:
- Return of the 39.6 percent ordinary income tax bracket and 20 percent capital gains rate for taxpayers with taxable income over $400,000 ($450,000 for couples)
- New Net Investment Income Tax (NIIT) of 3.8 percent for taxpayers with MAGI over $200,000 ($250,000 for couples)
- Medicare Surtax on earned income of 0.9 percent for taxpayers with more than $200,000 ($250,000 for couples) of earned income
- Phase-out of itemized deductions and personal exemptions for taxpayers with AGI above $250,000 ($300,000 for couples)
If you find yourself above these thresholds, here are six ideas to consider that can help reduce your income:
- Invest in tax free municipal bonds. If you are subject to the top tax bracket and the NIIT of 3.8 percent, tax free bonds become much more attractive and help keep the thresholds outlined above lower. Similarly, investing in tax efficient index funds can help accomplish the same goals.
- Make charitable contributions from your IRA. If you are over age 70½, you can make charitable contributions directly from an IRA until the end of 2013 and exclude the amount of your IRA distribution from your income. Note that you cannot also take a charitable deduction; however, this technique lowers your AGI and you get the benefit of the full reduction if you are subject to the phase-out for itemized deductions.
- Boost retirement plan savings. Increase your elective deferrals and contributions to your qualified retirement plans.
- Take advantage of capital losses. If you have large capital gains, and if they are in line with your overall investment strategy, consider harvesting unrealized capital losses. However, you need to be wary of wash sale rules.
- Defer income. If you are not subject to the alternative minimum tax, consider deferring income such as a year-end bonus to next year. This strategy could keep you below some of the thresholds outlined above. Or, if this still will not keep you below the thresholds, you can at least defer paying the tax on that income for one more year since rates are not currently scheduled to increase in 2014.
- Check out an HSA. If you participate in a qualifying high deductible health plan, consider making or increasing contributions to a health savings account (HSA). These contributions can be deducted in adjustments to gross income, thereby decreasing your AGI. Withdrawals from HSAs are tax free if used for qualified medical expenses.
Tax planning gets more challenging each year, and these ideas are just a few of the ways you can reduce your tax bill. Please contact one of the professionals in our Tax Strategies group to discuss the techniques that work best for you.