2013 Year-End Outlook: Higher Taxes Are Here
/2013 has been a big year for taxes. Earlier in the year, Congress passed legislation averting the so-called "fiscal cliff," and many of the "Obamacare" changes have taken effect, or are about to. While few of us who watched the process would consider it Washington's finest hour, we now have answers to many of the questions that have made proactive planning so difficult over the past few years. And now, as the end of the year draws close, it's time to pull out the Magic Eight Ball and start to plan.
Here are the highlights:
• First, the Bush tax cuts are permanently extended for income up to $400,000 ($450,000 for joint filers). Ordinary income above those thresholds is taxed at 39.6%, while qualified corporate dividends and long-term capital gains above those thresholds are taxed at 20%.
• Third, the Alternative Minimum Tax has finally been indexed for inflation. This means Congress will no longer have to "patch" it every year to avoid entangling millions more taxpayers in its web.
Fund Your SIMPLE IRA
You can defer up to $12,000 of your salary to your SIMPLE IRA this year, plus $2,500 more if you're over age 50. Maximizing your SIMPLE IRA contribution can help assure your retirement security as well as cut this year's tax.
Fund Your Employer's 401k Plan
You can defer up to $17,500 of your salary to your 401k this year, plus $5,500 more if you're over age 50. Maximizing your 401k contribution can help assure your retirement security as well as cut this year's tax. Alternatively, if your plan allows it, choosing a "Roth" deferral can provide tax-free income in retirement.
Fund Your SEP Plan
You can contribute up to 25% of pay or $51,000, whichever is greater, into a SEP-IRA. (But beware; you'll also have to cover most employees.) Maximizing your SEP contribution can help assure your retirement security as well as cut this year's tax.
Fund Your Business's 401k Plan
You can defer up to $17,500 of your salary to your 401k this year, plus $5,500 more if you're over age 50. You can also make an employer matching or profit-sharing contribution of up to 25% of your pay or $33,500, whichever is greater. Maximizing your 401k contribution can help assure your retirement security as well as cut this year's tax. Alternatively, if your plan allows it, choosing a "Roth" deferral can provide tax-free income in retirement.
New Roth IRA Conversion Opportunity
New rules now let you convert your traditional IRA to a Roth IRA, regardless of your current income. This is actually one of the bright spots of the of the current tax picture.
Traditional tax planning holds that it makes sense to defer income into retirement accounts now, when you're in your peak earning years (and highest tax bracket) - then withdraw it later during retirement, when your income and tax bracket will presumably be lower. However, tax rates are currently at historic lows, and it's entirely possible they will be higher when you're retired. This suggests the smarter strategy may be to pay tax on retirement funds now in order to withdraw them tax-free when rates are higher.
New Tax on Interest Income
The healthcare reform act imposes a new "Unearned Income Medicare Contribution" of 3.8%, beginning on January 1, 2013, on interest income. This tax may make municipal bonds and money market funds more attractive relative to fully taxable vehicles. However, the recent economy has jeopardized state and local tax revenues, so there may be credit quality issues to consider. You might also consider deferred annuities and permanent life insurance for fixed-income portions of your portfolio.
New Tax on Dividend Income
Tax on "qualified corporate dividends" is now capped at 20% for income exceeding $400,000 ($450,000 for joint filers). The healthcare reform act also imposes a new "Unearned Income Medicare Contribution" of 3.8% on dividend income for individuals earning over $200,000 ($250,000 for joint filers). Consider favoring stocks that pay little or no dividend in taxable accounts and holding stocks paying higher dividends in tax-deferred accounts.
Permanent Life Insurance for Tax-Free Income
As mentioned earlier, the healthcare reform act imposes a new "Unearned Income Medicare Contribution" of 3.8% on "investment income" (broadly defined to include interest, dividends, capital gains, rents, royalties, and annuity distributions) for individuals making over $200,000 ($250,000 for joint filers). Permanent life insurance offers a variety of investment options for accumulating cash values, along with tax-free withdrawals and loans so long as you keep the policy in force.
New Tax on Real Estate Income
The healthcare reform act imposes an "unearned income Medicare contribution" of 3.8% on income from real estate investments and taxable gains from the sale of your primary residence, for individuals making over $200,000 ($250,000 for joint filers). There are several strategies you can use to minimize taxable real estate income, including favoring tax-deductible "repairs" over depreciable "improvements" and cost segregation strategies to maximize depreciation deductions.
Higher Tax on Capital Gains
Tax on long-term capital gains (from sales of property you hold more than 12 months) is now capped at 20% for income exceeding $400,000 ($450,000 for joint filers). The recent healthcare reform act also imposes a new "Unearned Income Medicare Contribution" of 3.8% on capital gains for individuals earning over $200,000 and families earning over $250,000. When you plan to sell appreciated assets, check with us first, to discuss if you can use tax-free exchanges, installment sales, charitable trusts, or similar strategies to minimize or even eliminate tax on those sales.
Estate Tax Uncertainty Resolved
The estate tax has veered from zero (in 2010) to 35% on estates exceeding a $5 million "unified credit" (2011-2012). The "fiscal cliff" bill keeps the unified credit at $5 million, indexes it for inflation (so the actual credit is $5.25 million for 2013), and raises the rate to 40% on assets above that threshold. This means that smart estate planning will still be a part of affluent families' financial plans.
Next Steps
We're sure you appreciate this brief outline of the recent tax changes. While smart information is crucial, intelligence alone is useless without the right action. If the changes we've discussed so far have you worried about your financial future, you owe it to yourself to take a more comprehensive look at your taxes and finances, so that we can determine exactly which concepts and strategies will work from here. Give us a call!
Sincerely,
Larry Stone
Any tax advice contained in the body of this presentation was not intended or written to be used, and cannot be used, by the recipient for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code or applicable state or local tax law provisions.