Graves
& Company, P.C.
Certified Public
Accountants and Financial Advisors
Tax Planning Guide
2016 - 2017
Tax planning for the 2012 tax year was a major
challenge because of the uncertainty as to whether
significant tax increases scheduled for 2013 would go into
effect. On Jan. 1, 2013, Congress passed the
American Taxpayer
Relief Act of
2012 (ATRA), which prevented income tax rate increases
for most taxpayers and addressed many expired tax
breaks. However, ATRA did not provide as much
relief to higher-income taxpayers. Many will see rate
hikes on income exceeding certain thresholds. Expanded
Medicare taxes will also affect higher-income taxpayers this
year. Even though many of ATRA’s provisions are
suppose to be permanent, this simply means that the
provisions do not have expiration dates. Congress can still
pass additional changes affecting your tax liability this
year or in future years. For this, and many other
reasons, tax planning continues to be a complicated and
critical task. The following information is intended to
help you familiarize yourself with key tax law changes and to
make the most of the tax-savings opportunities available to
you. Feel free to contact us regarding clarification or
to obtain additional strategies for 2014 and beyond.
DEDUCTIONS AND
ALTERNATIVE MINIMUM TAX (AMT)
Should tax law changes affect your planning this
year? ATRA made lower ordinary-income tax
rates permanent for most taxpayers, but some, previously in
the 35% bracket, now face the 39.6% rate’s return. ATRA
also brought back a reduction on many deductions. It
kicks in when adjusted gross income (AGI) exceeds $250,000
(singles), $275,000 (heads of households) or $300,000 (joint
filers). Whether or not you’re affected by these tax
increases, you may want to implement the traditional timing
strategies of deferring income and accelerating
deductible expenses to reduce, or at least defer, tax.
The Alternative Minimum Tax (AMT) - When
planning for deductions, the first step is to consider the
AMT — a separate tax system that limits some deductions
and doesn’t permit others, such as state and local
income tax deductions, property tax deductions, and
miscellaneous itemized deductions subject to the 2% of AGI
floor (for example, investment expenses and unreimbursed
employee business expenses). You must pay the AMT if
your AMT liability exceeds your regular tax liability. You
may be able to time income and deductions to avoid the AMT,
reduce its impact or even take advantage of its lower maximum
rate. ATRA has made planning a little easier because it
includes long-term AMT relief. Before the act,
unlike the regular tax system, the AMT system wasn’t
regularly adjusted for inflation. Instead, Congress had to
legislate any adjustments. Typically, it did so via an
increase in the AMT exemptions. ATRA has set higher
exemptions permanently, indexing them — as well as the
AMT brackets — for inflation going forward.
Home-related breaks - Consider both
deductions and exclusions:
Property tax deduction. Before paying your
bill early to accelerate the itemized deduction into
2013, review your AMT situation. If you’re subject to
the AMT, you’ll lose the benefit of the deduction for
the prepayment.
Mortgage interest deduction. You
generally can deduct interest on up to a combined total of $1
million of mortgage debt incurred to purchase, build or
improve your principal residence and a second
residence. Points paid related to your residence also
may be deductible.
Home equity debt interest deduction.
Interest on home equity debt used for any
purpose (debt limit of $100,000) may be deductible. So
consider using a home equity loan or line of credit to pay
off credit cards or auto loans, for which interest
isn’t deductible and rates may be higher.
Warning: Beware of the AMT — if
the home equity debt isn’t used for home improvements,
the interest isn’t deductible for AMT purposes.
Home office deduction. If your use of
a home office is for your employer’s benefit and
it’s the only use of the space, you generally can
deduct a portion of your mortgage interest, property taxes,
insurance, utilities and certain other expenses, as well as
the depreciation allocable to the office space. Or
you may be able to take the new, simpler, “safe
harbor” deduction. (Contact your tax advisor for
details.) Home office expenses are a miscellaneous itemized
deduction, which means you’ll enjoy a tax benefit
only if these expenses plus your other miscellaneous itemized
expenses exceed 2% of your AGI.
SOMETHING NEW! Additional Medicare
tax now applies to higher earners. Who’s
affected? Taxpayers with earned
income exceeding certain thresholds.
Key changes: Under the health
care act, starting in 2013, taxpayers must pay an additional
0.9% Medicare tax on FICA wages and self-employment
income exceeding $200,000 per year ($250,000 for
joint filers and $125,000 for married filing separately).
Employers are obligated to withhold the additional
tax beginning in the pay period when wages exceed $200,000
for the calendar year — without regard to an
employee’s filing status or income from other sources.
So your employer might withhold the tax even if you
aren’t liable for it — or it might not withhold
the tax even though you are liable for
it.
Planning tips: You may be able
to implement timing strategies to avoid or minimize the
additional tax. If you don’t owe the tax but
your employer is withholding it, you can claim a credit on
your 2013 income tax return. If you do owe the tax
but your employer isn’t withholding it, consider filing
a W-4 to request additional income tax withholding,
which can be used to cover the shortfall and avoid
interest and penalties.
Home sale gain exclusion. When you sell your
principal residence, you can exclude up to $250,000 ($500,000
for joint filers) of gain if you meet certain tests.
Warning: Gain that’s allocable to a
period of “nonqualified” use generally
isn’t excludable.
Home sale loss deduction. Losses on the sale
of a principal residence aren’t deductible. But if part
of your home is rented or used exclusively for your business,
the loss attributable to that portion will be deductible,
subject to various limitations.
Debt forgiveness exclusion. Homeowners who
receive debt forgiveness in a foreclosure, short sale or
mortgage workout for a principal residence generally
don’t have to pay federal income taxes on that
forgiveness. Warning: As of this writing,
this break is scheduled to expire after 2013.
Rental income exclusion. If you rent out all
or a portion of your principal residence or second home for
less than 15 days, you don’t have to report the income.
But expenses directly associated with the rental, such as
advertising and cleaning, won’t be deductible.
Health-care-related breaks - If your medical
expenses exceed 10% of your AGI, you can deduct the excess
amount. Eligible expenses include health insurance premiums,
long-term care insurance premiums (limits apply), medical and
dental services, and prescription drugs. Consider
“bunching” non-urgent medical procedures and
other controllable expenses into one year to exceed the
10% floor.
Warning: Before 2013, the floor
was only 7.5% for regular tax purposes, making it easier to
exceed. Taxpayers age 65 and older can still enjoy that 7.5%
floor through 2016. The floor for AMT purposes, however, is
10% for all taxpayers (the same as it was before 2013).
Also remember that expenses that are reimbursed (or
reimbursable) by insurance or paid through one of the
following accounts aren’t deductible:
1. HSA. If you’re covered by
qualified high-deductible health insurance, a Health Savings
Account
allows contributions of pretax
income (or deductible after-tax contributions) up to $3,250
for self-
only coverage and $6,450 for
family coverage (for 2013), plus an additional $1,000 if
you’re age 55 or
older. HSAs bear interest or
are invested and can grow tax-deferred similar to an IRA.
Withdrawals
for qualified medical expenses
are tax-free, and you can carry over a balance from year to
year.
2. FSA. You can redirect pretax income
to an employer-sponsored Flexible Spending Account up to
an employer-determined limit
— not to exceed $2,500 for plan years beginning in
2013. The plan
pays or reimburses you for
qualified medical expenses. What you don’t use by the
end of the plan
year, you generally lose. If
you have an HSA, your FSA is limited to funding certain
“permitted”
expenses.
Charitable donations - Donations to
qualified charities are generally fully deductible for both
regular tax and AMT purposes, and they may be the easiest
deductible expense to time to your tax advantage. For large
donations, discuss with your tax advisor which assets to give
and the best ways to give them. For example:
Appreciated assets. Publicly traded
stock and other securities you’ve held more than one
year can make one of the best charitable gifts. Why? Because
you can deduct the current fair market value and avoid the
capital gains tax you’d pay if you sold the property.
Warning: Donations of such
property are subject to tighter deduction limits. Excess
contributions can be carried forward for up to five
years.
Charitable Remainder Trust's (CRT).
For a given term, a charitable remainder trust
pays an amount to you annually (some of which generally is
taxable). At the term’s end, the CRT’s
remaining assets pass to one or more charities. When
you fund the CRT, you receive an income tax deduction.
If you contribute appreciated assets, you also can
minimize and defer capital gains tax. You can name
someone other than yourself as income beneficiary or fund the
CRT at your death, but the tax consequences will be
different.
FAMILY AND
EDUCATION:
If you’re a parent, a student or even a grandparent,
valuable deductions, credits and tax-advantaged savings
opportunities may be available to you or to your family
members. Some child- and education-related breaks had been
scheduled to become less beneficial in 2013, but the
tax-saving outlook is now brighter because ATRA extended most
enhancements — in many cases, making them
permanent.
Child and adoption credits - Tax credits
reduce your tax bill dollar-for-dollar, so make sure
you’re taking every credit you’re entitled to.
For each child under age 17 at the end of the year, you may
be able to claim a $1,000 child credit.
2013 family and education tax breaks: Are you
eligible?
Tax Break Single Filer Joint Filer
Child Credit
(1)
$75,000 -
$95,000
$110,000 - $130,000
Child or Dependent Care Credit
(2)
$15,000 -
$43,000
$194,580 - $234,580
ESA
Contribution
$95,000 -
$110,000
$190,000 - $220,000
American Opportunity
Credit
$80,000 -
$90,000
$160,000 - $180,000
Lifetime Learning
Credit
$53,000 -
$63,000
$107,000 - $127,000
Student Loan Interest
Deduction
$75,000 -
$125,000
$125,000 - $155,000
(1) Assumes one child. The phase-out end is higher for
families with more than one eligible child.
(2) The phase-out is based on AGI rather than
MAGI. The credit does not phase out altogether, but
the minimum credit
percentage of 20% applies to AGIs above $43,000.
If you adopt in 2013, you may qualify for an adoption credit
or an employer adoption assistance program income exclusion;
both are $12,970 per eligible child. Some enhancements to
these credits had been scheduled to expire after 2012, but
ATRA made them permanent. (Contact your tax advisor for
details.)
Warning:
These credits phase out for
higher-income taxpayers.
Child care expenses - A couple of
tax breaks can help you offset these costs:
Tax credit. For children under age 13 or
other qualifying dependents, you may be eligible for a credit
for a portion of your dependent care expenses. Eligible
expenses are limited to $3,000 for one dependent and $6,000
for two or more. Income-based limits reduce the credit but
don’t phase it out altogether. The credit’s
value had been scheduled to drop in 2013, but ATRA made
higher limits permanent.
FSA. You can contribute up to $5,000 pretax
to an employer-sponsored child and dependent care Flexible
Spending Account. The plan pays or reimburses you for these
expenses. You can’t use those same expenses to claim a
tax credit.
Individual Retirement Accounts
(IRAs) for teens - IRAs can be perfect for
teenagers because they likely will have many years to let
their accounts grow tax-deferred or tax-free. The 2013
contribution limit is the lesser of $5,500 (up from $5,000 in
2012) or 100% of earned income. Traditional IRA contributions
generally are deductible, but distributions will be taxed. On
the other hand, Roth IRA contributions aren’t
deductible, but qualified distributions will be
tax-free. Choosing a Roth IRA is typically a no-brainer
if a teen doesn’t earn income that exceeds the standard
deduction ($6,100 for 2013 for single taxpayers), because he
or she will likely gain no benefit from the ability to deduct
a traditional IRA contribution. If your children or
grandchildren do not want to invest their hard-earned money,
consider giving them the amount they’re eligible to
contribute — but keep the gift tax in mind. If they
don’t have earned income and you own a business,
consider hiring them. As the business owner, you can deduct
their pay, and other tax benefits may apply.
Warning: The children must be paid in line
with what you’d pay nonfamily employees for the same
work.
Kiddie Tax - The “kiddie tax”
applies to children under age 19 as well as to full-time
students under age 24 (unless the students provide more than
half of their own support from earned income).
For children subject to the tax, any unearned
income beyond $2,000 (for 2013) is taxed at their
parents’ marginal rate rather than their own, likely
lower, rate. Keep this in mind before transferring
income-generating assets to them.
529 plans - If you’re saving for
college, consider a Section 529 plan. You can choose a
prepaid tuition program to secure current tuition rates or a
tax-advantaged savings plan to fund college expenses:
--Contributions aren’t deductible for federal purposes,
but plan assets can grow tax-deferred.
--Distributions used to pay qualified expenses (such as
tuition, mandatory fees, books, equipment,
supplies and, generally, room and
board) are income-tax-free for federal purposes and
typically
for state purposes as well.
--The plans typically offer high contribution limits, and
there are no income limits for contributing.
--There’s generally no beneficiary age limit for
contributions or distributions.
--You remain in control of the account, even after the child
is of legal age.
--You can make tax-free rollovers to another qualifying
family member.
--The plans provide estate planning benefits: A special break
for 529 plans allows you to front-load
five years’ worth of annual gift tax
exclusions and make a $70,000 contribution (or $140,000 if
you
split the gift with your spouse).
The biggest downsides may be that your investment options
— and when you can change them — are limited.
Education credits and deductions - If you
have children in college now, are currently in school
yourself or are paying off student loans, you may be eligible
for a credit or deduction:
American Opportunity credit. This tax break
covers 100% of the first $2,000 of tuition and related
expenses and 25% of the next $2,000 of expenses. The maximum
credit, per student, is $2,500 per year for the first four
years of postsecondary education. The credit had been
scheduled to revert to the less beneficial Hope credit after
2012, but ATRA extended the enhanced credit through 2017.
Lifetime Learning credit. If you’re
paying postsecondary education expenses beyond the first four
years, you may be eligible for the Lifetime Learning credit
(up to $2,000 per tax return).
Tuition and fees deduction. If you
don’t qualify for one of the credits because your
income is too high, you might be eligible to deduct up to
$4,000 of qualified higher education tuition and fees.
Warning: ATRA extended this break only
through 2013.
Student loan interest deduction. If
you’re paying off student loans, you may be able to
deduct up to $2,500 of interest (per tax return). ATRA made
certain enhancements to the deduction permanent; contact your
tax advisor for details.
Warning: Income-based phase
outs apply to these breaks, and expenses paid with
distributions from 529 plans or ESAs (see “What’s
new!” above) can’t be used to claim
them.
Tax planning for investments gets even more
complicated this year 30 days before or
after you sell the security that created the loss.
You can recognize the loss only when you sell the
replacement security.
Fortunately, there are ways to avoid triggering the wash sale
rule and still achieve your goals. For example, you can
immediately buy securities of a different company in the same
industry or shares in a mutual fund that holds securities
much like the ones you sold. Or, you may wait 31 days to
repurchase the same security. Alternatively, before selling
the security, you can purchase additional shares of that
security equal to the number you want to sell at a loss, and
then wait 31 days to sell the original portion.
Swap your bonds. With a bond swap, you sell
a bond, take a loss and then immediately buy another bond of
similar quality and duration from a different issuer.
Generally, the wash sale rule doesn’t apply because the
bonds aren’t considered substantially identical. Thus,
you achieve a tax loss with virtually no change in economic
position.
Mind your mutual funds. Mutual funds with
high turnover rates can create income that’s taxed at
ordinary-income rates. Choosing funds that provide primarily
long-term gains can save you more tax dollars because of the
lower long-term rates.
See if a loved one qualifies for the 0%
rate. ATRA made permanent the 0% rate for
long-term gain that would be taxed at 10% or 15% based on the
taxpayer's ordinary-income rate. If you have adult
children in one of these tax brackets, consider transferring
strategy can be even more powerful if you would be subject to
the 3.8% Medicare contribution tax or the 20% long-term
capital gains rate if you sold the assets.
Warning: If the child will be under
age 24 on Dec. 31, first make sure he or she won’t be
subject to the “kiddie tax.” Also, consider
any gift tax consequences.
SOMETING NEW! - Will you owe the 3.8% Medicare tax on
investment income? Who’s affected?
Investors with income exceeding certain
thresholds.
Key changes: Under the health care
act, starting in 2013, taxpayers with modified adjusted gross
income (MAGI) over $200,000 per year ($250,000 for joint
filers and $125,000 for married filing separately) may owe a
new Medicare contribution tax, also referred to as the
“net investment income tax” (NIIT). The tax
equals 3.8% of the lesser of your net investment income or
the amount by which your MAGI exceeds the applicable
threshold. The rules on what is and isn’t included in
net investment income are somewhat complex, so consult your
tax advisor for more information.
Planning tips: Many of the strategies
that can help you save or defer income tax on your
investments can also help you avoid or defer NIIT liability.
And because the threshold for the NIIT is based on MAGI,
strategies that reduce your MAGI — such as making
retirement plan contributions — can also help you avoid
or reduce NIIT liability.
Loss carryovers - If net losses exceed net
gains, you can deduct only $3,000 ($1,500 for married
taxpayers filing separately) of the net losses per year
against ordinary income (such as wages, self-employment and
business income, and interest). You can carry
forward excess losses indefinitely. Loss carryovers can be a
powerful tax-saving tool in future years if you have a large
investment portfolio, real estate holdings or a closely held
business that might generate substantial future capital
gains. But if you don’t expect substantial future
gains, it could take a long time to fully absorb a large loss
carryover. So, from a tax perspective, you may not want to
sell an investment at a loss if you won’t have enough
gains to absorb most of it. (Remember, however, that capital
gains distributions from mutual funds can also absorb capital
losses.) Plus, if you hold on to the investment, it may
recover the lost value. Nevertheless, if
you’re ready to divest yourself of a poorly performing
investment because you think it will continue to lose value
— or because your investment objective or risk
tolerance has changed — don’t hesitate solely for
tax reasons.
Beyond gains and losses - With some types of
investments, you’ll have more tax consequences to
consider than just gains and losses:
Dividend-producing investments. ATRA made
permanent the favorable long-term capital gains tax treatment
of qualified dividends. Such dividends had been scheduled to
return to being taxed at higher, ordinary-income tax rates in
2013.
Warning: Higher-income
taxpayers will still see a tax increase on qualified
dividends if they’re subject to the new 3.8% Medicare
contribution tax (see “What’s new!” on page
11) or the return of the 20% long-term capital gains
rate.
Interest-producing investments. Interest
income generally is taxed at ordinary-income rates. So, in
terms of income investments, stocks that pay qualified
dividends may be more attractive tax-wise than, for example,
CDs or money market accounts. But nontax issues must be
considered as well, such as investment risk and
diversification.
Bonds. These also produce interest income,
but the tax treatment varies:
--Interest on U.S. government bonds is taxable on federal
returns but generally exempt on state and
local returns.
--Interest on state and local government bonds is excludable
on federal returns. If the bonds were
issued in your home state, interest also may be
excludable on your state return.
--Tax-exempt interest from certain private-activity municipal
bonds can trigger or increase the
alternative minimum tax (AMT — see page 2)
in some situations.
--Corporate bond interest is fully taxable for federal and
state purposes.
--Bonds (except U.S. savings bonds) with original issue
discount (OID) build up “interest” as they
rise
toward maturity. You’re generally
considered to earn a portion of that interest annually
— even
though the bonds don’t pay this interest
annually — and you must pay tax on it.
Stock options. Before exercising (or
postponing exercise of) options or selling stock purchased
via an exercise, consult your tax advisor about the
complicated rules that may trigger regular tax or AMT
liability. He or she can help you plan accordingly.
What’s the maximum capital gains tax
rate?
Assets
held:
2012
2013
(1)
12 months or less (short term)
35%
39.6% 2 (2)
More than 12 months (long term)
15%
20% 2 (2)
Some key
exceptions:
Long-term gain on collectibles, such as artwork and antiques
28%
28%
Long-term gain attributable to certain recapture of
prior depreciation on real property
25%
25%
Long-term gain that would be taxed at 15% or less based
on
the taxpayer’s ordinary-income rate
0%
0%
(1) In addition, under the 2010 health care act, a new 3.8%
Medicare contribution tax applies to net
investment income to the
extent that modified adjusted gross income (MAGI) exceeds
$200,000
(singles and heads of households)
or $250,000 (married couples filing jointly).
(2) Rate increase over 2012 applies only to those with
taxable income exceeding $400,000 (singles),
$425,000 (heads of households)
or $450,000 (married couples filing jointly).
RETIREMENT - Retirement planning is one area
that was only minimally affected by ATRA. However
that does not mean it should not be an important element in
your tax planning this year. Tax
advantaged retirement plans can help you build and preserve
your nest egg - but only if you
contribute as much as possible, carefully consider your
traditional vs. Roth options, and are tax-smart when making
withdrawals. Maximizing your contributions to a
traditional plan could even keep you from being pushed into a
higher tax bracket or becoming subject to the new 3.8%
Medicare contribution tax on net investment income.
401(k)s and other employer plans -
Contributing to a traditional employer-sponsored defined
contribution plan is usually a good first step:
--Contributions are typically pretax, reducing your taxable
income.
--Plan assets can grow tax-deferred — meaning you pay
no income tax until you take distributions.
--Your employer may match some or all of your contributions
pretax. The 2013 employee contribution
limits.
Because of tax-deferred compounding, increasing your
contributions sooner rather than later can have a significant
impact on the size of your nest egg at retirement. If,
however, you’re age 50 or older and
didn’t contribute much when you were younger,
you may be able to partially make up for lost time with
“catch-up” contributions. If your employer offers
a match, at minimum contribute the amount necessary to get
the maximum match so you don’t miss out on that
“free” money.
Retirement Plan Contribution Limits for 2013 Chart - Build
and preserve your nest egg with tax-smart planning:
Regular
Catch-up
Contribution
Contribution
(1)
Traditional and Roth
IRAs
$
5,500
$ 1,000
401(k)s, 403(b)s, 457s and SARSEPs
(2)
$
17,500 $
5,500
SIMPLEs
$
12,000
$ 2,500
(1) For taxpayers age 50 or older by the end of the tax
year.
(2) Includes Roth versions where applicable.
Note: Other factors may further limit your maximum
contribution.
More tax-deferred options - In certain situations,
other tax-deferred savings options may
be available:
You’re a business owner or
self-employed. You may be able to set up a
plan that allows you to make much larger contributions.
You might not have to make 2013 contributions, or even
set up the plan, before year end. Your employer
doesn’t offer a retirement plan. Consider a traditional
IRA. You can likely deduct your contributions, though
your deduction may be limited if your spouse participates in
an employer-sponsored plan. You can make 2013 contributions
as late as April 15, 2014.
Roth options - A potential downside of
tax-deferred saving is that you’ll have to pay taxes
when you make withdrawals at retirement. Roth plans, however,
allow tax-free distributions; the tradeoff is that
contributions to these plans don’t reduce your
current-year taxable income:
1. Roth IRAs. Your annual
contribution limit is reduced by any traditional IRA
contributions you make
for the year. An income-based
phase-out may also reduce or eliminate your ability to
contribute.
Estate planning advantages are an
added benefit: Unlike other retirement plans, Roth IRAs
don’t
require you to take distributions
during your life, so you can let the entire balance grow
tax-free over
your lifetime for the benefit of
your heirs.
2. Roth conversions. If you have
a traditional IRA, consider whether you might benefit
from converting some or all of
it to a Roth IRA. A conversion can allow you to turn
tax-deferred
future growth into tax-free growth
and take advantage of a Roth IRA’s estate planning
benefits.
There’s no income-based limit
on who can convert to a Roth IRA. But the converted amount
is
taxable in the year of the
conversion. Whether a conversion makes sense for you depends
on factors
such as your age, whether the
conversion would push you into a higher income tax bracket or
trigger
the Medicare contribution tax on
your net investment, whether you can afford to pay the tax on
the
conversion, your tax bracket now and
expected tax bracket in retirement, and whether you’ll
need the
IRA funds in retirement.
3. “Back door” Roth IRAs.
If the income-based phase-out prevents you from making
Roth IRA
contributions and you don’t
have a traditional IRA, consider setting up a traditional
account and
making a nondeductible contribution
to it. You can then wait until the transaction clears and
convert
the traditional account to a Roth
account. The only tax due will be on any growth in the
account
between the time you made the
contribution and the date of conversion.
4. Roth 401(k), Roth 403(b), and Roth 457
plans. If the plan allows it, you may
designate some
or all of your contributions as
Roth contributions. (Any employer match will be made to a
traditional
plan.) No income-based phase-out
applies, so even high-income taxpayers can contribute.
Under
ATRA, plans can now more broadly
permit employees to convert some or all of their existing
traditional plan to a Roth plan.
Early withdrawals - Early withdrawals from
retirement plans generally should be a last resort. With a
few exceptions, distributions before age 59½ are
subject to a 10% penalty on top of any income tax that
ordinarily would be due on a withdrawal. This means that you
can lose a substantial amount to taxes and penalties.
Additionally, you’ll lose the potential tax-deferred
future growth on the withdrawn amount. If you must make
an early withdrawal and you have a Roth account, consider
withdrawing from that. You can withdraw up to your
contribution amount free of tax and penalty. Another option,
if your employer-sponsored plan allows it, is to take a plan
loan. You’ll have to pay it back with interest and make
regular principal payments, but you won’t be subject to
current taxes or penalties.
Early distribution rules are also important
to be aware of if you change jobs or retire and receive a
lump-sum retirement plan distribution. To avoid the
early-withdrawal penalty and other negative tax consequences,
request a direct rollover from your old plan to your new plan
or IRA. Otherwise, you’ll need to make an
indirect rollover within 60 days to avoid tax and potential
penalties. Warning: The check you receive from your old plan
may be net of 20% federal income tax withholding. If you
don’t roll over the gross amount (making up for the
withheld amount with other funds), you’ll be subject to
income tax — and potentially the 10% penalty — on
the difference.
Required minimum distributions - After you
reach age 70½, you must take annual required minimum
distributions (RMDs) from your IRAs (except Roth IRAs) and,
generally, from your defined contribution plans. If you
don’t comply, you can owe a penalty equal to 50% of the
amount you should have withdrawn but didn’t. You can
avoid the RMD rule for a non-IRA Roth plan by rolling the
funds into a Roth IRA. So, should you take
distributions between ages 59½ and 70½, or take
more than the RMD after age 70½? Distributions in any
year your tax bracket is low may be beneficial. But also
consider the lost future tax-deferred growth and, if
applicable, whether the distribution could:
1. Cause your Social Security payments to become
taxable
2. Increase income-based Medicare premiums and
prescription drug charges, or
3. Affect other deductions or credits with
income-based limits.
Warning: While retirement plan
distributions aren’t subject to the health care
act’s new 0.9% or 3.8% Medicare taxes, they are
included in your modified adjusted gross income (MAGI) and
thus could trigger or increase the 3.8% tax on net investment
income, because the thresholds for that tax are based on
MAGI.
If you’ve inherited a retirement plan,
consult your tax advisor regarding the applicable
distribution rules.
Estate planning may be a little less challenging now
that we have more certainty about the future of estate, gift
and generation-skipping transfer (GST) taxes. ATRA makes
exemptions and rates for these taxes, as well as certain
related breaks, permanent. Estate taxes will increase
somewhat, but not as much as they would have without the
legislation. And the permanence will make it easier to
determine how to make the most of your exemptions and keep
taxes to a minimum while achieving your other estate planning
goals. However, it’s important to keep in mind that
“permanent” is a relative term — it simply
means there are no expiration dates. Congress could still
pass legislation making estate tax law changes.
Estate tax - Under ATRA, for 2013 and future
years, the top estate tax rate will be 40%. This is a five
percentage point increase over the 2012 rate. But it’s
significantly less than the 55% rate that was scheduled to
return for 2013, and it’s still quite low
historically. The estate tax exemption will continue to
be an annually inflation-adjusted $5 million, so for 2013
it’s $5.25 million. This will provide significant tax
savings over the $1 million exemption that had been scheduled
to return for 2013. It’s important to review your
estate plan in light of these changes. It’s possible
the exemption and rate changes could have unintended
consequences on your plan. A review will allow you to make
the most of available exemptions and ensure your assets will
be distributed according to your wishes.
Gift tax - The gift tax continues to follow
the estate tax exemption and rates. Any gift tax
exemption used during life reduces the estate tax exemption
available at death. You can exclude certain gifts of up
to $14,000 per recipient each year ($28,000 per recipient if
your spouse elects to split the gift with you or you’re
giving community property) without using up any of your gift
tax exemption. This reflects an inflation adjustment over the
$13,000 annual exclusion that had applied for the last few
years. (The exclusion increases only in $1,000 increments, so
it typically goes up only every few years.)
GST Tax - The GST tax generally applies to
transfers (both during life and at death) made to people more
than one generation below you, such as your grandchildren.
This is in addition to any gift or estate tax due. The GST
tax continues to follow the estate tax exemption and top
rate. ATRA also preserved certain GST tax protections,
including deemed and retroactive allocation of GST tax
exemptions, relief for late allocations, and the ability to
sever trusts for GST tax purposes.
State taxes - ATRA makes permanent the
federal estate tax deduction (rather than a credit) for state
estate taxes paid. Keep in mind that many states impose
estate tax at a lower threshold than the federal
government does. To avoid unexpected tax
liability or other unintended consequences, it’s
critical to consider state law. Consult a tax advisor with
expertise on your particular state.
Tax-smart giving - Giving away assets now
will help reduce the size of your taxable estate. Here are
some strategies for tax-smart giving:
Choose gifts wisely. Consider both
estate and income tax consequences and the economic aspects
of any gifts you’d like to make:
To minimize estate tax, gift property with
the greatest future appreciation potential.
To minimize your beneficiary’s income
tax, gift property that hasn’t already
appreciated significantly since you’ve owned it.
To minimize your own income tax, don’t
gift property that’s declined in value. Instead,
consider selling the property so you can take the tax loss
and then gift the sale proceeds. Plan gifts to
grandchildren carefully. Annual exclusion gifts
are generally exempt from the GST tax, so they also help you
preserve your GST tax exemption for other transfers. For
gifts that don’t qualify for the exclusion to be
tax-free, you generally must apply both your GST tax
exemption and your gift tax exemption.
Gift interests in your business. If
you own a business, you can leverage your gift tax exclusions
and exemption by gifting ownership interests, which may be
eligible for valuation discounts. So, for example, if the
discounts total 30%, in 2013 you can gift an ownership
interest equal to as much as $20,000 tax-free because the
discounted value doesn’t exceed the $14,000 annual
exclusion. Warning: The IRS may challenge the calculation; a
professional, independent valuation is recommended.
Gift FLP interests. Another way to
potentially benefit from valuation discounts is to set up a
family limited partnership. You fund the FLP and then gift
limited partnership interests.
Warning: The IRS
scrutinizes FLPs, so be sure to set up and operate yours
properly. Pay tuition and medical expenses. You may pay
these expenses without the payment being treated as a taxable
gift to the student or patient, as long as the payment is
made directly to the provider.
SOMETHING NEW! - Exemption
portability for married couples now permanent.
Who’s affected? Married couples and their
loved ones. Key changes: If one spouse dies and part
(or all) of his or her estate tax exemption is unused at his
or her death, the estate can elect to permit the surviving
spouse to use the deceased spouse’s remaining estate
tax exemption. Before ATRA, this “portability”
had been available only if a spouse died in 2011 or 2012. And
even this relief was somewhat hollow, because it provided a
benefit only if the surviving spouse made gifts using the
exemption, or died, by the end of 2012. ATRA makes
portability permanent. Be aware, however, that
portability is available only for the most recently deceased
spouse, doesn’t apply to the GST tax exemption,
isn’t recognized by some states, and must be elected on
an estate tax return for the deceased spouse — even if
no tax is due.
Planning tips: The portability
election is simple and will provide flexibility if proper
planning hasn’t been done before the first
spouse’s death. But portability doesn’t protect
future growth on assets from estate tax like applying the
exemption to a credit shelter trust does. Trusts offer other
benefits as well, such as creditor protection, remarriage
protection, GST tax planning and state estate tax benefits.
So married couples should still consider setting up marital
trusts — and transferring assets to each other to the
extent necessary to fully fund them. Transfers to a spouse
(during life or at death) are tax-free under the marital
deduction, assuming he or she is a U.S. citizen.
Make gifts to charity. Donations to
qualified charities aren’t subject to gift taxes and
may provide an income tax deduction.
Trusts -
Trusts can provide significant tax savings while
preserving some control over what happens to the transferred
assets. You may want to consider these:
A credit shelter (or bypass) trust can help minimize
estate tax by taking advantage of both
spouses’ estate tax exemptions.
A qualified terminable interest property
(QTIP) trust can benefit first a surviving spouse
and then children from a prior marriage.
A qualified personal residence trust (QPRT)
allows you to give your home to your children today —
removing it from your taxable estate at a reduced tax cost
(provided you survive the trust’s term) — while
you retain the right to live in it for a certain period.
A grantor-retained annuity trust (GRAT)
works similarly to a QPRT but allows you to transfer other
assets; you receive payments from the trust for a certain
period. Finally, a GST — or “dynasty”
— trust can help you leverage both your gift and GST
tax exemptions, and it can be an excellent way to potentially
lock in the currently high exemptions.
Insurance - Along with protecting your
family’s financial future, life insurance can be used
to pay estate taxes, equalize assets passing to children who
aren’t involved in a family business, or pass leveraged
funds to heirs free of estate tax. Proceeds are generally
income-tax-free to the beneficiary. And with proper planning,
you can ensure proceeds aren’t included in your
taxable estate.