We don't want to pay any more taxes than we have to. That means taking advantage of every strategy, deduction and credit that we qualify for. However, the window of opportunity closes December 31. It's important to evaluate your tax situation now, while there's still time to affect your bottom line.
Consider opportunities you have to defer income. For example, you may be able to defer a year-end bonus, or delay the collection of accounts payable until 2014. Doing so may allow you to put off paying tax on the income until next year. If there's a chance that you'll be in a lower income tax bracket next year, deferring income could mean paying less tax on that income as well.
Similarly, consider ways to accelerate deductions. If you itemize, then you might accelerate deductible expenses like medical expenditures, qualifying interest, state and local taxes or, making a year end charitable contribution.
What if I'll be in a higher tax bracket in 2014?
If you know you'll be paying taxes at a higher rate next year (for example, an out-of-work spouse will be reentering the workforce in January), you might take the opposite approach. Consider whether it makes sense to accelerate income into 2013, and to postpone deductible expenses until 2014.
Factoring Alternative Minimum Tax (AMT)
Make sure that you factor in the AMT. If you're subject to AMT, traditional year-end maneuvers, like deferring income and accelerating deductions, can have a negative effect because the AMT-essentially a separate federal income tax system with its own rates and rules-effectively disallows a number of itemized deductions. For example, if you're subject to the AMT in 2013, prepaying 2014 state and local taxes won't help your 2013 tax situation, but could hurt your 2014 bottom line.
Landscape changed for high-income individuals
Most individuals will pay federal income taxes for 2013 based on the same federal income tax brackets that applied for 2012 (10%, 15%, 25%, 28%, 33%, and 35%). The same goes for the maximum tax rate that generally applies to long-term capital gains and qualifying dividends (for those in the 10% or 15% marginal income tax brackets, a special 0% rate generally applies. For those in the 25%, 28%, 33%, and 35% brackets, a 15% maximum rate will generally apply).
Starting this year, however, a new 39.6% federal income tax rate applies if your taxable income exceeds $400,000 ($450,000 if married filing jointly, $225,000 if married filing separately, $425,000 if filing as head of household). If your income crosses that threshold, you'll also be subject to a new 20% maximum tax rate on
long-term capital gains and qualifying dividends.
You could see a difference even if your income doesn't reach that level. That's because, if your adjusted gross income (AGI) is more than $250,000 ($300,000 if married filing jointly, $150,000 if married filing separately, $275,000 if filing as head of household), your personal and dependency exemptions may be phased out this year, and your itemized deductions may be limited.
Two new Medicare taxes need to be accounted for this year as well. If your wages exceed $200,000 this year ($250,000 if married filing jointly or $125,000 if married filing separately), the hospital insurance (HI) portion of the payroll tax-commonly referred to as the Medicare portion- increased by 0.9%. Also, a new 3.8% Medicare contribution tax now applies to some or all of your net investment income if your modified adjusted gross income (MAGI) exceeds these dollar thresholds.
Retirement plans are key
Make sure that you're taking full advantage of tax-advantaged retirement savings plans. Traditional IRAs (assuming that you qualify to make deductible contributions) and employer-sponsored retirement programs such as 401(k) plans allow you to contribute pretax funds, reducing your 2013 taxable income. Contributions you make to a Roth IRA (assuming you meet the income requirements) or a Roth 401(k) aren't deductible, so there's no tax benefit for 2013, but qualified Roth distributions are
completely free from federal income tax-making these retirement saving plans
For 2013, you can contribute up to $17,500 to a 401(k) plan ($23,000 if you're age 50 or older), and up to $5,500 to a traditional IRA or Roth IRA ($6,500 if age 50 or older). The window to make 2013 contributions to an employer plan typically closes at the end of the year, while you generally have until the due date of your 2013
federal income tax return to make 2013 IRA contributions.
Big changes to note
Home office deduction rules: Starting with the 2013 tax year, those who qualify to claim a home office deduction can elect to use a new simplified calculation method; under this optional method, instead of determining and allocating actual expenses, the square footage of the home office is simply multiplied by $5. There's a cap of 300 square feet, so the maximum deduction under this method is $1,500. Not everyone can use the optional method, and there are some potential disadvantages. However, for many the new simplified calculation method is a welcome alternative.
More health-care reform changes take effect in 2014: Beginning next year, you'll be required to have adequate health-care coverage or face a tax penalty. However, a number of exceptions apply. A new premium tax credit will also be available to qualifying individuals.
A number of key provisions are scheduled to expire at the end of 2013. These include:
Increased Internal Revenue Code (IRC) Section 179 expense limits and "bonus" depreciation provisions end.
The increased 100% exclusion of capital gains from the sale or exchange of qualified small business stock (provided certain requirements, including a five-year holding period, are met) will not apply to qualified small business stock issued and acquired after 2013.
The above-the-line deductions for qualified higher education expenses, and for up to $250 of out-of-pocket classroom expenses paid by education professionals, will not be available after the 2013 tax year.
If you itemize deductions, 2013 will be the last year you'll be able to deduct state and local sales tax in lieu of state and local income tax.
Once you reach age 70½, start taking required minimum distributions (RMDs) from traditional IRAs and employer-sponsored retirement programs (special rules apply if you're still working and participating in your workplace retirement plan). You have to make the required withdrawals by the due date - end of the year for most individuals-or a 50% penalty tax applies.
Absent new legislation, 2013 will be the last year you'll be able to make qualified charitable contributions (QCDs) of up to $100,000 from an IRA directly to a qualified charity if you're 70½ or older. These distributions may be excluded from income and count toward satisfying RMDs you would otherwise have to receive from your IRA in 2013.
Talk to a professional
When it comes to year-end tax planning, there's always a lot to think about. A financial professional can help you evaluate your situation, keep you apprised of any legislative changes, and determine if any year-end strategies make sense for you.
For more information or advice contact the author by email or call 1-800-980-3048.
Rev. Dr. John C. Bryant, Ph.D., MBA, RFC®, QKA™, ALB, ACS is an American family man, author, consultant, entrepreneur and speaker who is intentional about the practice of personal development. Dr. Bryant provides fee-only advisory services from his home office based in the Pacific Northwest where he integrates education, financial consulting, and other professional services to help his private client group of individuals, families, and small organizations live their life, achieve their goals, and leave their legacy. Dr. Bryant is publisher of the new book, Personal Financial Planning and articles at www.BryantWealthManagement.com.
Chris Bryant is an American financial advisor.