2013 Tax Planning Advice From Fidelity

1040 tax returnFidelity Investing offers some great tax planning advice that you can use before the end of the year.  Every year, there are changes to the tax laws that may have a profound impact on your tax returns.


The 2013 federal tax code contains a large number of new items, with implications for taxpayers of nearly all income levels. So, now may be a good time to take a serious look at how the changes could affect your 2013 tax bill—and how some smart year-end tax planning could save you money when you file your tax return in 2013.

            First, a refresher

For most taxpayers, there’s no change to their ordinary income and capital gains rates. But tax rates for high earners have increased, including:

  • A new top marginal tax rate of 39.6% (it was 35% in 2012) on income above $400,000 for singles and $450,000 for married couples filing jointly
  • A new 20% tax rate on capital gains and qualified dividends (it was 15% in 2012) for taxpayers who are in the 39.6% marginal tax bracket

High-income taxpayers are also subject to limits on exemptions and deductions in 2013. The income threshold for the Pease and PEP (personal exemption phase-out) limitations is $300,000 in adjusted gross income (AGI) for joint filers and $250,000 for singles. The Pease limitation reduces the value of charitable contributions; mortgage interest; state, local, and property taxes; and miscellaneous itemized deductions. For 2013, this limitation is the lesser of 3% of AGI above the threshold up to 80% of the amount of the itemized deductions otherwise allowable. The PEP limitation reduces the total personal exemption by 2% for every $2,500 of income above the same income thresholds with no upper limitations. That means it’s possible for some taxpayers to completely phase-out of their personal exemptions.

Changes to the estate and gift tax structure are minimal. The federal estate exclusion will be adjusted for inflation going forward and is currently $5,250,000 in 2013, (up from $5 million in 2012) and the top rate on amounts above the exemption has been raised to 40%, from 35%.

In addition, tax provisions included in the Affordable Care Act went into effect in 2013. Specifically, taxpayers with modified adjusted gross income (MAGI) above $200,000 for singles and $250,000 for couples may owe:

  • An additional Medicare tax of 0.9% on income for those with MAGI above the thresholds
  • A Medicare surtax of 3.8% on the lesser of net investment income or MAGI above the thresholds

Also, legally-recognized same-sex marriages are now recognized for federal income tax purposes and Medicare benefits, after the U.S. Supreme Court struck down a key section of the federal Defense of Marriage Act (DOMA). Every same-sex legally married couple should examine their individual situation to determine the impact of various filing statuses on the amount of tax they will owe.

How can you be more tax efficient in light of these changes? Let’s take a look at some tax strategies to consider by the end of the year.

            Strategy 1: Reduce income

The simplest way to lower current-year taxes is by contributing to a 401(k), 403(b), governmental 457, traditional IRA, Simplified Employee Pension (SEP) plan, or other type of qualified retirement savings plan. Qualified contributions reduce your taxable income.

Consider contributing as much as you can to a 401(k), or at least enough to receive your full employer match—if one is offered. For 2013, the contribution limit increased by $500, to $17,500 if you’re under age 50, and to $23,000 if you’re age 50 or older.

Next, make a tax-deductible contribution to a traditional IRA, if you qualify. For 2013, the limits for tax deductibility are up to $59,000 in AGI for full deductibility if single and up to $95,000 for full deductibility if married, filing jointly; from $59,000 to $69,000 for partial deductibility if single, and from $95,000 to $115,000 for partial deductibility if married, filing jointly. In addition, full deductibility of a contribution is available for working or nonworking spouses who are not covered by an employer-sponsored plan whose MAGI is less than $178,000 for 2013; partial deductibility for MAGI up to $188,000. Contribution limits have increased for 2013 to $5,500 for taxpayers under 50, and $6,500 for those 50 and older. Self-employed individuals with a SEP, meanwhile, can contribute up to $51,000 or 20% of their adjusted earned income for 2013.

If you are still working, not using Medicare, and are enrolled in a high-deductible health plan (HDHP), another way to reduce taxable income is by contributing to a Health Savings Account (HSA). In 2013, you can contribute up to $3,250 annually as an individual, or $6,450 as a family. And if you’re age 55 or older, you can save an extra $1,000. Contributions are pretax and qualified withdrawals are also income tax free. Some employers are contributing to these accounts on behalf of their employees.

            Strategy 2: Manage capital gains and dividends

Minimizing exposure to the capital gains tax is even more important for some taxpayers, given the increase in the top rate to 20%, along with the new 3.8% Medicare surtax on net investment income. Taxpayers in the highest income tax bracket could owe as much as 23.8% in tax on their net investment income.

Be careful when selling highly appreciated assets, such as stocks, land, fine art, precious metals (including certain ETFs that invest in them), or antiques. Some of these are taxed as collectibles and are subject to higher capital gains taxes. A large capital gain could push you into a higher marginal income tax rate.

No matter what rate you pay, tax-efficient investing can be a smart strategy. One popular method for reducing taxable income is investing in municipal bonds or municipal bond funds whose earnings are not subject to federal tax. There are even municipal bond funds that seek to avoid exposure to the alternative minimum tax (AMT) as well. Another option is to consider tax-managed funds that keep capital gains and dividend payouts low.

Tax-loss harvesting is another possibility. If your investments have done well this year—as many investors’ have—you might want to consider selling securities that have lost value to help reduce capital gains elsewhere in your portfolio. If you end up with more capital losses than gains, you can use the remaining losses to offset ordinary income by up to $3,000, or you can carry them forward to offset capital gains and ordinary income in future years.

Be careful, however, not to put your desire to lower your taxes ahead of sound investing strategy. Typically, you should harvest losses only from depreciated assets that you were considering selling anyway, perhaps because they no longer fit into your diversified portfolio or because you anticipate that they will continue to decline in value. Here’s a hypothetical example. John is in the 15% capital gains tax bracket and has a long-term capital gain of $5,000 in Investment A, and a long-term capital loss of $3,000 in Investment B. Because, he can offset the $5,000 gain with a $3,000 loss, his net long-term gain on the sale of Investment A and Investment B is only $2,000, with a $300 federal capital gains tax. If he did not have the loss, the tax on his $5,000 long-term gain would be $750.

            Strategy 3: Be charitable

Another way to reduce your taxable income is to give to charity. It could be even more valuable if you donate highly appreciated assets that you have owned for at least a year. You could claim the current fair market value as a tax deduction (up to the allowable limits) without having to realize the gain as income on your tax return.

Consider this hypothetical example (shown in the chart to the right). Bill and Margaret own securities with long-term unrealized gains. They need to decide which giving strategy will work best: giving the securities directly to the charity (Scenario 1) or selling the securities and donating the proceeds to charity (Scenario 2). Let’s compare the potential tax benefits of each side by side.

If they sell the securities first, Scenario 2, and then donate the proceeds to charity, Bill and Margaret will pay a federal long-term capital gains tax of $7,140.

Now let’s look at what happens if they give their securities directly to their favorite charity (Scenario 1). With a direct donation to charity, the capital gains tax from selling the securities no longer applies. Bill and Margaret’s federal income taxes are reduced by an extra $9,967 and the charity receives an additional $7,140. Bill and Margaret will usually save more in taxes and do more good for their designated charity if they donate appreciated securities, instead of cash. On the flip side, if these long-term securities were at a loss, it might be better to sell the security first, realizing a loss (which could be used to offset future gains or income), and donate the proceeds as cash to potentially receive a charitable deduction.

A donor-advised fund, or DAF, enables you to maximize the allowable tax benefits and create a reserve of money that you can use now and ongoing to support charitable causes. For example, if you’re fortunate enough to have high capital gains or particularly high income in 2013—for a bonus, sale of a business, or Roth IRA conversion, for instance—you could contribute a large lump sum to a DAF (including a highly appreciated asset) to claim the tax-lowering charitable contribution this year, then have the fund spread out distributions to the charities of choice on a timetable that works for you.

If you’re age 70½ or older, another charity-related tax strategy to pay attention to this year is a provision that allows IRA owners to make a tax-free distribution to a qualified charity. Under current law, this provision will expire at the end of 2013, so you might not have another opportunity. Many retirees find this to be an attractive strategy because they claim the standard deduction rather than itemizing, which means they don’t typically receive a tax benefit for their charitable contributions. Plus, qualified distributions, up to $100,000, can count as a retiree’s minimum required distribution for the year. (Note: You cannot donate a tax-free IRA distribution to a DAF.)

            Strategy 4: Bunch and accelerate deductions

Several significant deductions that are on the books for 2013—but not beyond—include:

  • State sales tax deduction in lieu of state income tax deduction. This is popular in states with low or no state income tax.
  • Exclusion for debt forgiveness on foreclosed homes. Homeowners who were caught up in the foreclosure crisis are allowed to exclude up to $2 million (couples) or $1 million (singles) in debt that was forgiven on their principal residence.
  • Educator expense deduction. Qualified educators are allowed to deduct up to $250 in unreimbursed expenses for books, supplies, and other materials used in their classrooms.
  • Residential energy property credit. You may claim a tax credit of 10% of the cost of qualified energy-saving improvements to your principal residence.

Although they’ve been renewed before, there’s no guarantee that these provisions will continue to be available. You may want to consider taking these deductions for 2013. For example, if you take advantage of the sales tax deduction and you know you’re going to be making a major purchase in the next few months, you might want to do so before the end of the year. Or if you’re in the middle of a foreclosure proceeding, you should do what you can to ensure that it’s completed in 2013.

In the past, only your medical expenses that exceeded 7.5% of AGI were deductible, but that increased to 10% for this year, making the deductibility threshold harder to reach. There is an exception, however. People age 65 and older can continue to deduct medical expenses that exceed the 7.5%, through 2016.

            Strategy 5: Use your annual gift tax exemption

If you’re looking for ways to help your children or other family members, you may want to consider several gifting options to help reduce or avoid federal gift and estate taxes. An individual can give up to $14,000 a year to as many people as you choose ($28,000 if you and your spouse both make gifts) to help reduce the amount of your estate. This may include cash, stocks, bonds, and portions of real estate. This is your annual gift tax exemption, and you can also give a separate $5.25 million, per person, over the course of your lifetime or at death, free from gift or estate taxes. However, anything above $14,000 per person per year may be subject to gift taxes, so it’s important to keep track of this information. Separately, you can pay college tuition costs or eligible medical expenses directly for someone else and avoid having those amounts count as a taxable gift. For more information, speak with your tax adviser and review IRS Publication 950, Introduction to Estate and Gift TaxesOpens in a new window..

If you would like to contribute money toward your child’s education, consider a 529 plan account. You can contribute up to $14,000, the annual gift tax exemption, to the account as a single filer, or $28,000 for a married couple filing jointly. Your contributions are generally considered to be removed from your estate, even though you control the assets and their distribution. There are also accelerated transfers available, whereby you can contribute up to $70,000 (for single filers) or $140,000 per married couple. This “front-loaded” contribution can be spread out over five years for tax purposes. You can also make a payment directly to an educational institution and pay no gift tax.1 And with 529 plans, you have the flexibility to change the account beneficiary. So if a particular child decides not to attend college, you as the account owner can change the beneficiary to a sibling, cousin, or other qualified family member.

            Make your moves before December 31, 2013

There have been many significant and permanent changes to the federal tax code for 2013, so don’t wait until it’s too late to implement strategies that can potentially save you money when you file your 2013 tax return. A key is to work with professionals who understand how the new provisions affect your personal and financial situation.


source: https://www.fidelity.com/viewpoints/personal-finance/tax-tips-year-end?ccsource=email_weekly

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