Thursday, December 5, 2013

Year-End Tax Planning For Individuals

Tax planning presents more challenges than usual this year due to the passage of the American Taxpayer
Relief Act of 2012 (ATRA), which was signed into law on January 2, 2013, as well as certain tax provisions of the Patient Protection and Affordable Care Act of 2010 taking effect in 2013 and 2014.

Tax planning strategies for individuals this year--and for the next several years--require careful consideration of taxable income in relation to threshold amounts that might bump a taxpayer into a higher or lower tax bracket, thus, subjecting him or her to additional taxes such as the Net Investment Income Tax (NIIT) or an additional Medicare tax.
Even so, there are several more general tax planning strategies taxpayers might consider such as:

  • Selling any investments on which you have a gain or loss this year. For more on this, see Investment Gains and Losses, below.
  • If you anticipate an increase in taxable income in 2014 and are expecting a bonus at year-end, try to get it before December 31. Keep in mind however, that contractual bonuses are different, in that they are typically not paid out until the first quarter of the following year. Therefore, any taxes owed on a contractual bonus would not be due until you file a tax return for tax year 2014.
  • If your company grants stock options, you may want to exercise the option or sell stock acquired by exercise of an option this year if you think your tax bracket will be higher in 2014. Exercise of the option is often but not always a taxable event; sale of the stock is almost always a taxable event.
  • If you're self employed, send invoices or bills to clients or customers this year in order to be paid in full by the end of December.

Accelerating Income and Deductions

Accelerating income into 2013 is an especially good idea for taxpayers who anticipate being in a higher tax bracket next year or whose earnings are close to threshold amounts ($200,000 for single filers and $250,000 for married filing jointly) that make them liable for additional Medicare tax or NIIT (see below).
Here are several examples of what a taxpayer might do to accelerate deductions:

  • Pay a state estimated tax installment in December instead of at the January due date. However, make sure the payment is based on a reasonable estimate of your state tax.
  • Pay your entire property tax bill, including installments due in year 2014, by year-end. This does not apply to mortgage escrow accounts.
  • Try to bunch "threshold" expenses, such as medical and dental expenses (10% of AGI starting in 2013) and miscellaneous itemized deductions. For example, you might pay medical bills and dues and subscriptions in whichever year they would do you the most tax good. Threshold expenses are deductible only to the extent they exceed a certain percentage of adjusted gross income (AGI). By bunching these expenses into one year, rather than spreading them out over two years, you have a better chance of exceeding the thresholds, thereby maximizing your deduction.

In cases where tax benefits are phased out over a certain adjusted gross income (AGI) amount, a strategy of accelerating income and deductions might allow you to claim larger deductions, credits, and other tax breaks for 2013, depending on your situation.

The latter benefits include Roth IRA contributions, conversions of regular IRAs to Roth IRAs, child credits, higher education tax credits and deductions for student loan interest.
If you know you have a set amount of income coming in this year that is not covered by withholding taxes, increasing your withholding before year-end can avoid or reduce any estimated tax penalty that might otherwise be due.

On the other hand, the penalty could be avoided by covering the extra tax in your final estimated tax payment and computing the penalty using the annualized income method.

Additional Medicare Tax

Taxpayers whose income exceeds certain threshold amounts ($200,000 single filers and $250,000 married filing jointly) are liable for an additional Medicare tax of 0.9% on their tax returns, but may request that their employers withhold additional income tax from their pay to be applied against their tax liability when filing their 2013 tax return next April.

Alternative Minimum Tax

The Alternative Minimum Tax (AMT) exemption "patch" was made permanent by ATRA and is indexed for inflation. It's important not to overlook the effect of any year-end planning moves on the AMT for 2013 and 2014.

Items that may affect AMT include deductions for state property taxes and state income taxes, miscellaneous itemized deductions, and personal exemptions.

Residential Energy Tax Credits

Non-Business Energy Credits

ATRA extended the non-business energy credit, which expired in 2011, through 2013 (retroactive to 2012). You may claim a credit of 10 percent of the cost of certain energy saving property that you added to your main home. This includes the cost of qualified insulation, windows, doors and roofs, as well as biomass stoves with a thermal efficiency rating of at least 75%.

In some cases, you may be able to claim the actual cost of certain qualified energy-efficient property. Each type of property has a different dollar limit. Examples include the cost of qualified water heaters and qualified heating and air conditioning systems.

To qualify for the credit, your main home must be an existing home located in the United States. New construction and rentals do not qualify. The credit has a maximum lifetime limit of $500; however, only $200 of this limit can be used for windows.

Not all energy-efficient improvements qualify, so be sure you have the manufacturer's credit certification statement. It is usually available on the manufacturer's website or with the product's packaging.

Residential Energy Efficient Property Credits

The Residential Energy Efficient Property Credit is available to individual taxpayers to help pay for qualified residential alternative energy equipment, such as solar hot water heaters, solar electricity equipment and residential wind turbines. Qualifying equipment must have been installed on or in connection with your home located in the United States.
Geothermal pumps, solar energy systems, and residential wind turbines can be installed in both principal residences and second homes (existing homes and new construction), but not rentals. Fuel cell property qualifies only when it is installed in your principal residence (new construction or existing home). Rentals and second homes do not qualify. There are specific guidelines that have to be met for these items to qualify.

The tax credit is 30% of the cost of the qualified property, with no cap on the amount of credit available, except for fuel cell property.

Generally, labor costs can be included when figuring the credit. Any unused portions of this credit can be carried forward. Not all energy-efficient improvements qualify so be sure you have the manufacturer's tax credit certification statement, which can usually be found on the manufacturer's website or with the product packaging.

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