By Alex Eccard, CPA, CVA, ABV
Principal

During this time of the year, we are working with our clients to determine if these and other steps make sense for them given their specific tax and financial situation.  Our clients find it valuable to know the potential dollar impact from these types of decisions but also the other non-financial impact. In addition, we work with our clients to make sure they have paid in enough tax for 2013 to mitigate tax underpayment penalties and interest as well as get a handle on how much tax they are going to owe.  There are a lot of situations where higher income taxpayers are going to owe more this year than last due to increased tax brackets and other changes to the tax law that have come into effect for 2013 including the 3.8% Medicare Investment Tax.

Tax planning can be critical at the end of the year. Here are some new ideas to contemplate, along with tried-and-true year-end tax-saving techniques.

1. Prepay Deductible Expenditures if You Itemize

If you itemize deductions, it makes sense to accelerate some deductible expenditures into this year to produce higher 2013 write-offs if you expect to be in the same or lower tax bracket next year. See the table at the end of this article for the estimated 2014 federal income tax brackets.

Perhaps the easiest deductible expense to prepay is included in the house payment due on January 1. Accelerating that payment into this year will give you 13 month’s worth of deductible interest in 2013. You can use the same prepayment drill with a vacation home. However, if you prepay this year, you’ll have to continue the policy for next year and beyond. Otherwise, you’ll have only 11 month’s worth of interest in the first year you stop.

Next up on the prepayment menu are state and local income and property taxes that are due early next year. Prepaying those bills before the end of the year can decrease your 2013 federal income tax bill, because your itemized deductions total will be that much higher.

Consider prepaying expenses that are subject to deduction limits based on your AGI. The two prime candidates are medical expenses and miscellaneous itemized deductions. For 2013, medical costs are deductible only to the extent they exceed 10 percent of AGI for most people. However, if you or your spouse will be age 65 or older as of year-end, the deduction threshold is a more-manageable 7.5 percent of AGI. Miscellaneous deductions — for investment expenses, job-hunting expenses, fees for tax preparation and advice, and unreimbursed employee business expenses–count only to the extent they exceed 2 percent of AGI. If you can bunch these kinds of expenditures into a single calendar year, you’ll have a fighting chance of clearing the 2 percent-of-AGI hurdle and getting some tax savings.

Warning: Prepayment can be a bad idea if you owe the alternative minimum tax (AMT) for this year. That’s because write-offs for state and local income and property taxes are completely disallowed under the AMT rules and so are miscellaneous itemized deductions. Therefore, prepaying these expenses may do little or no tax-saving good for AMT victims. Your tax adviser can tell you if you are in the AMT mode.

2. Consider Deferring Income

It may also pay to defer some taxable income from this year into next year if you expect to be in the same or lower tax bracket in 2014 (see the table at the end of this article for the 2014 brackets). For example, if you’re in business for yourself and a cash-method taxpayer, you can postpone taxable income by waiting until late in the year to send out some client invoices. That way, you won’t receive payment for them until early 2014.

You can also defer taxable income by accelerating some deductible business expenditures into this year. Both moves will postpone taxable income from this year until next year. Deferring income can also be helpful if you’re affected by unfavorable phase-out rules that reduce or eliminate various tax breaks (the child tax credit, the two higher-education tax credits, and so on). By deferring income every other year, you may be able to take more advantage of these breaks every other year.

3. Sell Loser Stocks Held in Taxable Accounts

Selling losing investments held in taxable brokerage firm accounts can lower your 2013 tax bill because you can deduct the resulting capital losses against capital gains from earlier in the year. If your losses exceed your gains, you will have a net capital loss.

You can deduct up to $3,000 of net capital loss (or $1,500 if you are married and file separately) against ordinary income from salary, self-employment activities, alimony, interest, or whatever. Any excess net capital loss is carried forward to future years and puts you in position for tax savings in 2014 and beyond.

4. Set Up Loved Ones to Pay 0 Percent on Investment Income

For 2013, the federal income tax rate on long-term capital gains and qualified dividends is still 0 percent for gains and dividends that fall within the 10 or 15 percent rate brackets. While your tax bracket may be too high to take advantage of the 0 percent rate, you probably have loved ones who are in the bottom two brackets.

Consider giving these individuals appreciated stock or mutual fund shares. They can sell the shares and pay no tax on the resulting long-term gains. Remember: their gains will be long-term as long as your ownership period plus the gift recipient’s ownership period equals at least a year and a day.

Giving away dividend-paying stocks is another bright tax idea. As long as the dividends fall within the gift recipient’s 10 or 15 percent rate bracket, they will qualify for the 0 percent federal income tax rate. However, be aware that if you give away assets worth over $14,000 during 2013 to an individual gift recipient, it will reduce your $5.25 million unified federal gift and estate tax exemption. However, you and your spouse can together give away up to $28,000 without reducing your respective exemptions.

Warning: If your gift recipient is under age 24, the “Kiddie Tax” rules could potentially cause some of his or her capital gains and dividends to be taxed at the parent’s higher rates. That would defeat the purpose. Contact your tax adviser if you have questions about the Kiddie Tax.

5. Convert a Traditional IRA into a Roth IRA

The best scenario for this strategy is when you expect to be in the same or higher tax bracket during retirement. There is a current tax cost for converting, because a Roth conversion is treated as a taxable liquidation of your traditional IRA followed by a non-deductible contribution to the new Roth account. After the conversion, all the income and gains that accumulate in the Roth account, and all withdrawals, will be free from federal income tax — assuming they are qualified withdrawals. In general, qualified withdrawals are those taken after:

You have had at least one Roth account open for more than five years; and

You’ve reached age 59 1/2. With qualified withdrawals, you avoid having to pay higher tax rates that may apply during your retirement years. While the current tax hit from a Roth conversion is unwelcome, it could be an acceptable price to pay for the future tax savings. If the Roth conversion idea sounds appealing, contact your tax adviser for a full analysis of all the relevant variables.

6. Give to Charity

If you have charitable inclinations, here are three suggestions.

Donate appreciated stock to charity. If you have appreciated stock or mutual fund shares (currently worth more than what you paid) that you’ve owned for more than a year, consider donating them to IRS-approved charities. You can generally claim an itemized charitable deduction for the full market value at the time of the donation and avoid any capital gains tax hit.

Sell loser investments and donate cash. On the other hand, don’t donate loser stocks. Sell them, book the resulting capital loss, and give away the cash sales proceeds. That way, you can generally write off the full amount of the cash donation while keeping the tax-saving capital loss for yourself. Warning: You must itemize deductions to gain any tax-saving benefit from charitable donations, except for donations out of an IRA, as explained immediately below.

Make charitable donations out of your IRA. For 2013, you can make up to $100,000 in cash donations to IRS-approved charities directly out of your IRA — if you’ll be age 70 1/2 or older by year end. Such direct-from-IRA donations are called qualified charitable distributions, or QCDs. Donations made in this fashion don’t directly affect your tax bill, because QCDs are tax-free, and no deductions are allowed for them.

However, QCDs count as withdrawals for purposes of meeting the required minimum distribution (RMD) rules that apply to traditional IRAs. Therefore, taxes can be avoided by arranging for tax-free QCDs in place of taxable RMDs. If your spouse owns one or more IRAs and is over age 70 1/2, he or she is entitled to a separate $100,000 QCD privilege for 2013.

This article only outlines some strategies that might be available. If you are interested in some of these planning ideas or would like us to take a look at your 2013 tax picture, please give us a call.  It is important that a lot these ideas be moved on before the end of the year to have benefit for 2013.alex-article