As the year-end quickly approaches, there is still time to do some year-end tax planning. This 2013 tax year will be tough on many taxpayers due to recent tax law changes and the uncertain future of tax reform. Basically, taxpayers will have to deal with the following recent tax law changes:
As always, it is essential to know the customary year-end planning techniques that can cut income taxes. It all starts with a tax projection of whether you will be in a higher or lower tax bracket next year. Once your tax brackets for this year and next year are known, there are two basic income tax planning considerations:
However, life is never that simple. Tax law uncertainty, always makes for some real guesswork. As discussed below, when it comes to certain deductions that have tax threshold limitations, bunching of deductions to one year may force the timing into a tax year where the tax bracket is lower than the other tax year in question. But this may be the only way to get a tax break for these deductions.
As a further irritant, year-end tax projections must take into account the maddening alternative minimum tax and the new parallel universe of the 3.8% medicare tax. Yikes.
For discussion purposes, the following strategies assume that the taxpayer’s income will be higher next year. Where income will be taxed at a higher tax bracket next year, accelerating income to this year results in less taxes being paid. At the same time deductions and tax credits deferred into next year will become more valuable as they offset income taxed at a higher marginal bracket.
Accelerating income to the current year and deferring deductions must take into account the impact on cash flow and the time value of money when paying taxes on income a year earlier. However, due to our current low-interest rate environment, time value of money implications are quite minimal and may not be a significant consideration.
If a taxpayer expects income to decrease next year they should use the opposite approach.
So be sure to remember that the following lays out the basic ideas for income acceleration and deduction/credit deferral where income projects to be taxed at a higher level next year.
For taxpayers who think that they will be in a higher tax bracket next year, here are some targeted forms of income to consider accelerating into this year.
Example: Mr. Appreciation has low basis stock that has appreciated in value. The rate for capital gains can rise as taxable income increases. So before selling any securities he needs to run the numbers to see if it makes sense to sell this year or next year or spread such sales between the two years. He also needs to consider in the 3.8 percent surcharge on capital gains and how such decision impacts itemized deduction limitations.
Important Planning Point: For an older taxpayer or one in ill-health, this strategy may not make income tax sense. When a person dies their assets get a step up in basis to the date of death value. As a result, when the estate sells such assets there is no capital gain. So a sale right before death would trigger a needless capital gain tax.
Planning Note: The wash sale rules do not apply when selling at a gain, so taxpayers can cash out their gains and then repurchase identical securities immediately afterwards.
For taxpayers who think that they will be in a higher tax bracket next year, here are some actions to consider in deferring deductions into next year. Remember, we are assuming that income will be higher next year, so deductions are more valuable next year. (Obviously, if income is higher this year, it is better to have deductions accelerated into this year). In any event, taxpayers must watch out for the impact of the alternative minimum tax.
In the past, Congress has extended many, but not all, expiring provisions to future years. However, there is a lot of uncertainty now as there is talk of major tax reform and still out of control budget deficits. Prudence may dictate the possible loss of some of the following tax provisions:
Remember that these are just some of the major year-end income tax strategies and are not all-encompassing. Taxpayers must take into account possible tax law changes for next year and last-minute tax laws enacted before year-end.
Most importantly remember that income tax strategies depend on the specific income or expenses of each taxpayer and their overall income, gift and estate tax setting. This discussion offers some, but not all tax strategies.
The one certainty in this uncertain tax environment is to “run the numbers” to find the best approach for each taxpayer’s particular tax and financial situation.
As always, it is quite beneficial to have tax counsel look at the details of your particular income tax situation to carve out specific tax strategies to cut taxes owed.
I hope this article has been of value to my readers. Please feel free to contact me, ask a question or make comments below.
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