There are other changes in play as well: new Medicare taxes laid out in the federal health care overhaul, the end of the 2% payroll tax holiday, the return of phase-outs for itemized deductions and a higher threshold for writing off medical expenses. Affluent Californians will also face an added state income tax, approved by voters in November under Proposition 30.
"For people in the higher income brackets, in some shape or form, taxes are going up," says Lyle Benson, president of financial planning and CPA firm L.K. Benson in Baltimore and chairman of the executive committee of the American Institute of CPAs' Personal Financial Planning division.
To gear up for the tax changes, Financial Planning asked a dozen tax professionals to highlight the most important strategies you can use to help clients handle the new rules. Many of the planning ideas that follow are geared toward helping you ease clients into the new, higher tax reality.
1. FACE THE MEDICARE SURTAX
Unlike other tax changes this year, the Medicare surtax hasn't been on the negotiating table since last summer, when the Supreme Court upheld the health care law. To cover its costs, beginning this year, there is an additional 3.8% levy on unearned net income for individuals making more than $200,000 or married couples with joint incomes of more than $250,000.
Of course, there is no impact for those earning less than those amounts. And for clients well above the cutoffs, there's little that planning can do to minimize the surtax. But "to those clients who are at that threshold, my best advice for them is to minimize unearned income," says Theodore Sarenski, a certified financial planner and certified public accountant who heads Blue Ocean Strategic Capital in Syracuse, N.Y.
Advisors and their clients may want to think carefully about shifting more money into municipal bonds, which pay tax-free income, Sarenski says.
Timing matters, too: Individuals should consider when to realize gains, perhaps focusing on years when their earned income falls below the threshold - such as during the year of a job loss or in retirement - and can control their unearned investment income that way.
But remember that the tax doesn't apply only to income from traditional investments: Rental income and capital gains from a property sale also fall into this category. "Someone who is single and living in my area, who bought a home 30 years ago for $100,000, may be selling it for over $1 million," says Michael Eisenberg, founder of Eisenberg Financial Advisors in Los Angeles. "Imagine what their capital gain is going to be."
2. CHECK THE WITHHOLDING
You're not done with Medicare yet: On top of the surtax on unearned income, there's an additional 0.9% Medicare payroll tax for high earners, taking the Medicare levy to 2.35% from 1.45%. "That one's a little sneaky," says Tim Steffen, director of financial planning for Baird's Private Wealth Management Group in Milwaukee.
Steffen cautions that although the tax is applied to incomes of more than $200,000 for individuals and more than $250,000 for married couples filing jointly, some high earners may be taxed even if they don't reach the cutoff. The reason: In order to comply with the provision, payroll departments have been advised to begin tacking on the additional 0.9% for married employees making more than $200,000 because there's no way for employers to know how much the spouse makes - "even if, ultimately, that employee is not subject to the tax," Steffen says.
Be sure to review withholdings on your clients' W-4 forms if they fall into that gap. (And it's not a bad idea even if they don't: The IRS issued 104 million refund checks last year, suggesting that most taxpayers are having too much withheld from their paychecks.)
3. MAXIMIZE ADJUSTMENTS
With the arrival of a new high-end tax bracket, the top marginal rate for the highest earners has jumped to 39.6% from 35%. To keep taxes down, you'll want to focus on a client's adjusted gross income and find as many above-the-line deductions - technically "adjustments" - as possible.
Contributions to a 401(k) or 403(b) plan (which can top out at $17,500 following a 2013 limit increase, and more for those age 50 and older) will reduce a client's adjusted gross income - so "you want to maximize how much [goes] into the 401(k)," Sarenski says. Other items that fall into this category are moving expenses, health savings accounts and expenses listed on Schedule C forms for self-employed clients.
