Last-Minute Tax Moves for Wealthy Clients

The end of the year is the prime time for advisors to help taxpayers improve their positions. By taking smart steps, they can minimize the effects of new taxes and higher rates. A year ago, no one knew what the tax landscape would be. The problem now is that much is new and more complex.

"The end of last year was a disaster for tax planning," says Grafton "Cap" Willey, managing director of the accounting firm CBIZ. "There was a lot of year-end planning last year, but it was done without any certainty as to what would happen.

"For example, we did a lot of accelerating of capital gains," he says. "With the increase in capital gains rates from 15% to 20% for people making more than $250,000, plus the new Medicare tax of 3.8%, this year we're taking a hard look at net investment income."

"It's become a complicated calculation," he says. "If someone is in the threshold area, we try to keep their net investment income down to get below the threshold. If not, we try to minimize the impact of the increased rates. We might use municipal bonds, or take a look at tax-deferred annuities, which could take income out of the current year."

 

NEW THRESHOLDS

There are a number of new thresholds coming into play, Willey says. The Medicare 3.8% tax applies to net investment income of taxpayers with adjusted gross income exceeding $200,000 for single taxpayers or $250,000 for joint filers.

The 3% phase-out of itemized deductions and the 2% phase-out of exemptions have been reinstated. "Between $200,000 and $400,000, managing AGI is helpful because you can save tax on phase-outs and net investment income surcharges," Willey says. "Look at things that can affect those - for example, the opportunity to max out retirement contributions and anything that's tax-deferred. Also, you have to be concerned about taking distributions from retirement plans because they can increase AGI."

Another tool is an installment sales agreement, he observes. "It spreads out gains over future years and lowers AGI in a particular year. "

"This year's tax planning is going to be heavily focused on reducing above-the-line amounts," says Monic Ramirez, senior tax manager at Sensiba San Filippo. "There are several thresholds for adjusted gross income that taxpayers should manage in order to avoid the Medicare tax hike of 3.8% on investment income, the Medicare high-earner tax of 0.9% and the Pease limitation on itemized deductions. And in California, managing taxable income will have an added benefit of avoiding the higher tax brackets enacted by Proposition 30."

Ramirez suggests maximizing contributions to 401(k), 403(b), 457, 529, HSA, SEP and Keogh plans. "If self-employed, set up a self-employed retirement plan, and revisit decisions to contribute to a traditional versus a Roth retirement plan," she says.

For a taxpayer near the threshold for the new Medicare tax, he or she "should consider moving Roth contributions to a traditional retirement plan," she says. This "could reduce taxable income below the threshold."

"Long-term capital gains still maintain their preferential rates," Ramirez says. "However, long-term capital gains received a 5% increase and are subject to the additional 3.8% Medicare investment tax. Even worse, short-term capital gains are subject to ordinary income rates and the 3.8% Medicare investment tax. Therefore, tax-deferral mechanisms for significant tax gains should be considered, such as a Section 1031 exchange for real property sales or structuring the sale as an installment sale."

"An installment sale spreads the gain over several tax periods in order to minimize or entirely avoid the Medicare tax on investment income," she adds. Taxpayers can also reduce income by using other tax-exempt investment vehicles, like municipal bonds. "And in most states, home-state bonds are also state tax-exempt."

If a loss in a flow-through has been incurred, make sure that it's deductible, she says. "Taxpayers can increase their basis in a partnership or S corporation if doing so will enable them to deduct a loss from it this year."

A taxpayer with self-employment income should consider capital expenditures that will be needed in the coming year, Ramirez suggests. "Favorable Section 179 deductions and bonus depreciation have been extended through the end of 2013. Purchasing qualified property and placing it in service before the year end will accelerate the depreciation deduction allowed on the assets into 2013 and reduce the earnings potentially subject to the 0.9% Medicare surtax."

A big difference between last year and this year is that the rates are "quite a bit higher" now for upper-income taxpayers, notes Robin Christian, a senior tax analyst at Thomson Reuters.

"The fiscal cliff legislation passed in January increased the maximum rate for higher-income individuals to 39.6%, up from 35%," she notes. "This change only affects taxpayers with taxable income above $400,000 for singles, $450,000 for married joint-filing couples, $425,000 for heads of households, and $225,000 for married individuals who file separate returns."

Where taxpayers are near the standard deduction amount, Christian recommends bunching together expenditures for itemized deduction items every other year, while claiming the standard deduction in the intervening years.

"Say the taxpayer is a joint filer whose only itemized deductions are about $44,000 of annual property taxes and about $8,000 of home mortgage interest," she says. "If the taxpayer prepays their 2013 property taxes by Dec. 31 of this year, they could claim $16,000 of itemized deductions on their 2013 return. Next year, they would only have the $8,000 of interest, but they could claim the standard deduction, which will probably be around $12,500 for 2014. Following this strategy will cut taxable income by a meaningful amount over the two-year period. The drill can be repeated all over again in future years."

Taxpayers should take advantage of the Section 179 deduction this year, since the maximum deduction is scheduled to drop to $25,000 beginning in the 2014 tax year from $500,000. Likewise, she urges, take advantage of the 50% first-year bonus depreciation, since it will expire at year's end unless it is extended by Congress.

 

MAXIMIZING BENEFITS

John Vento, a New York CFP and CPA, advises clients to check with their HR departments to understand the benefits available to them. "They should take advantage of their tuition reimbursement plan and fully fund their 401(k) plan," he says. "If they're 50 or older, they should take advantage of the catch-up provisions, which allow them to contribute an additional $1,000 to their IRA. They should also check out the provisions where benefits are paid out in pretax dollars, such as tax-free reimbursement of child care and even transit passes."

The energy efficiency credit, which was slated to expire at the end of last year, was extended for one year, Vento says. "While it may be renewed, there is no guarantee."

Vento notes that each dependent child can earn up to $6,100 in 2013 without having to pay federal income tax. "Consider establishing a Roth IRA in the child's name," he suggests. "The child can withdraw money from it to pay for college, and the withdrawal will be taxed at the child's tax rate, which could be as low as zero."

 

 

Roger Russell is a senior editor of Accounting Today.

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