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 Eight Smart Year-End Tax Moves

While the April 15 income tax filing deadline is dubbed “Tax Day,” there is another very important deadline taxpayers need to keep in mind. Each year, the U.S. tax code changes, and many financial moves necessary to minimize your tax liability must be made by the calendar year-end: December 31.

Significant legislation, including the American Taxpayer Relief Act of 2012 (ATRA) and the Patient Protection and Affordable Care Act (PPACA), is the primary change agent in the tax code this year. The most significant changes are in store for those with high annual earned income, where the tax rate can be as high as 39.6% for individuals earning more than $400,000 ($450,000 for married couples filing a joint return), and itemized deductions are limited for those who earn more than $250,000 ($300,000 for married couples filing jointly).1 Changes also affect charitable giving and individual retirement accounts (IRAs), among others.

The good news is that there is still time to potentially minimize your tax obligation, bolster your retirement savings and make your charitable contributions go further. Consider whether these eight smart year-end moves are right for your situation.

  1. Increase deduction. This year, the standard deduction rises to $6,100 ($12,200 for married couples filing jointly), up from $5,950 ($11,900 for married couples filing jointly) in 2012.2 If you itemize your deductions – your financial advisor and this IRS guide can help you determine whether that’s a good idea – be sure you’re capturing all of the deductions to which you’re entitled. Legitimate income tax deductions, which can include home mortgage interest, medical bills and property taxes, reduce your amount of taxable income. You can also pre-pay state and local income taxes. However, if your earnings put you in Alternative Minimum Tax territory, those deductions are disallowed, so paying them early holds no advantage.
  2. Calculate your personal exemption. The good news: Your personal exemption, which reduces your taxable income, in 2013 is $3,900—up $100 over last year. The bad news: The exemption is subject to a phase-out starting at individual adjusted gross income (AGI) levels in excess of $250,000 ($300,000 for married couples filing jointly). For every $2,500 of AGI over the threshold, the exemption is reduced 2%, and the exemption phases out completely at $372,500 ($422,500 for married couples filing jointly).3 In some cases, it may make sense for married couples to file separately to maximize their exemptions. Again, check with your tax preparer to determine the best filing option for your situation.
  3. Maximize retirement plan contributions. If you haven’t reached your 403(b), 401(k) or traditional IRA contribution limit, consider saving more in these plans to either lower your taxable income or to increase your tax deductions. In 2013, you can contribute $5,500 for a traditional IRA (assuming you have taxable compensation at that level) and may be eligible for an income tax deduction for that amount. (Those age 50 and over can contribute as much as $6,500 this year). IRA contributions can be made up until the April 15th tax return filing deadline.4
  4. Consider varied strategies. If your income comes from a number of sources, other strategies may apply. As an example, in 2013, assume you expect to receive a salary and also some capital gains income from investments. In addition, you’ll complete some paid speaking and writing engagements unrelated to your job during the year. Depending on the total earnings in each category, you might maximize salary contributions to both your 401(k) plan and IRA, defer some capital gains income, and create a limited liability company (LLC) through which you conduct your speaking and writing engagements. The latter could entitle you to additional deductions related to your independent business activities, reducing your tax liability. Your financial advisor can help you review these and other strategies.
  5. Review investments. As a provision in the PPACA, an additional 3.8% Medicare tax on net investment income will apply to single filers making more than $200,000 and married joint filers with combined incomes of more than $250,000 in 2013. This may be the time to calculate losses and gains to determine your true taxable capital gains. For example, if you have sustained losses in the stock market or other investments, you may wish to work with your financial advisor to determine the exact losses and claim them to offset them against your capital gains. Also, discuss your current asset allocation with your advisor to explore whether your distribution is properly tax advantaged for your situation.
  6. Give. Depending on the nature of the charity and the type of asset given, charitable contributions made to qualifying nonprofit organizations may be fully deductible for income tax purposes – subject to certain limitations. For example, a cash gift to a public charity is fully deductible up to 50% of your AGI.5 If you’re over age 70½, consider donating from your IRA. In 2013, you can transfer as much as $100,000 from your traditional IRA to charitable organizations tax free through the end of the year. This gift can count toward satisfying your required minimum distributions (RMD) for the year.6Contributing directly from your IRA eliminates the income increase you’ll have if you take the RMD yourself and then make the donation. This could have important implications for your Medicare premiums. For example, if you are an individual with a modified adjusted gross income of $85,000 or less per year, your monthly Medicare Part B premium is $104.90 in 2013. However, if you take a required minimum distribution that pushes your income over income thresholds where your itemized deductions begin to phase out–$250,000 for individuals and $300,000 for married couples filing jointly—you could end up with a significantly higher AGI, adding hundreds or even thousands per year to your Medicare premiums. Read more about how premiums are calculated here.
  7. Engage in some estate planning. ATRA provides for tax-free transfer of estates with values up to $5.25 million in 2013.7 As you get closer to retirement, it’s a good idea to review your estate tax situation with your financial advisor and begin making plans to mitigate your tax liability, which may include creating plans for wealth transfer or, charitable giving. Even if your estate doesn’t approach that threshold, it’s still important to review your plan with a trusted advisor before the year’s end. You may have state-level estate tax issues that can be mitigated through planning. Also, factors such as remarriage and multiple generation trust planning can affect your liability. You can find a good overview of post-ATRA estate-planning basics here. In addition, it’s a good idea to review some non-tax issues with your financial advisor, such as whether you have adequately planned for incapacity and have appropriate insurance for your stage of life, family situation, and asset levels.
  8. Beware of “bracket creep.”In 2013, an additional Medicare tax of 0.9% applies to annual earned income amounts in excess of $200,000 for single taxpayers or $250,000 married couples. If you’re close to the threshold for new or increased taxes, check into income deferral opportunities. While it can be tricky for employees to defer income from an employer, there are some possibilities such as requesting that your year-end bonus be paid in 2014 rather than 2013.However, postponing your earnings only makes sense if you’re going to be in the same or a lower tax bracket the next year. If you think you might approach these income thresholds in 2014 but not this year, explore whether it’s possible to avoid “bracket creep” by accelerating your income, perhaps by working overtime hours to get ahead on next year’s work load or requesting bonus payment before the end of the year. Again, this is not always possible, but should be considered if it is.

There may be other tax moves you can make based on your own specific situation. Consult us to learn more.

US Tax Consultants. Tel +34 915194392. Madrid. info@ustaxconsultants.net