2013 Year-End Tax Planning
The tax tips contained below are for informational purposes only. The information provided is not to be considered as tax or legal advice. The laws discussed here are only selective matters and do not include all important 2013 tax issues. While they are fairly standard in our profession, they may not be suitable for everyone. Due to the complexity of 2013 tax laws, it is imperative more than ever to seek legal and tax advice from competent tax advisors before taking any action on these subjects. Based on the Windsor Case, these laws apply to same-sex married couples to comply with the Equal Protection Clause.
The single taxpayers with taxable income in excess of $400,000 a year ($450,000 for married filing jointly and $225,000 for spouses filing separately) would pay additional 4.60 %= (39.60-35.00) in taxes on the excess amounts.
Tax Tip: It may be tax-advantageous to accelerate other income (such as year-end bonuses) if you will have more income in 2014, or delay it if you will have less income in 2014. Considering the current budgetary dilemma in the US, there is no certainty about future tax rates. Therefore, any decision assuming the status quo may run the risk of higher future tax rates.
0.9% Medicare Tax Hospital Insurance Tax
The employee’s share of the Federal Insurance Contributions Act (FICA) withholding from wages has increased from 1.45% to 2.35% on wages in excess of $250,000 for joint filers and $200,000 for married taxpayers filing separately. The extra tax is imposed on the combined salaries of the spouses for joint filers, including the self-employed individuals as well.
Tax Tip: It may be tax-advantageous to accelerate other income (such as year-end bonuses) if you will have more income in 2014, or delay it if you will have less income in 2014. Any reclassification of income for a tax advantage must be analyzed thoroughly to ensure its legality.
Net Investment Income Tax (NIIT)
A 3.8% Medicare tax is imposed on certain net investment income (NII) of individuals, estates, and trusts by the 26 USC § 1411 on the lesser of:
A. Taxpayer’s net investment income is the investment income reduced by applicable associated cost; interest, dividends, rents, annuities, royalties, and net capital gains from disposition of property not used in a trade or business, or
B. Modified Adjusted Gross Income (MAGI; adjusted for foreign earnings) that exceeds the threshold of $250,000 for married filing joint taxpayers or $200,000 for single taxpayers.
In general, investment income includes, but is not limited to: interest, dividends, capital gains, rental and royalty income, non-qualified annuities, income from businesses involved in trading of financial instruments or commodities, and businesses that are passive activities to the taxpayer. The NII is reduced by certain expenses properly allocable to the income.
Kinds of gains are included in Net Investment Income
To the extent that gains are not otherwise offset by capital losses, the following gains are common examples of items taken into account in computing the NII:
A. Gains from the sale of stocks, bonds, and mutual funds.
B. Capital gain distributions from mutual funds.
C. Gains from the sale of investment real estate, including gain from the sale of a second home.
D. Gains from the sale of interests in partnerships and S corporations (to the extent you were a passive owner).
What are some common types of income that are not NII?
Wages, unemployment compensation, operating income from a non-passive business, Social Security Benefits, alimony, tax-exempt interest, self-employment income, gain on the sale of a personal residence, and distributions from certain Qualified Plans.
Tax Tips: Eliminating or minimizing the 3.8% tax may be done by deferring the NII or reducing the MAGI, or both. Disposition of commercial rental properties with prior suspended losses may release those losses and reduce your tax burden. This is unchartered territory and requires sophisticated, professional advice.
Direct Transfer of IRA to a Charity
The American Taxpayer Relief Act of 2012, enacted January, 2, 2013, extended to 2013 the provision authorizing qualified charitable distributions (QCDs) — otherwise taxable distributions from an IRA owned by someone, 70½ or older, paid directly to an eligible charitable organization. Each year, the IRA owner can exclude from gross income up to $100,000 of these QCDs.
Tax Tip: Anyone who doesn’t need his or her IRAs is encouraged to make such contribution before December 31, 2013.
Capital Gains Tax
Capital Gains and Dividends tax rates increased from 15% to 20% for taxpayers with taxable income in excess of the thresholds mentioned above ($400,000 for single filing status, etc). Net capital gains from selling collectibles (such as coins or art) are taxed at a maximum 28% rate. The rate will remain 15% for the middle class and the taxpayers in the 10% and 15% bracket still pay zero taxes on their Capital Gains.
Tax Tip: Consider selling worthless stocks or losing stocks and repurchasing them 31 days later (to avoid wash sale), if advisable. Remember the §§ 1202 and 1244 stocks explained below.
Section 1202, Qualified Small Business Stock (QSBS)
Under 26 US §1202, taxpayer excludes 75% of the gain recognized from the sale or exchange of QSBS that is held more than five years on a qualified stock acquired on or before September 27, 2010 and after February 17, 2009 and 100% on qualifying stock acquired after September 27, 2010, and before Jan. 1, 2014.
Tax Tip: The stock must be issued by domestic C corporation, originally issued after August 10, 1993, with total gross assets of $50 million or less, at least 80% of the value of the corporation’s assets was used in the active conduct of qualified businesses, held by non-corporate taxpayer, held more than five years, etc.
Section 1244 (small business) stock
The loss from the sale of a qualified corporation may be used against ordinary income (similar to net operation loss) up to $50,000 for single filers and $100,000 for married filing jointly.
Tax Tip: To qualify as section 1244, stock must be issued by a domestic corporation, issued for money or other property. The total amount of money and other property received by the corporation for its stock as a contribution to capital and paid-in surplus generally may not exceed $1 million, etc.
The Mortgage Debt Relief Act of 2007 generally allows taxpayers to exclude up to $2 million of forgiven debt ($1 million if married filing separately) from the discharge of debt on their principal residence through foreclosure, restructuring, or short sale, thorough December 31, 2013. California conforms to this law. Unless Congress acts otherwise, this will expire on December 31, 2013.
Tax Tip: If you are going through the unfortunate process of a foreclosure or short sale, make sure it is done by no later than December 31, 2013.
Mortgage Insurance Premiums
Mortgage insurance premiums treated as qualified residence interest, Section163 (h), extended through 2013.
Tax Tip: This is a tax deduction that may be incorporated in your 2013 estimated taxes.
Itemized State & Local Taxes, Medicare and Miscellaneous Deductions
Beginning Jan. 1, 2013, you can claim deductions for medical expenses not covered by your health insurance that exceed 10 percent of your adjusted gross income. There is a temporary exemption from Jan. 1, 2013 to Dec. 31, 2016 for individuals age 65 and older and their spouses. If you or your spouses are 65 years or older or turned 65 during the tax year you are allowed to deduct unreimbursed medical care expenses that exceed 7.5% of your adjusted gross income. The threshold remains at 7.5% of AGI for those taxpayers until Dec. 31, 2016.
Tax Tip: If tax advantageous, the amount of medical expense, state & local taxes and miscellaneous deductions, you may expedite or defer them to 2014. Do not fall into the Alternative Minimum Tax (AMT) trap, because some of these are AMT preference and adjustment items.
Individual Retirement Account (IRA)
Traditional tax deductible IRA Contribution is $5,500, plus $1,000 catch up for over 50 years.
Tax Tip: Contribution must be made by no later than the tax return due date: April 15, 2014.
Non-tax deductible contribution is $5,500, plus $1,000 catch up for over 50 years, Married filing jointly with AGI less than $178,000. More than $188,000, no contribution
Tax Tip: Contribution must be made by no later than the tax return due date; April 15, 2014.
Simplified Employee Pension Plan (SEP) IRA
IRC § § 402(h) and 415 limit the amount of contributions made to an employee’s SEP-IRA to the lesser of $51,000 for 2013 or 25% of the eligible employee’s compensation.
Tax Tip: Contribution may be made until the filing of the tax returns, including extensions.
Foreign Account Tax compliance Act (FATCA)
Under the requirements of Sections 1471 through 1474 of the IRC, commonly known as Foreign Account Tax compliance Act (FATCA), certain U.S. taxpayers holding specified foreign financial assets with an aggregate value exceeding $50,000 must report information about those assets on new Form 8938, which must be attached to the taxpayer’s annual income tax return.
Tip: Include all earnings from FATCA accounts in your 2013 estimated taxes. If you have never reported these accounts to the US Treasury, consult a tax attorney with international and foreign bank accounts experience immediately.
Report of Bank & Financial Accounts (FBAR)
If you have a financial interest in or signature authority over a foreign financial account, including a bank account, brokerage account, mutual fund, trust, or other type of foreign financial account, exceeding $10,000, the Bank Secrecy Act requires you to cause the delivery of a special report on the account yearly to the US Treasury by no later than June 30, 2014. Effective July 1, 2013, all FBAR forms must be filed electronically through a new 2013 form.
Tip: Include all earnings from FBAR accounts in your 2013 estimated taxes. If you have never reported these accounts to the US Treasury, consult a tax attorney with international and foreign bank accounts experience immediately.
Documentation of charitable contribution
The substantiation requirements for monetary donations of less than $250 remain fairly informal under Sec. 170(f) (17): The donor should maintain a bank record of the contribution or written communication from the donee stating the name of the donee organization, as well as the date and dollar amount of the donation. For donations of $250 or more, Sec. 170(f)(8) requires that the donor must obtain a contemporaneous written acknowledgment, stating the amount of the contribution, whether the donee provided goods or services in consideration for the donation, in whole or in part, and a good-faith estimate of the value of any goods or services the organization provided. If goods or services received consist solely of intangible religious benefits, the contemporaneous documentation must contain a statement to that effect.
Tax Tip: Obtain supporting documents at the time of making the contribution.
Non-Business Energy Property Credit
You may claim a credit of 10 percent of the cost of certain energy saving property that you added to your main home. This includes the cost of qualified insulation, windows, doors and roofs. In some cases, you may be able to claim the actual cost of certain qualified energy-efficient property. Each type of property has a different dollar limit. Examples include the cost of qualified water heaters and qualified heating and air conditioning systems. This credit has a maximum lifetime limit of $500. You may only use $200 of this limit for windows. Your main home must be located in the U.S. to qualify for the credit. Not all energy-efficient improvements qualify, so be sure you have the manufacturer’s credit certification statement. It is usually available on the manufacturer’s website or with the product’s packaging. The credit was to expire at the end of 2011. A recent law extended it for two years through the end of 2013.
Tax Tip: You can take advantage of this credit until December 31, 2013. Confirm with the manufacturer of these items to ensure eligibility.
Residential Energy Efficient Property Credit
This tax credit is 30 percent of the cost of alternative energy equipment that you installed on or in your home. Qualified equipment includes solar hot water heaters, solar electric equipment and wind turbines. There is no limit on the amount of credit available for most types of property. If your credit is more than the tax you owe, you can carry forward the unused portion of this credit to next year’s tax return. You must install qualifying equipment in connection with your home located in the United States. It does not have to be your main home. The credit is available through 2016.
Tax Tip: Check with the manufacturer of these items to ensure eligibility.
Alternative Minimum Tax (AMT)
Alternative Minimum Tax (AMT), which hits many middle class families with additional taxes, will be adjusted for inflation. The 2013 amounts are $80,800 and $51,900 for the married filing jointly and filing separately taxpayers, respectively.
Tax Tip: Consult your tax advisor regarding AMT consequences of following any other tax tips to avoid falling into an AMT trap.
Recognition of Same-Sex Marriage
In United States v. Windsor, the Supreme Court held that section 3 of the Defense of Marriage Act (DOMA) is unconstitutional because it violates the principles of equal protection. It concluded that this section “undermines both the public and private significance of state-sanctioned same-sex marriages” and found that “no legitimate purpose” overcomes section 3’s “purpose and effect to disparage and to injure those whom the State, by its marriage laws, sought to protect” (Windsor, 133 S. Ct. at 2694-95). This ruling provides guidance on the effect of the Windsor decision on the Internal Revenue Service’s interpretation of the sections of the Code that refer to taxpayers’ marital status.
Tax Tip: Because of the Windsor holding, all of the tax laws discussed herein are applicable to the Same-Sex couples as well.
Litigation attorneys, beware, settlement awards may be taxable
Some plaintiffs or even lawyers may assume that settlements awards are tax free. Not so, says Uncle Sam. Internal Revenue Code (IRC) § 61 states all income from whatever source (this includes lawsuit awards) derived is taxable, unless specifically excluded by another Code section. IRC § 104 is the exclusion from taxable income with respect to lawsuit settlements, and awards.
The 1996 amendment added to IRC § 104(a) (2) the word physical to the clause “on account of personal physical injuries or physical sickness.” Therefore, in order for damages to be excludible from income, the judgment or settlement must be derived from personal physical injuries or physical sickness. Prior to the 1996 amendment, IRC § 104(a) (2) was extensively litigated with respect to what was personal injuries.
Tax Tip: The litigators are highly encouraged to discuss the tax consequences of their potential awards and their settlement structure with a tax attorney, before the case is settled, to ensure that their clients will get a tax advantageous settlement. At times, the winning plaintiff ends up with heavy duty taxes including unexpected AMT. The plaintiffs need to do their own tax planning and try not to fall into an AMT trap as well.
Foreign Provision; the Foreign Investment in Real Property Tax Act (FIRPTA)
The Foreign Investment in Real Property Tax Act (FIRPTA) requires a tax of 20% (up from 10% in 2012) of the amount realized on the disposition of all US real property. A buyer of U.S. real property interest from a foreign investor is considered the withholding agent and is obligated to find out if the seller is a foreign person. If the transferor is a foreign person and the transferee fails to withhold, the buyer may be held liable for the tax. The seller must report that sale of the real property interests by filing a U.S. Federal Tax Form 1040-NR or Form 1120-F.
The withholding agent must remit the withholding of tax to the IRS by the 20th day of the date of the transfer.
Note: Acquisition of the US Real Property by Foreign Persons from countries under the US Economic Sanctions are subject to specific licensing requirement of the US Treasury Office of Foreign Assets Control (OFAC). Also, purchase of these properties from the foreign persons from those countries may subject to the same laws. These countries include but are not limited to Cuba, Syria, North Korea, Iran, etc.
Tax Tip: The transferee; ascertain the nationality of the transferor and withhold the required taxes.
The transferor: You may be eligible for a lesser withholding in the following circumstances:
A. The disposition of the U.S real property interest takes place under one of the non-recognition provisions of the Internal Revenue Code.
B. When the transferor’s maximum tax liability on the disposition is less than the amount otherwise required to be withheld.
C. The transferor or transferee wants to come under certain installment sale rules.
D. The transferor or transferee enters into an agreement with the IRS by posting a type of security (letter of credit, bond, etc.).
E. The transferor or transferee may enter into a 12 month agreement with the service to obtain a “blanket withholding certificate” for multiple properties.
F. A nonstandard application may be submitted for unique situations that do not fit into the above categories.
Reasonable Compensation for Shareholders who work for the Corporation
When a stockholder works for the corporation, they must be paid a reasonable amount of salary for the services performed. The Government Accountability Office has reported many employment tax abuses with respect to S corporation shareholders who worked for the corporation, alleging unreasonably low compensation paid to these shareholders. The IRS has ascertained corporate income tax abuses by unreasonably excessive compensation of C corporation shareholders who worked in the corporation.
Tax Tip: Pay the working shareholder a reasonable amount of salary before January 1, 2014 and incorporate any estimated taxes into W-2 form.
S Corporation or Limited Liability Company (LLC) losses
The amount of losses from an S corporation or an LLC you can deduct is limited to your basis (your capital adjusted for earnings, drawls, etc.) in each entity.
Tax Tip: The above-mentioned losses are suspended and not deductible. Do not take any deduction for these losses.
Bonus and Section 179 Depreciation
50% bonus and section 179 depreciation is extended through 2013. In addition, some transportation and longer period production property is eligible for 50% bonus depreciation through 2014.
The total amount you can elect to deduct under section 179 for most property placed in service in 2013 is $500,000. If you acquire and place in service more than one item of qualifying property during the year, you can allocate the section 179 expense deduction among the items in any way, as long as the total deduction is not more than $500,000.
Reduced dollar limit for cost exceeding $2 million
If the cost of your qualifying section 179 property placed in service in 2013 is over $2 million, you must reduce the dollar limit (but not below zero) by the amount of cost over $2 million. If the cost of your section 179 property placed in service during 2013 is $2,500,000 or more, you cannot take a section 179 expense deduction and you cannot carry over the cost that is more than $2,500,000.
Tax Tip: You may purchase any necessary business equipment before January 1, 2014. The 2014 Section 179 will decline to $25,000, and the phase-out amount will be $200,000, unless Congress acts otherwise.
Depreciation on a Luxury passenger car
The deprecation deduction for a passenger car is limited to $11,160 (1st year), $5,100 (2nd year), $3,050 (3rd year), and $1,875 each year thereafter.
Tax Tip: The passenger car must be used in the ordinary course of business.
2013 Credit Card Charges
Any charges made to your credit cards before January 1, 2014, to pay business expenses may be deducted as 2013 deductible in 2013, although the actual payments may be made in 2014.
Tip: These deductions may be incorporated into your 2013 estimated taxes.
Work Opportunity Tax Credit (WOTC)
The American Taxpayer Relief Act of 2012 extended the Work Opportunity Tax Credit (WOTC) for hiring certain workers through Dec. 31, 2013. The VOW to Hire Heroes Act of 2011 made changes to the Work Opportunity Tax Credit (WOTC), including adding new categories to the qualified veterans targeted group and expanding the WOTC to make a reduced credit available to tax-exempt organizations for hiring qualified veterans. The VOW Act also extended the WOTC for qualified veterans hired before Jan.1, 2013. The other targeted group categories were not extended by the VOW Act and expired for targeted group members other than qualified veterans hired after Dec.31, 2011.
ATRA extends the WOTC for qualified veterans hired before Jan. 1, 2014. ATRA also extends the WOTC for targeted group members, other than qualified veterans, hired after Dec.31, 2011, and before Jan.1, 2014.
Tax Tip: Employment must take place before January 1, 2014.
In most cases, you must pay estimated taxes for 2013 if both of the following apply.
1- You expect to owe at least $1,000 in tax for 2013, after subtracting your withholding and refundable credits.
2- You expect your withholding and refundable credits to be less than the smaller of:
a. 90% of the tax to be shown on your 2013 tax return, or 100% of the tax shown on your 2012 tax returns;
b. Your 2012 tax return must cover all 12 months.
Note. The percentages in (2a) or (2b) above may be different if you are a farmer, fisherman or higher income taxpayer.
Tax Tip. The purpose of making estimated tax payments is to avoid underpayment and late payment penalties and interest. The 2013 estimates are of particular importance because of the following factors:
A. New 4.6% tax for the high earners;
B. New 0.9% Medicare tax; and,
C. New 3.8% NIIT explained above.
In addition, preparation of quarterly financial statements for business would be instrumental in calculating accurate estimated taxes.
The life-time gift exclusion is $5,250,000. Any amount in excess of this threshold is taxed at 40 %. This rate will be 45% in 2014. The annual gift exclusion is $14,000 per person.
Tax Tip: The annual gift, including funding an Irrevocable Life Insurance Trust (ILIT) must be paid before January 1, 2014. Do not forget the “Crummey Power”.
Estate Tax and Planning
The life-time estate exclusion is $5,250,000. Any amount in excess of this threshold is taxed at 40 %. This rate will be 45% in 2014. The estate portability, by which the surviving spouse may use the Deceased Spouse’s Unused Exclusion amount, is now permanent and available through an election by the estate of decedent spouse.
Tax Tip: Discuss with your estate planning attorney whether an A-B trust is still suitable to you particular situation. A portability election must be made if advisable.