The fiscal cliff deal that was reached by Congress just in time for the New Year resulted in the American Taxpayer Relief Act of 2012 (ATRA). Although the deal resulted in a clarified tax code, more tax burden for higher income earners, and the extension of some tax credits (like those related to child care, higher education, lower wage earners, and small businesses), the impace won't be felt by the wealthy alone. Though you can’t escape the effects of 2013 tax changes altogether, you can apply a bit of strategy to keep more of your money working directly for you by making less of it subject to tax. Here are five expert recommendations on improving your tax strategy under a new set of rules.
Keep more of your paycheck.
The expiration of the payroll tax cut means that every paycheck you earn is effectively reduced by two more percentage points than it was in 2012. In short, every $100 you earn now equates to $98 of take home pay. The Tax Policy Center estimates that households making between $40,000 and $50,000 will face an average tax increase of $579 in 2013; those making between $50,000 and $75,00 could see their taxes increase by about $820. Because you’ll feel the reduction of expendable income in every paycheck, it’s critical that you accurately estimate your tax withholding for 2013, particularly if you typically get a significant tax return. The IRS offers a calculator on its site
. Since you’ll already have documents like recent paystubs and W-2s along with last year's return on hand, tax season is a convenient time to adjust your tax withholding accurately.
Lump your medical spending.
In 2013, you must have qualified medical expenses that are more than 10% of your adjusted gross income (AGI) in order to take a deduction, but Tiffany Y. Washington of Washington Accounting Services says that taxpayers age 65 or older can still use the 7.5% threshold through 2016. To maximize deductions, cluster your medical expenses so they take place in the same year. If your employer offers a flexible spending account, use it to pay for unreimbursed medical costs, up to the maximum allowed limit of $2,500 in 2013.
Take advantage of retirement.
Don’t think you can afford to contribute more to retirement? Consider whether you’d rather put the money to your future—or to taxes. Shomari Hearn of Palisades Hudson Financial Group
explains that contributions to employer-sponsored plans reduce taxable income and can help reduce exposure to the net investment income tax, particularly for those in upper income levels.
Consider a couple making $275,000: If both spouses contribute a combined $35,000 to their 401(k) plans, they’ll reduce taxable income to $241,000—and avoid the $250,000 threshold that will subject them to more tax this year. (In 2013, you can contribute up to $17,500 to your 401(k). If you're 50 or older, you can add an extra $5,500 to that amount). Once you’ve exhausted contribution limits, contribute to a traditional IRA account as an additional means of lowering your AGI and tax obligations.
Already retired and looking for strategies to save money? Though some taxpayers may benefit from converting a traditional IRA to a Roth IRA, keep an eye on your income thresholds before you pull the trigger. Hearn says that while distributions from traditional IRAs are excluded in calculating net investment income, they are
included when calculating your modified adjusted gross income (MAGI), and could increase your exposure to the new tax. With a Roth IRA, qualified distributions are income tax free and are excluded from both net investment income and MAGI, but the conversion amount counts as taxable income. If you’re on the threshold of upper income limits, spread the conversion over a number of years to avoid entering a higher tax bracket.
Rethink passive income.
If you’ll make $200,000 as a single filer, or you’re a married couple filing jointly at more than $250,000 this year, it’s time to focus on where your money comes from, and how you claim it. In addition to the new 0.9% increase in Medicare payroll taxes on income above $200,000 ($250,000 for married couples filing joint), tax attorney Jared Callister of Fishman Larsen Goldring & Zeitler
says those taxpayers could be hit with an extra 3.8% tax on passive income received from things like dividend payouts, capital gains, interest payments, and rental property income. He suggests first referring to Section 469 to ensure that you pass the so-called “material participation” test, and reconsidering how you structure streams of income, and to what degree you participate in them. Some strategies to avoid the tax might include increasing Roth and retirement plan distributions to reduce taxable income, investing in high-growth stocks versus dividend-yielding ones, and becoming more involved in your rental income interests in order to satisfy the IRS criterion around participation.
Keep an eye on household income thresholds.
One key change to the 2013 tax law rests on itemized deductions for taxpayers with incomes in excess of $250,000 (single) or $300,000 (married filing jointly). David Reid of WTP Advisors
says the return of the personal exemption phase-out (PEP) and itemized deduction (PEASE) limitation could ultimately result in the denial of personal exemptions, and a loss of up to 80% of itemized deductions for upper income filers. Jill Schneider of Mayer Meinberg
advises those taxpayers to strategize whether any deductions can be pushed into 2014. Additionally, those who are close to exceeding the $400,000/$450,000 income threshold should determine whether any income can be deferred into 2014 in order to keep capital gains and qualified dividends at a 15% tax rate.
Invest in your business
. If you own a business and are ready to invest in it, wait no more: New business equipment and machinery placed into service this year qualifies for the 50% first-year deprecation allowance (or bonus depreciation allowance)—but not for long. Reid says the American Taxpayer Relief Act of 2012 authorized a one-year extension of the bonus depreciation allowance for qualified property acquired and placed in service before January 1, 2014. But unless Congress extends it again, it will not be available for property placed in service in 2014.
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