2013 tax increases make effective planning more important than ever
Tax planning last year involved preparing for significant tax increases scheduled for 2013, though there was uncertainty about whether those increases would be allowed to go into effect. On Jan. 1, 2013, Congress passed the American Taxpayer Relief Act of 2012 (ATRA), which prevented income tax rate increases for most taxpayers.
But ATRA didn’t provide as much relief to higher-income taxpayers. While you’ll enjoy the benefits of the extended lower rates on at least a portion of your income, you may see rate hikes on income exceeding certain thresholds. These hikes — combined with expanded Medicare taxes that go into effect this year under the 2010 health care act — could cause you to face significantly higher taxes in 2013. In addition, even though many of ATRA’s provisions are “permanent,” this simply means that the provisions don’t have expiration dates. Congress can still pass additional changes affecting your tax liability this year or in future years.
So in 2013, effective tax planning is more important than ever. This guide is intended to help you familiarize yourself with key tax law changes and make the most of the tax-savings opportunities available to you. But we don’t have room here to cover all strategies that may apply to your situation. So please contact your tax advisor to learn the best ways to minimize your tax liability for 2013 and beyond.
Contents and Excerpts –
Year-to-date review [Page 2] – Higher-income taxpayers will see a variety of tax increases on their “ordinary income” this year. Ordinary income generally includes salary, income from self-employment or business activities, interest, and distributions from tax-deferred retirement accounts. But ordinary income isn’t all taxed the same way. For example, some types of ordinary income are subject to employment tax; others aren’t. And if you’re subject to the AMT, your ordinary income will be taxed differently. By starting to plan now, you may be able to take steps that will minimize the impact of tax hikes on your ordinary income.
Executive compensation [Page 6] – If you’re an executive or other key employee, you might be rewarded for your contributions to your company’s success with restricted stock, stock options or nonqualified deferred compensation (NQDC). The tax planning for these forms of compensation, however, is generally more complicated than for salaries, bonuses and traditional employee benefits. And planning gets even more complicated this year, because of the potential impact of higher tax rates and expanded Medicare taxes.
Investing [Page 8] – For higher-income taxpayers, in many cases the answer will be “yes.” ATRA brings back the top long-term capital gains rate of 20%, and the 2010 health care act introduces a new 3.8% Medicare tax on net investment income. This means that investors subject to both taxes could see an 8.8 percentage point tax increase on some or all of their long-term capital gains and qualified dividends. While tax consequences should never be the primary driver of investment decisions, this year’s tax increases make it especially important that taxes be considered.
Real Estate [Page 12] – As the real estate market slowly recovers and potential taxes go up for many, tax planning for real estate — whether your home, your vacation home or a rental property — is becoming more important. Higher-income taxpayers could see the benefit of some of their home-related deductions reduced and face higher income tax rates plus the new 3.8% Medicare tax on real estate income and gains.
Business ownership [Page 14] – When it comes to taxes, owning a business provides both opportunities and risks. For example, you may be able to set up a tax-advantaged retirement plan that allows you to make larger contributions than you could make if you were an employee participating in an employer-sponsored plan. But if you don’t carefully plan for your exit from the business, you could lose much of the net worth you built up in the business to taxes.
Charitable giving [Page 16] – Deductions are more valuable when tax rates are higher, and higher-income taxpayers face higher rates in 2013. So you may reap greater savings from your donations this year. Donations to qualified charities are generally fully deductible for both regular tax and AMT purposes. By carefully choosing what you donate and how you donate it, you may be able to enjoy additional benefits. But it’s important to pay attention to the myriad rules and limits that apply — such as the itemized deduction reduction. (See “What’s new!” on page 5.) If you don’t, your benefit could be smaller than expected.
Family and education [Page 18] – Whether you’re a parent or a grandparent, you likely want to do what you can to start the children in your life off on the right financial track. By helping them take advantage of tax-deferred and tax-free savings opportunities, you can do just that. Or you may be able to benefit from opportunities that save tax while you provide for your children’s or grandchildren’s education expenses, which will also help put them on firm financial footing as they enter adulthood.
Retirement [Page 20] – Tax-deferred (or tax-free, in the case of Roth accounts) compounding can have an exponential effect on your investment returns, and the increase in the top tax rate to 39.6% this year means that the tax deferral (or tax savings) can be even greater. Maximizing your contributions to a traditional plan could also keep you from becoming subject to the 39.6% rate or the new 3.8% Medicare contribution tax on net investment income. But when it comes to distributions, traditional plans could have the opposite effect — pushing you into the 39.6% bracket or triggering the 3.8% tax. So careful planning is critical.
Estate planning [Page 22] – Estate planning may be a little less challenging now that we have more certainty about the future of estate, gift and generation-skipping transfer (GST) taxes. ATRA makes exemptions and rates for these taxes, as well as certain related breaks, permanent. Estate taxes will increase somewhat, but not as much as they would have without the legislation. And the permanence will make it easier to determine how to make the most of your exemptions and keep taxes to a minimum while achieving your other estate planning goals. However, it’s important to keep in mind that “permanent” is a relative term — it simply means there are no expiration dates. Congress could still pass legislation making estate tax law changes.
Tax rates [Page 24] – 2013 individual income tax rate schedules