The annual scramble to make smart tax moves before Dec. 31 is proving especially vexing this year, here are some of our CPA in Chicago suggestions.
Congress still hasn’t settled 2013 tax rates on income, investments, large gifts and estates. Deductions and other breaks are also in doubt, now that politicians from both parties are calling for cutbacks—although in different ways. Many questions remain unanswered even for the 2012 tax year. For example, the Internal Revenue Service on Nov. 13 warned lawmakers that if they don’t act soon, the alternative minimum tax, which reduces the value of some tax breaks, will apply to 33 million households for 2012 rather than four million. More than 60 million people might not be able to file returns or receive refunds until late March, the IRS says, because it would have to reprogram computers.
Yet despite the uncertainties, year-end tax planning is possible and it will impact your Income Tax. We do know that 2013 will mark the debut of the 3.8% flat levy on net investment income for joint filers with adjusted gross income of $250,000 or more ($200,000 for singles). Congress passed this levy, plus a 0.9% increase in Medicare tax for affluent earners, to help fund the massive 2010 health-care changes. The tax introduces new layers of complexity into investors’ planning. (For more details, see box on this page.)
Big unknowns include the top rates on long-term capital gains and qualified dividends, both now 15%. The rate on gains could hit 23.8% or more, and the rate on dividends could be as high as 43.4%. .
There are few ways taxpayers can shrink 2012 taxes after Dec. 31, other than contributing to some retirement accounts or health savings accounts. Here are moves to consider before year end, plus a few to avoid.
- Make charitable gifts. The best value often comes from donating appreciated assets, because donors can get a full deduction while skipping capital-gains tax on the asset’s growth. Cash donations to charities are often deductible up to 50% of adjusted gross income.
- If you want to donate IRA assets to charity, wait a bit longer. Since 2006, IRA owners 70½ and older have been able to give up to $100,000 of the required payout directly to a charity. There’s no deduction, but no taxable income either. This wildly popular provision expired at the beginning of 2012, but lawmakers might yet reinstate it—as they did in 2010.
- Make an extra mortgage payment, or pay down principal. Usually taxpayers can’t accelerate more than one month of mortgage interest, but that helps a bit if you think the mortgage-interest deduction will be curbed next year. Or find cash to pay down principal, which reduces overall interest.
- Maximize contributions to employer-sponsored retirement plans. Unlike with IRAs, the deadline for 401(k) contributions is Dec. 31. This year, the employee limit is $17,000, or $22,500 for workers 50 or older.
- Harvest capital losses, up to a point. Investment losses can offset investment gains plus up to $3,000 of ordinary income, both for single and joint filers. Note that “wash sale” rules penalize buyers who acquire the same asset within 30 days of selling at a loss.
- Use up funds in a medical flexible-spending account. They often don’t carry over, although some employers will allow workers to spend 2012 funds in the first weeks of 2013. Next year, the contribution limit will be $2,500, less than some employers now allow.
- Accelerate medical expenses. The threshold for deducting these expenses, now 7.5% of adjusted gross income (10% for AMT payers), rises to 10% next year for most taxpayers. People who are 65 and older, however, can use the 7.5% threshold through 2016. This phase-in will be useful, say advisers, because most taxpayers claiming large medical deductions are in the final years of life. Note that the IRS’s list of what’s deductible is far broader than what insurance typically reimburses, extending to contact-lens solution, assisted-living costs and even special education.
- Write next semester’s tuition checks before year end. The American Opportunity Tax Credit allows qualified taxpayers to get a benefit this year for next spring’s tuition if the payment is made before year end—even though the credit is set to expire for 2013.
- Prepay state taxes. Deductions for state and local income, sales and property taxes are already disallowed by the alternative minimum tax, and they might shrink further next year, even if Congress reinstates the expired sales-tax deduction for 2012. Consider accelerating next year’s state tax payments if they don’t throw you into the AMT, in which case you’ll lose the write-off altogether.
- Make gifts up to $13,000 to relatives or friends. Such gifts are tax-free, and the number of recipients isn’t limited as long as the value of each gift doesn’t exceed $13,000. Cash is often the best gift, as presents of assets such as stock carry their “cost basis” with them.
- Contribute to 529 education savings accounts. Assets in these accounts enjoy tax-free growth, and withdrawals from them are tax-free when used for tuition and other qualified expenses. Some states also provide tax benefits to givers. These accounts also offer a rare benefit: Contributions leave the giver’s estate, yet he or she can take back the principal without penalty if the money is needed. Contributions do count toward the $13,000 gift limit, however.
Please call Accountants in Chicago at 773-728-1500. We can help you plan and get the right tax deductions.