TAX PLANNING BASICS
With a substantial portion of provisions in the Internal Revenue Code (Code) set to expire the end of this year, I am strongly encouraging my clients to take advantage of the current tax planning opportunities available this year. Below is a starting point for assessing your tax situation and determining whether or not consulting a tax attorney might help you reduce your bottom line this year.
Because many tax benefits are tied to or limited by adjusted gross income (AGI) — IRA deductions, for example — a key aspect of tax planning is to estimate both your 2013 and 2014 AGI. Also, when considering whether to accelerate or defer income or deductions, you should be aware of the impact this action may have on your AGI and your ability to maximize itemized deductions that are tied to AGI.
Another important number is your “tax bracket,” i.e., the rate at which your last dollar of income is taxed. Due to legislation in early 2013, the tax rates for 2013 changed from 2012 and are 10%, 15%, 25%, 28%, 33%, 35% and 39.6%. Although tax brackets are indexed for inflation, if your income increases faster than the inflation adjustment, you may be pushed into a higher bracket. If so, your potential benefit from any tax-saving opportunity is increased (as is the cost of overlooking that opportunity).
Individuals who are not active participants in an employer pension plan may make deductible contributions to an IRA. The annual deductible contribution limit for an IRA for 2013 is $5,500. For 2013, a $1,000 “catch-up” contribution is allowed for taxpayers age 50 or older by the close of the taxable year, making the total limit $6,500 for these individuals.
Individuals who are active participants in an employer pension plan also may make deductible contributions to an IRA, but their contributions are limited in amount depending on their AGI. For 2013, the AGI phase-out range for deductibility of IRA contributions is between $59,000 and $69,000 of modified AGI for single persons (including heads of households), and between $95,000 and $115,000 of modified AGI for married filing jointly. Above these ranges, no deduction is allowed.
Roth IRA and the Conversion Rule:
The Roth IRA permits nondeductible contributions of up to $5,500 for 2013. Earnings grow tax-free, and distributions are tax-free provided no distributions are made until more than five years after the first contribution and the individual has reached age 591/2. Distributions may be made earlier on account of the individual’s disability or death. The maximum contribution is phased out in 2013 for persons with an AGI above certain amounts: $178,000 to $188,000 for married filing jointly, and $112,000 to $127,000 for single taxpayers.
Regardless of income, taxpayers can convert traditional IRA accounts to Roth IRA accounts. Previously, taxpayers with modified adjusted gross income over $100,000 could not make the conversion. Such a rollover, however, is treated as a taxable event, and you will pay tax on the amount converted, however no penalties will apply if all the requirements for such a transfer are satisfied.
Increased Capital Gains Rates:
The long term capital gains rate increases to 20% in 2013 for taxpayers in the 39.6% tax bracket. 0% if an individual is in the 10% or 15% marginal tax bracket and 15% for individuals in the 25%, 28%, 33% and 35% brackets. Capital gains on property held one year or less are taxed at an individual’s ordinary income tax rate.
Depending on the recipient’s modified AGI and the amount of Social Security benefits, a percentage — up to 85% — of Social Security benefits may be taxed. To reduce that percentage, it may be beneficial to defer receipt of other retirement income. One way to do so is to elect to receive a lump-sum distribution from a retirement plan and to rollover that distribution into an IRA. Alternatively, it may be beneficial to accelerate income so as to reduce the percentage of your Social Security taxed in 2014 and later years.