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Trends & Developments - October 2013 - Tax Update - It's Not Too Early for Year-End Tax Planning

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The American Taxpayer Relief Act of 2012 introduced many tax planning opportunities in connection with individual income tax, estate and trust provisions, and more. As a result, heading into the 2013 year-end there are many pre-year-end tax planning matters to take advantage of to help reduce 2013 tax liabilities and to get a head start on 2014 tax planning.

  1. Review 2013 income tax withholdings and estimated tax payments (attributable to compensation, dividends and interest, and other income) – year-to-date and projected at December 31, 2013. 
    1. 2013 Estimated Tax Payments Safe Harbor – the lesser of 110% of 2012 tax liability, or 90% of 2013 tax liability. Therefore,
      1. Review 2012 taxable income and estimated 2013 taxable income (federal and state) to determine appropriate strategy.
      2. The top federal ordinary income tax rate is 39.6% (on income over $450,000; increased from 35% in 2012), and 20% for qualified dividends and long term capital gains (increased from 15% in 2012).
       
    2. There is an additional .9% in Medicare tax on earned income over $250,000. Employees' share of payroll tax increased to 6.2%.
    3. Offset capital gain with losses in 2013 to reduce capital gain tax and the 3.8% Medicare tax (see below) exposure
     
  2. Additionally, in 2013 there is a 3.8% Medicare Contribution Tax liability on unearned income. Identify investment expenses that can be used to offset investment income, therefore reducing the 3.8% surcharge.  
    1. Unearned income generally includes investment income such as capital gains, dividends, interest, and annuities; royalties and rents are additional examples. Any investment income that had previously been characterized as "tax exempt" would not be subject to the new tax.
    2. State tax payments made by year-end may offset the 3.8% Medicare Contribution Tax liability, so may be advantageous despite AMT limitations.
    3. Trusts and estates have a much lower threshold ($11,950) with respect to this tax.  In view of this, consider whether certain classes of income should be directed to certain beneficiaries.
     
  3. Review adjusted gross income (AGI) in excess of $300,000 (for couples); excess income will result in a phaseout of itemized deductions and personal exemptions.
    1. The phaseout of the personal exemption (sometimes called "PEP") means for every $2,500 of AGI (or portion thereof) above $300,000, the $3,900 per-person personal exemption will be reduced by 2%. For married couples, personal exemptions will be fully phased out once their AGI exceeds $422,501, or for single filers if AGI exceeds $372,501.
     
  4. For those age 70 ½ and taking required minimum distributions, use a qualifed charitable contribution deduction
    1. The act extended the qualified charitable distribution (QCD) provisions for 2012 and 2013. Several special transition rules were included in ATRA to enable taxpayers to have a donation made before February 1, 2013, treated as a 2012 QCD.
    2. The contribution will not increase adjusted gross income, which has the effect of not decreasing the deductibility of medical expenses (§ 213(a)) or miscellaneous itemized deductions (§ 67(a)), or increasing the reduction of itemized deductions, increasing the taxability of Social Security benefits and Medicare.
    3. This strategy would not increase state income taxes that use federal adjusted gross income as the basis for computing state income taxes but does not allow a charitable deduction.
     
  5. 2013 pre-year-end tax planning to minimize or eliminate AMT is a multi-tax year computation, with the consideration of facts and assumptions, 2012 (for 2013 estimated tax purposes) and 2013 estimated AMT and 2014 forecasted taxable income should be considered. For example:

You are subject to the AMT (at 28%) in the current year, but don't expect to be next year; therefore, general considerations include:

    • Deferring until next year any deductions that are not deductible for AMT purposes,
    • Accelerating ordinary income into the current year to benefit from the lower 28% AMT rate, and
    • Delaying the exercise of any incentive stock options ("ISOs") or other current year AMT income adjustments or preference items, since you will be assessed AMT on the spread between the fair market value and the exercise price. If you already exercised the options, consider a disqualifying disposition.

You are not in the AMT in the current year and will be taxed at the regular tax rate (above 28%), but expect to be in the AMT next year; therefore, general considerations include:

    • Prepaying deductions that are not deductible for AMT purposes to obtain the full tax deduction benefit this year rather than lose the tax deduction benefit next year,
    • Prepaying your current-year fourth-quarter state and local income tax estimate by December 31 of the current year,
    • Prepaying deductions this year (that are deductible against the AMT), such as charitable contributions, to gain the benefit of the higher ordinary tax rate this year,
    • Deferring ordinary income, such as bonuses if possible, to next year to take advantage of the lower AMT rate, and
    • Reviewing your ISO plans to determine if you can exercise any shares before the end of the year (and other current-year AMT income adjustments or preference items). The exercise will be tax-free this year up to the extent of the break-even point between your regular tax and the AMT.
  1. Education Tax Credits: The American Taxpayer Relief Act of 2012 extended the Opportunity Tax Credit (AOTC) by an additional five years of life.
    1. It's time for parents of both college students and high school juniors and seniors to learn about how this valuable tax break works. The credit reduces your federal tax bill dollar-for-dollar by up to $2,500 per year for each eligible college student for whom you pay qualified tuition expenses. It can be claimed on behalf of an undergraduate for four years—that's a $10,000 tax subsidy, over four years. And if you have more than one child in college at the same time, you can claim more than one credit. This break had been set to expire at the end of 2012, but is now extended for tax years 2013-2017.
     
  2. The American Taxpayer Relief Act of 2012 rescinded the temporary lower 4.2% rate for employees' portion of the social security payroll tax.
    1. The 4.2% employee tax rate (in effect in 2011 and 2012) for the Social Security payroll tax was not extended by the Act and has reverted to 6.2% on the first $113,700 in wages.
    2. Planning opportunity: Contributing to an employer flexible spending account creates an income and payroll tax deduction, and allows the participant to pay out of pocket health care costs on a pre-tax basis
  3. For 2013 gifts and wills and trusts in force or contemplated: Act before the end of 2013.
    • Obtain/review a current balance sheet (cost basis and fair values).
    • The 2013 annual gift tax exclusion (per donee/recipient) is $14,000; $28,000 for married donors.
    • In 2013, a $5,250,000 estate tax exclusion (per decedent; $10,500,000 for a married couple) remains in place.
    • Review beneficiaries under your will(s).
    • Review trustee(s) under wills.
    • Review guardian selections for minor children.
  4. Review or have drafted, before year-end, advanced health care directives and durable powers of attorney.
    • These documents are in addition to wills and names persons who can make medical decisions, financial decisions, and defined actions on your behalf if you are unable to do so.
     
  5. Review life insurance in-force and long-term disability income insurance in–force; consider obtaining or increasing coverage as warranted.  
      1. The purpose is to fund family needs in the event of death or disability. Objective: Provide for a fund balance to fund annual cash flow needs through or beyond a target date
        . Example: for future generations
    • Types of life insurance (term, whole, universal, variable, other).
    • Premium payment modes and options.
    • Modeling premium payment modes (permanent and term models).
    • Ownership and titling of life insurance (i.e.,  a family trust). 
  6. Additional insurable risk management issues: Review and obtain coverage for:
    • Property (real estate and non-real estate).
    • Casualty.
    • Special risks/circumstances.
     
  7. Businesses should consider locking in on accelerated deductions by buying qualifying assets before the end of the year and placing in service before year-end, including bonus depreciation. The section 179 expensing limitation is slated for a dramatic reduction in 2014.
  8. On August 29, 2013 the U.S. Department of the Treasury and the Internal Revenue Service ruled that same-sex couples, legally married in jurisdictions that recognize their marriages, will be treated as married for federal tax purposes.
    1. The ruling applies regardless of whether the couple lives in a jurisdiction that recognizes same-sex marriage or a jurisdiction that does not recognize same-sex marriage. 
    2. On June 26, 2013 the United States Supreme Court rulings struck down the Defense of Marriage Act (DOMA), reinstating same-sex marriage in California and having significant immediate effects on legally married same-sex couples. There are over 1,000 federal statutes providing rights, privileges and obligations for married couples which are now applicable to same-sex couples.
    3. Chief among these are married couples may file joint tax returns and can make unlimited lifetime transfers through gifts or bequests to their spouses free of federal estate and gift taxes.
    4. Among the many items and issues same-sex filers should consider are potential tax refunds which may be available by filing amended joint tax returns for open tax years, generally the last three years. These refunds may result from lower joint income tax brackets, spousal health insurance benefits, child care credits, and dependent child credits, amongst others.
    5. Furthermore, any estate and gift taxes paid with respect to transfers to spouses are also refundable to the extent the statute of limitations is still open. You should contact your tax and legal advisors to review both prior-year tax filings and to update your estate planning.
     
  9. The Taxpayer Relief Act of 2012 extended the gain exclusion period for qualified small business stock.
    1. Consider a sale of qualifying stock before the end of 2013.
    2. In 2012 (pre-act), the law permitted 100% exclusion for stock issued between September 27, 2010 and December 31, 2011.
    3. The Taxpayer Relief Act extended this period allowing for qualified stock issued during 2012 and 2013 to qualify for 100% gain exclusion.
    4. This exclusion also applies to the new 3.8% Medicare Contribution Tax on net investment income.
    5. In addition to extending the exclusion period, the law also provides for more favorable treatment under the alternative minimum tax ("AMT") regime. The previous law required that 42% of the excluded gain, or 28% for stock with holding periods that began after December 31, 2000, be added back for purposes of AMT. The Taxpayer Relief Act made permanent a provision from the Jobs and Growth Tax Relief Reconciliation Act of 2003 which allows for a 7% addback rather than 42% or 28%. The 7% addback is a permanent change in the law and is effective for tax years beginning after December 31, 2012.  
    6. With capital gains rates rising and the addition of the 3.8% Medicare Contribution Tax, these changes in the law provide significant incentives for investors to seek out investment in qualified small businesses.
    7. The gain exclusion and favorable AMT treatment will help small businesses attract investment and raise additional capital.
    8. Those companies and shareholders that believe they can benefit from the Qualified Small Business Stock rules should consider taking advantage of the period of exclusion by seeking to raise additional capital through stock offerings in 2013.
  10. Taxpayers should take advantage of tax provisions set to expire including (but not limited to):
    1. Deduction for state and local sales taxes (for taxpayers residing in no or low tax states who have large purchases).
    2. Credit for health insurance costs.
    3. Deduction for mortgage insurance premiums as qualified interest.
    4. Certain energy provisions.
  11. Taxpayers should review at-risk and activity logs to determine whether losses from pass-through entities can be deducted and whether such deduction is limited to offsetting other passive activities.  
  12. U.S. citizens residing abroad should consider whether pre-payment of foreign taxes is beneficial to reduce federal income tax liability, and those returning back to the United States should consider whether their foreign work days can be beneficial in optimizing the utilization of foreign tax credits not otherwise utilized.  
  13. U.S. citizens or green card holders residing abroad who have not filed U.S. tax returns can still consider the IRS streamlined filing procedures to remain current, noting that any delinquent FBAR filings will need to be efiled under most circumstances. U.S. citizens who do not qualify for this program still have the opportunity to disclose their offshore accounts through the offshore voluntary disclosure program, especially given the increased disclosures required, increase in cross border information exchanges, and the continued adoption of FATCA abroad.

Trends & Developments - October 2013

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