Tax Planning for 2013

There are several tax law changes that could be taking effect on January 1, 2013. We wanted to make you aware of some of the more significant changes, and give you some suggestions to help you manage your current and future tax liabilities.

There are two new taxes that will be in place starting in 2013 as a result of the 2010 health care law. These two taxes are 1) a 0.9% surtax on earned income and 2) a 3.8% surtax on unearned income. The 0.9% surtax on earned income applies to taxpayers with earned income in excess of $250,000 if married, filing a joint return, $125,000 if married filing separately, and $200,000 for all other taxpayers (i.e., single, head of household). It is a tax on income that is subject to Medicare tax (i.e., wages, and self-employment income).  The 3.8% surtax on unearned income applies if adjusted gross income exceeds the amounts listed previously, and the taxpayer also has investment income (interest, dividends, capital gains, etc.). Listed below are some suggestions that you can use to help lower the surtaxes.

Reducing the 0.9% surtax on earned income:

1. If you are a business owner, consider converting to an S corporation. The distributions you receive from an S corporation are not considered earned income. By combining lowered, but still reasonable, wages with distributions of remaining profits, you may be able to avoid the surtax completely. But be cautious with this strategy because it may cause unintended state income tax consequences, depending on where you live.
2. Utilize fringe benefit programs such as education reimbursement programs, child care programs, employer provided auto use, etc. These fringes can be used in conjunction with a W-2 reduction or in lieu of a bonus to provide surtax-free income.
3. Employers of all sizes can establish accountable expense plans, rather than allowances, to reimburse employee business expense directly. If employers reimburse employees directly, the reimbursement isn’t included in W-2 wages for the employee, and as such won’t be subject to the surtax.
4. Business owners who own buildings that they rent to their businesses, should maximize the rent paid by the business. The rental income will not be subject to the 0.9% surtax. But again, be cautious with this strategy because it may also cause unintended state tax consequences depending on the ownership structure of your real estate.

Reducing the 3.8% surtax on unearned income:

1. Consider converting retirement accounts to Roth IRAs in 2012. Future Roth withdrawals would not be considered income, and as such, would not be subject to the surtax. Also, Roth withdrawals, as opposed to withdrawals from traditional retirement plans, do not count as “income” for purposes of the income threshold that would trigger the surtax. Converting your retirement plans to Roth IRAs would increase your 2012 income taxes, but at presumably lower rates than you would pay in the future.
2. If you are considering selling stock in a closely held business, land, or similar “capital”
   assets after 2012, you should consider selling these assets on an installment basis. This will reduce total adjusted gross income, and possibly keep you under the threshold  for the surtax.
3. Maximize deferrals into 401(k) and Simple retirement plans. This will reduce adjusted gross income, and future withdrawals from these plans will not be subject to the surtax.
4. Consider moving investments into municipal bonds. This income is not subject to the surtax, regular income tax, nor in most cases to AMT.

Thanks to the extension of the so-called “Bush Tax Cuts” through 2012, the current federal income tax environment remains favorable through year-end. That said, now is the time to take advantage because we don’t know what tax rates will be in 2013 and beyond. Listed below are some strategies that you may consider using to reduce future tax liability.

1. If you think the Bush tax cuts will be allowed to expire at the end of this year, consider accelerating income into this year and deferring deductions until next year. That way, more income will be taxed at this year’s lower rates.
2. If you think you’ll pay a higher tax rate next year, you may want to claim the standard deduction this year and bunch your itemized deductions into 2013 where they can offset the higher taxed income. You can do this by waiting until next year to pay expenses such as medical and dental bills and holding charitable contributions until next year.
3. One of the tax breaks that is set to expire is the 0%/15% tax rate on capital gains. If you think the tax breaks will be allowed to expire, consider selling appreciated stocks to take advantage of the lower rate in 2012.
4. The Section 179 deduction limit for 2012 is $139,000. Starting in 2013, the deduction is scheduled to drop back to $25,000. If you want to take advantage of the higher Section 179 limit for 2012, you may want to make equipment purchases in 2012, rather than waiting until 2013 or later. Note, however, that Section 179 cannot create or increase an overall business tax loss. If you think this is an issue for your business, please contact us.
5. Your business can claim first-year bonus depreciation of 50% of the cost of most new (not used) equipment and software purchased up to December 31, 2012. Unlike the Section 179 deduction, bonus depreciation can create or increase a business loss.

If you want to take advantage of any of these tax planning ideas or if you would like more details, please contact us today.