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Tax Planning after the Tax Extension

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October 16, 2013

Now that the October 15 filing deadline is out of the way for all those many taxpayers who had to file an extension due to the delayed tax season, there are a number of tax planning options for next year.

Greg Rosica, a tax partner at Ernst & Young and a contributing author to the Ernst & Young Tax Guide, noted that many people are busy finishing their taxes, especially when they receive their K-1 forms within the last few weeks just ahead of the September 16 deadline.

“They obviously have all of their information as of at least that date to be able to finalize and file their tax return,” he said. “As people are going through and pulling those things together, there are some things to think about, both in terms of the 2012 tax filings that they’re doing as well as 2013. With 2012 tax filings that they have been wrapping up, certainly they are thinking about what have they done that they can reconsider."

Greg Rosica

One thing they might want to reconsider is a Roth IRA conversion.

"If they have done a Roth IRA conversion, that’s something that you can recharacterize up until October 15," Rosica said in an interview last week. "If they did a Roth conversion in 2012, they can look back and reflect on what they have done and decided that perhaps that wasn’t the right financial move for themselves, perhaps because the investments went down significantly in value as of this point in time, or perhaps they thought they would have the cash to make the tax payment on that conversion, but life changes have occurred. Then they could re-evaluate that as well and potentially do a recharacterization, which is undoing what they had done before.”

Those who are self-employed also could make contributions to a Simplified Employee Pension, or SEP, plan until October 15.

The fiscal cliff deal at the beginning of the year also opens up some possibilities for next year’s tax planning. “For the 2012 filing we’re still dealing with the older tax rules the way they were for the most part,” said Rosica. “To the extent that they have done IRA contributions to charity up to $100,000, that remains a provision that exists for both 2012 and 2013. Although you can’t still do it today for last year, you can certainly do it for 2013.”

For those practitioners who have just wrapped up the 2012 tax returns of clients who were on extension, they should take a look at how their clients' income may have changed for 2013. “See what kinds of deductions that you receive a benefit from and how those may change in light of the provisions that come back into play, such as with itemized deductions having some of the phase-out that had occurred previously but had not been in play for the last few years,” Rosica suggested. “That comes back into play in 2013, so higher-income 2013 taxpayers may really want to look at some of their deductions and determine things like real estate taxes and other itemized deductions, as to whether they’re going to get some of the benefit that they’ve received in the past from those, and whether through some timing of when they pay them, they might be able to put themselves in a better situation. Also, as they look toward higher tax rates and increased surcharges and contributions to taxes, are there ways to continue to defer or deflect to other taxpayers or other family members income that’s properly movable into some of the lower tax brackets?”

Taxpayers and tax practitioners can also do some planning around some of the newer taxes imposed by the Affordable Care Act, such as the Additional Medicare Tax or Net Investment Income Tax.

“Really it’s looking at the investable assets that you have and where those are located,” said Rosica. “To the extent you hold investment assets outside your tax-deferred or tax-exempt plans, the interest and dividends and capital gains will be subject to it [taxes]. But items that are inside an IRA or 401(k) are not. It may even be worth looking at what you have. Where are the interest-bearing investments you have, such as bonds, versus where are your capital gains and dividend-producing assets? Depending on where they are in your portfolio—in a taxable or tax-deferred or tax-free account—that might be something that’s worth looking at as to how to minimize the Medicare tax on those types of investments."

Business investors should also examine their tax situation. "If you’re an investor in a partnership, or in an S corporation or some other type of flow-through entity, if you don’t materially participate, which is a tax term for whether something can be considered passive or active, that can have an impact because anything you are passive in will also be subject to the Medicare contribution tax. If it’s possible to increase your level of involvement in that particular investment that you have, such that you can get treated as active, that’s also a way to decrease [your taxes]," said Rosica. "But here we are in October, and if you’re trying to meet the 500 material participation hours [requirement], there’s probably not 500 hours left to work in the year.”

Even though as part of the fiscal cliff deal at the beginning of the year Congress made permanent the patch to keep the alternative minimum tax from spreading to millions more taxpayers, Rosica noted that the AMT continues to be an issue that many people will face. “Depending on what tax bracket you’re in, if you’re in the higher ordinary tax brackets, then the gap between the AMT and the ordinary rates is wider, and therefore there is less potential to be in AMT,” he pointed out. “But certainly if you’re not in the top higher rate, and you’ve been in AMT in the past, there’s a good chance you’ll continue to be in that as well.”

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