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Tax Planning for the New Year

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By Michael Cohn
December 26, 2013

Even though taxpayers aren’t facing the prospect of a looming fiscal cliff and a potential jump in income tax rates next year, there are still plenty of issues to contend with in the New Year.

“The overall posture of planning at the end of 2013 is certainly much different for the end of 2013 than it was for the end of 2012,” said Greg Rosica, a tax partner at Ernst & Young and contributing author to the EY Tax Guide 2014. “We’ve had significant changes in tax rates and tax laws so a lot of the planning that was being done at this time last year was to try to accelerate income and defer deductions. I think we’re really in the opposite mode today where we’re looking at how can we accelerate deductions and defer income because we’re in a much higher tax rate situation now than we were last year. So deductions are worth more sooner, and income postponed and paying tax into the future are all beneficial to do.”

Rosica noted that several tax provisions are expiring at the end of the year. “If you’re going through a foreclosure or some kind of debt restructuring on your principal residence, any cancellation of debt that you may have on that principal residence is not subject to income taxes, but only through 2013,” he said. “That’s something that if you’re in the process of, it would be important to get that finished up before the end of the year, if possible. Because in 2014, as we currently stand, then that income could be subject to income taxes at that point in time.”

Greg Rosica

Similarly another expiring provision involves mortgage insurance premiums. “On your mortgage, part of your payment may be for mortgage insurance premiums,” Rosica said in an interview early this month. “Those are still deductible, but only for 2013, so you want to make sure you take advantage of that. Those are payments you would already have to make, but you want to make sure you deduct those. Then those are no longer deductible starting in 2014.” 

Some deductions for state and local sales taxes are also going away next year. “Any state and local sales tax that you may pay on items, to the extent that those items are greater than [your state income taxes] or you live in a state that does not have a state income tax, those are very popular and favorable deductions that are available in 2013 as well, but wouldn’t be there next year,” said Rosica. “That’s something that if you were contemplating a fairly large purchase that might span the calendar tax year, you might consider accelerating that into 2013 if you can take advantage of that type of tax deduction.”

The prospects for Congress extending popular tax breaks like the sales tax deduction and the research tax credit remain uncertain again as we go into the New Year. “We don’t know if that’s going to happen,” said Rosica. “If it’s something that might impact your situation, take advantage while there’s certainty, and we do have certainty for 2013 on that.”

Another provision that is expiring at the end of the year relates to IRA distributions to charity. “If an individual has a large IRA and is looking to make some charitable contributions, and they’re of that age where they’re taking distributions in their IRA already, then they should seriously consider looking at how up to $100,000 can be moved from the IRA to the charity,” said Rosica. “You don’t have the income take-up on there. You also don’t get the charitable deduction, but it basically eliminates from your return both the income and the deduction. Because of some of the other tax provisions that came into play in 2013, that’s going to land you in a much more favorable tax situation than if you had taken the income and paid tax on it and gotten the deduction. You’ll be better off making those direct IRA distributions to a charity.”

Other items to consider at the end of the year relate to how to minimize the income that could be potentially subject to a higher tax rate. “That includes maximizing retirement plan contributions,” said Rosica. “If you work with a 401(k), make sure you’ve looked at trying to maximize that. Perhaps put the full $17,500 into your 401(k) before the end of the year if you have not already done so. And if you don’t have a 401(k) or are self-employed, the opportunity to use a self-employed plan, a SEP or a Keogh, and be able to put away perhaps up to $51,000 that will be deducted from your income, can be very powerful in light of our current tax situation. Also, looking at IRA contributions, both deductible and non-deductible, Roth or traditional, all make a lot of sense to be contemplating. Many of these decisions, particularly the IRA ones, can be done next year up until April 15. But the 401(k) and establishing SEPs and Keoghs are things you need to take action on before the end of the year.”

The estate tax rates and exemptions are now more or less set since the fiscal cliff deal a year ago, so there is more certainty going forward. The top rate is 40 percent, and the exclusion is indexed to inflation, with the IRS making it $5.25 million for 2013.

“We certainly have certainty around what the current estate tax exemptions are as well as the rates on those, and we’re not faced with a situation of those going away next year, so people have time to contemplate what the right transaction is,” said Rosica.  “But there is one thing that does go away. Every year, you get the ability to use your annual exclusion amount of $14,000 per person, and if you don’t use it during the calendar year, you lose it. So it makes a lot of sense for folks, if they’re looking to transfer assets to others—traditionally to children, but it can go to absolutely anyone—each person can give each other person $14,000 without any kind of income or estate or gift tax ramifications. That can be a very effective planning strategy, not only for a way to shift assets from one generation to another, but also a way to have effective tax planning too, because you might be able to shift items down to your lower generations that have lower tax rates and they’ll be able to sell those items and realize an overall lower tax bill on those. It really can combine gift planning, estate planning, as well as income tax planning when you contemplate those types of transactions.”

Clients should also look at investing and perhaps rebalancing their portfolios. “This year was obviously a very strong year in the market, so many people may have portfolios that are now out of allocation and need to be rebalanced,” said Rosica. “I think people should be careful as they enter into that to make sure that they’re not harvesting a lot of gains at the end of the year, but if they do have losses in some of the securities, that they are looking to take those losses. So realize the losses and you can use them this year to offset some of the gains. Also, if you’re rebalancing, be careful if you’re investing into mutual funds in the month of December, because you could end up getting a surprise tax bill as a result of making an investment that you didn’t even earn any money on. You could have significant tax ramifications for doing that.”

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