Grant Thornton has released a set of tax season tips for both individuals and businesses.
The firm noted that 2013 marked the first time in years that individual income tax rates rose. Coupled with the new 3.8 percent tax on net investment income, many taxpayers will see a marked increase in their personal tax liability.
“Many of the taxpayers subject to these higher taxes are actually able to mitigate their exposure, even in the new year,” said David Walser, managing director in Grant Thornton’s Washington National Tax Office, in a statement. “But by properly planning for the next year and beyond, a taxpayer can avoid the headaches of filing season and fatten their wallet in the process. The earlier you start, the better you’ll feel about your return this time next year.”
Grant Thornton has developed tax tips on what to consider when filing your 2013 tax returns, what taxpayers can still do to lower their tax liability and how to make the most of planning for 2014.
What’s changed since last year?
There are new benefits for same-sex married couples. For the first time ever, the tax law has been harmonized to treat same-sex married couples the same as other married couples. Following the Supreme Court’s landmark decision in U.S. v. Windsor, the IRS issued new rules allowing same-sex married couples to file joint returns and enjoy equivalent treatment in all areas of federal income, gift and estate tax law. In fact, all couples with valid marriages, whether same sex or not, must file as a married couple in 2013, either married filing jointly or married filing separately.
Higher-earning individuals face higher taxes. For the first time in more than a decade, Congress raised individual tax rates. Individuals earning more than $400,000 and couples earning more than $450,000 are now subject to a 39.6 percent top rate. The top capital gains and dividend rates also went up from 15 percent to 20 percent, not including the new Medicare tax. Finally, the personal exemption phaseout (PEP) and “Pease” phaseout of itemized deductions are back in 2013. Both phaseouts complicate tax planning and return preparation while raising taxes.
A new tax comes due. Another first for your 2013 returns is the calculation and payment of the 3.8 percent Medicare tax on net investment income. The tax became effective at the beginning of 2013 and imposes a 3.8 percent tax on investment income, like dividends, rents, royalties, interest, capital gains and annuities. Passive income from a trade or business in which you do not materially participate is also subject to the tax.
Alternative Minimum Tax indexed for inflation. Congress didn’t eliminate the AMT, as many had hoped. As part of New Year’s Eve legislation in 2012, lawmakers did decide to index the tax for inflation for the first time. Previously, Congress had simply “patched” the AMT for one or two years at a time.
It’s not too late to make changes, Grant Thornton pointed out. While the books have closed on a taxpayer's income, gain and loss at the end of 2013, there are still ways to reduce tax liability, such as contributing to a traditional individual retirement account or converting to a Roth IRA.
Contribute to an IRA. Taxpayers can still get an above-the-line deduction on their 2013 returns by contributing to an IRA now, before filing their income tax return. Taxpayers who don’t have an IRA can set one up today, fund it, and still take advantage of the deduction. Contribution limits for 2013 are $5,500 plus a $1,000 catch-up for those 50 years old and older. If the taxpayer was an active participant in their employer’s retirement plan, contributions to an IRA offer deductions only at income levels below $112,000 for joint filers and $68,000 for singles.
Reconsider a Roth IRA rollover. In 2010, Congress eliminated the $100,000 income limit on rollovers from an IRA or 401(k) to a Roth IRA. Rolling over allows you to pay tax on the conversion in exchange for no taxes in the future (if withdrawals are made properly). These rollovers have been very popular. They should become even more popular in the future because, unlike distributions from a regular IRA, distributions from a Roth IRA do not increase a taxpayer's AGI—which is used in determining the new Medicare tax and the amount of the PEP and “Pease” phaseouts.
Make a grouping election. The new 3.8 percent Medicare tax on net investment income will generally apply to any income received from a business in which the taxpayer does not materially participate. While it’s too late to go back and change the amount of participation in a business last year, taxpayers may be able to make a grouping election when they file their returns to combine their activities for various business interests and satisfy the material participation tests.
Make the 65-day election. Like individuals, most trusts are also subject to the new 3.8 percent tax on net investment income. “Complex trusts” are subject to the new tax in 2013 to the extent their undistributed investment income exceeds $11,950. By making a distribution of the income within 65 days of the end of 2013 (March 6, 2014), the trustee can elect to have the distribution treated as if it were made in 2013, shifting the income for tax purposes to the beneficiary. If the beneficiary is in a lower tax bracket than the trust, the election can reduce the overall tax burden.
Lawmakers have debated tax reform for years, and 2014 may present the best opportunity for Congress to dramatically change our tax laws, Grant Thornton noted. But, will reform be a benefit to individual taxpayers? It’s hard to tell. The top individual rates have risen to 39.6 percent, and Congress has discussed lowering corporate rates from their current peak of 35 percent. That could influence whether a business is organized as a pass-through entity, like a partnership or limited liability company, or as a corporation. After all, the greater the disparity in corporate and individual rates, the more opportunity to change the entity classification of your business.
Materially participate in your business. The 3.8 percent Medicare tax on net investment income is imposed on passive income. For example, an individual taxpayer who doesn’t “materially participate” in a business will see that income taxed at a higher rate, due to this tax. By materially participating in the business, that investor can eliminate the 3.8 percent tax. Doing so can be tricky, but especially for family businesses that have relatives as owners, it makes sense to look into how to materially participate in the business.
Understand foreign bank account reporting. The IRS and Department of Justice have, for the last several years, taken a hard look at U.S. taxpayers with unreported offshore financial accounts. Penalties for not reporting offshore income or the existence of those accounts are steep, and can include prison time. The IRS has a voluntary disclosure program for those individuals, which allows for reduced penalties and no prosecution. Keep in mind that the foreign bank account reporting form is not filed with your tax return. Instead, it must be filed by June 30 of each year with the Financial Crimes Enforcement Network (FinCEN), an agency within the Treasury Department.