First the good news: Mid-year tax planning this year looks to be much more settled than last year. We went through all of 2012 with all of the regularly expiring provisions already expired and with uncertainty as to the extent to which the Bush tax cuts would be extended beyond 2012. Most of those regularly expiring provisions got extended through 2013 and the Bush tax cuts were addressed in legislation that gave them some permanency, either preserving them for lower-income taxpayers or letting certain of them expire for higher-income taxpayers.
Now the bad news: Congress continues to be deadlocked over budget issues. Serious discussions are being given to significant tax reform, but there does not seem to be a clear path toward a meeting of the minds on those issues. An agreement on tax reform could mean lower rates, but also a loss of many tax breaks currently in the law, including many of those regularly expiring provisions.
Although tax reform could mean lower rates eventually, higher-income taxpayers this year will have to cope with higher marginal tax rates, higher capital gains tax rates, restoration of the phase-out of itemized deductions and exemptions, and, from health care reform, a higher Medicare contribution tax on earned income and a new tax on net investment income. Health care reform also brings in 2014 a new credit to help lower-income taxpayers obtain health insurance and a new penalty for higher-income taxpayers for failure to obtain health insurance. Even the Supreme Court decision in Windsor may fall into the bad news category, as many same-sex married couples with dual incomes may find themselves paying higher federal income taxes in 2013 as joint filers than they did as single filers.
All of these issues warrant some discussions with clients well before year-end.
REGULARLY EXPIRING PROVISIONS
Although the regularly expiring provisions have for the most part been renewed eventually over the years without a cap, there seems to be a growing risk that some of them will fall by the wayside, either as part of a tax reform package or a stalemate on the budget that prevents their extension. Year-end planning should assume the possibility that some or all of them will not be around next year.
Sales tax deduction. The deduction for all state and local taxes has been on the hit list for several tax reform proposals. Clients who have the potential to utilize the sales tax deduction, rather than the income tax deduction, and are considering some major purchases may want to consider making those purchases before year-end to maximize availability of the deduction.
IRA distributions to charity. Taxpayers age 70-1/2 or older had trouble making required minimum distributions directly to charity last year because of the delays in the enabling legislation. Clients who made 2013 IRA distributions to charity in January that were counted as 2012 distributions will not want to forget and treat those also as 2013 distributions. IRA distributions to charity for 2013 should be made before year-end.
Exclusion for discharge of principal residence indebtedness. Similar to last year, the exclusion for discharge of principal-residence indebtedness expires at the end of the year. Taxpayers still working through a foreclosure process will want to think about trying to get the process finalized before year-end in the event that the exclusion is not around next year.
Expiring provisions. Other tax breaks currently expiring at the end of 2013 that might warrant some planning for particular taxpayers are the residential energy property credit, the teacher's classroom expense deduction, the qualified tuition deduction, parity for vanpool/mass transit benefits, the deduction for mortgage insurance premiums, and the contributions of capital gain real property for conservation purposes.
Taxpayers with taxable incomes in excess of $400,000 for single filers or $450,000 for joint filers will face the restored 39.6 percent ordinary income rate and 20 percent capital gain rate. It will be even more advantageous this year for them to review their investment portfolio for investments that they might be inclined to dispose of before year-end at a loss to offset other capital gains in their portfolio. Taxpayers should also have been taking these higher rates into account in their estimated tax payments during the year.
Those with adjusted gross incomes in excess of $250,000 for single filers ($300,000 for joint filers) will face in 2013 a return of the phase-out of itemized deductions and exemptions. The phase-out potentially impacts such itemized deductions as the state and local tax deduction, the mortgage interest deduction, the charitable contribution deduction, and the miscellaneous itemized deduction. The phase-out does not apply to the deductions for medical expenses, investment interest, and casualty, theft or wagering losses.
MEDICAL EXPENSE DEDUCTION
Taxpayers should be reminded that, for those under age 65, the threshold for the deduction of medical expenses has been increased to 10 percent of AGI. This will make it even more difficult to reach the threshold and will put more of a premium on concentrating elective procedures into one year to try to top the threshold.
MEDICARE CONTRIBUTION TAXES
The 2010 health care reform legislation enacted two Medicare contribution taxes to help pay for health care reform -- an additional 0.9 percent tax on earned income in excess of $200,000 for single filers and $250,000 for joint filers and a new 3.8 percent tax on net investment income on the lesser of the amount of net investment income or adjusted gross income in excess of $200,000 for single filers or $250,000 for joint filers. Planning strategies have included looking at shifting income out of categories that qualify as net investment income. Exactly what income qualifies as net investment income itself has been an issue with regard to certain passive, business and rental activities, requiring a careful look at much-anticipated final regulations when they are issued. Both Medicare contribution taxes also should be taken into account in determining estimated tax payments over the course of the year.
SAME-SEX MARRIED COUPLES
Although as of this writing the IRS has not yet come out with procedures as to how it will handle tax returns for same-sex married couples in compliance with the Supreme Court's Windsor decision, many same-sex married couples will likely be required to file a joint federal tax return for the first time in 2013. For many dual-income couples, joint filing might result in higher taxes, and taxpayers should be prepared for that eventuality. The threshold amounts for the new higher tax rates on ordinary income and capital gains, for the phase-out of itemized deductions and exemptions, and the Medicare contribution taxes create an additional risk of a marriage penalty for joint filers.
It is not clear at this point how the IRS will treat same-sex married couples residing in a state that does not recognize same-sex marriages, or how it will treat civil-union couples who are permitted for state tax purposes to file joint returns.
HEALTH INSURANCE ISSUES
Starting in 2014, taxpayers with household incomes between 100 and 400 percent of the federal poverty level will be entitled to a new credit to help them pay for health insurance on one of the new insurance exchanges being set up in the states. Also, taxpayers with household incomes over the tax return filing threshold and who are deemed to be able to afford health insurance coverage may be subject to a penalty for failure to obtain coverage. Practitioners will want to counsel their clients about these new requirements to make sure that they are aware of these new requirements and take action as they deem appropriate to qualify for the credit or avoid the penalty.
Guidance is still coming out on the details involving these requirements. State exchanges are supposed to begin operations on October 1, but some are starting to doubt whether they will all be fully operational on that date.
While there is still much uncertainty about what action, if any, Congress may take this year, it appears that that action or inaction will only affect future tax years, not 2013, unlike last year when we were waiting for Congress to clarify 2012 tax issues. Practitioners can therefore help clients plan for what we know is new for 2013 and what is currently scheduled to change in 2014. As usual, we do not know at this point what the full tax picture will look like in 2014, so clients will have to be counseled about the possibilities and options for year-end planning opportunities.
George G. Jones, JD, LL.M, is managing editor, and Mark A. Luscombe, JD, LL.M, CPA, is principal analyst, at CCH Tax and Accounting, a Wolters Kluwer business.
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