2013 TAX PLANNING TIPS FOR INDIVIDUALS

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1 2013 TAX PLANNING TIPS FOR INDIVIDUALS The 2012 American Taxpayer Relief Act, which was enacted in early January 2013, was a sweeping tax package that included permanent extension of the Bush-era tax cuts for most taxpayers, revised the top tax rates on ordinary and capital gain income upward for high-income individuals, modified the estate tax, provided permanent relief from the AMT for some individual taxpayers, reinstated limits on itemized deductions and personal/dependent exemptions for high-income taxpayers and extended several tax breaks for individuals and businesses. An overview of some of the important tax law changes for this year and tax planning ideas for 2014 are below Increase in Tax Rates for High-Income Taxpayers For tax years 2013 and forward, the Bush-era tax rates, which ranged from 10% - 35% were made permanent. However, a new 39.6% rate was enacted which applies when taxable income reaches $400,000 for single filers and $450,000 for joint filers. In addition, for this same group of taxpayers the maximum income tax rate on capital gains and qualified dividends increased from 15% to 20%. Medicare Surtax Provisions Two key Medicare surtax provisions went into effect January 1, 2013 which will affect higher income taxpayers. The first provision is a 0.9% increase in Medicare tax on earned income (wages and self-employment income) above $200,000 for single filers and $250,000 for joint filers. The second provision is a 3.8% Medicare tax on the lesser of net investment income or modified adjusted gross income above $200,000 for single filers and $250,000 for joint filers. Net investment income includes taxable interest income, dividends, capital gains, annuity distributions, and rental and royalty income. Net investment income does not include tax-exempt income, distributions from retirement plans or income from an active trade or business. In addition, the 3.8% tax also applies to trusts and estates. For these taxpayers, it applies to the lesser of undistributed net investment income or the excess of adjusted gross income over a very low threshold (for 2013 the threshold is only $11,950). This means that trusts and estates with undistributed investment income over $11,950 will be paying a combined marginal tax rate of 43.4% (39.6% top regular tax rate plus 3.8% Medicare surtax) on this type of income. The details of the Medicare surtax provisions are complex but there may be certain tax planning opportunities to minimize exposure to this tax. Limits on Itemized Deductions and Personal/Dependent Exemptions Limitations on itemized deductions and personal/dependent exemptions affecting higher income taxpayers, both of which had been suspended, are back for Under these provisions, the total amount of itemized deductions is reduced by 3% of the amount by which the taxpayer s adjusted gross income (AGI) exceeds $250,000 for single filers and $300,000 for joint filers. The reduction cannot exceed 80% of otherwise allowable deductions. Each person filing a 2013 tax return is allowed a personal exemption of $3,900. There is an additional $3,900 exemption for each person claimed as a dependent. However, for high income taxpayers, personal exemptions and dependency exemptions are phased out for single filers with AGI above $250,000 and for joint filers with AGI above $300,000. The impact of these phase-outs is to reduce the tax benefit from otherwise allowable deductions and exemptions and to increase the taxes payable by the taxpayers to whom they apply. Continued on page 2

2 Other Individual Tax Breaks Extended through 2013 The new law extended the following through the end of 2013: The itemized deduction for sales tax paid The above-the-line $250 deduction for teacher classroom expenses The above-the-line deduction for tuition and fees The exclusion from gross income for IRA distributions made to charities Alternative Minimum Tax The new law permanently increased the alternative minimum tax (AMT) exemption amounts. For 2013, the exemptions are $51,900 for single filers and $80,800 for joint filers. In addition, starting in 2014 the exemption amounts will be indexed for inflation. However, the tax benefit of the AMT exemption is phased out for higher income taxpayers. Children with Unearned Income Subject to Tax Under the kiddie tax, the unearned income (such as interest, dividends and capital gains) of certain children in excess of $2,000 for both 2013 and 2014 is taxed at the parents marginal tax rate. The rule applies to children under age 19 at the close of the tax year and to full-time (usually college) students who have not attained age 24 by the end of the year. This rule applies only to children whose earned income does not exceed one-half of the amount of their support. If certain conditions are met, the parents can elect to include the child s gross income on their own return. No Personal Exemption for Dependent On His/Her Own Return Parents with dependent children that will be filing their own tax returns should ensure that each dependent child does not claim his or her own personal exemption. It is important that the dependent exemption or personal exemption be taken on the correct return. If you claim the child as your dependent on your own tax return, no personal exemption is allowed on the child s return. If the exemption is claimed on more than one return, the second return will be rejected by the IRS. If rejected, an amended return for the first-filed return and a paper-filed return for the second-filed return are needed to get the exemption onto the proper return. Standard Mileage Rate The 2013 rate for the business use of your car is 56.5 cents per mile. The medical care use rate is 24 cents per mile and the charitable contribution rate is 14 cents per mile for The 2014 mileage rates have not yet been released by the IRS. Penalty for Failure to Report Foreign Financial Accounts Citizens, residents, or persons doing business in the U.S. must keep records and file a foreign bank report ( FBAR ) when they maintain an account with a foreign bank or other financial institution. The 2004 American Jobs Creation Act added an additional civil penalty that may be imposed on persons who violate the reporting requirements. Penalties range from $10,000 to $100,000 for violations of this provision. Please be sure to inform us if you have any foreign bank or financial accounts. The 2013 FBAR is required to be electronically filed with the Department of Treasury no later than June 30, Specified Foreign Financial Assets You may be required to report ownership interests in foreign corporations, partnerships or other foreign assets on Continued on page 3

3 Form This form is separate and distinct from the reporting of foreign bank accounts on Form TD F ( FBAR ). Taxpayers may be required to file both forms depending on their specific facts for each particular year. As with the FBAR, penalties for non-compliance are severe. Noncash Charitable Contributions No deduction is allowed for used clothing and household items unless the items are at least in good condition. The IRS may deny a deduction for any item that has minimal monetary value. Taxpayers must be prepared to prove both the condition and the value of their donation. Keeping pictures of the items donated is an excellent way to prove condition, especially for higher value items. If you make a non-cash contribution in excess of $5,000, you must obtain a qualified appraisal. You must also provide IRS Form 8283 that has been signed by both the appraiser and an authorized representative of the donee organization. This form must be submitted with your tax return. Note that contributions of publicly-traded securities for which market quotations are readily available on an established securities market do not need an appraisal. Strict rules apply to donations of autos, boats, and airplanes to charitable organizations. In general, for vehicles valued in excess of $500, the donor s deduction is limited to the amount the charitable organization receives as proceeds from the sale of the vehicle (unless the charity intends to significantly use the vehicle in its regularly conducted activities or if material improvements are made to the vehicle). The charitable organization must provide the donor with an acknowledgement via Form 1098-C containing information specified by the IRS and such acknowledgement must be submitted with the donor s tax return in order to claim the deduction. Charitable Deduction Acknowledgement Letters For a cash contribution of $250 or more, or a donation of $75 or more for which you received any goods or services, you must obtain a contemporaneous, written acknowledgment from the donee organization to deduct the contribution. For donations of $250 or more, the acknowledgement must include a statement as to whether the donee organization provided any goods or services in consideration of the donation. It must include a description or good faith estimate of the value of any goods or services provided, or a statement that no such goods or services were provided. In recent tax cases, the courts have supported the IRS denial of deductions on such technicalities. To be contemporaneous, you must obtain the acknowledgment on or before the date you file your tax return including extensions. These written statements do not need to be attached to your tax return. However, you must retain them with your tax records in case of audit. Please review all charitable donation letters received during the year for donations that exceed $250 for the required language. If you have letters that do not include this language, you should contact the charitable organization to send you a corrected letter before filing your tax return. Deduction of Long-Term Care Insurance Premiums The limit for the amount of long-term care insurance premiums that you can include as an itemized medical deduction has increased. The 2013 limit is a per-person limit, beginning at $360 for age 40 or under, up to $4,550 for age 71 or over. Increase in AGI Floor for Medical Deductions For taxpayers under age 65, the floor for deducting itemized medical deductions has increased to 10% of AGI in Continued on page 4

4 2013. As an example, assume a taxpayer (under age 65) has AGI of $100,000 and incurs out of pocket medical expenses totaling $12,000. Due to the 10% of AGI floor, the taxpayer would only be able to deduct $2,000. Taxpayers over age 65, or filing a joint return where one of the spouses is at least age 65, are allowed a 7.5% floor until the end of After 2016, the 10% floor applies to all taxpayers regardless of age. Information for Seller-Financed Mortgages If you are a buyer or seller with a seller-financed residential mortgage, you will need the name, address, and taxpayer ID number of the person to whom the interest was paid or from whom it was received. The IRS will charge a $50 penalty if the complete information is not on your return. A seller-financed residential mortgage arises from the acquisition of a principal residence or a second home where the seller provides some or all of the mortgage financing to the buyer. If you don t already know the taxpayer ID number of the other person, use Form W 9 to obtain it. Reporting Household Employees on Your 1040 During 2013, if you paid someone $1,800 or more to work in or around your home or to watch your children, you must report household employee tax on your 1040 using Schedule H. You must pay the taxes due along with any other taxes by April 15, If this applies, you will need to provide each employee with a W-2 by January 31, You will have to file copies of the W-2s with the Social Security Administration. There are penalities for failure to report on a timely basis. Residential Energy Efficient Property Credit For property placed in service before 2017, a taxpayer is allowed an annual credit for the purchase of residential energy efficient property equal to the sum of 30% of the amount paid for: qualified solar energy property, qualified solar water heating property, qualified fuel cell property, qualified small wind energy property, and qualified geothermal heat pump property. New Qualified Plug-in Electric Drive Motor Vehicle Credit A taxpayer can claim a credit for each new qualified plug-in electric drive motor vehicle placed in service during the tax year. The amount of the credit ranges between $2,500 and $7,500. The credit starts to phase-out beginning in the second calendar quarter following that in which a manufacturer sells its 200,000th plug-in electric drive motor vehicle for use in the US after This credit can be claimed against AMT. Child Tax Credit For tax years 2013 through 2017, you may be eligible for the child tax credit of up to $1,000 for each qualifying child under 17 (one for whom you can claim a dependency exemption and who is your child or other direct descendant or your eligible foster child). The credit begins to phase out when adjusted gross income AGI (as specially modified) exceeds $110,000 for joint filers, or $75,000 for single filers and head of households, and $55,000 for marrieds filing separately. Adoption Tax Credit A nonrefundable tax credit of up to $12,970 is available for qualified adoption expenses in The credit begins to phaseout for taxpayers with modified AGI of $194,580 and is fully eliminated at $234,580 of modified AGI. For foreign adoptions, the credit is not allowed until the year in which the adoption is finalized. Continued on page 5

5 American Opportunity Tax Credit For tax years beginning before 2018, you may be able to claim a tax credit of up to $2,500 per year for each eligible student for qualified higher education tuition, fees, and course materials. The AOTC credit may be elected for a student s expenses for the first four years of college. The credit phases out for single taxpayers with AGI between $80,000 and $90,000 and for joint filers with AGI between $160,000 and $180,000. Lifetime Learning Credit This credit is equal to 20% of up to $10,000 of qualified tuition and related expenses for a maximum credit of $2,000. This credit is available for each year of post-secondary education including graduate school. Unlike the American Opportunity Tax Credit which is available for the qualifying expenses of each student, only one maximum $2,000 Lifetime Learning Credit is available each year. The credit phases out for single taxpayers with AGI between $53,000 and $63,000 and for joint filers with AGI between $107,000 and $127,000. Student Loan Interest Deduction You can deduct up to $2,500 of interest paid on an education loan. The deduction phases out over $60,000 to $75,000 of AGI as specially modified ($125,000 to $155,000 on joint returns). Maximum 401(k) Deferrals The maximum elective deferral which may be made to a 401(k) plan is $17,500 for 2013 and If you are age 50 or older by the close of the tax year, you can contribute an additional $5,500 for 2013 and Catch-up contributions may only be made if the plan permits this type of contribution. Any deferral you made for 2013 should already be noted on your W-2. Traditional IRAs If you are not an active participant in an employer s retirement plan and you have sufficient compensation or selfemployment income, you may make deductible contributions to an IRA. The 2013 and 2014 deductible limit is 100% of compensation up to $5,500. If you are covered by a company-sponsored retirement plan, you may still be able to deduct some or all of your IRA contribution depending on your AGI. For 2013, the AGI phase-out range is between $59,000-$69,000 for single taxpayers, and $95,000-$115,000 for married filing joint taxpayers. Above these ranges, no deduction is allowed. In addition, for 2013 and 2014 a $1,000 catch-up contribution is allowed for taxpayers age 50 or older by the close of the taxable year, subject to the same limitations above. Roth IRAs For 2013 and 2014, if you have sufficient compensation or self-employment income, you can make a nondeductible contribution of up to $5,500 ($6,500 if age 50 or older) annually to a Roth IRA (reduced by your other IRA contributions). The account builds up tax-free and distributions from it are tax-free, too, if made after a 5-year period for one of several specified reasons (e.g., after age 59½) and after the Roth IRA has been open at least five years. The ability to make contributions begins to phase out for joint filers with an AGI of more than $178,000 ($112,000 for singles). Contributions are also limited by compensation or self-employment income. Converting a Traditional IRA to a Roth IRA There are no income or filing status restrictions on conversions of traditional IRA s into Roth IRA s. However, a Roth Continued on page 6

6 conversion triggers income taxes on previously tax deferred amounts in your traditional IRA. Your current tax rate, as well as expectations regarding future tax rates should be considered before making a Roth conversion. Deductible IRAs Available to Spouses The IRA rules allow a spouse who isn t a participant in a company-sponsored retirement plan to make a deductible IRA contribution. This is so even if the other spouse is an active participant in a retirement plan. A nonworking spouse can utilize this rule to make a deductible IRA contribution based upon the working spouse s earned income. A fully deductible IRA contribution for 2013 can be made if the joint return shows AGI of $178,000 or less. The deduction is phased out for AGIs between $178,000 - $188,000. Contributions must be made by April 15, 2014, to be deductible in However, if you are eligible, you should consider making any IRA contribution to a Roth IRA instead of a deductible IRA. Depending on the circumstances, the Roth may make more sense, even though the contributions are not deductible. Required IRA Distributions Beginning at Age 70½ You must begin taking minimum distributions from your IRAs no later than the Required Beginning Date, which is April 1 of the year following the calendar year in which you reach age 70½. Severe penalties are imposed if you fail to take your required minimum distribution ( RMD ) each year. The IRS has simplified the calculation of the minimum amount and made designation of a beneficiary more flexible. Sale of Your Home Generally, you will only need to report the sale of your principal residence if your gain is more than $250,000 ($500,000 if married filing a joint return). This exclusion applies to each qualifying sale. You must have owned and used the house as your principal residence for at least two years out of the five year period ending on the date of sale. However, the exclusion of gain is not available on the sale of a principal residence acquired in a like-kind exchange within five years of acquisition. The Housing Assistance Tax Act of 2008 added new rules to the gain exclusion provisions. For sales and exchanges after Dec. 31, 2008, the homesale exclusion will not apply to the extent gain from the sale or exchange of a principal residence is allocated to periods of nonqualified use. Generally, nonqualified use is any period (other than any period before Jan. 1, 2009) during which the property is not used as a principal residence of the taxpayer or spouse. This rule restricts the availability of the exclusion for second homes and vacation homes significantly. However, several important exceptions apply.. Gift and Estate Tax Thresholds For 2013, the estate and gift tax exemption amount is $5,250,000 and the maximum estate, gift and generation skipping transfer tax rate is 40%. The gift tax annual exclusion for 2013 and 2014 is $14,000. The State of Washington has a stand-alone estate tax which applies to estates of Washington residents and to the estates of non-residents having personal property or real property located in Washington. The tax is calculated on Washington taxable estates exceeding $2,000,000. Note that the exemption amount for Washington estate tax purposes remains at $2,000,000 in 2013 even though the federal exemption is $5,250,000. It is important to note that an estate may have a state filing requirement without Continued on page 7

7 being required to file a Federal Form 706. You should update your estate planning and gifting program each year to be sure to take full advantage of the changing laws.