The American Taxpayer Relief Act of 2012, (the “Act”) made a number of changes to the Internal Revenue Code. The Act increased income tax rates for high-income earners, trusts, and estates. The top federal income tax rate is now 39.6%, which is up from 35% in 2012. Trusts and estate reach the highest rate of 39.6% at $11,950 of income. In addition, the federal capital gains/qualified dividend tax rate is now 20%, which is up from 15% in 2012. This Act also increased the federal gift, estate, and generation-skipping transfer tax rates to 40%, up from 35% in 2012. The Act, however, also increased the gift and estate tax exemption amounts to $5,250,000.00 per person, and this exemption was $5,120,000.00 per person in 2012. These changes may negatively affect you and in order to properly analyze this situation, you should review your current 2013 year-end tax planning matters with your accountant to see if certain strategies can be implemented to reduce your tax bill.
The Act brought back the limitations on itemized deductions that existed previously for single taxpayers with gross incomes of $250,000.00 or more, and for joint taxpayers with gross income greater than $300,000.00. This limitation is called the Pease Limitations, and it reduces the allowable itemized deductions that such taxpayers may utilize. These limits will primarily affect itemized deductions such as state income taxes, mortgage interest, and charitable deductions.
The Act imposes a new Medicare tax, which will be in effect for single taxpayers with adjusted gross income over $200,000.00 and joint taxpayers with adjusted gross income exceeding $250,000.00. Thus, an individual taxpayer will owe 2.35% of tax on earned income above these levels. These taxpayers may also be subject to a 3.8% tax on all unearned income. This unearned income includes interest, dividends, royalties, rental income, gross income from passive activities, and other types of investment activities. Trusts and estates may also be subject to this 3.8% tax on unearned income. Because of this Medicare tax, care must be taken to make sure that you are avoiding an underpayment penalty. Also, for trust beneficiaries, consideration should be given to distributing discretionary income to those trust beneficiaries who may be in lower tax rate brackets, and thus, pay less income tax than if the trust would retain the income itself.
Taxpayers should consider the following strategies in order to reduce their taxable income and thus pay less tax:
- Sell the stock at a loss to offset any potential capital gains. If you try to implement this strategy, you need to make sure that you do not violate the “wash sale rule.” This rule disallows you from recognizing any loss if you buy nearly identical securities 30 days before or after the sale.
- Make sure that any deferred compensation elections are in place by December 31.
- Consider installment sales, rather than an outright sale, as a way to defer income taxes on the gain until you actually receive the proceeds from the sale of the property.
- Closely-held and self-employed business owners should consider establishing qualified plans to defer income
- Consider paying estimated state income tax in December 2013 rather than January 2014.
- Consider donating to charities. These gifts to charities can include cash, qualified appreciated stock, and long-term capital gain property other than qualified appreciated stock. Gifting certain appreciated assets to charities can provide a significant benefit, as you not only will receive an income tax deduction for the fair market value of the donated asset, but you also will not have to pay any capital gains tax on that asset’s unrealized appreciation. Please note that the number of charitable deductions can be limited by certain factors, such as your adjusted gross income, the types of assets being gifted, and the type of organization receiving those assets. In 2013, taxpayers over age 70—1/2 can make a direct transfer of up to $100,000.00 from an IRA to qualified charities, and this contribution will count towards your required minimum distribution.
- For high net worth individuals, consider making gifts of the annual gift tax exclusion to your family members. In 2013, federal law allows individuals to gift up to $14,000.00 per person, and for married couples to gift up to $28,000.00 per individual without triggering any gift taxes. These gifts may save estate taxes in the future.
As you can see, there are a number of tax changes that may affect you in 2013. Therefore, please contact your tax advisors for help in establishing a year-end tax plan that fits your specific tax situation.
NOTE: This general summary of the law should not be used to solve individual problems since slight changes in the fact situation may require a material variance in the applicable legal advice.
James F. Contini II, Esq.
Certified Specialist in Estate Planning,
Trust & Probate Law by the OSBA
Krugliak, Wilkins, Griffiths & Dougherty Co., LPA
158 North Broadway
New Philadelphia, Ohio 44663