Shelving your taxes until next spring could cost you money,
especially this year. The tax law passed earlier in the year as
part of the deal to avert the fiscal cliff imposes a new 39.6%
marginal rate on taxable income over $400,000 ($450,000 for married
couples). Taxpayers in this bracket will pay 23.8% on dividends and
long-term capital gains -- not the 15% rate that applies to most
Other changes reach down the income chain. Taxpayers with
adjusted gross income of $250,000 or more ($300,000 for married
couples) will effectively pay higher marginal rates because
Congress resurrected phaseouts of itemized deductions and personal
exemptions. And taxpayers with modified adjusted gross income of
$200,000 or more ($250,000 for married couples) face a new 3.8%
surtax on net investment income.
That tax could hit people like Mike and LaVerna Leach of
Virginia Beach, Va. Mike is a retired Marine helicopter pilot who
receives about half of his retirement income from his investment
portfolio; LaVerna is a watercolor artist who owns her own
business. Mike says they sold some property last year to beat the
tax increase and will probably check in with their tax adviser,
Cynthia Jeanguenat, before year-end to see whether they need to do
There are ways to mitigate these tax hikes, especially if you
Make your investment portfolio more tax-efficient. Mike says he
doesn't expect to make major changes to his portfolio because he
doesn't want to "let the tax tail wag the investment dog." That's
good advice. But it's important to pay close attention to the types
of investments in taxable accounts and the types in tax-deferred
accounts, such as your 401(k) plan. Savvy investors often keep
investments that generate a lot of taxes, such as taxable bonds,
real estate investment trusts and high-turnover mutual funds, in
their tax-deferred accounts; they keep index funds and other
tax-efficient investments in their taxable accounts. Higher tax
rates make that even more important.
If you need income from your taxable account, consider municipal
bonds, suggests Greg Womack, a certified financial planner with
Womack Investment Advisers, in Edmond, Okla. Interest on muni bonds
is exempt from federal taxes and, in most cases, from income taxes
of the state in which the bonds were issued. In addition, munis are
exempt from the 3.8% investment surtax, which makes them even more
attractive, Womack says. Keep in mind, though, that interest from
some types of muni bonds is subject to the alternative minimum
It is also a good time to review your portfolio for potential
losses you could use to offset capital gains. If you were planning
to sell appreciated investments this year, ditching some of your
losers will help you lower or eliminate taxes on the gains.
Take advantage of tax-deferred accounts. The new tax rates and
phaseouts are tied either to adjusted gross income or to taxable
income. (AGI is the amount before subtracting the value of
exemptions and deductions; taxable income is the amount that's
actually taxed.) So it's more important than ever to look for ways
to hold down both figures. One of the most effective strategies is
to max out your contributions to tax-deferred retirement plans.
In 2013, employees younger than age 50 may contribute up to
$17,500 to a 401(k) plan; workers 50 and older may contribute an
Contributing to a health savings account will reduce both AGI
and taxable income; the money grows tax-deferred, and it can be
withdrawn tax-free for qualified medical expenses. To be eligible
for an HSA, you must be covered by a high-deductible health
insurance policy, either through your employer or on your own. In
2013, a high-deductible plan is one with a deductible of at least
$1,250 for individual coverage or $2,500 for a family.
You may contribute $3,250 to an HSA this year for individual
coverage or $6,450 for a family; if you're 55 or older, you can
kick in an additional $1,000. That's considerably more than the
$2,500 maximum you can put in a medical flexible spending account,
another tax-favored way to pay health care expenses. And unlike
flex plans, which come with a use-it-or-lose-it proviso, HSAs let
you roll over unused funds for future years.
Give appreciated assets to your adult children. Are your kids
struggling to pay off student loans? If you're willing and able to
help, give them appreciated stocks or mutual funds instead of cash.
When they sell, they may pay lower taxes on the gain than you would
owe. The long-term capital gains rate for taxpayers in the 10% or
15% tax bracket (with taxable income up to $36,250 for singles or
$72,500 for married couples) is 0%.
Giving appreciated securities to family members "is a way to
diversify across tax brackets," says Greg Rosica, a tax partner
with Ernst & Young. You can give securities valued at $14,000
per person in 2013 without filing a gift tax return; if you're
married, you and your spouse can give $28,000 to any number of
To qualify for the special rate for long-term gains, the
securities must have been held for more than 12 months. For gift
securities, however, the holding period includes the time that you
owned the assets, so your children don't have to wait a year to
sell their stocks or funds, Rosica says. But if your children are
younger than age 19 or full-time students younger than age 24, note
that they will be subject to the "kiddie tax," which means
investment income exceeding $2,000 will be taxed at your tax
Give appreciated securities to charity. Donating appreciated
stocks or mutual funds to charity has always been a smart strategy
for high-income taxpayers, and it makes even more sense now. By
giving appreciated assets, you avoid taxes on the gains and still
get to deduct the full value of the securities. Now that the top
long-term capital gains rate is 23.8%, "pushing the gain off to
charity is even more important," says Tim Steffen, director of
financial planning for Robert W. Baird. The charity doesn't have to
pay taxes on the profits when it sells the securities.
Donor-advised funds are another avenue: You get the write-off in
the year you donate, but you can decide later which charities will
benefit from your philanthropy.
Make charitable gifts from your IRA. Congress extended through
2013 a provision that allows seniors age 70½ and older to transfer
up to $100,000 from traditional IRAs directly to charity. Such
contributions can count toward required minimum distributions for
Your contribution won't be deductible, but it will lower your
AGI. As in the past, that could qualify you for tax breaks and
reduce or even eliminate taxes on Social Security benefits; now, it
could also help you avoid new tax hits, such as the phaseout of
other deductions, Rosica says.
Check your withholding. Starting this year, taxpayers will owe
an additional 0.9% Medicare tax on earned income of more than
$200,000 for single filers or $250,000 for married couples who file
jointly. For example, if you're single and earn $225,000 this year,
your employer will be required to withhold 1.45% on the first
$200,000 and 2.35% on the next $25,000.
Suppose, though, that you're married and you each earn $150,000.
Your employers won't withhold the extra 0.9% payroll tax because
your individual earnings are under the threshold. But you'll still
owe the additional levy on $50,000 of your joint income, notes
Heidi Tribunella, associate professor of accounting at the Simon
School of Business at the University of Rochester.
That alone won't trigger an underpayment penalty. But you could
run into problems if you also have investment income that's subject
to the 3.8% surtax, says Stephen DeFilippis, an enrolled agent in
Wheaton, Ill. To avoid penalties, you may need to adjust your
withholding. If you're self-employed, you may need to adjust your
quarterly estimated tax payments to cover the new tax.
Plan ahead for medical deductions. Deducting medical expenses
will be more difficult this year. To qualify for a write-off, your
unreimbursed medical expenses must exceed 10% of your adjusted
gross income, up from 7.5% in the past. For taxpayers 65 and older,
the threshold remains at 7.5% through 2016. And remember, you can
deduct only expenses that exceed the 7.5% or 10% threshold.
The change will put the deduction out of reach for even more
taxpayers. But you may have a better shot if you schedule elective
procedures, such as braces for the kids, in the same year that you
have other high medical costs, Tribunella says. Some married
couples can boost their chances of claiming the deduction by filing
separate tax returns, particularly if one spouse has a lower income
and high medical expenses. Be aware, though, that you give up other
money-saving tax breaks when you file separately.
Make sure you keep track of all qualifying expenses. In addition
to items such as hearing aids and eyeglasses, you can deduct a
portion of premiums for long-term-care insurance. Also deductible:
travel costs for medical services.
Reconsider the home-office deduction.
New IRS rules make it easier
for self-employed taxpayers to deduct the cost of their home
offices. In the past, claiming this money-saving tax break required
filling out a 43-line tax form itemizing expenses, such as the
percentage of utilities consumed by the home office. The hassle,
plus the fact that this write-off was widely viewed as an
invitation to an IRS audit, apparently persuaded some self-employed
workers to skip a break they deserved.
The streamlined rule allows you to deduct $5 per square foot, up
to a maximum of 300 square feet, or $1,500. The requirements for
deducting a home office haven't changed: It must be used regularly
and exclusively for your business. And you should still keep a
record of the costs of your home office because, in some instances,
the itemizing method could deliver a bigger tax break.
Finally, as you plan your tax strategies for 2013, keep an eye
on Washington. President Obama has proposed capping itemized
deductions at their value for taxpayers in the 28% bracket. That
means the tax-saving power of itemized deductions would be reduced
for taxpayers in the 33%, 35% and 39.6% brackets. The President's
2014 budget also proposed capping the amount that taxpayers can
contribute to tax-favored retirement savings accounts when they
reach $3.4 million (see
Obama Proposes Putting a Lid on Retirement Savings
Neither plan will be enacted this year. But as lawmakers
continue to look for ways to lower the deficit, proposals to limit
deductions "have got a lot of people concerned," says Steffen, of
Robert W. Baird. If it appears that Congress will cap deductions
next year, he says, high-income taxpayers may want to consider
accelerating some of their deductible expenses, such as charitable
contributions, so that they occur in 2013.