Year End Tax Planning – Part One – Individual

Tax planning this year, you have got to be kidding me! Fiscal cliff, mandated cuts and election uncertainty - how do you plan for that? Unless Congress acts, tax rates will go up next year, many more individuals will be snared by the alternative minimum tax (AMT), and various deductions and other tax breaks will be unavailable including the expanded tax credits for higher education. Individuals will face higher tax rates next year on their income, including capital gains and dividends, and estate tax rates will be higher as well.

  1. Tax Loss Harvesting. As always, take the year end to review your investment holdings to determine if there are gains or losses that you might want to take this year. Net losses up to $3,000 can be deducted against other income on the tax return. Capital gains have a favorable 15%/0% tax this year. Next year capital gains are scheduled to go up and an additional 3.8% tax may apply to the earnings if you are a 'high-income-earner'.
  2. FSA changes. Keep in mind that beginning next year, the maximum contribution to a health FSA will be $2,500. And don't forget that you can no longer set aside amounts to get tax-free reimbursements for over-the-counter drugs, such as aspirin and antacids.
  3. HSA's. If you become eligible to make health savings account (HSA) contributions late this year, you can make a full year's worth of deductible HSA contributions even if you were not eligible to make HSA contributions for the entire year. This opportunity applies even if you first became eligible in December.
  4. Roth Conversions. Consider, if appropriate, converting traditional IRAs to Roth IRAs this year to avoid potentially higher individual rates in coming years. IRA distributions themselves will not be income that will become subject to that 3.8% investment income tax but it might raise your income level to that which would subject your what would have been otherwise 'exempted' from the tax income to that which would be subject to the tax!
  5. RMD. Make sure you have taken your required minimum distribution from your retirement accounts if you are age 70-1/2 or older this year. Failure to take the minimum can result in a 50% penalty on the amount that was failed to be distributed. Remember the conversation above about the Roth conversion strategy; the same would apply to the consideration of taking your first year RMD by April 1st of next year. If you wait and have to take two distributions next year (your 2012 you postponed plus the 2013 that would be required), you could boost income up to where your investment income gets hit with the 3.8% extra tax. So maybe you want to take the distribution this year rather than waiting.
  6. Medical Deductions Will Have to Exceed 10% . Yes, next year to get a medical deduction you must have qualified medical expenses that exceed 10% of your adjusted gross income. Of course, you still need enough itemized deductions in total to get tax benefit from itemizing, that hasn't changed! So, if you have any 'discretionary' qualified medical expenses that you were planning to take next year, you may want to take them this year!
  7. Under withholding Penalties . If you are facing an under withholding penalty because you haven't taken enough out of your paycheck yet, consider taking more out of the remaining paychecks of the year so that you will have withheld enough to avoid any penalties.
  8. Gifts. Gifts of $13,000 per year can be made to any number of individuals. If your spouse also gifts, a family could gift up to $26,000 to any individual. If a gifting strategy is appropriate or desired, do it before December 31st to use up the annual gift amount. Remember, if that gifted asset was property (stocks and bonds) that produces income subject to that 3.8% investment income tax, then gifting that asset to someone who would have an income level not be subject to that tax (AGI $200,000 for individuals, AGI $250,000 for married) might be advantageous for the 'family'. I am talking 'irrevocable' gifting of a 'present interest' here. There are rules about 'parking money' with family members and income recognition requirements under imputed interest rules that might apply so be careful if you were thinking about that kind of a move to avoid the 3.8% tax!

I hope this gives you some ideas to review before year end. This is certainly not an all-inclusive list as any strategy needs to be considered in the 'whole of your financial circumstances'. For the tax loss harvesting strategy I always like to remind people that you shouldn't let the tax tail wag the investment dog. Review the investments on their investment merits not just their 'tax benefit'.

With respect to the election, fiscal cliff and other matters of uncertainty, once the dust settles it will be time to review the totality of our tax circumstances with better clarity, I hope. Lol.

In Part two we will look at "Business Year End Tax Moves".

David Bergmann, CFP ® , EA, CLU, ChFC

Managing Principal

The David Bergmann Group

Marina Del Ray, CA

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

Copyright © 2010 FPA All Rights Reserved

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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