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FAMILY TAXATION


Skippin’ RocksMost of what we, as taxpayers, understand about taxation comes from our focus on taxes and how they affect us either individually or as a business. With the business owner, tax strategies will often be managed in aggregate between the business tax return and the owner’s personal return so as to optimize benefits and deductions and minimize taxes.

Rarely, however, do households look at aggregate family taxation to develop strategies for life’s expenditure requirements or desires – college education, first time homebuyer assistance, weddings, family member ‘support’, inter vivos wealth transfers, etc., etc., etc. The concept here is one of wealth and resources management through family income shifting and tax effect optimization. When, as practitioners, we do see family taxation considered in family financial activities there is usually a CERTIFIED FINANCIAL PLANNING™ professional involved.

So what are some of those family taxation considerations that the “pro’s” use for income shifting and tax effect optimization?

ASSETS YOU WON’T NEED AND ASSETS FOR SPECIFICALLY FUNDED PURPOSES

If you gift assets away, $14,000 per individual in 2013, they become the property of the transferee, your daughter for example, presuming you made what is called an irrevocable gift. The income on that asset will now become the income of, in this case, your daughter. If the asset gifted away is sold by your daughter, a gain or loss may be recognized by her based on your original purchase value and the tax rate upon the sale by the daughter will generally be based on the holding period (long term or short term) starting with you, not your daughter’s date of ownership. The strategy here for tax effect optimization is to have the income or gain from the asset taxed at the lowest rate of a family member.

If the gift was made to a minor, it would be made through a Uniform Transfer to Minors Account or a Uniform Gift to Minors Account. The purpose of this type of arrangement is to provide oversight of the asset until the child reaches the age of majority in the state. One issue that comes up with gifts to minors (and to those under age 24) is what is called the “Kiddie Tax”. The “Kiddie Tax” may limit the tax benefit from this income shifting opportunity by subjecting amounts of unearned income exceeding $2,000, in 2013, to taxation at the applicable parent’s tax rate.

This shifting assets (income) strategy also is designed to take assets that might be taxed upon death at an estate tax rate that might reach 40% and puts them into the hands of the beneficiary whose individual tax rates might be, today, perhaps as high as 43.4%. The ‘estate’ tax ‘individual’ tax rate differential obviously is not as compelling today (individual rate is higher than the estate rate) for the avoid estate taxation argument of inter vivos wealth transfers nonetheless they should be looked at depending on the facts of each situation. Additionally estates are not even taxed until they exceed $5,250,000 in 2013 so for most there will never be, lol, an estate tax to worry about.

An advantage to your receiving an asset after someone dies rather than having it gifted to you during their lifetime is that there is a step-up in value (presuming an increased value in the asset) to the value at the date of death. For example, if Mom was the last to die and she and Dad paid $100,000 for a home that you inherit when it is valued at $900,000 and you sell it for $900,000 there is no gain or loss. Under the gift scenario, based on these facts alone, the $800,000 gain would not be ‘stepped up’ so a tax would be due on that appreciated value upon a dispositive event – a sale. With respect to this ‘step up in value concept’, one should be aware that IRA’s, annuities, Pensions and Retirement Accounts that have never been taxed do not get a step up in basis.

So if we know we would not need an asset in our lifetime, or if we know that we are dedicating an asset for a specific life expenditure occurring at some date in the future (college, bar or bat mitzvah, etc.), would we benefit from shifting that asset, and the income thereupon, to another in order to most optimally accumulate funds for our dedicated expenditure purpose? Would that give us more available for the expenditure or, perhaps, give us the amount needed sooner? Should we do this type of thing now, and if not, when? In doing so, would we be putting assets into the hands of someone, a child for example, who then would be precluded, for example, from getting financial aid for school because they ‘owned’ too much in assets? Would the asset transferred become subject to the control or potential attachment of another? There are lots of causes and effects to any strategy hence the need to think not only of tax optimization but asset preservation and protection.

EMPLOYING FAMILY MEMBERS IN A BUSINESS OR IN THE HOUSEHOLD

If we have a business, or if we have a housekeeper or maintenance worker (gardener), rather than employing other than a family member to work in those activities, we could employ our child, family member, or related children in doing that work. An advantage to employing family members in our business or in our household is that they will have earned income shifted to, or earned by, them by being paid a wage. Earned income can be excluded from taxation up to the amount of our personal exemption and standard deduction. So for a 16 year old child claimed as a dependent on her parent’s tax return helping with filing and office clean up during the year in Mom’s business they could earn $6,100 + $1,000 in income and not pay any taxes on that income. With just $6,000 of ‘earned’ income the child could fund a Roth IRA which would not be a tax deduction to the child but it wouldn’t be needed as such anyway. The advantage to a Roth over other types of IRAs is that you can access your contributions to a Roth IRA at any time. You do not have to wait five years. You do not have to wait until age 59 ½. Contributions to Roth’s can be accessed at any time, earnings on Roth’s, however, are another story.

Even if there is not a business for a child to work in they certainly can do work around the home, do gardening or do baby-sitting, for example, all of which are examples of earning ‘earned’ income in a household doing domestic services. Of course, unlike the business activity, employment of your children in the household would not provide a tax deduction to the family just like the gardener or pool man is not deductible to the family today. For certain businesses employing under age 18 family members there may even be payroll taxes avoided (See Pub 15 Page 12).

CONCLUDING THOUGHTS

Making the most of what we are able to earn and keep for ourselves is so important to families today. Parents who have worked their whole lives to have what they have want to ensure what they have earned and accumulated is most fully shared by those they wish to benefit. Having income or transfer taxes eat up what we have or are able to acquire is a terrible thing if it can be avoided. Making the best of good family tax strategies is a wonderful thing. Take the time to think about your fiscal responsibilities and life’s expenditures and see if you are optimizing your resources for them.

David Bergmann, CFP®, EA, CLU, ChFC
Managing Principal
The David Bergmann Group
Marina Del Ray, CA


21 Comments

Keeping What You Make – Managing Taxes Owed on Income Received


The Debt Crisis Isn't Over YetTax Rates Overview

Under our current tax code, The Tax Act of 1986, as amended to date, the income that we earn for income tax purposes can be subject to either ‘no taxation’, ‘regular income taxation’, or an ‘alternative rate of taxation’ known as capital gains rates.

For some taxpayers the regular income taxation rate will be defaulted to a ‘parallel’ tax system known as the Alternative Minimum Tax (AMT) and an alternative tax rate on that income which is a flat tax rate of 26 or 28%.

For individuals who are not subject to AMT, their income would be subject to one of the following tax rates – 10%, 15%, 25%, 28%, 33%, 35% and 39.6% ($400,000 single or head of household or $450,000 if married filing jointly). Well technically one who is subject to the 33% tax rate, for example, is subject to each of the 10, 15, 25, and 28% tax rates because we have a progressive tax system that taxes us at various levels as we fill up those lower income tax rate buckets with income. If we took each bucket’s tax and related income number, we could calculate a weighted average tax paid from all of those buckets of income and we would call it the taxpayer’s ‘effective tax rate’. The lower one can get that effective tax rate for a given level of income, the better one will have done to ‘manage’ their tax liability on income.

For taxpayers making over $200,000, as single or head of household, and $250,000, as married filing jointly there will be an additional 3.8% tax on investment income which could be either (1) regular income, called ordinary income, like interest earned, (2) qualified dividend income, like income on your NYSE traded stock, or (3) capital, like capital gains. This new 3.8% tax will alter how we manage our income resources for those at these income levels.

Capital gains and qualified dividend taxes could be 0%, 15%, 20% (taxpayers making over $400,000 single or head of household and $450,000 married filing joint), 25% (real property depreciation unrecaptured gain) or 28% if a collectible is sold at a gain.

Social Security income is tax free if we do not earn too much income so for those who are receiving social security benefits managing income and the taxability upon it is crucial. Too much income annually is defined by the IRS as $25,000 for single, head of household, qualifying widow or widower with a dependent child or married individuals filing separately who did not live with their spouse at any time during the year; $32,000 for married couples filing jointly; and $0 for married persons filing separately who lived together at any time during the year. For every dollar of income earned over those thresholds a dollar of otherwise tax free social security benefits becomes taxable. For a taxpayer in the 35% tax bracket, for example, the loss to taxes from social security benefits becoming entirely taxable would be 32 cents on a dollar – (85% maximum of benefits that could be taxed) times (35% the marginal tax bracket). The least amount of benefits that could become subject to taxation if you go over the threshold is 50%.

3.8% Investment Tax Effect

Interest Income from a bond taxable at 35% or interest free? What is better? The formula for determining net yield after tax would be (yield) minus [(yield) times (tax)]. So to determine the tax equivalent of a municipal (tax free) bond to a corporate bond we would divide the tax free yield by (one) minus (marginal tax rate). For example, before the 3.8% extra tax a taxpayer in the 35% tax bracket would have been indifferent between a corporate bond that paid 5% and a tax free bond that paid 3.25%. Now, after the 3.8% additional tax is imposed, the same taxpayer earning the taxable 5% would be indifferent if the tax free rate was only 3.07%. Alternatively stated, to earn the equivalent of a 3.25% tax free, now the taxpayer would be looking for a taxable bond earning 5.29%.

Strategy Considerations

For Investment Income: Interest, Qualified Dividends and Capital Gains

The first thought is to re-allocate your CD type money into a dividend paying stock. For a single person in the 28% tax bracket ($87,850 to $183,250) that would save .13 cents on every dollar of earnings (.28 – .15). For a single person in the 15% tax bracket ($8,925 to $36,250) that would save .15 (.15 – 0) cents on every dollar. But is that penny wise and pound foolish? It might be because unlike your CD investment where your principal is secure, and most likely FDIC protected, the stock price associated with your investment paying that dividend may decline. A 1% negative move in a $20 dividend paying stock, 20 cents, would wipe out the tax gain you were trying to achieve by seeking out dividend income over ordinary income. So consider both your personal ability to tolerate risks of loss and determine the appropriateness to your financial circumstances of putting your principal to that risk.

To ensure that your capital gains get the favorable 0, 15%, or 20% (plus 3.8%, if applicable) tax treatment the investment must be held for more than one year. Knowing that the market does not go straight up, it might not be appropriate to seek capital gains by investing in the stock market if the money you are investing might be needed in the short to intermediate term – 3 to 5 years. Again, risk tolerance and diversification should always be taken into consideration.

For those subject to the 3.8% tax muni bonds can avoid that tax so they have become somewhat more attractive (as illustrated above a tax free rate of 3.25 is now equivalent to 5.29% rather than 5% without that tax being imposed. There are a significant number of strategies with regard to the 3.8% tax so consult with your advisor if you are subject to the tax.

For Social Security Taxability

When one is receiving social benefits it is even more important to manage the timing and character of income (ordinary, tax free, capital) so that one minimizes the impact of taxation on those benefits. Municipal bond income is tax free but it is considered taxable for purposes of determining whether or not, and how much of, your social security benefits could become taxable. To the extent the muni bond can provide more income than the taxable bond considering all of these factors it may (always run the numbers) be a tax optimizing investment choice when one is drawing social security benefits. Alternatively, an investment that provides cash flow without large taxable components to the cash flow might be a very good strategy to manage social security benefit’s taxability. An immediate annuity purchased with after tax dollars will have an exclusion ratio to the payments received that will then provide cash flow without taxation.

Concluding Thoughts and Observations

Wealth accumulation and wealth management require vigilance in both tax and portfolio risk management from the investment perspective. Tax rates have a huge impact on our net returns so strategizing for optimizing our tax impact with consideration of our own risk tolerance, and need to take risk, if any, for investment returns is an ongoing responsibility. Choices of tax-free, tax deferred, ordinary or capital gains income are very important in achieving optimal results with our resources earned over our lifetime. I hope you are maximizing and keeping all that you have worked so hard to earn.

David Bergmann, CFP®, EA, CLU, ChFC
Managing Principal
The David Bergmann Group
Marina Del Ray, CA


49 Comments

Keeping What You Make – Managing Taxes Owed On Income Received


What I Learned From the Tax SeasonTax Rates Overview

Under our current tax code, The Tax Act of 1986, as amended to date, the income that we earn for income tax purposes can be subject to either ‘no taxation’, ‘regular income taxation’, or an ‘alternative rate of taxation’ know as capital gains rates.

For some taxpayers the regular income taxation rate will be defaulted to a ‘parallel’ tax system known as the Alternative Minimum Tax (AMT) and an alternative tax rate on that income which is a flat tax rate of 26 or 28%.

For individuals who are not subject to AMT, their income would be subject to one of the following tax rates – 10%, 15%, 25%, 28%, 33%, 35% and 39.6% ($400,000 single or head of household or $450,000 if married filing jointly). Well technically one who is subject to the 33% tax rate, for example, is subject to each of the 10, 15, 25, and 28% tax rates because we have a progressive tax system that taxes us at various levels as we fill up those lower income tax rate buckets with income. If we took each bucket’s tax and income number, we could calculate a weighted average tax paid from all of those buckets of income and we would call it the taxpayer’s ‘effective tax rate’. The lower one can get that effective tax rate for a given level of income, the better one will have done to ‘manage’ their tax liability on income.

For taxpayers making over $200,000, as single or head of household, and $250,000, as married filing jointly there will be an additional 3.8% tax on investment income which could be either regular income, called ordinary income, like interest earned, or capital, like capital gains. This new tax will alter how we manage our income resources.

Capital gains taxes could be 0%, 15%, 20% (taxpayers making over $400,000 single or head of household and $450,000 married filing joint), 25% (real property depreciation unrecaptured gain) or 28% if a collectible is sold at a gain.

Social Security income is tax free if we do not earn too much income so for those who are receiving social security benefits managing income and the taxability upon it is crucial. Too much income annually is defined by the IRS as $25,000 for single, head of household, qualifying widow or widower with a dependent child or married individuals filing separately who did not live with their spouse at any time during the year; $32,000 for married couples filing jointly; and $0 for married persons filing separately who lived together at any time during the year. For every dollar of income earned over those thresholds a dollar of otherwise tax free social security benefits becomes taxable. For a taxpayer in the 35% tax bracket, for example, the loss to taxes from social security benefits becoming entirely taxable would be 32 cents on a dollar – (85% maximum of benefits that could be taxed) times (35% the marginal tax bracket). The least amount of benefits that could become subject to taxation if you go over the threshold is 50%.

3.8% Investment Tax Effect

Interest Income from a bond taxable at 35% or interest free? What is better? The formula for determining net yield after tax would be (yield) times (tax). So to determine the tax equivalent of a municipal (tax free) bond to a corporate bond we would divide the tax free yield by (one) minus (marginal tax rate). For example, before the 3.8% extra tax a taxpayer in the 35% tax bracket would have been indifferent between a corporate bond that paid 5% and a tax free bond that paid 3.25%. Now, after the 3.8% tax, the same taxpayer would be indifferent if the tax free rate was only 3.07%. Alternatively stated, to earn equivalent of a 3.25% tax free now, the taxpayer would be looking for a taxable bond earning 5.29%.

Social Security Income Taxability Management

When one is receiving social benefits it is even more important to manage the timing and character of income (ordinary, tax free, capital) so that one minimizes the impact of taxation on those benefits. Municipal bond income is tax free but it is considered taxable for purposes of determining whether or not, and how much of, your social security benefits could become taxable. To the extent the muni bond can provide more income than the taxable bond considering all of these factors it may (always run the numbers) be a tax optimizing investment choice when one is drawing social security benefits. Alternatively, an investment that provides cash flow without large taxable components to the cash flow might be a very good strategy to manage social security benefit’s taxability. An immediate annuity purchased with after tax dollars will have an exclusion ratio to the payments received that will then provide cash flow without taxation.

Concluding Thoughts and Observations

Wealth accumulation and wealth management require vigilance in both tax and risk management from an investment perspective. Tax rates have a huge impact on our net returns so strategizing for optimizing our tax impact with our own risk tolerance, and need to take risk, if any, for investment returns is an ongoing responsibility. Choices of tax-free, tax deferred, ordinary or capital gains income are very important in achieving optimal results with our resources earned over our lifetime. I hope you are maximizing and keeping all that you have worked so hard to earn.

David Bergmann, CFP®, EA, CLU, ChFC
Managing Principal
The David Bergmann Group
Marina Del Ray, CA


7 Comments

Who’s Preparing Your Tax Return?


For many of you, your answer will be “I prepare my own return.” If your return is a simple one because all you have is a W-2 form for your wages and maybe you have some interest income and you are taking the standard deduction, then this may be the right move for you.

For the rest of you, the answer is you may need a paid preparer to provide you with the expertise to file a complete, accurate and correct tax return. If you have not used a paid preparer in recent years, you have missed a lot of what the Internal Revenue Service (IRS) has done to improve the procedures and controls over the paid preparer tax community.

Several years ago, the IRS put in place a PTIN program for preparers. PTIN stands for Preparer Tax Identification Number and was meant to replace using the Social Security Number of the tax preparer for security purposes. In 2011, the IRS began the next phase requiring anyone paid to prepare tax returns to have a PTIN and to sign the returns that they were paid to prepare. All paid preparers were also required to be licensed, pass a basic competency test and take continuing education classes. Today one of the following certifications or licenses is required to prepare, sign, and be paid for a tax return:

  1. Attorney
  2. Certified Public Accountant
  3. Enrolled Agent
  4. Registered Tax Return Preparer

Each of these groups has different requirements for maintaining their license to practice. They also have different requirements with respect to keeping abreast of the tax laws and ethics of preparing tax returns. So let’s look at each category of preparer.

  1. Attorneys. Individuals who are attorneys gain their right to be an attorney from each state. The rules are different in each state for maintaining their license. The IRS grants them the ability to prepare and sign tax returns by virtue of their state issued license, but they still need a PTIN to file tax returns. They have annual continuing education requirements designated by their state to keep their license. A lawyer may represent a tax client before the IRS for any tax matter for any year as well as represent that client before state tax authorities.
  2. Certified Public Accountants (CPA). A CPA receives and maintains their license under the rules of each state they are licensed to practice in. The state rules determine the amount and type of continuing education that each CPA must have each year. The IRS allows CPA’s to prepare and file tax returns by virtue of their CPA license but they still need a PTIN to file tax returns. A CPA may also represent a client before the IRS and state tax authorities for any tax matter for any year even if the CPA did not prepare the original return.
  3. Enrolled Agents (EA). A person who is an EA is federally licensed by the IRS and has unlimited practice rights to represent any clients before the IRS on any tax matter. This license is obtained by taking a comprehensive 3-part exam that requires a minimum passing score in the areas of individual tax, corporate tax, and regulation. Some people may obtain their EA license through their work experience with the IRS in certain job areas. Like the attorney and the CPA, the EA can represent the client on any tax matter for any year even if the EA did not prepare the original tax return. The IRS has established that an EA must have 72 hours of continuing education on tax matters every three years and a minimum of 16 hours in any one year. These hours must include 2 hours of ethics training per year. Failure to meet these education requirements will result in loss of the EA designation.
  4. Registered Tax Return Preparer (RTRP). In 2011 the IRS established a new designation of RTRP for individuals who want to be tax preparers but do not have the above noted licenses. This license is obtained by taking a basic competency test on individual taxation. The rules for 2012 and beyond require that all tax preparers (other than the above licensed preparers) must be an RTRP as the minimum designation to be a paid tax preparer and signer of any tax return they prepare. This RTRP license is limited in scope when it comes to representing clients since they can only represent you on a return that they prepared. They cannot represent you on prior year returns which they did not prepare and they cannot represent you on all collection activities that you might become subject to if your return is selected for audit. The IRS has established a minimum of 15 hours of continuing education per year for individuals with the RTRP license with 2 hours being ethics training.

Given the newness of the RTRP tax preparation license, it is important to understand the breadth and limits of the person who has the RTRP designation. When the new designation was established in 2011, anyone who wished to prepare tax returns could register to get the RTRP designation and the corresponding PTIN number. For that group, they had until the end of 2013 to take and pass a basic test of their knowledge of the preparation of a Form 1040 tax return. They were also required to have the 15 hours of continuing education in 2012 to keep the RTRP into 2013 and they had to re-register their PTIN number by December 31, 2012.

For individuals who want to have the RTRP designation in 2013 and were not previously registered as a RTRP, they have to first take and pass the RTRP exam for the Form 1040 tax return and, in 2013, have 15 hours of continuing education on current tax rules and ethics.

All categories of tax preparers are required to renew their PTIN each year, meet continuing education requirements, and sign each return certifying that the return is complete and accurate to the best of their knowledge. All preparers also are subject to the requirements of Treasury Circular 230 which sets forth the Regulations Governing Practice before the Internal Revenue Service, including penalties for non-compliance.

So as you contemplate who to use as your paid tax preparer for your 2012 tax return, use this information to have an informed discussion with the person or persons you are considering entrusting with this task. Be sure that this person is signing the return because they are attesting to the completeness and accuracy of the amounts you are reporting on your tax return. If the person who prepares your return does not sign the return or does not have one of the credentials noted above, you may be signing an incorrect return and be setting yourself up for penalties if your return is selected for audit. You may also have to engage an attorney, CPA or EA to assist you with resolving the issues the IRS wants to discuss with you. If a preparer is not willing to sign a return that they prepare, they are not likely to stand by you when the IRS comes knocking.

FrancisStOnge

Francis St. Onge, CFP®
President
Total Financial Planning, LLC
Brighton, MI


2 Comments

Want to Avoid Capital Gains and Get a Tax Deduction?


How to Give Like a BillionaireTax rates are almost certain to increase in 2013. But did you know that there is something you can do to avoid capital gains tax and get a tax deduction to boot? If you regularly give cash to your favorite charities, early planning and strategic gifting could net you and your favorite charity more than you expected. This holiday season, consider giving appreciated stock instead of cash to charity…its one way you can avoid paying capital gains and get a tax deduction.

Larger Tax Deduction
According to “Giving USA: The Annual Report on Philanthropy”, Americans gave close to $300 billion to charities in 2011. There are so many ways to help your favorite charity: you can donate your time, clothing and other household items, vehicles and boats, and of course money. But, did you know that you can also donate stock? In fact, if you own highly appreciated stock, you might be better off donating the stock versus cash. Let’s assume you plan to give $5,000 to charity this year. You could write a check for $5,000. However, if you own stock that you purchased for $1,000 and it’s now worth $5,000, the IRS allows you to deduct the fair market value of the donated asset (the higher amount). A win-win situation for both your charity and you.

Zero Capital Gains Tax
Capital gain is the profit you make on the sale of an asset; it is the difference between the sales price and your cost. Capital gains are subject to tax, and the maximum tax rate is currently 15 percent, but it is highly anticipated to rise in 2013. Continuing with the same example, assume you bought $1,000 of PowerShares QQQ (index fund that tracks the NASDAQ) several years ago, and it’s now worth $5,000. If you sold your QQQs, you would owe capital gains tax on the profits ($4,000) of about $600. However, if you donate your shares, you will not only receive a $5,000 tax deduction, but you will also avoid having to pay capital gains tax on the profit.

About Donor Advised Funds
Although donating stock can be a smart move from a socially conscious perspective as well as a financial one, many smaller charities are not setup to accept stocks as donations. Additionally, what if you do not want to give the entire $5,000 to one charity? It can be administratively difficult to subdivide stocks into small donations if you were planning on making several “smaller” donations to multiple charities. From a purely financial perspective, sometimes it is usually more prudent to make one large donation for tax and estate planning purposes. The good news is that through a donor advised fund, you can do both: make one large donation and decide later on which charities will get the money.

A donor advised fund is an investment vehicle that lets you irrevocably donate cash, securities, or other assets to the fund to get the tax deduction in the year you fund it. Once donated, the assets belong to the fund and you recommend whom the fund should donate money to. The donor advised fund can either make the donation in your name or anonymously. Continuing with our previous example, assume you donated the $5,000 of PowerShares QQQ to a donor advised fund in the year 2012, you can then have the fund make donations on your behalf whenever and to whichever charities you wanted in much smaller increments. While donor advised funds are very easy to manage and setup, like most things in life, they come with a cost. Some firms impose annual fees and others require a minimum donation to start the fund, so do your due diligence. But given the numerous tax, financial, and estate planning benefits, a donor advised fund is still worthwhile to consider.

Ara OghoorianAra Oghoorian, CFP®, CFA
Founder and President
ACap Asset Management
Los Angeles, CA


1 Comment

Are You Ready for Some Tax Planning?


While we are all awaiting to see what Congress does to deal with our tax rates for 2012 and 2013, I thought it would be good to deal with some practical tax planning that will work for you regardless of what Congress does with all the tax issues they need to address. (I will write about the tax changes they make once we know what those are.)

Let’s start with how we can reduce our tax liability by using our Schedule A-type itemized deductions to help us over several years. All tax payers get to use the standard deduction or to itemize for certain items as a choice. For instance, we can claim a standard deduction of $5,950 if we are Single or Married Filing Separately or $11,900 if we are filing as Married Filing Jointly (MFJ). If we are 65 and older, the amount is increased by $1,450 if Single and by $1,150 for MFJ. So if both taxpayers are over age 65 and MFJ, the standard deduction is now $14,200 and if both were disabled the amount goes up to $15,500.

For many taxpayers, the ability to itemize and exceed these limits rests on whether they have a mortgage and own a house (real estate taxes). Without these two items, your ability to itemize is reduced unless you have high medical expenses or make charitable contributions. In some cases, you barely get over the standard amount allowed with what deductions you do have. So this article is meant for people who do not have enough to itemize or barely get over the limits each year.

If you are below the limit or barely over each year, you may want to look at how you pay things like real estate property taxes. In some states (Michigan is one), you receive two real estate tax each year with one of them due in the early part of the year. This gives you the option of paying it in December or in January, thus the opportunity for some tax planning. If you are not able to get the advantage of itemizing this year, you could wait and pay this tax bill in January 2013 and then plan on paying the December 2013/January 2014 bill in December of 2014.

Assuming the above might work for you, the next item would be to look at your charitable contributions. If you were going to postpone the real estate bill to January 2013, then you might also wait until January 2013 to write those year-end checks to charities. Should this become your plan for this December, then put a note on your calendar that next December you will write the charity donation checks in December to again double up on the donation items for 2014. This also works for those donated articles of clothing and other items that you drop off periodically at places that take donated items. Just remember to make that detailed list of the items donated, maybe take a picture for documentation purposes, get your receipt from the charity, and then make the right value of each item for tax purposes. For those checks you wrote, be sure to get a receipt from the charity for amounts over $250.

Now let’s move on to medical expenses. As you know, medical expenses need to exceed 7.5% of your adjusted gross income before you can take any medical expense deduction. This exclusion amount is going up to 10% in 2013, so you may want to look at getting some health care needs met in 2012 in order to help get this deduction. Examples of year-end health care might be a dental checkup, eye glass exams and new glasses, and filling prescriptions in December that you might normally fill in early January. I am not suggesting spending money without a reason, but many times we might have exams in the first quarter of the year that could be performed in December. Remember if you put the amount you are responsible for on your credit in December, it is considered paid for tax purposes even though you may not pay the credit card balance until next year. If you have a medical expense deduction for tax purposes, be sure to count up the miles that you incurred to get that medical treatment at round trip miles including to pick up your prescriptions and doctor office visits ($.23 per mile is what is allowed for medical miles in 2012).

This plan for itemizing one year and using the standard deduction in the next year should result in you claiming more over the two years than you would have claimed by not doing this planning. For instance, let’s assume you are Single and under age 65 with a standard deduction amount of $5,950 and your itemized deductions were normally $6,500 each year. With no planning you would be taking the $6,500 each year. You do your analysis and you find that there is $1,000 of the $6,500 that you can control as to when you pay out this money and thus get the tax deduction. So for the first year you take the standard deduction of$5,950 and in the second year you have $7,500 of itemized deduction for a total of $13,450 over the two years. This is $450 more than what you claimed by itemizing each year, saving you $68 in taxes if you are in the 15% tax bracket. Now that is tax planning and you get rewarded for this great planning.

To your list of things that you can do to move deductions from one year to the next, add making estimated tax deposit for state income taxes you know you will owe when the tax return is due (make the deposit in December 2012 rather than January 2013.) Make your January 2013 mortgage payment so you can claim an extra month’s mortgage interest each year.

For your charitable contributions, if you give stocks or mutual funds that have a huge capital gain to the charity, you get to claim the current market value rather than what you paid for the stock as the donation, just be sure to transfer the stock certificate rather than selling it. If you sell it first then you have the gain and the tax bill.

After the Schedule A items, your next stop is to look closely at your taxable investment portfolio to see how each investment is doing as it relates to what you paid for it originally. While we want all of our investments to grow, it would be unrealistic to think they are all worth more than what we paid for them. So consider harvesting the ones with loses, because you can take $3,000 of losses each year against your other income and that will reduce your taxable income with the tax bill going down by $450 if you are in the 15% tax bracket.

Finally, if these two ideas can reduce your taxable income enough to keep you in the 15% tax bracket, then any dividend income for 2012 will get taxed at Zero% versus 15% if you should end up in the 25% tax bracket.

FrancisStOnge

Francis St. Onge, CFP®
President
Total Financial Planning, LLC
Brighton, MI


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Year End Tax Planning – Part Two – Business


Year-end tax considerations for businesses are not quite as up in the air as is the individual tax situation so let’s take a look at a few of them.

Will the 3.8% Net Investment Income Tax Come Into Play?
With respect to that 3.8% net investment income tax coming in 2013, don’t worry, the tax doesn’t apply to income from trades or businesses conducted by a sole proprietor, partnership, or S corporation. But income, gain, or loss on working capital isn’t treated as derived from a trade or business and thus is subject to the tax.  Additionally, gain or loss from a disposition of an interest in a partnership or S corporation is taken into account by the partner or shareholder as net investment income and, therefore, could cause the 3.8% tax to apply.

Considering Buying Equipment?
Current law allows you to ‘write-off’ (expense), up to $139,000 of qualifying property placed in service in the tax year. If you have already placed in service $560,000 of qualifying property this strategy will not work because for every dollar of qualifying assets that you place in service above this level you lose a dollar of ‘expensing’ benefit. If you haven’t exceeded the maximum yet, and you need the machine but do not have the cash, put the purchase on your credit card that will qualify it as having been purchased this year. You can also get substantial write-offs in 2012 from a purchase of a more than 6,000 pound vehicle that may be used in a trade or business.

Do you need to ‘shelter’ income or want to save for the future?
Setting up a retirement plan is fairly easy. The costs of a plan can be very minimal or they can get very expensive if you want ‘tailored or targeted’ plan design or a, so-called defined benefit plan, which has annual actuarial costs and other expense factors. Without going into details regarding selection or design factors let’s look at some of the basic choices for retirement plans other than an individual retirement account …

Plan Type:   Simple
Establish Date:  October 1st  
Fund By Date:  Due date return + Extension
Max. if <50 yrs. old:  $11,500 + 3% or 2%

Plan Type: 401 (K)
Establish Date:  December 31st
Fund By Date:  Due date return + Extension
Max. if <50 yrs. old:  $16,500 + 25%*

Plan Type: Defined Benefit
Establish Date: December 31st
Fund By Date: Due date return + Extension
Max. if <50 yrs. old:  Actuarially Determined

Plan Type: SEP
Establish Date:  Due date of return + Extension
Fund By Date: Due date of return + Extension
Max. if <50 yrs. old: $49,000 (25%* of comp)

[*Note that 25% is actually 20% because it is 25% of income ‘in respect of’ (after) the deduction so $100,000 of income minus $20,000 =’s $80,000.   $20/$80 is 25%]

Need Employees?
If you are thinking of hiring, consider hiring a veteran before year-end to qualify for a work opportunity credit. The credit, a dollar for dollar reduction in tax liability, can range from $2,400 to $9,600 depending on a variety of factors.

Are you a Corporation?
If you are incorporated, you may want to consider a stock redemption (buy-back) which may, depending on a multitude of factors, create a long-term capital gain or a dividend which will receive the favorable 15% tax rate if done this year. Remember, unless Congress acts, capital gains rates will be going up and that 3.8% net investment income tax could apply if you make more than $250,000 married, $125,000 married filing separately and $200,000 individually.

Are you a Partnerships or a S-Corporation?
When our ‘amount at risk’ in an activity is not sufficient to allow us to, possibly, take a loss from an activity, our loss will be ‘suspended’ until such time as we have sufficient amounts ‘at-risk’. If you might not be able to utilize a loss currently because you didn’t have sufficient amounts ‘at-risk’, consider adding capital, or, alternatively, if possible, add debt that you are ‘personally responsible for’ to the activity which, by definition, will increase your at-risk. That will allow you, then, to take the loss currently. Remember, though, if this is a passive activity, there are other hurdles to overcome in order to take a ‘passive loss’ currently.

Closing Thoughts
These are but a few of the year end considerations. For 2013 ‘larger’ small businesses who offer health care to their employees, or even those that do not offer health care to employees currently, will need to review provisions of the Patient Protection and Affordable Care Act to determine the tax impact of the Act on their benefit plans and what course of action might be most prudent to pursue with respect to benefit plan(s) design for the business.

I hope that your 2012 tax year was a good one for you, your family and your employees, and I hope that 2013 is even better for ALL!

David Bergmann, CFP®, EA, CLU, ChFC
Managing Principal
The David Bergmann Group
Marina Del Ray, CA