Even More 2013 Year End Tax Planning Tips for Physicians

Posted on November 20, 2013 by Dr. David Edward Marcinko MBA MEd CMP™

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Last Minute Considerations for Medical Professionals … and Us All

By Robert Whirley CPA

2500-190 North Winds Parkway

Alpharetta GA 30009-2245

Dear ME-P Readers:

Year-end tax planning could be especially productive this year because timely action could nail down a host of tax breaks that won’t be around next year unless Congress acts to extend them, which, at the present time, looks doubtful. I have tried to keep this brief but, as typical, the changes this year are voluminous.

High-Income Earners

High-income-earners have other factors to keep in mind when mapping out year-end plans. For the first time, they have to take into account the 3.8% surtax on unearned income and the additional 0.9% Medicare (hospital insurance, or HI) tax that applies to individuals receiving wages with respect to employment in excess of $200,000 ($250,000 for married couples filing jointly and $125,000 for married couples filing separately).

Medicare Tax

The additional Medicare tax may require year-end actions. Employers must withhold the additional Medicare tax from wages in excess of $200,000 regardless of filing status or other income. Self-employed persons must take it into account in figuring estimate tax. There could be situations where an employee may need to have more withheld toward year end to cover the tax.

For example, an individual earns $200,000 from one employer during the first half of the year and a like amount from another employer during the balance of the year. He would owe the additional Medicare tax, but there would be no withholding by either employer for the additional Medicare tax since wages from each employer don’t exceed $200,000.

Also, in determining whether they may need to make adjustments to avoid a penalty for underpayment of estimated tax, individuals also should be mindful that the additional Medicare tax may be over-withheld. This could occur, for example, where only one of two married spouses works and reaches the threshold for the employer to withhold, but the couple’s income won’t be high enough to actually cause the tax to be owed.

Checklist

I have compiled a checklist of additional actions based on current tax rules that may help you save tax dollars if you act before year-end. Not all actions will apply in your particular situation, but you will likely benefit from many of them.

Tax

[Year-End Tax Planning Moves for Individuals]

• Increase the amount you set aside for next year in your employer’s health flexible spending account (FSA) if you set aside too little for this year.

• If you become eligible to make health savings account (HSA) contributions in December of this year, you can make a full year’s worth of deductible HSA contributions for 2013.

• Realize losses on stock while substantially preserving your investment position. There are several ways this can be done. For example, you can sell the original holding, then buy back the same securities at least 31 days later. It may be advisable for us to meet to discuss year-end trades you should consider making.

• Postpone income until 2014 and accelerate deductions into 2013 to lower your 2013 tax bill. This strategy may enable you to claim larger deductions, credits, and other tax breaks for 2013 that are phased out over varying levels of adjusted gross income (AGI). These include child tax credits, higher education tax credits, the above-the-line deduction for higher-education expenses, and deductions for student loan interest. Postponing income also is desirable for those taxpayers who anticipate being in a lower tax bracket next year due to changed financial circumstances. Note, however, that in some cases, it may pay to actually accelerate income into 2013. For example, this may be the case where a person’s marginal tax rate is much lower this year than it will be next year or where lower income in 2014 will result in a higher tax credit for an individual who plans to purchase health insurance on a health exchange and is eligible for a premium assistance credit.

• If you believe a Roth IRA is better than a traditional IRA, and want to remain in the market for the long term, consider converting traditional-IRA money invested in beaten-down stocks (or mutual funds) into a Roth IRA if eligible to do so. Keep in mind, however, that such a conversion will increase your adjusted gross income for 2013.

• If you converted assets in a traditional IRA to a Roth IRA earlier in the year, the assets in the Roth IRA account may have declined in value, and if you leave things as-is, you will wind up paying a higher tax than is necessary. You can back out of the transaction by recharacterizing the rollover or conversion, that is, by transferring the converted amount (plus earnings, or minus losses) from the Roth IRA back to a traditional IRA via a trustee-to-trustee transfer. You can later reconvert to a Roth IRA.

• It may be advantageous to try to arrange with your employer to defer a bonus that may be coming your way until 2014.

• Consider using a credit card to prepay expenses that can generate deductions for this year.

• If you expect to owe state and local income taxes when you file your return next year, consider asking your employer to increase withholding of state and local taxes (or pay estimated tax payments of state and local taxes) before year-end to pull the deduction of those taxes into 2013 if doing so won’t create an alternative minimum tax (AMT) problem.

• Take an eligible rollover distribution from a qualified retirement plan before the end of 2013 if you are facing a penalty for underpayment of estimated tax and the increased withholding option is unavailable or won’t sufficiently address the problem. Income tax will be withheld from the distribution and will be applied toward the taxes owed for 2013. You can then timely roll over the gross amount of the distribution, as increased by the amount of withheld tax, to a traditional IRA. No part of the distribution will be includible in income for 2013, but the withheld tax will be applied pro rata over the full 2013 tax year to reduce previous underpayments of estimated tax.

• Estimate the effect of any year-end planning moves on the alternative minimum tax (AMT) for 2013, keeping in mind that many tax breaks allowed for purposes of calculating regular taxes are disallowed for AMT purposes. These include the deduction for state property taxes on your residence, state income taxes (or state sales tax if you elect this deduction option), miscellaneous itemized deductions, and personal exemption deductions. Other deductions, such as for medical expenses, are calculated in a more restrictive way for AMT purposes than for regular tax purposes in the case of a taxpayer who is over age 65 or whose spouse is over age 65 as of the close of the tax year. As a result, in some cases, deductions should not be accelerated.

• Accelerate big ticket purchases into 2013 in order to assure a deduction for sales taxes on the purchases if you will elect to claim a state and local general sales tax deduction instead of a state and local income tax deduction. Unless Congress acts, this election won’t be available after 2013.

• You may be able to save taxes this year and next by applying a bunching strategy to “miscellaneous” itemized deductions, medical expenses and other itemized deductions.

• If you are a homeowner, make energy saving improvements to the residence, such as putting in extra insulation or installing energy saving windows, or an energy efficient heater or air conditioner. You may qualify for a tax credit if the assets are installed in your home before 2014.

• Unless Congress extends it, the up-to-$4,000 above-the-line deduction for qualified higher education expenses will not be available after 2013. Thus, consider prepaying eligible expenses if doing so will increase your deduction for qualified higher education expenses. Generally, the deduction is allowed for qualified education expenses paid in 2013 in connection with enrollment at an institution of higher education during 2013 or for an academic period beginning in 2013 or in the first 3 months of 2014.

• You may want to pay contested taxes to be able to deduct them this year while continuing to contest them next year.

• You may want to settle an insurance or damage claim in order to maximize your casualty loss deduction this year.

• If you are age 70-1/2 or older, own IRAs and are thinking of making a charitable gift, consider arranging for the gift to be made directly by the IRA trustee. Such a transfer, if made before year-end, can achieve important tax savings.

• Take required minimum distributions (RMDs) from your IRA or 401(k) plan (or other employer-sponsored retired plan) if you have reached age 70-1/2. Failure to take a required withdrawal can result in a penalty of 50% of the amount of the RMD not withdrawn. If you turned age 70-1/2 in 2013, you can delay the first required distribution to 2013, but if you do, you will have to take a double distribution in 2014-the amount required for 2013 plus the amount required for 2014. Think twice before delaying 2013 distributions to 2014-bunching income into 2014 might push you into a higher tax bracket or have a detrimental impact on various income tax deductions that are reduced at higher income levels. However, it could be beneficial to take both distributions in 2014 if you will be in a substantially lower bracket that year, for example, because you plan to retire late this year.

• Make gifts sheltered by the annual gift tax exclusion before the end of the year and thereby save gift and estate taxes. You can give $14,000 in 2013 to each of an unlimited number of individuals but you can’t carry over unused exclusions from one year to the next. The transfers also may save family income taxes where income-earning property is given to family members in lower income tax brackets who are not subject to the kiddie tax.

US capitol

[Year-End Tax-Planning Moves for Businesses & Business Owners]

• Businesses should consider making expenditures that qualify for the business property expensing option. For tax years beginning in 2013, the expensing limit is $500,000 and the investment ceiling limit is $2,000,000. And a limited amount of expensing may be claimed for qualified real property. However, unless Congress changes the rules, for tax years beginning in 2014, the dollar limit will drop to $25,000, the beginning-of-phaseout amount will drop to $200,000, and expensing won’t be available for qualified real property. The generous dollar ceilings that apply this year mean that many small and medium sized businesses that make timely purchases will be able to currently deduct most if not all their outlays for machinery and equipment. What’s more, the expensing deduction is not prorated for the time that the asset is in service during the year. This opens up significant year-end planning opportunities.

• Businesses also should consider making expenditures that qualify for 50% bonus first year depreciation if bought and placed in service this year. This bonus writeoff generally won’t be available next year unless Congress acts to extend it. Thus, enterprises planning to purchase new depreciable property this year or the next should try to accelerate their buying plans, if doing so makes sound business sense.

• Nail down a work opportunity tax credit (WOTC) by hiring qualifying workers (such as certain veterans) before the end of 2013. Under current law, the WOTC won’t be available for workers hired after this year.

• Make qualified research expenses before the end of 2013 to claim a research credit, which won’t be available for post-2013 expenditures unless Congress extends the credit.

• If you are self-employed and haven’t done so yet, set up a self-employed retirement plan.

• Depending on your particular situation, you may also want to consider deferring a debt-cancellation event until 2014, and disposing of a passive activity to allow you to deduct suspended losses.

• If you own an interest in a partnership or S corporation you may need to increase your basis in the entity so you can deduct a loss from it for this year.

Assessment

These are just some of the year-end steps that can be taken to save taxes.

Conclusion

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2012 Year End Tax Planning for Medical Professionals

Posted on September 6, 2012 by Dr. David Edward Marcinko MBA MEd CMP™
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How to Reduce Exposure to Higher post-2012 Taxes on Investment Income and Gains

By Perry Dalesandro CPA perry@dalecpa.com

Doctors and most all individuals face the prospect of a darker tax climate in 2013 for investment income and gains. Under current law, higher-income taxpayers will face a 3.8% surtax on their investment income and gains under changes made by the Affordable Care Act. Additionally, if current tax-reduction provisions sunset, all taxpayers will face higher taxes on investment income and gains, and the vast majority of taxpayers also will face higher rates on their ordinary income. This Alert explores year-end planning moves that can help reduce exposure to higher post-2012 taxes on investment income and   gains. This first part explains who has to worry about the 3.8% surtax and what it covers. It also briefly discusses key sunset rules, and begins examining some essential year-end moves.

Future parts will describe other planning moves in detail.

Who has to worry about the 3.8% Surtax and what it covers

For tax years beginning after Dec. 31, 2012, a 3.8% surtax applies to the lesser of (1) net investment income or (2) the excess of modified adjusted gross income (MAGI) over the threshold amount ($250,000 for joint filers or surviving spouses, $125,000 for a married individual filing a   separate return, and $200,000 in any other case). MAGI is adjusted gross income (AGI) increased by the amount excluded from income as foreign earned income (net of the deductions and exclusions disallowed with respect to the foreign earned income).

Illustration 1: For 2013, a single taxpayer has net investment income of $50,000 and MAGI of $180,000. He won’t be liable for the tax, because his MAGI ($180,000) doesn’t exceed his threshold amount ($200,000).

Illustration 2: For 2013, a single taxpayer has net investment income of $100,000 and MAGI of $220,000. He would pay the tax only on the $20,000 amount by which his MAGI exceeds his threshold amount of $200,000, because that is less than his net investment income of $100,000. Thus, the surtax would be $760 ($20,000 × 3.8%).

Observation: An individual will pay the 3.8% tax on the full amount of his net investment income only if his MAGI exceeds his threshold amount by at least the amount of the net investment income.

Ilustration 3: For 2013, a single taxpayer has net investment income of $100,000 and MAGI of $300,000. Because his MAGI exceeds his threshold amount by $100,000, he would pay the tax on his full $100,000 of net investment income. Thus, the tax would be $3,800 ($100,000 × .038).

The tax is taken into account in determining the amount of estimated tax that an individual must pay, and is not deductible in computing an individual’s income tax.

What is net investment income? For purposes of the Medicare contribution tax, “net investment income” means the excess, if any, of:

(1) the sum of:

… gross income from interest, dividends, annuities, royalties,   and rents, unless those items are derived in the ordinary course of a trade or business to which the Medicare contribution tax doesn’t apply (see below),

… other gross income derived from a trade or business to which the Medicare contribution tax does apply (below),

… net gain (to the extent taken into account in computing taxable income) attributable to the disposition of property other than property held in a trade or business to which the Medicare contribution tax doesn’t apply, over

(2) the allowable deductions that are properly allocable to that gross income or net gain.

Trades and businesses to which tax applies. The 3.8% surtax applies to a trade or business if it is a passive activity of the taxpayer, or a trade or business of trading in financial instruments or commodities.

Investment income won’t include amounts subject to self-employment tax. Specifically, net investment income won’t include any item taken into account in determining self-employment income and subject to the self-employment Medicare tax

Observation: Thus, the same item of income can’t be subject to both self-employment tax and the Medicare contribution tax. If self-employment tax applies, the Medicare contribution tax won’t apply.

The tax doesn’t apply to 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.

Exception for certain active interests in partnerships and S corporations. 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 only to the extent of the net gain or loss that the transferor would take into account if the entity had sold all its property for fair market value immediately before the disposition.

Retirement plan distributions. Investment income doesn’t include distributions from tax-favored retirement plans, such as qualified employer plans and IRAs.

Looming Sunsets Would Affect Almost all Taxpayers

Unless Congress acts, the Bush-era tax breaks-those in the EGTRRA and JGTRRA legislation of 2001 and 2003-will come to an end (i.e., they will sunset) at the end of 2012. Depending on how the November elections play out, the sunsets may be: (1) abolished for everyone, (2) deferred for everyone (as they were in December of 2010, when they originally were to   sunset), or (3) deferred for all taxpayers other than those with higher incomes. Still a fourth, albeit unlikely, possibility is that the parties will not be able to agree on remedial legislation and the Bush-era tax breaks actually will sunset at the end of 2012 for everyone.

There are scores of income tax rules that would be altered if the Bush-era tax breaks sunset at the end of 2012, but arguably the most important ones are as follows:

… Tax brackets. The 10% bracket will disappear (lowest bracket will be 15%); the 15% tax bracket for joint filers &  qualified surviving spouses will be 167% (rather than 200%) of the 15% tax bracket for individual filers; and the top four tax brackets will rise from 25%, 28%, 33% and 35% to 28%, 31%, 36% and 39.6%.

… Taxation of capital gains and qualified dividends.  Currently, most long-term capital gains are taxed at a maximum rate of 15%, and qualified dividend income is taxed at the same rates that apply to   long-term capital gains. Under the sunset, most long-term capital gains will be taxed at a maximum rate of 20% (18% for certain assets held more than five years). And, dividends paid to individuals will be taxed at the same rates that apply to ordinary income.

If the EGTRRA/JGTRRA sunset rules go into effect at the end of 2012 and dividends and interest are taxed at ordinary income rates up to 39.6% in 2013, it seems highly unlikely that dividends and interest also would be subjected to a 3.8% surtax on net investment income (i.e., Congress would at least repeal the surtax).

Year-end Planning for Investments

Beginning below, and to be continued in future articles, are specific steps that taxpayers can take now in order to reduce or avoid exposure to the 3.8% surtax as well as possibly higher tax rates on capital gains and dividend income.

Accelerate Home Sales

The sale of a residence after 2012 can trigger the 3.8% surtax in one of two ways. It also can expose taxpayers to a higher capital gain tax rate if the sunset rules affect them next year.

  •  Under Code Sec. 121, when taxpayers sell their principal residences, they may exclude up to $250,000 in capital gain if single, and $500,000 in capital gain if married. Gain on a post-2012 sale in excess of   the excluded amount will increase net investment income for purposes of the 3.8% surtax and net capital gain under the general tax rules. And if  taxpayers sell a second home (vacation home, rental property, etc.) after 2012, they pay taxes on the entire capital gain and all of it will be subject to the 3.8% surtax.

Recommendation: A taxpayer expecting to realize a gain on a principal residence substantially in excess of the applicable $250,000/$500,000 limit who is planning to sell either this year  or the next should try to complete the sale before 2013. Doing so rather than selling after 2012 will remove the portion of the gain that doesn’t qualify for the Code Sec. 121 exclusion from the reach of the 3.8% tax. It also will reduce the taxpayer’s exposure to possibly higher rates of tax on capital gains under the sunset rules.

Illustration 4: A married couple  earn a combined salary of $260,000. They plan to sell their principal residence for $1.2 million, and should net a gain of about $700,000, of which $500,000 will be excluded under Code Sec. 121. If they sell this year they  will pay a tax of $30,000 (15%) on their $200,000 of taxable residence gain.  If they wait till next year to sell, their gain will be fully exposed to the  surtax, which in their case equals 3.8% multiplied by the lesser of: (1) $200,000 of net investment income; or (2) $210,000 ($460,000 of MAGI  [$260,000 salary + $200,000 of taxable home sale gain] − the $250,000  threshold). Thus, the tax on their gain will be at least $37,600 ([.15 +   .038] × $200,000). The tax could be even more if they are subject to a higher capital gains tax next year under the sunset rule (or a modified sunset rule).

Illustration 5: A single taxpayer earns a salary of $170,000 and also has $30,000 of investment income (interest and dividends). He plans to sell his vacation home for $500,000 and will net a gain of approximately $400,000. If he sells this year, he’ll pay a $60,000 tax on his gain (.15 × $400,000). If he waits till next year, his MAGI will swell to $600,000 ($170,000 salary + $30,000 investment income +  $400,000 gain). He will pay an additional $15,200 of tax on his vacation home  gain (3.8% of $400,000), on top of the regular capital gain tax.  Additionally, sale of the vacation home in 2013 will expose his $30,000 of  investment income to an additional $1,140 of tax (3.8% of $30,000).

Conclusion

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