Alert: This conventional strategy may still work for you, but it’s not so cut-and-dried in 2013. Due mainly to ATRA, you may be inclined to do the exact opposite, especially if you expect to be in a higher tax bracket next year than this year.
For starters, there are several changes taking effect in 2013 that could affect year-end tax planning for individuals (see box below). Therefore, you should assess where you are this year and where you figure you’ll be next year. Keeping that in mind, here’s a list of 10 top year-end tax strategies for individuals.
1. Harvest capital gains or losses. Traditionally, investors look to realize capital losses from securities sales at the end of the year. The losses can offset capital gains plus up to $3,000 of ordinary income. Any excess loss is carried over to the next year.
But you may harvest long-term capital gains instead this year if the gains will be taxed at only a 15% federal rate. At higher income levels, the maximum federal rate on long-term gains is 20% for 2013 and thereafter. Similarly, you might postpone long-term losses that would offset some long-term gains if you expect your long-term gains to be taxed at 20% in 2014 but only 15% this year.
2. Do the AMT math. The alternative minimum tax (AMT) system runs on a track next to the regular tax system. After calculating AMT liability based on certain adjustments, “tax preference items” and subtracting an exemption amount, you effectively pay the higher of the two taxes.
Despite increases in the exemption amounts by ATRA, you still might have to pay the AMT. Possibly, you might avoid the AMT by postponing tax preference items. Alternatively, if you’re an annual AMT payer, extra income accelerated into 2013 will be taxed at an AMT rate no higher then 28% (26% for AMT income up to $179,500).
3. Give tax-wise gifts to charity. Generally, you can deduct the full amount of monetary donations made to qualified charities if you meet substantiation requirements. Plus, you may be able to deduct the fair market value of donated long-term capital gain property such as stocks you've held longer than a year.
In fact, you can currently deduct a donation charged by credit card in 2013, even if you don’t pay off the charge until 2014. But be aware that the charitable deduction is one of the itemized deductions reduced for upper-income taxpayers (see box below). Consider the best year for deducting large gifts in your situation.
4. Shift income within the family. If you’re in a high tax bracket in 2013, you may decide to transfer income-producing property to other family members, like young children or grandchildren, who are in much lower brackets. For instance, with a tax rate differential of 29.6% between the top bracket of 39.6% and the lowest bracket of 10%, a family may save $2,960 in tax on $10,000 of earnings.
But don’t forget about the “kiddie tax.” Unearned income received by a dependent child under age 19 or a full-time student under age 24 is generally taxed at the parents’ top tax rate to the extent it exceeds an annual threshold ($2,000 in 2013).
5. Get tax cure for medical expenses. Medical expense deductions aren’t affected by the reduction in itemized deductions, but they already have a built-in floor. For 2013, the floor is 10% of AGI for most individuals (up from 7.5% of AGI in 2012). It remains 7.5% of AGI for taxpayers age 65 or older.
When possible, schedule nonemergency physician and dentist visits in 2013 if you will qualify for a deduction. Otherwise, you might as well postpone expenses to 2014 and take your best shot next year.
6. Speed up retirement distributions. Generally, you must take annual “required minimum distributions” (RMDs) from IRAs and qualified retirement plans, like a 401(k), after you reach age 70½. RMDs are taxed at ordinary income rates.
If you must take a RMD this year and expect to be in a lower marginal tax bracket this year than in future years, consider increasing the amount you withdraw in 2013 by taking out more than the mandatory minimum amount.
7. Generate residential energy credits. Under ATRA, you may still qualify for a residential energy credit if you install qualified property in your home. The credit is generally equal to 10% of qualified expenses, up to a lifetime maximum credit of $500, although other special limits may apply. The residential energy credit is now scheduled to expire after 2013, but it has already been extended several times in the past. If you were going to buy the energy-saving property anyway, you might as well do it this year.
8. Bolster your sales tax deduction. ATRA reinstates the tax law provision allowing taxpayers to choose between a deduction for state and local income taxes, and a deduction for general state and local sales taxes. The sales tax deduction may be based on actual receipts or, more conveniently, an amount listed in a state-by-state table.
If you elect to deduct sales tax, be aware that certain “big-ticket items,” like cars and boats, can be added to the table amount. Thus, a year-end purchase of a big-ticket item can significantly boost the total deduction.
9. Add a dependency exemption. Generally, you can claim a dependency exemption deduction of $3,900 for each dependent child who is under age 19 or a full-time student under age 24. But you have to provide more than 50% of the child’s support to qualify for the exemption. If it’s a close call, give some extra support to seal the deal.
Remember that personal exemptions phase out for high-income taxpayers. Nevertheless, if an exemption is still available for an older child in 2013, grab it.
10. Go to the head of tax class. Eligible parents can either claim a tuition deduction or one of two tax credits—the American Opportunity Tax Credit (AOTC) and the Lifetime Learning Credit (LLC)—for higher education expenses paid or incurred in 2013. But the tax benefits phase out for high-income taxpayers.
Generally, the AOTC is preferable, because it provides a maximum $2,500 credit per student, as opposed to a maximum LLC credit of $2,000 per family. Either credit is available in 2013 for tuition paid this year for academic periods that begin in the first three months of 2014.
Tip: Coordinate individual tax strategies to best suit your personal situation.
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