Saturday, April 27, 2013

Are You Ready for the New Investment Tax?

Laura Sacnders for the Wall St. Journal writes: It's time to grapple with the new 3.8% tax on investment income.  The ordeal of 2012 taxes is barely over. But it isn't too early to understand and cushion the blow of the investment-income levy, which Congress passed in 2010 to help fund the health-care overhaul.
The tax, which took effect Jan. 1, applies to the "net investment income" of married joint filers who have more than $250,000 of income (or $200,000 for singles). Only investment income—such as dividends, interest and capital gains—above the thresholds is taxed. The rate is a flat 3.8% in addition to other taxes owed.
"Affluent investors who ignore this tax will be in for a total shock next April 15," says David Lifson, a certified public accountant specializing in tax at Crowe Horwath in New York. Such income is typically not subject to withholding, and people won't be factoring it into their estimated taxes. Lower-bracket taxpayers who receive a windfall large enough to owe the tax will also be in for a surprise.
The new levy is one of several tax increases taking effect this year, including higher top rates on income and capital gains, limits on deductions, and an extra 0.9% payroll tax. But the 3.8% tax will cost many Americans even more.
The reason: an odd interaction between the regular income tax and the alternative minimum tax, or AMT, a separate levy that rescinds the value of some tax benefits. This year, many affluent taxpayers will have higher income because of new limits on exemptions and deductions. But this higher income will also help lower their alternative minimum tax.
As a result, many people paying AMT won't owe much more in 2013—unless they have investment income subject to the 3.8% tax.
"This brand-new tax is independent of most other provisions in the code," says David Kautter, a CPA at the Kogod Tax Center at American University. He gives an example, using figures from President Barack Obama and his wife Michelle's 2012 tax returns and a calculator from the nonpartisan Tax Policy Center in Washington.
Last year, the Obamas had gross income of about $662,000 and owed federal income tax of about $108,000. Under 2013 law, Mr. and Mrs. Obama would lose more than $25,000 of their deductions and exemptions, but their AMT would also fall by about 40%.
The upshot: They would owe about the same income tax as they did in 2012.
However, less than 2% of the Obamas' 2012 income was from investments. If half of their income had been from dividends, interest and capital gains, then the Obamas' 2013 income-tax bill would rise by at least $11,000 because of the 3.8% tax, says Mr. Kautter.
Given the tax code's many quirks, individual results will vary. To find out how the new tax will affect you, check out the Tax Policy Center's free online tool atcalculator.taxpolicycenter.org. Users can plug in numbers from 2012 returns—or any numbers—and get a side-by-side comparison of taxes for 2012 and 2013, detailing which elements will change.
Congress and the Internal Revenue Service have designed the 3.8% tax to cast a wide net. (See box on this page.) But there are exceptions, plus strategies for minimizing the hit. Here are steps to consider.
• Minimize your adjusted gross income. The trigger for the 3.8% tax is $250,000 of adjusted gross income for joint filers ($200,000 for singles). Only net investment income above that is taxed.
Adjusted gross income, or AGI, is the number at the bottom of the front page of Form 1040. It includes certain adjustments to income but not itemized deductions, such as charitable donations, mortgage interest and state taxes.
So if a couple has $245,000 of AGI, they wouldn't owe the tax, even if all of it is investment income. But if they have $255,000, they would owe 3.8% of $5,000.
What reduces AGI? Among other items: deductible contributions to tax-favored retirement plans such as 401(k)s, individual retirement accounts or pensions; a charitable contribution of IRA assets by taxpayers 70½ or older; moving expenses; deferred compensation; and capital losses up to $3,000 deducted against ordinary income.
• Rearrange your assets. The new tax is even more reason to move income-generating investments such as high-yield bonds or high-turnover mutual funds into tax-sheltered accounts such as IRAs, says Eric Lewis, a principal at Bedrock Capital Management, a financial-planning firm in Los Altos, Calif.
This advice also applies to real-estate investment trusts, he says, because they generate "nonqualified" dividends taxed at ordinary rates. For taxable accounts, he favors tax-free municipal bonds, which aren't subject to the new tax.
• Time income if possible. Say a single investor with $150,000 of AGI wants to sell stock with $100,000 in long-term gains. If he sells it all at once, he will owe $1,900 due to the new tax. But if he sells half his stake on Dec. 31 and the other half on Jan. 1, there's no tax.
Lower earners who can foresee a windfall will often benefit from planning, notes Mr. Lewis. If a couple routinely has $125,000 of income but expects a $300,000 gain from a one-time asset sale, they would owe $2,850 in the new tax. "Good planning can probably avoid it," he says.
Options include an installment sale that spreads payments over a number of years or a "like-kind" exchange, a tactic in which an investor swaps assets instead of selling them, says Kogod's Mr. Kautter.
• Harvest losses. The new tax applies to "net" investment income, so investors can reduce their capital gains by subtracting capital losses. One of the tax code's great benefits is that losses on one asset can offset gains from another—and excess losses can be carried over for use in the future.
• Don't fret about your house—in most cases. The new tax applies to gains on the sale of a principal residence, but it probably won't matter for most people. That's because sellers can reduce their gain by the purchase price of the house, plus capital improvements, plus $500,000 per couple (or $250,000 for singles). Only gains above that amount are subject to the tax, assuming the sellers exceed the income thresholds.
Say a couple bought a house for $300,000 in 1990 and paid $100,000 for an addition in 1998. This year they sell it for $850,000. The gain in the house would be $450,000, which would be fully covered by the $500,000 exclusion.
• Know how retirement income helps—and hurts. Taxable payments from pension plans, regular IRAs and Social Security aren't subject to the 3.8% tax. But such income raises AGI in a way that can expose other investment income to the tax.
For example, a couple with $290,000 of taxable income from IRAs and Social Security wouldn't owe any 3.8% tax—but that situation is unusual. If $100,000 of their income came instead from dividends, interest and capital gains, then $40,000 would be subject to the 3.8% tax, because they have that much investment income above $250,000.
For this reason, the "best" income is a qualified Roth IRA payout. The payout doesn't raise income and isn't taxable. An added bonus: It doesn't help raise Medicare premiums or tax on Social Security payments.
• Consider Roth IRA conversions. Full income taxes are due on the conversion of regular IRA assets to Roth accounts, but such shifts can make sense for taxpayers who expect their income to rise above the $250,000 or $200,000 thresholds later in retirement.
"If income is lower now because people are waiting until 70 to take Social Security and IRA withdrawals, we consider Roth conversions," says Mr. Lewis.
• Understand what's exempt. Tax-free municipal-bond interest isn't subject to the 3.8% tax. The income from taxable Build America Bonds is subject to it, however, as would be capital gains from trading munis.
Life-insurance proceeds, gifts and inheritances are also not subject to the tax, nor are appreciated assets donated to charity.
Another exception: income from real-estate activities earned by "qualified professionals." Such people must spend a minimum of 750 hours actively managing real estate (not just arranging financing), and that must equal more than half their working hours, says Stewart Karlinsky, a CPA and professor emeritus at San Jose State University in California.
Owners of Subchapter S firms might also escape the tax if they are actively involved in the business. There are various tests of active involvement, but the most common is working at least 500 hours a year. "This is a good reason to have family members work in a family-owned business," says Mr. Karlinsky.
Finally, active partners don't owe the 3.8% tax on their share of a partnership's business income, unless it's from trading financial instruments or commodities, says Monte Jackel, a tax expert in Silver Spring, Md.
• Check in with your hedge fund. Tax strategist Robert Gordon of Twenty-First Securities in New York suggests that hedge-fund investors ask managers about possible changes that could pose problems.
The 3.8% tax is prompting some managers to consider taking their own incentive pay as a fee rather than as "carried interest" subject to the 3.8% tax. While this could help the managers, it could put investors at a disadvantage by giving them large amounts of nondeductible investment expenses, says Mr. Gordon.
Hedge funds with "trader" tax status could face a worse problem: Current rules don't allow the funds to offset gains with losses before paying the 3.8% tax. "A trader fund could actually have a loss, and investors would still owe the new tax," he says.
• Go offshore. The 3.8% tax gives wealthy taxpayers yet another reason to invest legally through offshore funds in the Cayman Islands and elsewhere, says David Miller, an attorney at Cadwalader, Wickersham & Taft in New York.
Using a "blocker" corporation allows investors to delay the payment of the 3.8% tax by letting income build up in the offshore fund. This strategy can also reduce tax when paid, because the tax would be owed on net rather than gross income.
• Know what's different for trusts. The 3.8% tax applies at a much lower threshold for trusts—$11,950 of income instead of $250,000 or $200,000. But that's only for investment income retained in the trust. If the income is paid out to beneficiaries, their own tax rates apply.
• Hold investments until death. As with the capital-gains tax, the new levy doesn't apply to assets held at death.
Such assets are marked up to their current value and become part of an estate. The current federal estate-tax exemption is a generous $5.25 million per individual this year (and indexed for inflation), so holding highly appreciated assets until death could be a smart move.
For example, say an elderly woman owns a beach property now worth $1 million that was valued at $50,000 when she inherited it in the mid-1970s. If it's sold while she's alive, she would owe as much as $36,100 due to the 3.8% tax, plus capital-gains tax. If she still owns the property at death, however, neither tax will apply.


Posted on 5:50 AM | Categories:

Tax Calculators & Tools / These tools will help you better assess and calculate the tax implications of your investments.

From Fidelity comes Tax Calculators & Tools.   These tools will help you better assess and calculate the tax implications of your investments.



All tax calculators & tools

NameDescription
Charitable Planning CalculatorOpens in a new window.Learn how planned giving can help increase your charitable impact.
Fidelity Income Strategy Evaluator®Find a right mix of income-producing investments to meet your needs in retirement.
Grant CalculatorOpens in a new window.Estimate proceeds and tax implications before exercising stock options.
IRA Contribution CalculatorOpens in a new window.Estimate how much you may be able to contribute to your IRA this year and how much might be tax-deductible.
Minimum Required Distribution (MRD) CalculatorOpens in a new window.Determine your required retirement account withdrawals after age 70½.
Price-Yield CalculatorOpens in a new window.Calculate the estimated yield or price of a bond, including accrued interest, invoice price, yield-to-maturity, and yield-to-call.
Retirement Income PlannerIf you’re within five years of retirement or already retired, use this tool to create a comprehensive plan to help make your money last by projecting out your expenses against potential income sources in different kinds of market conditions.
Retirement Quick CheckIf you’re more than five years from retirement, use this tool to project how much you’ll need, compare it to what you’re on track to have, and identify changes you can make today to address any shortfall.
Securities Donation CalculatorOpens in a new window.Estimate the potential federal income tax deduction of donating to charity appreciated securities held longer than one year.
Tax Equivalent Yield CalculatorOpens in a new window.Compare the yield between taxable and tax-exempt bonds.
Posted on 5:50 AM | Categories:

Overlooked in the Online Sales Tax Bill: Free Tax Software

Patrick Clark for Businessweek writes: After years of griping from state governors, the Senate is considering another bill that would allow states to collect sales tax from out-of-state sellers. It would close a loophole created by a 1992 Supreme Court ruling that has allowed online behemoths Amazon (AMZN) and EBay (EBAY) to avoid collecting sales tax on many transactions. Unlike previous versions of the legislation, the Marketplace Fairness Act would compel businesses that sell $1 million or more annually in states in which they don’t have a physical location to collect tax on those sales.
Last month, 75 senators voted in principle to support the bill—estimated to add $23 billion annually to states’ coffers—though that’s no guarantee it will become law. (If that’s confusing, here’s a primer.) Yesterday the Senate ended debate on the bill, and its final vote is scheduled for May 6. If it passes, it will face opposition in the House.
What would the law mean for small businesses? The answer varies on a case-by-case basis. For every story about entrepreneurs worried about the added tax compliance burden, there’s another on small business owners who crave the consistency they say the law would give them.
Still, amid all the howling by forces on both sides of the debate, a key piece of the Senate proposal is often overlooked: The law requires states to provide businesses with sales tax compliance software for free. To get a sense of how that will work, it’s useful to read up on the Streamlined Sales and Usage Tax Agreement. The Supreme Court ruling that effectively exempted out-of-state sellers from collecting sales tax argued that the hodgepodge of tax laws in different states made compliance too complex. To try to simplify the process, 24 states signed on to SSUTA.
As part of the deal, the administrative body for the agreement certified six software providers to help businesses voluntarily pay sales tax on remote sales. To keep costs down for retailers, states agreed to pay the software companies a commission of 2 percent to 8 percent on taxes collected. Participating states have collected $1.2 billion in sales tax since 2005, says Craig Johnson, executive director at the Streamlined Sales Tax Governing Board. “If this was really such a burden on remote sellers, you wouldn’t expect them to collect taxes when they don’t have to,” Johnson says.
At least one service provider, TaxCloud, already offers free sales tax compliance software in “Streamlined” states, according to Daniela Saunders, a sales and marketing executive at the company. TaxCloud integrates with e-commerce platforms and calculates taxes at the point of sale, and handles other administrative processes, including filing tax returns. “We expect that if the legislation passes, other states will join SSUTA,” Saunders says. Meanwhile, TaxCloud is talking to states about how to offer software without joining the Streamlined agreement.
Of course, simplicity is in the eye of the beholder. “Someone who hasn’t had to collect the tax up to now is going to look at this as an added step,” says Michael Mazerov, a tax expert at the Center on Budget and Policy Priorities. Still, thousands of businesses have had to collect out-of-state sales tax, and “some version of the software has been commercially available for decades,” Mazerov says. 
(Corrects to show Washington, D.C., didn't sign the Streamlined Sales and Usage Tax Agreement)

Posted on 5:49 AM | Categories:

Estate Planning: New Hazards

Kelly Greene for the Wall St. Journal writes: You thought your estate plans were finally set? Not so fast.  It turns out the "permanent" $5 million estate-tax exemption enacted earlier this year could change after all, sending families back to the drawing board to sort out their strategy.
A provision in President Barack Obama's fiscal year 2014 budget calls for lowering in 2018 the estate-, gift- and generation-skipping-transfer-tax exemption limits.
Those limits were just made "permanent" in January at $5 million and indexed for inflation. (This year's exemption is $5.25 million.)
The Obama administration proposed lowering the exclusion to $3.5 million for estate and GST taxes, and to $1 million for gift tax. Those amounts—a return to 2009 levels—would no longer be indexed for inflation.
All three tax rates would go up, too, with the top rate rising to 45% from the current 40%.
But wasn't the $5-million-plus exemption made permanent just four months ago?
"Permanent doesn't mean Congress will never revisit it. It just means there's no expiration date built into it," says Bruce Steiner, an estate-planning lawyer at Kleinberg Kaplan Wolff & Cohen in New York.
If the proposal gathers steam and is enacted, he predicts "the same thing as last December, with another big flood of people giving away assets because they can," he says.
If you feel like the estate-tax exemption limit has bounced around a lot, you're right. It has been changing every few years since 2001. Even some lawyers who get to charge by the hour are frustrated.
"We just need stability," says Christine Finn, a lawyer at Marcum LLP, a New York accounting and advisory firm. "With the $5 million limit now [for estate and gift taxes], it's going to be hard to get people back to thinking about the planning they'd need to do if the gift-tax rates go back down to $1 million."
Still, ratcheting down the three exemptions and closing other "estate-tax loopholes" would raise $79 billion over 10 years, according to the budget proposal.
The budget includes other ways to cut the deficit that could affect family inheritance planning as well. Here's what to watch.
• Discounts could disappear. Now, if you give a family member a minority share in your business, an appraiser legally can discount its value.
The reasoning: A minority owner lacks control of the asset, can't liquidate it, can't get income from it unless the business makes a distribution and can't sell it easily.
Mr. Obama's annual budget proposals have called for limiting, or getting rid of, such discounts to family members—until now. Gordon Schaller, an estate-planning lawyer in Irvine, Calif., contends that the provision's absence from this year's proposed budget could mean that "they're getting ready to issue regulations to do it, so they don't need to talk about legislation anymore."
If that happens, families wouldn't be able to transfer as much wealth effectively tax-free, Mr. Schaller says. So families who have been considering such transfers should make them now.
• GRATs could get watered down. So-called grantor-retained annuity trusts, or GRATs, let people give a portion of an asset's future profits to heirs tax-free. The trusts have been popular tools for passing along battered stocks, especially because GRATs work best when interest rates are low.
But GRATs also have been a target in Mr. Obama's budget proposals for several years.
The person who sets up the trust gets annual payments adding up to the asset's original value, plus a return based on a fixed interest rate set by the Internal Revenue Service. That rate currently is only 1.4%.
When you give an asset to a GRAT, you retain the right to regular payments for a set time period. What you actually are giving away is any future appreciation on the asset—free of taxes.
When the GRAT's term ends, the asset goes to the beneficiaries free of gift or estate tax on the appreciation, even though it has been transferred.
The biggest risk is that the owner will die before the trust expires, generally subjecting its entire value to estate tax. Because of that risk, GRATs typically are set up with shorter terms, such as two years.
But the proposed budget would require GRATs to have a minimum term of 10 years. The change is expected to generate $3.9 billion in 10 years.
"If you're thinking about setting up a GRAT, do it now while you know you can, because you may not be able to do it as favorably tomorrow," Mr. Steiner says.
• Thousand-year trusts could get shortened. In the 1980s, many states adopted a statute that limited family trusts to a 90-year span. But since then, about half the states have repealed that rule or lengthened the "permissible perpetuities period," in some cases to as long as 1,000 years, Mr. Steiner says.
Such lengthy trusts can keep large chunks of wealth out of the tax man's reach for decades, or maybe even forever, he adds.
But Mr. Obama's budget proposal, echoing provisions called for in previous years, would have the generation-skipping-transfer exemption expire after 90 years, making the assets subject to taxes at that point.
Since the proposal would apply only to new trusts created after its enactment, you might want to set up your trust now, Mr. Steiner says.
• Individual retirement accounts could get emptied faster. People who inherit IRAs and other tax-deferred retirement accounts are allowed under current law to "stretch" their withdrawals across their life expectancy, paying income tax only on distributions.
The budget proposal would require most heirs, other than widows or widowers, to empty retirement accounts within five years. The measure would raise almost $5 billion in 10 years, the budget proposal claims.
The move already has prompted some older adults whose wealth is concentrated in IRAs to consider moving them into trusts to help their families keep up with, and follow, the rules correctly.
And people who had planned to convert IRA holdings to Roth IRAs are starting to reconsider. IRA owners have to pay income tax on any tax-deferred assets being converted, but future withdrawals are income-tax-free, even for heirs, as long as they meet holding requirements.
If stretching the withdrawals past five years is no longer possible, there could be less advantage to paying the upfront tax bill, says Jeffrey Levine, a certified public accountant at Ed Slott & Co. in Rockville Centre, N.Y.

Posted on 5:48 AM | Categories:

5 Rules That Make the Roth 401(k) Different

Kevin Chen for Fool.com writes: Just as important as what companies you invest in are the tools you invest with. As more and more employers offer a Roth 401(k), you may have come across this option, and wonder how it differs from the Traditional 401(k). Additionally, you may wonder how a "Roth" 401(k) differs from a Roth IRA. Here are five key facts that will keep your head straight, and maximize your retirement dollars.
1. No income restrictions for Roth 401(k)Whether you're a millionaire or a pauper, it doesn't matter. You can contribute to a Roth 401(k) no matter what your adjusted growth income (AGI) is. That's completely unlike the Roth IRA – which taxpayers can only contribute to if they have a certain AGI (less than $112,000 for single filers and $178,000 for joint filers in 2013). The only real question to whether you can contribute to a Roth 401(k) is if your employer offers it. And to find that answer, all you need to do is shoot a quick email to human resources.
2. Forced distribution age is in-line with "Traditional" accountsRoth 401(k)s require contributors to start withdrawing funds at age 70 1/2. The penalty for not doing so is 50% of your minimum distribution. The Traditional 401(k) and Traditional IRA follow similar rules.
Unlike the rest, the Roth IRA has no forced distribution age.
3. "Roth" = "Post-tax"Similar to the Roth IRA, Roth 401(k) contributions are taxed post-tax. Meanwhile, contributing to Traditional 401(k) and Traditional IRA are pre-tax.
What does that mean? Well, pre-tax means you'll pay tax when you take distributions (withdraw) at retirement. Meanwhile, post-tax means that you pay your tax now, but any future distributions -- hopefully after growing your investments -- are tax-free.
How does that affect you? Well, if you're young, not making much, but expect to earn a greater salary as you near your retirement, then a Roth 401(k) may be the best choice for you. If you expect to be in a lower tax bracket by retirement, then the Traditional 401(k) may be best for you. This may feel like it's going over your head, but luckily, Fool contributor Dan Caplinger has 401(k) tax planning covered.
4. "Roth" = 5 Year "Seasoning" PeriodSimilar to both IRAs and Traditional 401(k)s, Roth 401(k) contributors can begin distributions at age 59-½ or if you become disabled. However, with the Roth 401(k), you also have to wait five years before you can start your distributions if you want to get its full benefits.
The same is true of those who have contributed to a Roth IRA.
So, if you're nearing your retirement and want to contribute to a Roth 401(k), you may be better off going traditional if you're going to need the money very soon.
5. "Roth" stays a "Roth"When you leave your employer, you have the option to rollover your 401(k) to an IRA. Now, if you have a Traditional 401(k), rejoice! You have two options: You can roll it over to either aTraditional IRA or a Roth IRA.
On the other hand, contributing to a Roth 401(k) limits your rollover option to just the Roth IRA.
Roth 401(k): Another tool in your retirement kitWhile it may be arduous at times, learning all the ins and outs of all the retirement accounts can be fun. Just think: If you minimize your taxes and penalties, you're creating a bigger nest egg. And, if you plan it right, you may get to lie on that Caribbean beach overlooking the crystal ocean a bit sooner.
To make sure you're making the right choices, it helps to figure out what others are doing wrong. With most people chronically under-saving for their retirement, it's clear that not enough is being done. Don't make the same mistake as the masses. Make sure you have enough for retirement now. Learn about The Shocking Can't-Miss Truth About Your Retirement. It won't cost you a thing, but don't wait, because your free report won't be available forever.
Editor's note: In a previous version of this article, the author confused the meanings of "pre-tax" and "post-tax." The Fool and the author regret the error.
Comments:
  • On April 26, 2013, at 8:48 AM, LSails2 wrote:
    This article says, "Well, post-tax means you'll pay tax when you take distributions (withdraw) at retirement. Meanwhile, pre-tax means that you pay your tax now, but any future distributions -- hopefully after growing your investments -- are tax-free". I think this is backwards.
    "pretax" means you don't pay tax now, but do later when you withdraw and "posttax" means you are contributing money that you have already paid tax on and so, withdraw with no tax".
    Or have I misunderstood all these years?
  • Report this CommentOn April 26, 2013, at 10:40 AM, Maximizese wrote:
    I believe LSalls2 is correct. I had to re-read that sentence a few times because it seemed wrong to me. I believe the author had pre-tax and post-tax explanation reversed.
  • Report this CommentOn April 26, 2013, at 11:40 AM, ahayes07 wrote:
    You are both correct. The author is wrong. That is a pretty big mistake to make when its the #1 difference between a traditional and a Roth 401k. Yikes...
  • Report this CommentOn April 26, 2013, at 12:46 PM, xxmikey wrote:
    This is so irresponsible to be that idiotic and post such incorrect infomation. You should take this article down immediately and fire the idiot who wrote it!
  • Report this CommentOn April 26, 2013, at 2:58 PM, TMFGalagan wrote:
    @Lsails and all - The author did get mixed up here. We're in the process of getting it fixed. Thanks for pointing out the error!
    best,
    dan (TMF Galagan)

Add your comment.

Posted on 5:48 AM | Categories:

Advisers, Clients Plan For Next Tax Season

Arden Dale for the Wall St. Journal writes: For a lot of taxpayers, tax season doesn't end on April 15.  Soon after sending off their returns and other documents to the Internal Revenue Service, many people start right back again planning for the next tax season.
Financial advisers have already stepped in this year, post Tax Day, to help clients estimate taxes for their upcoming quarterly payments, amend their returns, adjust their tax withholding on IRA distributions, and much more.
Bernard M. Kiely, an adviser in Morristown, N.J., with $55 million under management, has three clients he will help file tax returns on extension. Two are waiting for K-1 statements from partnerships and trusts.
"The third is an elderly gentleman who takes his time to get the paperwork together," Mr. Kiely said.
While many tax advisers take a break after April 15, others stay busy preparing for the upcoming tax season.
For example, one of the two accountants adviser Eve Kaplan works with throughout the year "was on the first flight out of New Jersey on April 16 for a vacation--not an atypical travel pattern for the CPAs," said Ms. Kaplan, in Berkeley Heights, N.J., who manages $30 million.
The other accountant, however, has emailed Ms. Kaplan post-April 15 about a client who wanted to close a certain investment account. The man didn't grasp the large tax hit that would follow. Because he owned investments in the account for less than a year, ordinary income tax rates would apply, not lower capital-gains rates.
In fact, taxes are never far from Ms. Kaplan's thoughts.
"I work quietly in the background on an ongoing basis to generate tax harvesting opportunities throughout the year in order to lower the taxable investment income my clients pay," she said.
Katherine Dean, managing director of wealth planning at Wells Fargo Private Bank in San Francisco, said estimating taxes will be a harder task this year for wealthy people because of new, higher income tax rates and a 3.8% surtax on investment income. Many advisers and their clients have already started the process to understand the new yet unfamiliar tax regime.
What's not so complicated to figure out: The next quarterly payment for estimated taxed is due on June 17. Taxpayers with adjusted gross income above a certain amount--$150,000 for 2012--pay 110% of the total tax shown on their prior year tax returns in estimated taxes.
This month, Ms. Dean said, her group has talked with corporate executives about whether to defer income in their compensation plans in light of the higher income tax rates. The alternative minimum tax complicates these talks in some cases, however.
The AMT replaces personal exemptions and some deductions, including the standard deduction and that for state and local taxes, with an AMT exemption ($50,600 for individuals and $78,750 for married, filing jointly, for 2012). It applies tax rates, 26% on the first $175,000 and 28% on any over that, to the resulting AMT taxable income.
AMT rules are complicated, and tax advisers consider AMT planning especially challenging. Some kinds of stock options are taxed under the AMT, while others aren't, for example. The same goes for certain investments, including some kinds of bonds.
Figuring out whether a client would be better off in a given year to pay the AMT or the regular tax can be counterintuitive. The AMT uses a lower tax rate, which can be a boon in certain years for some taxpayers. But AMT payers also may pay more because of the deductions the AMT eliminates.
"Having that conversation is important, but they tend to get stuck there," said Ms. Dean. "That's where we loop in the accountant to run some illustrations."

Posted on 5:48 AM | Categories:

What Happens if You Make a Tax Error? & Is It Better to Itemize Your Taxes or Not?

Gregory Hamel for Demand Media writes: Preparing a tax return can require filling out dozens of tax forms and making hundreds of calculations, which introduces the possibility that you'll make a mistake somewhere along the way. The effect of a tax error depends on a variety of factors such as what caused it and whether it resulted in an underpayment of tax. Small errors may do little more than cause a slight delay in processing your return, while major errors can result in tax penalties.


SMALL ERRORS

The complexity of tax filings makes it easy for small errors like mistakes in computations to find their way into returns. The Internal Revenue Service usually corrects small math errors for you, so you might not have to do anything to correct them yourself. The government can also request missing forms so that it is able to process your return. Certain mistakes, like listing the wrong Social Security number, may cause your return to be rejected, in which case you have to correct the error and resubmit it.

INCOME AND TAX BREAKS

Mistakes that cause you to report the wrong amount of income or tax breaks are more severe than general errors. The purpose of a tax return is to ensure that you pay the correct amount of tax. Errors related to income reporting and tax breaks can cause you to pay the wrong amount. If the IRS suspects you are claiming too many deductions and credits or failing to report income, it can audit you to investigate your tax records. On the other hand, if you forget to claim tax breaks, you could end up paying more tax than you should.

TAX PENALTIES

If tax errors cause you to underpay on taxes or miss the tax filing deadline, you could be hit with tax penalties. According to the IRS, a late payment penalty of one-half a percent of the amount of tax you owe is tacked onto your bill for each month your payment is late up to a maximum of 25 percent. You can also be slapped with a failure to file penalty of 5 percent of the amount owed for up to five months until you submit your return. If you show disregard for IRS filing rules by making careless errors, you could face a 20 percent penalty for negligence. Intentional errors on a return can lead to a fraud penalty of 75 percent and criminal prosecution.

CORRECTING ERRORS

Although the IRS can correct certain small errors on your return, it is up to you to fix mistakes that cause you to overpay. You can alter a previously filed tax return by submitting an amended return using Form 1040X. An amended return can allow you to change your tax filing status and claim deductions and credits you forgot the first time around. Form 1040X must be filed within three years from the due date of your original return or within two years from the date you paid the tax, whichever is later. If your original return resulted in a tax refund, wait until you receive your refund before mailing in your amended return, which cannot be filed electronically.


Is It Better to Itemize Your Taxes or Not?


Filing a tax return gives you the chance to claim tax deductions that cut the amount of tax you owe. Each deduction you claim shrinks your taxable income, which reduces the amount you pay and may even drop you to a lower tax bracket. One of the most important decisions you make when fling a tax return is choosing whether to itemize your deductions. Whether it makes sense for you to itemize depends on your tax filing status and the itemized deductions you can claim.


STANDARD DEDUCTIONS

The standard deduction is a fixed amount that the Internal Revenue Service lets you subtract from your annual income when filling out your tax return. If you claim the standard deduction, you can't itemize your deduction on Schedule A. The amount of the standard deduction varies depending on your tax filing status. For example, for the 2013 tax year the standard deduction is $6,100 for single taxpayers and $12,200 for married couples filing jointly.

ITEMIZED DEDUCTIONS

Itemized deductions are tax write-offs that you can only claim if you forfeit your standard deduction and file Schedule A of Form 1040 with your tax return. A variety of common living expenses count as itemized deductions, such as property taxes, home mortgage interest, and certain medical and dental expenses. Certain job-related expenses like the cost of working out of a home office and using your car for your job are also deductible.

CHOOSING TO ITEMIZE

To choose the best deduction option, you need identify all of your itemized deductions and add them up. If the total of your itemized deductions is greater than your standard deduction, you stand to save on your taxes by itemizing. On the other hand, if your itemized deductions are less than your standard deduction, it’s better not to itemize. Homeowners are more likely to benefit from itemizing than renters, since property taxes and mortgage interest alone may exceed the standard deduction.

CHARITABLE GIVING

Most itemized deductions are offered on expenses over which you have little or no control. For example, you have to pay your property taxes and mortgage to keep your home. You can, however, boost your itemized deductions by giving to charity: you can take an itemized deduction for any cash you donate as well as the fair market value of property you give away. If your itemized deductions are just below your standard deduction toward the end of the year, charitable giving can put you over the top. You won't save money by itemizing if you use this strategy, though.
For example, suppose you're a single taxpayer in the 15 percent bracket, and your itemized deductions amount to $6,050. If you make an extra charitable contribution of $100, you will save $7.50 on your tax bill: the 15 percent of the extra $50 you got to write off by itemizing $6,150, instead of taking the $6,100 standard deduction. You've spent $100 to save $7.50. If your goal were strictly to save money, you'd be better off taking the standard deduction. On the other hand, this strategy can allow you to give money to a good cause and save yourself a few bucks.
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