For
a vast majority of Americans, the current tax-filing season will be
business as usual, with few changes to the ground rules of recent years.
For the very affluent, it may bring sticker shock.
Tax
rates have increased and deductions and credits have been reduced for
many affluent people. But at nearly every income level, dealing with the
tax code is often a frustrating business, and discovering the best way
to manage the burdens and benefits can alleviate some of the distress.
Barbara Weltman,
a tax lawyer in Vero Beach, Fla., says that some people whose “income
looks good on paper are cash-short and will feel socked” when they learn
what they owe for 2013. Still, all taxpayers should file their returns
on time to avoid a late-filing penalty, and some might consider
requesting an installment agreement. If you file Form 9465, such an
agreement is automatic up to $25,000, Ms. Weltman said, and almost
automatic up to $50,000. A convenience fee and interest are charged, but
the cost will generally be less than if you pay by credit card, she
said.
Ms.
Weltman, the author of “J.K. Lasser’s 1,001 Deductions and Tax Breaks
2014,” as well as a contributing editor to “J.K. Lasser’s Your Income
Tax 2014,” (Wiley & Sons), is among the tax experts who cited both
opportunities and traps for the current filing season, and who offered
some tips for getting personal finances in shape for long-term tax
efficiency:
Simpler Home-Office Math
The
Small Business Administration says 52 percent of businesses are
home-based, but according to Ms. Weltman, many people who qualify fail
to take a home-office deduction. In the past, that may have been because
the paperwork was too daunting. Now, for 2013 returns, there is an easy
alternative: simply deduct $5 a square foot for a home office, up to a
maximum of $1,500.
To
qualify, a home office must be necessary for a business, and must be
used regularly and exclusively for it. But the office does not need to
be a separate room, or even partitioned off, Ms. Weltman said, so long
as it is a clearly defined space. There must be enough income to offset
the deduction; the difference cannot be carried forward to future years.
Medical Deduction Whittled
Feeling
pain at tax time? You may feel more. Previously, taxpayers who itemized
deductions and had high unreimbursed medical and dental costs could
deduct them if they exceeded 7.5 percent of adjusted gross income. But
last year, the threshold was raised to 10 percent for people under age
65. Beginning in 2017, the 10 percent threshold will apply to all
taxpayers.
The Tax-Break Fog
Altogether,
55 tax breaks that Congress had long renewed annually expired at the
end of 2013, Ms. Weltman said, but some may be renewed and made
retroactive. She advised people over age 70 1/2 who want to make
charitable contributions directly from an I.R.A., for example, as well
as business owners who want to take a big upfront write-off for buying
equipment, to check whether Congress has renewed those provisions
retroactively before doing so. One expired provision that Julian Block, a tax lawyer in Larchmont, N.Y.,
is confident will be renewed that way is the option to deduct state and
local sales taxes instead of income taxes on federal returns. (He noted
that Florida and Texas, two states that do not have an income tax, have
big Congressional delegations.)
A Free Calculator
One
way to get a handle on what you’re likely to owe in April is to use the
free and simple Total Tax Insights calculator, offered by the American
Institute of Certified Public Accountants at totaltaxinsights.org. It
tells users much more than their projected income-tax bills: By clicking
on your state and filling out a form, you can gauge the impact of more
than 20 different federal, state and local taxes.
Edward S. Karl,
the institute’s vice president for taxation, says the goal is to help
people develop “a broad picture of their financial situations.” It isn’t
meant for tax preparation, he said, and entries are not saved or stored
electronically. Information is cleared when users leave the site or
click the “clear data” button.
Harvesting Losses
Larry Krause,
president of Tessara Financial Advisors, an independent wealth advisory
firm in Larkspur, Calif., notes that many investors hate to sell any
holding at a loss, hoping that it will bounce back in price. But capital
losses offset capital gains dollar for dollar, so if you are going to
recognize a gain, look for an offsetting loss to sell, he said. If you
like the investment, you can replace it after 31 days or look for a
similar holding now. Many people held gold as a hedge last year, he
said, but it lost value, so when they took gains on stocks, he advised
them to sell gold as the offset.
Saving for Education
Mr.
Krause is enthusiastic about qualified tuition programs, often called
Section 529 plans after the section of the tax code that authorized
them. These plans are operated by states or educational institutions and
offer a wide range of investments. The account owners — typically
parents, grandparents or other relatives — retain control over the
money. The beneficiary is the prospective student, and, what’s more, the
beneficiary can be changed.
The
money put into the account is not deductible at the federal level, but
some states, including New York and Virginia, offer tax breaks, he said,
and the account’s growth is tax-deferred. Money paid out of it for
qualified education expenses is exempt from federal taxes. If money is
withdrawn for unapproved reasons, the owner will owe taxes and a
penalty, but over time the money earned in the account may offset those
costs.
Underwater Uncertainty
Many
people owe more money on their home than it is now worth and would like
to have their mortgages reduced. But a tax problem could loom,
according to Mr. Block, the author of several tax books including
“Julian Block’s Home Seller’s Guide to Tax Savings.” Normally when a
legal debt is forgiven, the amount is deemed taxable income. A special
provision from last year, under which qualified home buyers were
exempted from that tax obligation, has expired. As a result, anyone
seeking to renegotiate a mortgage this year should check into possible
tax consequences.
Strategies for Giving
If
you’d like to give money to someone, there are no tax consequences for
individual gifts of up to $14,000 a recipient, or up to $28,000 if
members of a couple give individually to a recipient, because each
spouse is counted separately. For higher amounts, it’s necessary to file
a gift-tax return on Form 709, but no gift tax is owed until the total
exceeds the lifetime credit of $5.25 million, according to Mr. Block.
How the Rich Are Hit
Who
qualifies as rich? The answers may vary, but provisions of two laws
that came into effect for 2013 returns will certainly raise taxes for
people at the top of the income distribution. For more than 95 percent
of filers, the American Taxpayer Relief Act, passed on New Year’s Day
last year, made permanent the Bush-era tax cuts, which had been
scheduled to expire after 2012. But the relief act raised the rate for
the upper echelon. And that group also faces two increases on 2013
returns from the Affordable Care Act, which was passed in 2010.
The
American Taxpayer Relief Act sets a top federal income tax bracket of
39.6 percent for single filers with taxable income above $400,000 and
for couples filing jointly with taxable income above $450,000, and it
raises their rate on qualifying dividends and long-term capital gains to
20 percent from 15 percent.
In addition, the act limits itemized deductions and personal exemptions. Itemized deductions will be cut for joint filers with adjusted gross income above $300,000 and for single filers above $250,000. The cut will be the smaller of 3 percent of all itemized deductions, or 80 percent of certain itemized deductions — those for medical and dental expenses, investment interest expense, casualty and theft losses of personal-use or income-producing property, and gambling losses. Each personal exemption claimed by a married couple filing jointly is reduced by 2 percent for each $2,500 of adjusted gross income above $300,000. At $425,000, their personal exemptions are completely phased out. The threshold for a single filer is $250,000, and the exemption is completely phased out at $375,000.
The
increases related to health care are a surcharge of 0.9 percent on
wages and self-employment income above $200,000 for single filers and
above $250,000 for joint filers, and a surcharge of 3.8 percent on net
investment income for people whose adjusted gross incomes top the
$200,000 and $250,000 thresholds. Investment income is broadly defined,
including rent and royalty income and passive income, as well as
dividends, interest and capital gains.
Sidney Kess,
a New York tax lawyer and C.P.A. who acts as counsel to the law firm
Kostelanetz & Fink, notes that many upper-income people have trusts,
which will be hit especially hard by the two laws. Trusts with
undistributed income above $11,950 owe $3,090 in income tax, plus 39.6
percent of the amount above $11,950, as well as the 3.8 percent Medicare
surcharge on net investment income.
States Getting Aggressive
Many
states are stepping up efforts to collect taxes, Mr. Kess said, and
that can have consequences for people who often travel on business. They
may need to file multiple state returns, generally claiming a credit
for income tax paid to another state against the liability due their
home state.
In Fringe Benefits, Audit Flags
While
a fringe benefit may seem like a great perk, some can bring tax
problems to both employees and employers, especially small-business
owners who may not have a separate tax department. Richard C. Farley
Jr., a director of PricewaterhouseCoopers in New York, listed what his
firm sees as the top five fringe benefits that auditors often found
taxable to the people claiming them: company aircraft use for personal
travel, spousal accompaniment on business trips, travel away from home
for work, trips awarded for attaining performance goals, and
company-provided cellphones and tablet devices.
“There
is not much guidance” regarding these benefits, Mr. Farley said. “A
company needs to look at the facts and circumstances.”
If
you can show a legitimate business purpose — if, for example, you have a
German-speaking spouse who served as your translator on a business trip
to Germany — an auditor may agree that the cost of that spouse’s trip
isn’t taxable income to the employee. In such a case, however, the cost
is not a deductible business expense to the employer.
Of course, it’s always important to document expenses when incurred, and to keep records in case of an audit.
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