Year-End Tax Strategies
By Gregg Shaw – December 2013
As we prepare for the busy holiday season, year-end (2013) is quickly coming to a close. The 2013 federal tax code contains a large number of new items, with implications for taxpayers of nearly all income levels. Although tax season is months away and most likely furthest from our minds, savvy year-end tax planning could make a significant impact on tax savings.
For most taxpayers, there’s no change to their ordinary income and capital gains rates. Higher earners are seeing a combination of federal tax increases for 2013: a top marginal rate of 39.6%, up from 35%; a 20% tax on long-term capital gains and dividends, up from 15%; and a new 3.8% tax on investment income. Also, limits on exemption and deductions are taking effect for this tax year as well.
What tax efficient strategies are available in light of these new tax changes? Here are some things to consider by end of the year:
Strategy 1: Manage capital gains and dividends
At CWM, several months before the end of the year, we make it a priority to manage our client’s tax efficiency WITHOUT jeopardizing an investment strategy. A large capital gain could push a taxpayer into a higher marginal income tax rate. One popular method of reducing taxable income is investing in municipal bonds whose earnings are not subject to federal tax. However, understanding how a municipal bond fits in a portfolio based on an investor’s tax bracket is paramount to understanding the tax equivalent yield of a municipal bond to a taxable bond. Working with your financial advisor can help answer the type of fixed income that makes the most sense.
Strategy 2: Charitable Giving
One of the most overlooked strategies often missed is the opportunity to donate highly appreciated securities. With the S&P 500 up almost 30% this year, not only can one claim the current fair market value as a tax deduction but would not have to realize the gain as income. However, if any long-term securities were trading at a loss, most often it is better to sell the security first, realizing the loss, which could be used to offset future gains/income.
There are several ways to gift an appreciated security: gifting directly to a qualified (501(c)(3) charity or using a low cost, no load, charitable giving account (a.k.a. Donor Advised Fund). There are three basic components to a DAF:
- GIVE: Donors make an irrevocable, tax deductible contribution to a DAF which usually consists of an appreciated security
- GROW: Donors are able to allocate among various investment options. Any investment growth is tax free.
- GRANT: Donors are then able to recommend grants over time from their DAF to any qualified 501(c)(3) public charity
The American Taxpayer Relief Act of 2012 extended the qualified charitable distribution (QCD) for 2013 which allows an IRA owner who is 70 ½ or older to make an otherwise taxable distribution from an IRA to be paid directly to a qualified charity. An IRA owner can exclude from gross income up to $100,000 of a QCD which would also satisfy RMD’s for the year. For those who do NOT rely on their assets to maintain lifestyle, this option is a terrific way to reduce taxable income. As of this writing, this special tax advantage has not been extended beyond its current Dec. 31, 2013, expiration date. Stay tuned!
Strategy 3: Reduce Income
The simplest way to lower current year taxes is by contributing to a retirement plans such as a 401(k), 403(b), traditional IRA, SEP plan or other types of qualified retirement savings plan. Qualified contributions reduce taxable income. Consider contributing as much as possible to a 401k, or at least enough to receive a full employer match, if one is offered.
Strategy 3: Use your annual gift tax exemption
An individual may give up to an annual gift tax exemption of $14,000 a year to as many people ($28,000 if both spouses make gifts). In addition, one can also give a separate $5.25 million, per person, over the course of a lifetime or at death, free from gift or estate taxes. Separately, one can pay college tuition costs or eligible medical expenses directly for someone else and avoid having those amounts count as a taxable gift.
Don’t wait until it’s too late to implement strategies that can potentially save money when you file your 2013 tax return. A key is to work with your most trusted financial advisor/accountant who understands how the new provisions affect your personal and financial well-being. IT’S WORTH THE EFFORT!
On behalf of everyone at Chatham Wealth Management, we wish you and your family a happy holiday season and a safe and prosperous New Year!