In the last few years, year-end planning has been difficult because so many provisions of the law were set to expire at the end of each year, and Congress worked on the law through the holiday seasons. But with most provisions of the tax law settled in the early 2013 agreement, you can plan with some confidence.
Watch year-end income.
A few extra dollars of income can be dramatically expensive for some people. The new 3.8% net investment income tax, reductions in some tax benefits, higher Medicare premiums, higher taxes on Social Security benefits, and more are triggered or increased when adjusted gross income or modified adjusted gross income exceeds certain levels. Since the taxes and surtaxes are based on AGI, increasing itemized deductions generally won’t help avoid them.
When your income is near a trigger level for one or more of these taxes, you need to monitor carefully actions such as year-end asset sales, distributions from IRAs and annuities, employment bonuses, and mutual fund distributions.
Leverage charitable gifts.
Most people make charitable gifts near year end, and it is a good way to increase itemized deductions and reduce income taxes. But simply writing checks isn’t always the best way to make donations. You can donate appreciated investments, such as stocks and mutual funds, and deduct the fair market value of the assets.
You won’t owe any capital gains taxes on the appreciation during your ownership. Even better, when you have substantial assets and want to make a large donation, is to create a charitable remainder trust or charitable lead trust. These will provide income to you or a designated beneficiary, give you a charitable deduction, and benefit a charity. They also provide estate tax benefits if you need them.
Sell losing investments
Investments that now are worth less than you paid for them and are held in taxable accounts can be valuable tax assets. Sell them, and the loss will offset any capital gains you received this year dollar for dollar. Up to $3,000 of additional losses can be deducted from gross income. Compare any transaction costs with the tax savings before making this move. You can repurchase the investment after more than 30 days have passed or buy right away an investment that is not substantially identical. For example, sell a mutual fund and buy one with a similar investment style and performance but that is not identical.
Preserve the 0% tax bracket.
There’s a 0% tax bracket on long-term capital gains and qualified dividends until your taxable income exceeds $72,500 for a married couple filing jointly and $36,250 for single taxpayers. If you’re close to the line, it’s worthwhile to reduce taxable income to stay in the 0% bracket. Itemized deductions reduce taxable income, so they can be used to keep you in the 0% tax bracket for gains and dividends, along with the strategies available for reducing AGI.
Bob C. Carlson, Bob Carlson’s Retirement Watch, www.retirementwatch.com, 800-552-1152, December 2013
