Midyear Tax Moves to Save on Your 2013 Return
Shelving your taxes until next spring could cost you money, especially this year. The tax law passed earlier in the year as part of the deal to avert the fiscal cliff imposes a new 39.6% marginal rate on taxable income over $400,000 ($450,000 for married couples). Taxpayers in this bracket will pay 23.8% on dividends and long-term capital gains — not the 15% rate that applies to most investors.
See Also: The Most-Overlooked Tax Deductions
Other changes reach down the income chain. Taxpayers with adjusted gross income of $250,000 or more ($300,000 for married couples) will effectively pay higher marginal rates because Congress resurrected phaseouts of itemized deductions and personal exemptions. And taxpayers with modified adjusted gross income of $200,000 or more ($250,000 for married couples) face a new 3.8% surtax on net investment income.
That tax could hit people like Mike and LaVerna Leach of Virginia Beach, Va. Mike is a retired Marine helicopter pilot who receives about half of his retirement income from his investment portfolio; LaVerna is a watercolor artist who owns her own business. Mike says they sold some property last year to beat the tax increase and will probably check in with their tax adviser, Cynthia Jeanguenat, before year-end to see whether they need to do anything else.
There are ways to mitigate these tax hikes, especially if you act now.
Make your investment portfolio more tax-efficient. Mike says he doesn’t expect to make major changes to his portfolio because he doesn’t want to “let the tax tail wag the investment dog.” That’s good advice. But it’s important to pay close attention to the types of investments in taxable accounts and the types in tax-deferred accounts, such as your 401(k) plan. Savvy investors often keep investments that generate a lot of taxes, such as taxable bonds, real estate investment trusts and high-turnover mutual funds, in their tax-deferred accounts; they keep index funds and other tax-efficient investments in their taxable accounts. Higher tax rates make that even more important.
If you need income from your taxable account, consider municipal bonds, suggests Greg Womack, a certified financial planner with Womack Investment Advisers, in Edmond, Okla. Interest on muni bonds is exempt from federal taxes and, in most cases, from income taxes of the state in which the bonds were issued. In addition, munis are exempt from the 3.8% investment surtax, which makes them even more attractive, Womack says. Keep in mind, though, that interest from some types of muni bonds is subject to the alternative minimum tax.
It is also a good time to review your portfolio for potential losses you could use to offset capital gains. If you were planning to sell appreciated investments this year, ditching some of your losers will help you lower or eliminate taxes on the gains.
Take advantage of tax-deferred accounts. The new tax rates and phaseouts are tied either to adjusted gross income or to taxable income. (AGI is the amount before subtracting the value of exemptions and deductions; taxable income is the amount that’s actually taxed.) So it’s more important than ever to look for ways to hold down both figures. One of the most effective strategies is to max out your contributions to tax-deferred retirement plans.
In 2013, employees younger than age 50 may contribute up to $17,500 to a 401(k) plan; workers 50 and older may contribute an additional $5,500.
Contributing to a health savings account will reduce both AGI and taxable income; the money grows tax-deferred, and it can be withdrawn tax-free for qualified medical expenses. To be eligible for an HSA, you must be covered by a high-deductible health insurance policy, either through your employer or on your own. In 2013, a high-deductible plan is one with a deductible of at least $1,250 for individual coverage or $2,500 for a family.
You may contribute $3,250 to an HSA this year for individual coverage or $6,450 for a family; if you’re 55 or older, you can kick in an additional $1,000. That’s considerably more than the $2,500 maximum you can put in a medical flexible spending account, another tax-favored way to pay health care expenses. And unlike flex plans, which come with a use-it-or-lose-it proviso, HSAs let you roll over unused funds for future years.