Tax Planning: What to do before Year-End: An Article Authored by Dave Desmarais, CPA/PFS, MST, MBA, AEP® from KLR - Accounting Firm Boston, Massachusetts, Providence, Rhode Island


Tax Planning: What to do before Year-End

posted Dec 19, 2012 by Dave Desmarais, CPA/PFS, MST, MBA, AEP®

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Everyone is talking about the fiscal cliff.  What will happen with tax rates, itemized deductions, AMT, capital gains and the Estate Tax?  There are so many unanswered questions that providing clients with year-end tax advice may involve some what-if’s.  There is no one-size fits all planning and the time value of money is so low that it seems to blow many traditional strategies out of the water.  Even reverse thinking like accelerating income now and deferring deductions into 2013 isn’t a sure bet for future tax savings.
Since the presidential election, we now have a better sense about some changes we can probably expect in 2013:

  • The 3.8% Medicare Surtax on investment income and .9% Surtax on Wages will come into play for taxpayers with adjusted gross income (AGI) in excess of $250,000.
  • Tax Rates will go up, especially for taxpayers making more than $250,000.
  • The lifetime gift/estate tax exemption of $5.12 million per taxpayer and the gift/estate tax rate of 35% will be replaced with something much less favorable.
  • Capital gains rates will increase from 15% to 20% for higher income taxpayers.
  • Itemized deductions such as mortgage interest and charitable contributions may be limited for “high-income” taxpayers.

As they say, knowledge is power; so what can we do with this information before the end of the year?

Roth Conversion - With tax rates going up, not too many taxpayers can safely say that they expect their retirement tax rate to be lower than their current tax rate.  Once I hear this, I immediately starting thinking about a Roth Conversion which always leads to the Roth IRA discussion.  Converting your traditional IRA to a Roth causes a taxable event now, but you can later withdraw from the account tax free (after 5 years and age 59 ½).  Plus Roth IRAs are not subject to the Required Minimum Distribution (RMD) rules so this may help you get out of the 3.8% Medicare Surtax later on.  If you convert and the market tanks, you can reconvert the Roth back to a traditional IRA later (within certain limits).  If you don’t need to withdraw from the Roth account during your life, you can leave the Roth to your heirs and the minimum distribution rules will not start until they reach retirement age.  Thus, you will have many years to allow the account to grow in value tax-free. Read more about converting to a Roth IRA in our post titled “factors to consider when evaluating a Roth IRA conversion strategy”.

Give Appreciated Stock to Charity - If you have appreciated securities and don’t need the cash (or the additional tax), consider giving them to charity.  If you gift appreciated stock to a charity, you will receive an itemized deduction equal to the fair market value of the stock, NOT the price you paid for it. 

The best part is that you never have to pay the tax on the appreciation in value (gain).  It’s as if you sold the stock for market value, gave all the cash to charity, and never had to pay tax on the capital gain!  Just be a little cautious with this strategy though.  Remember that donations to public charities are limited to 50% of your Adjusted Gross Income and donations to private foundations are limited to 30% of your Adjusted Gross Income. 

Excess charitable contributions have only a 5 year carryover and may be further limited by pending legislation in 2013.  If you have net operating losses, or other large deductions, get in touch with your advisor to plan how much you can give and still receive the full tax benefit.  Donating dividend paying stocks to charity can also help lower your investment income subject to the 3.8% Medicare Surtax in 2013.

Present Interest Gifting - Take advantage of the $13,000 annual gift exclusion.  You and your spouse can each gift up to $13,000 annually ($14,000 for 2013) without a charge to your lifetime exemption.  If your children have spouses then you can gift up to $52,000 annually to the couple without incurring any gift tax or using up your lifetime exemption.  This is an easy way to transfer wealth without paying transfer taxes.

How to do it?

If you have young children, set up a section 529 plan for them.  As long as you meet the annual exclusion requirements above, there will be no taxable gifts incurred on contributions to the plan.  Starting in 2013, you can gift up to $14,000 each into the 529 plan and it will grow tax-tax free to fund your child’s college education.  You and your spouse can also each make an election to contribute $65,000 ($70,000 next year) now and treat is as if you made the contribution ratably over 5 years ($13,000/$14,000 per year) without a charge to your lifetime exemption.

If you have children about to enter college and have cash available, make the tuition payments directly to the institution.  Education payments for your dependents are always exempt from gift tax and do not count against the annual exclusion if paid to the school directly.  The same holds true for medical payments for dependents.  Make sure if you have children or elderly parents who are dependents, that you pay those medical bills directly to the medical provider.  If you have medical bills for 2012 that you haven’t paid yet, consider paying them before year end.  The limitation for medical expenses increases from 7.5% of Adjusted Gross Income to 10% of Adjusted Gross Income in 2013.

Estate Planning - Setup investment vehicles now to utilize your $5.12 million lifetime exemption. 

Benefits of giving assets now:

The overall goal is to gift assets now so that the post gift appreciation will be excluded from your estate and the estate tax.
You can make a generation skipping election which allows assets   to pass down to your grandchildren with no estate taxes – fostering greater growth through the generations

How to do it?

If you don’t have any estate planning/gifting strategies in place, get in touch with your advisor now to discuss your options.  Since the $5.12 million exemption expires on December 31, 2012 now is the last chance to set-up Irrevocable Trusts, Insurance Trusts, Annuity Trusts, Charitable Trusts, etc., and other investment vehicles to take advantage of the currently high exemptions.  These vehicles are complex and involve coordination with estate attorneys, accountants, and financial planners, but the end results are very powerful.

These are just a couple of ideas to help you navigate the fiscal cliff until Congress makes any concrete decisions.  Please contact any member of the Private Client Services Group for help analyzing your individual situation and implementing a great strategy