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Tax Newsletter
November, 2013

There have been a number of significant changes made by the American Taxpayer Relief Act of 2012 and the Patient Protection and Affordable Care Act of 2010 which make 2013 year-end planning particularly challenging. The interplay among various tax increase provisions makes planning worth serious consideration.

”Bush-era tax cuts” – Increase in highest tax brackets. For 2013, there is an increase in the highest brackets for taxpayers with taxable income over $450,000 (joint) or $400,000 (single)

  • The addition of a new 39.6 percent rate for ordinary income
  • Additional 5% tax for qualified dividends and long-term capital gains

3.8% Medicare Surtax. There is an additional 3.8% in Medicare surtax on net investment income for individuals with modified adjusted gross income greater than $250,000 (joint) or $200,000 (single).

.9% Medicare Tax. Individuals who earn more than $250,000 (joint) for the year ($200,000 for single) from wages or self employment will pay an additional .9% (i.e. from 1.45% to 2.35%) in Medicare tax.

Pease limitation and personal exemption phaseout. The “Pease” limitation reduces most itemized deductions by 3% of the amount by which adjusted gross income exceeds a specified threshold, up to a maximum reduction of 80% of itemized deductions.

The AGI or taxable income levels at which the foregoing changes apply are illustrated below:

Income Level [Married Joint/Single] 39.6% tax on Ordinary Income 20% Tax on Long-term capital gains Pease Limitation & Personal Exemption Phaseout 3.8% surtax on Net Investment Income (NII) .9% Medicare tax
450,000/ 400,000 (Taxable Income) 39.6% rate applies 20% rate applies Limitations apply 3.8% surtax applies If AGI includes $200K of wage income
300,000/ 250,000 AGI) Limitations apply 3.8% surtax applies If AGI includes $200K of wage income
250,000/ 200,000(AGI) 3.8% surtax applies If AGI includes $200K of wage income
200,000 of wage or self employment income .9% Medicare tax applies

Net Investment Income includes gross interest, dividends, royalties, rents, net capital gains, and income from passive activities less deductions allocable to such income. Net Investment Income does not include wages, IRA distributions, pension income, social security income and income taken into account for self-employment tax purposes.

The 3.8% surtax applies to the lesser of net investment income or the amount of modified adjusted gross income in excess of the threshold.

  • Example: A married couple has salaries totaling $230,000. They could be subject to the Medicare surtax if their net investment income is greater than $20,000. For example, if the couple has net investment income of $30,000, $10,000 will be subject to the 3.8% surtax.
  • Medical Expense Deduction. Taxpayers who itemize can claim a deduction for qualified unreimbursed medical expenses to the extent those expenses exceed 10% of Adjusted Gross Income. Note: taxpayers over the age of 65 may continue to apply the 7.5% threshold for tax years through 2016. Self employed individuals are allowed to claim 100% of the amount paid during the taxable year for medical insurance as an above-the-line deduction.

    Sunsetting Tax Incentives. The following provisions are scheduled to expire at the end of 2013:

    • Tax-free distributions (up to $100,000) from IRAs to charities
    • State and local sales tax deduction
    • Deduction of teacher’s classroom expenditures

    Year-end planning

    Since the foregoing tax increases apply when Adjusted Gross Income or taxable income exceeds specified thresholds, planning where possible should be directed towards reducing/deferring income or increasing/deferring deductions to fall below the threshold amounts. The planning horizon should include both 2013 and 2014, particularly if income in one year is anticipated to be significantly higher than the other.

    Strategies for reducing Net Investment Income and/or Adjusted Gross Income could include:

    • Sell loss securities to offset capital gains you have already recognized
    • Donate appreciated securities instead of cash in order to keep the capital gains out of your tax return and still receive a charitable deduction
    • Consider a Charitable Remainder Trust (CRT) to spread out the income/gains on appreciated property over the payout term of the CRT, thus spreading out the associated income taxes
    • Defer gains by spreading them out with an installment sale and/or participating in a Section 1031 Like Kind Exchange
    • Maximize deductible contributions to retirement plans
    • Invest in tax exempt investments
    • Invest in life insurance products and/or tax deferred annuity products

    Planning for Businesses

    • The Section 179 annual dollar limitation for the calendar year 2013 is $500,000. In contrast, for tax years beginning after 2013, that dollar limit is scheduled to plummet to $25,000;
    • Bonus depreciation of 50% is allowed for calendar year 2013, but is scheduled to expire after December 31, 2013. To qualify for the bonus depreciation, the property must be new, acquired and placed in service before January 1, 2014;
    • Energy saving property incentives (tax credits) are available for installation of extra insulation, energy saving windows, energy efficient heater or AC, as long as installed prior to 2014;
    • Qualified Small Business Stock – There would be no federal tax gain from the sale of such stock if it is (1) purchased after 9/27/10 and before 1/1/14, and (2) held for more than five years. California does not follow the Federal law for calendar year 2013, it has disallowed any exclusion on sale of QSBS stocks.
    • In 2013, California will phase in Net Operating Loss Carryback provisions for businesses and individuals. Taxpayers will be allowed a 2 year carryback as follows: 50% of the NOL generated in 2013, 75% of the NOL generated in 2014 and 100% of the NOL generated in 2015 and beyond.

    Estate and Gift Tax

    After many uncertain years, the American Taxpayer Relief Act of 2012 finally provided a permanent structure under which planning can now take place, including, maximum estate and gift tax rate of 40% with an inflation-adjusted $5 million exclusion for gifts made and estates of decedents dying after December 2012. The exclusion available for calendar year 2013 is $5,250,000.

    Each taxpayer can give an inflation-adjusted $14,000 to as many individuals as they wish without incurring any gift tax. These $14K gifts will not reduce the inflation adjusted $5M ($5,250,000 for calendar year 2013) applicable exclusion amount. Tuition payments made directly to a school and medical service payments made directly to the provider are not counted as part of the $14K annual exclusion.

    Current gifts remove any future appreciation out of the estate of the donor and save estate taxes down the road. One downside is that the basis of the property received as a gift is the tax basis of the donor, and this could result in capital gains tax if the asset is sold.

    Additionally, one of the key provisions of the American Taxpayer Relief Act is to make permanent the so-called “portability” of the applicable exclusion amount between spouses, which was enacted by Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010.

    Portability allows the first spouse to die the ability to transfer his/her unused estate tax applicable exclusion amount to the surviving spouse, who can then use it for his/her gift or estate tax purposes. Because of this recent development, to minimize estate tax liability while distributing assets according to your wishes, we would recommend that a current review of your estate plan take place.

    Affordable Care Act. Starting in 2014, the new national health insurance rules provides that individuals must carry health insurance or otherwise pay a monthly penalty (shared responsibility payment) unless exempt. Taxpayers who fail to have the minimum essential coverage are subject to the “shared responsibility payment”. The penalty for 2014, would be 1% of the yearly household income over the filing threshold, with the maximum penalty being the national average yearly premium for a bronze plan. The minimum penalty would be $95 per person for the year, or $47.50 per child under 18.

    Household income – generally is the sum of your adjusted gross income (AGI); Filing threshold for families is estimated to be $24,000; The Congressional Budget Office has estimated that the cost of a bronze level plan for a family would be between $12,000 and $12,500. Therefore, we will use this estimate for our discussion purpose example.

    To illustrate what 2014 would look like for a married filing joint couple, we will assume the AGI is $1M and the taxpayers are without minimum essential coverage. The penalty would be a) the lesser of the 1% of AGI or b) the average cost of the bronze level plan:

    1. Calculation: ($1,000,000 – $24,000) x 1% = $9,760
    2. Calculation: $12,500 = assumed average cost of a bronze level plan

    Looking at this example, the penalty for 2014 would be the lesser of $9,760 or $12,500, resulting in a penalty of $9,760. The penalty would be payable on the 2014 tax return.

    The Patient Protection and Affordable Care Act of 2010 requires most Americans have an active health insurance policy by March 31, 2014 or pay the higher of 1 percent of their annual income or $95 per person.

    Note: The penalties are scheduled to increase in later years. In 2015 the penalty is scheduled to be the greater of 2% of income or $325 per person, and in 2016 and later the penalty is scheduled to be the greater of $2.5% of income or $695 per person.

    No penalty will be imposed on individuals without coverage for fewer than 90 days (with only one period of 90 days allowed in a year).

    Running the numbers. We recommend running tax projections for 2013 and future years before implementing year-end tax strategies. Please let us know if you would like our assistance in preparing a projection. For taxpayers making estimated tax payments, such estimates may have to be increased to adjust to potentially higher tax rates on 2013 income.

    We often remind our clients that tax considerations should generally not drive financial decisions. However, once financial objectives are defined and understood, it becomes easier to determine the tax planning strategies that are consistent with overall objectives. Unfortunately, frequent changes in the income tax rules, coupled with the changes and uncertainty in the estate tax area, make both short and long-term planning more complex. With the year-end approaching, it may be a good time to review your financial objectives with a view toward assessing whether any of the recent tax incentives can be incorporated into the financial plan.


    The information contained in this newsletter is general in nature and does not constitute tax advice or opinion. Applicability to specific situations should be determined through consultation with your tax advisor.

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