A new tax rate of 39.6% when your taxable income exceeds $400,000 ($450,000 when you’re married filing jointly) is just one reason to create an income projection for 2013.
Another reason: Additional rate changes take effect this year. For example, the maximum long-term capital gain rate increased to 20% when your income puts you in the highest ordinary income tax bracket. In addition, a 3.8% surtax may apply to net investment income – a term that includes interest, dividends, and capital gains – when your modified adjusted gross income (AGI) exceeds $250,000 ($200,000 if you’re single).
Sorting inflows into various categories such as wages, investments, retirement plan distributions, passive income, and active business income gives you a clearer picture of what tax rules will apply.
For instance, this year you’ll pay an additional 0.9% Medicare tax on wages and self-employment income when the combined total of those items exceeds $250,000 on a joint return ($200,000 when you’re filing as single).
This tax is separate from, and based on a different type of income than the 3.8% net investment income tax. Depending on the sources of your income, you may be subject to both taxes. Some planning scenarios to consider are as follows:
* Planning suggestion 1: Investigate pre-tax fringe benefit options. The 0.9% additional tax is assessed on wages subject to Medicare tax. Health insurance premiums paid under your employer’s cafeteria plan are exempt from Medicare tax, as are contributions made by your employer to qualified retirement plans.
* Planning suggestion 2: Switch taxable investments – especially those with a built-in loss – to municipal bonds. Tax-exempt interest is not considered net investment income when calculating the 3.8% tax.
* Planning suggestion 3: Place income-generating investments in retirement accounts. Future withdrawals can increase your adjusted gross income, but are not themselves subject to the net investment income tax.
* Planning suggestion 4: Make tax-free distributions from your traditional IRA to qualified charities when you’re over age 70½. This provision was extended through the end of 2013.
* Planning suggestion 5: Increase the amount of time you actively participate in rental real estate activities, and evaluate the effect of grouping your properties in order to combine the time spent managing them.
* Planning suggestion 6: Evaluate the legal form of your business. Flow-through income from an S corporation in which you actively participate is not generally subject to either of the new taxes. Also, depending on your personal tax rate, you may want to take another look at converting to C corporation status.
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Tags: 2013 tax planning
Written by: Doug Rodrigues