With 2012 winding down, we’re rushing into the New Year amid utter insecurity about our tax lives. Talking heads expound on the “fiscal cliff” ad nausea. But without the passage of any legislation, the chatter provides no useful information to guide you into the coming year.
What issues will affect you the most — and what can you do about them right now? Here are a half-dozen.
Personal medical expenses
Costs are going up, but your deduction and tax benefits are going down in several ways.
For the past decade or so, to deduct your medical expenses, they had to be higher than 7.5% of your adjusted gross income (AGI). Next year, they must exceed 10% of your AGI. If you have upcoming medical or dental costs, or unpaid bills, consider paying them in 2012 to get the deduction this year.
Flexible Spending Account (FSA) contribution limits for 2013 have decreased to $2,500 (from $5,000 in 2012). However, that is the per-person limit. Each spouse may have an FSA with his or her own employer.
According to David Mellem, an enrolled agent in Wisconsin, someone with two or more employers that are not members of the same controlled group may elect up to $2,500 under each employer’s health FSA. In other words, you can have multiple FSA accounts to help you cover all your medical expenses before taxes.
If you have your own corporation, consider setting up an FSA for yourself and your employees. It can be done relatively cheaply with the help of your payroll service or tax professional.
Limits on deductions
The “Pease”-type limits to overall itemized deductions are back in 2013. As your income rises over $178,150 ($89,075 if you’re married, filing separately), your deductions will be reduced. In addition, the alternative minimum tax (AMT) will kick in. CCH, a tax and accounting consulting firm, is pretty certain that there will be a patch enacted of some sort, since both the House and the Senate passed differing legislation related to the AMT over the summer. The mystery is this: At what income level will the AMT affect taxpayers for 2013.
One strategy is to review your projected 2013 itemized deductions affected by the AMT. When legally possible, move work and business-related spending directly into your businesses or real-estate investments — off Schedule A and onto Schedules C, E, and F.
.09% Surtax on wages and earnings
The magic number for married couples is $250,000 ($125,000 for those who are married, filing separately). For singles and heads of households, it’s $200,000. This number applies equally to wages and self-employment income. Once you hit this threshold, you’ll be paying an extra .09% into Medicare. Don’t let it worry you that lawmakers are talking about making you wait an extra two years before you’ll be able to collect. That extra money will be there for the baby boomers who are tapping into Medicare now.
You can avoid this extra tax by taking advantage of all the special non-taxable benefits and before-tax benefits your employer offers: the flexible-spending plans, premium plans, health savings arrangements, education plans and so on.
The 0% and 15% tax rates on capital gains expire at midnight, Dec. 31. Regardless of the results of Congressional infighting, there will be an increase. Most likely, President Obama’s 20% rate will go into effect, according to CCH Group.
What can you do to minimize the impact for next year? If you are not living on the earnings, consider switching to appreciating stocks rather than dividend-paying securities. If you need the revenue, consider municipal bond funds, especially closed-end funds. Not only is the income tax-free for IRS purposes, but if you select a fund invested in your own state’s offering, the earnings are tax-free at the state level, too.
Consider meeting with your tax professional and a certified financial planner to explore alternatives.
Incidentally, while you’re selling off securities at a gain this year, don’t harvest those securities that have losses. Hold those until next year, so your losses can offset the higher-taxed capital gains.
Next year will be an expensive time to die for the very wealthy. On New Year’s Day 2013, the non-taxable estate will instantly drop on Jan. 1 from $5,120,000 to $1 million. The current maximum estate tax rate of 35% will rise to 55%. If someone is lying there on life support with no brain function and no hope of recovery … make your decisions this year.
Additional 3.8% Medicare taxes on net investment income
If your adjusted gross income is above a certain level — $250,000 for married couples filing jointly, $125,000 for married couples filing separately or $200,000 for singles and heads of households — you’ll be paying this extra tax into the Medicare fund on all your net investment income. That means sales of assets as well as passive income, like earnings from partnerships and real-estate rental profits. This tax won’t apply to sales of business assets.
But if you’re in the same position as one woman who called in to Bob McCormick’s Money 101 program on KFWB, you will be affected. This person is selling her home. After deducting the $500,000 personal residence exclusion for herself and her husband, she still expects to show a profit of $800,000.
How can you avoid the higher capital gains rates and the Medicare surcharge in this situation? Easy: Sell the property and close escrow this year.
Incidentally, here’s a TaxMama tip for folks who are in escrow this month and are running into those endless little snags that keep escrow from closing. Transfer the title before year-end, but keep the escrow open until all the i’s are dotted and t’s crossed.
How can you protect yourself?
1) Make sure the buyers have solid credit.
2) Get the buyer to put all the required money into escrow and agree to all the open terms and conditions.
3) File your own temporary mortgage against the property — to be removed when the buyer’s loan is funded within a specified number of days.
4) Make sure you have a really good real-estate attorney working out the details on your behalf.
Another strategy is to sell the home in a tax-free exchange. You don’t need to buy another residence. You may exchange the home (real estate) for other real estate. Section 1031 exchanges are complicated and require following very rigid rules and time tables. But when it means saving hundreds of thousands of dollars in taxes, it’s well worth the investment. For instance, this California caller could save over $420,000 in taxes by rolling the sale of her home into another property.
Floating on Air
Incidentally, here’s another tip. When you have really big bucks at stake, see your tax pro rather than turning to a radio call-in show for advice. (There isn’t enough time to think up a strategy while on the air.) Schedule an appointment with your own tax professional before the year ends, if you can. You need time to review your whole tax and financial situation.
If you don’t have a tax pro, get one now. You’ll be needing help for the coming year. Let GellerRagans help you in all of your tax and advisory planning needs in 2013.
Source: MarketWatch/The Wall Street Journal