One of the best things about a midyear tax checkup is having the time to investigate, plan, and implement strategies that can reduce your current-year taxes. That’s particularly true this year, since tax legislation enacted in January means many rules for 2013 are already in place, and there’s more certainty about what actions will be most effective. Here’s an overview of the rules, and suggestions to consider as you assess your situation:
1. Know your tax bracket
For 2013, seven tax rates – from 10% to 39.6% – apply to ordinary income reported on your personal federal return. The total tax you pay is based on the amount of your taxable income that falls into each rate group, or bracket.
For instance, when you’re single, the 25% tax bracket applies to your taxable income between $36,251 and $87,850 ($72,501 and $146,400 for married filing jointly). Income below the 25% bracket is taxed at 10% and 15%, and income above is taxed at 28%, 33%, 35%, and 39.6%.
Estimating your annual taxable income – and consequently, your top tax bracket – is a good starting point for midyear tax planning. Why? Here’s one example of how understanding the bracket break points can help.
Say you’re thinking of converting your traditional IRA to a Roth this year. Because you can convert any amount you choose, knowing when you’ll reach the next tax bracket lets you determine if it makes sense to defer part of the planned conversion to next year.
Retirement plan contributions present another opportunity to manage your tax bracket, because pre-tax contributions to plans such as a 401(k) reduce your taxable income. You can contribute up to $17,500 to your 401(k) during 2013 and add another $5,500 if you’re age 50 or older. Figure out how much you need to increase your retirement plan contribution to reach the maximum, and spread the total over your paychecks for the remainder of the year.
Not sure you want to increase your contributions? Here’s one more incentive: Retirement plan contributions can be even more valuable this year, since itemized deductions and personal exemptions may be limited. Reductions or phase-outs for both begin at $250,000 of adjusted gross income when you’re single ($300,000 for married filing jointly).
2. Size up your investments
Your tax bracket also affects the rate of the capital gain tax you pay on investment sales. Gains from the sale of assets you own one year or less are generally taxed at your regular tax rate. Gains on long-term assets – those held more than one year – may qualify for lower capital gain rates, and the lower rates apply to qualified dividends as well. For 2013, there are three capital gain rates for long-term asset gains and qualified dividends.
First, as in prior years, when you are in the 10% or 15% tax brackets, which means taxable income of up to $36,250 if you’re single ($72,500 for married filing jointly), the tax rate for long-term capital gains and qualified dividends is 0%. Second, when your income is within the next four brackets, the capital gain rate is 15%. Finally, a new 20% rate applies once your income reaches $400,000 when you’re single ($450,000 when you’re married filing jointly).
In addition, a new 3.8% net investment Medicare tax may also apply to your capital gains. Tax planning strategies to consider now include shifting some of your dollars to tax-efficient investments such as municipal bonds as you add to your portfolio or as you rebalance through the remainder of the year. Purchasing tax-efficient mutual funds instead of those that generate capital gains may also be helpful.
3. Tend to your business
Ordinary income tax rates generally apply to income from your sole proprietorship or Subchapter S corporation, so understanding your tax bracket can help you decide if your current business form is still the best option. The reason? Regular C corporations are taxed as separate entities, and the applicable rate may be lower than your personal federal tax rate. Keep in mind that tax rates are only one consideration when determining the form in which to operate your business, which is why examining your choices midyear is a good idea. If converting your business to another type of entity makes sense, you’ll have time to make tax-saving moves such as setting up a retirement plan.
No matter what legal and tax structure you choose, take advantage of available deductions and credits. Retirement plans are a good way to benefit from both. You get a business deduction for your contributions, and you may also qualify for a federal tax credit when you initially put the plan in place. Now’s the time to arrange asset purchases, too, as some enhanced depreciation deductions are scheduled to expire at the end of the year. One example is the Section 179 immediate expensing deduction, which lets you write off the cost of assets you purchase, finance, or lease. The maximum deduction for 2013 is $500,000.
Another example is the “bonus” depreciation deduction, which provides a way to expense up to 50% of the cost of new assets, including those that might not qualify for Section 179.
Other business and personal planning opportunities to investigate include learning if you qualify for the new simplified home office deduction, and weighing the benefits of making charitable contributions from your traditional IRA. Give us a call. We’ll be happy to help you create a comprehensive action plan for saving tax dollars.
WROBEL ACCOUNTING (813) 514-8273