Lower your income taxes. 2013 Tax rates are higher!

By Jeffrey Brooks, CPA, CFP,       MBA for Jbrooks Wealth Advisors, PC, a Professional CPA and CFP Firm  jeff@jbrookswa.com  602-292-2009  Please consult with your professional       tax CPA regarding your specific circumstances!

 

On     January 2, 2013, The American Taxpayer Relief Act of 2012 became law introduced     substantial new income tax burdens on high income taxpayers and trusts. In     addition, 2013 is the year in which both of the Medicare surtaxes of the     Patient Protection and Affordable Care Act of 2010 (sometimes referred to     as “Obamacare”) kick in. As a result, marginal tax rates can now be over     50%! Income taxes are now the highest expense of well off Americans.

 

My     mission is to find legal tax reduction techniques to reduce my client’s     income taxes.

In previous issues of my blog, I have discussed how to reduce taxes by     doing the following:
*    Maximize tax deductions by legally being able to move     personal expenditures to business deductions.
*    Reduce ordinary income to achieve capital gain
*    Invest to achieve tax exempt income
*    Shift deductible expenses and income to other taxpayers
*    Defer taxes to the future
*    Offset taxable income with tax losses

With these new tax laws, some review and new approaches will need to be     considered for non-grantor trusts and high income taxpayers.

*    For high income taxpayers, the new tax law takes away     part of each deduction. Up to 80% of a deduction can thus be eroded. This     can make the timing of when to take deductions especially important.
*    Under the new law and with the Obamacare surtaxes,     capital gain and ordinary income rates have moved closer together.
*    Delaying paying income taxes on earned income by     funneling it into a 401(k) or into IRAs is not the automatic best choice     anymore. For some clients, it may be better to recognize income now to achieve     future tax-free growth (e.g., by doing a Roth conversion or paying life     insurance premiums) since it does not appear that either federal or state     income tax rates are likely to come down any time soon. For example, for     Californians the top combined income tax rate now exceeds 54% and in New     York City the combined total top rate for federal, state and city income     tax exceeds 56%.
*    Limited liability companies (LLCs) or other family     entity/partnerships can be used to shift income from the founding generation     to younger family members who are in lower tax brackets.

*        Medical insurance is 100% deductible at the entity level but can be eroded     by the 7.5% or 10% floor and the percentage reduction in deductions at the     individual level.
*    Long-term care and disability insurance premiums, too,     are 100% deductible at the entity level but subject to up to 80% erosion at     the individual level. Plus, entity plans for providing this kind of     insurance can be discriminatory.

Adjusted     Gross Income (AGI) Is Key
The application of the deduction limitation is determined by the taxpayer’s     adjusted gross income (AGI), not taxable income. AGI is the last     line on page one of the Form 1040 or 1041 tax return. It includes wages and     salaries, capital gains, income from business entities that are reported on     Schedule C, and income reported on K-1s and 1099s. The Medicare surtaxes     application is determined by a slightly modified AGI (MAGI). AGI and MAGI     can be driven up dramatically by a one-time event (such as the sale of a     business, investment property or farmland), and can push a client who     usually has average income to the highest tax rates and deduction     limitations.

Individual     Income Tax Rates
The new tax law made permanent individual income tax rates of 10%, 15%,     25%, 28%, 33% and 35% for taxpayers with AGI at or below $450,000 for joint     filers and $400,000 for single filers and non-grantor trusts with     non-distributed income of less than $11,950. These thresholds are all     indexed for inflation after 2013.
*    The 39.6% rate applies above the income threshold     amounts.
*    The 3.8% Medicare surtax on investment income and the     0.9% Medicare surtax on earned income have a $250,000 joint/$200,000     single/$11,950 trust or estate MAGI threshold.

Planning Tip:     There are different thresholds for head of household and married filing     separately taxpayers.

Capital     Gain and Dividend Rates
The new tax law made permanent individual capital gain and dividend tax     rates of 15% maximum (0% for taxpayers in the 10% and 15% tax rate     brackets) for taxpayers with AGI at or below $450,000 for joint filers and     $400,000 for single filers.
*    A new 20% rate applies to capital gains and dividends     to the extent they plus other taxable income exceeds these AGI threshold     amounts.
*    The 3.8% Medicare Surtax applies on the lesser of (a)     total investment income and (b) MAGI over $250,000 joint, $200,000 single     and $11,950 trusts and estates.

Planning Tip: As     with the income tax rates, there are different capital gains and dividend     tax thresholds for unmarried head of household and married filing     separately taxpayers.

Planning Tip: The     increase in the top capital gain and dividend tax rate from 15% to 20% is a     5% increase in the tax rate, but results in a 33% increase in the amount     of the tax. Adding in the 3.8% Medicare surtax bumps the combined tax rate     to 23.8%. That is an 8.8% increase in the tax rate and a 59% increase in     the amount of the tax.

Itemized     Deductions Phase Out
At least as significant for high income taxpayers as the rate increases and     surtaxes is the itemized deduction phase-out. For taxpayers with AGI over     $300,000 joint ($250,000 single), itemized deductions are reduced by 3% of     AGI over the threshold level, up to a maximum of 80%total reduction. The     phase out applies to deductions other than medical expenses, investment     interest expenses, casualty losses (which have severe restrictions) and     gambling losses (which can only be offset against gambling income).

NOTE: Mortgage interest and charitable deductions are included in     the phase out.

Planning Tip: As     with the income, capital gains, and dividend tax rates, there are different     phase-out thresholds for unmarried head of household and married filing     separately taxpayers.

Planning Tip: The     timing of the deduction now becomes more important for the high income     taxpayer. A client may want to delay a substantial charitable gift to a     year in which his AGI is lower in order to fully utilize the deduction.

Planning Tip: The     itemized deduction phase out makes the direct IRA to charity transfer     doubly important to eligible (i.e., over 70.5) high income taxpayers.     Amounts so transferred do not increase AGI and are not subject to the     itemized deduction phase-out.

Medical     Expense Deduction Floor Increase
This is a change that affects all taxpayers who itemize deductions. The     floor on deductibility of medical expenses has increased from 7.5% of AGI     to 10% of AGI for taxpayers under age 65. For the others, the new floor     takes effect starting in 2017. Previously, a family with $100,000 AGI would     have to have medical expenses of more than $7,500 before being able to take     any as an itemized deduction; now they would have to have more than     $10,000.

Phase     Out of Personal Exemptions
There’s good news and bad news about the personal exemption. The good news     is that it is increased for 2013 from $3,800 to $3,900. The bad news is     that, similar to the phase out of itemized deductions, personal exemptions     are phased out if AGI is over the $300,000 joint ($250,000 single)     threshold. The phase-out rate is 2%/$2,500 of above-threshold AGI.

Planning Tip:     There are different thresholds and phase-out rates for unmarried head of     household and married filing separately taxpayers.

Medicare     Surtax on Investment Income
The Obamacare Medicare surtax on net investment income (NII) applies for     tax years starting after December 31, 2012. The surtax is 3.8% of the     lesser of (a) total NII; and (b) MAGI in excess of $200,000 for single     filers, $250,000 for joint filers, $125,000 for married taxpayers filing     separately and $11,950 for estates and trusts.

Planning Tip:     Previously, investment (also called “passive”) income was taxed at a lower     rate than earned or “active” income and could be offset against deductions     on real estate. Examples of passive income would include payouts to a     participant in an LLC who is not involved in management or to a former     business owner who is now in a limited partner role.

Medicare     Earned Income Surtax
There has been a lot of publicity about the 3.8% Medicare surtax, but it is     not the only Medicare surtax in Obamacare. Obamacare also includes a 0.9%     Medicare surtax on wages and self- employment income. This surtax is     on the amount by which wages and self-employment income minus MAGI     exceeds $200,000 for single filers, $250,000 for joint filers and $125,000     for married taxpayers filing separately. It, too, is effective for tax     years starting ater December 31, 2012.

Summary     of Major Tax Rate and Deduction Changes for Ordinary Income

Thresholds Single Head       of Household Married       Filing Jointly Married       Filing Separately
.9%       Medicare Earned Income Surtax         $200,000         $200,000         $250,000         $125,000
Phase       Out of Deductions         250,000         275,000         300,000         150,000
Personal       Exemption Phase-out         250,000         275,000         300,000         150,000
39.6%       Rate         400,000         425,000         450,000         225,000
Top       Cumulative Marginal Rate         43.4%         43.4%         43.4%         43.4%

Planning Tip:     Remember that state and local income taxes are in addition to the federal     income tax. These taxes, which can exceed 11%, are also subject to the     itemized deduction phase out.

Planning Tip:     Income tax planning does not focus on the client’s average tax rate,     which is the cumulative effect of the various tax brackets and the combined     deductions and credits. Tax planners look at the client’s highest marginal     rate. Deductions that can be taken and income that can be     deferred/offset/eliminated saves at the marginal rate. A lot of people     think they are in a lower tax bracket than they actually are and are     surprised to learn their marginal tax rate.

Summary     of Tax Rates on Investment Income

Thresholds Single Head       of Household Married       Filing Jointly Married       Filing Separately
3.8%       Medicare NII Surtax   $200,000   $200,000         $250,000         $125,000
Phase       Out of Deductions         250,000         275,000         300,000         150,000
Personal       Exemption Phase-out         250,000   275,000         300,000         150,000
20%       Capital Gains/Dividend Rate         400,000 425,000 450,000         225,000
Top       Cumulative Marginal Rate         24.592%         24.592%         24.592%         24.592%

 

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About Jeffrey Brooks

Jeffrey Brooks, CPA, CFP, MBA since 1976 has specialized in helping clients save significant taxes, help businesses increase their cash flow, revenues and profits while increasing their control and satisfaction. Jeff and his accounting firm sincerely cares about the happiness of his clients.

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JBrooks Wealth Advisors, PC.

Certified Public Accountant
Address: 4647 N 32nd Street, Suite B245
Phoenix, Arizona 85018
Phone: 602-292-2009
Email: jeff@jbrookswa.com