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Year-End Tax Planning for 2013-2014

Last update on: Dec 20 2018

We can do real year-end tax planning this year. In the last few years, year-end planning has been difficult because so many provisions of the law were set to expire at the end of each year, and Congress worked on the law through the holiday seasons. But with most provisions of the tax law settled in the early 2013 agreement, you can plan with some confidence.

Let’s look first at IRAs.

The charitable distribution strategy for those over age 70½ still is available through the end of 2013, after which it is scheduled to expire. Under this rule you can have one or more distributions totaling up to $100,000 made directly to charities by the end of 2013. The $100,000 limit is per IRA owner, not per IRA or per charity. The charity can’t be a donor-advised fund, and the distribution must be one that would be taxable if made directly to the IRA beneficiary.

When you make such a qualified charitable distribution, the amount is not included in your gross income and you don’t take a deduction for it. The distribution will be included in your form 1099-R as a regular distribution. You must include the distribution amount on line 15a of Form 1040 and then enter the taxable amount ($0 if it is your only distribution) on line 15b with the notation “QCD” to let the IRS know the full distribution amount is not taxable because it was a qualified charitable distribution.

The charitable distribution does count as part of a qualified minimum distribution (or required minimum distribution) for the year and can be the whole RMD. Other requirements of charitable contributions apply. So, you must receive written confirmation from the charity of the contribution and that no consideration was received for the gift. See our September 2013 visit for details.

Those over age 70½ also must take their RMDs by the end of the year or pay a penalty of 50% of the amount that was supposed to be distributed but wasn’t. The IRS in recent years started cracking down on failures to take RMDs, so you want to be sure to comply. It’s a simple calculation. See our December 2012 visit for details.

Those who turned 70½ during 2013 are allowed to delay their first RMD to April 1, 2014, but that’s usually not a good idea. You’ll be required to take your regular 2014 RMD by the end of 2014, so if you delay the first RMD until 2014 you’ll include two RMDs in 2014 gross income. That could push you into a higher tax bracket and trigger higher Medicare premiums and taxes on Social Security benefits, and other costs.

An IRA can be a tool for avoiding penalties for failure to pay estimated income taxes during the year. To avoid the penalty, estimated tax payments have to be made quarterly as the income is earned throughout the year. You can’t avoid the penalty by bunching the year’s taxes in the last payment of the year. But tax withholding payments are considered by the IRS to be made equally during the year, even when the withholding occurs at the end of the year.

Most IRA sponsors let you designate how much of a distribution you want withheld for taxes and deposited with the IRS. So, if you’ve underestimated your income for the year or failed for other reasons to make estimated tax payments as required, you might be able to avoid a penalty by taking a year end IRA distribution and having the bulk of it withheld for taxes. In fact, it appears that you can designate 100% of the distribution be withheld and deposited with the IRS, but some tax advisors recommend having at least a small portion distributed to you for appearances’ sake.

You’ll still have to include the distribution in your gross income for the year, so be sure to factor that into your tax planning.

Here’s a strategy some advisors recommend using to avoid a penalty. Schedule an IRA distribution late in the year and designate all or most of it be withheld for income taxes. Then, within 60 days deposit at least the amount of the distribution in the same or another IRA. You’ll need other funds to do this, but you would have paid those in taxes and penalties when filing your tax return anyway. This strategy allows you to avoid including the IRA distribution in gross income, because you’ve rolled over that amount to the same or another IRA within 60 days of the distribution.

Watch year-end income. A few extra dollars of income can be dramatically expensive for some people. The new 3.8% net investment income tax, reductions in some tax benefits, higher Medicare premiums, higher taxes on Social Security benefits, and more are triggered or increased when adjusted gross income or modified adjusted gross income exceeds certain levels. (See our January and June 2013 visits for details.) Since the taxes and surtaxes are based on AGI, increasing itemized deductions generally won’t help avoid them.

When you’re income is near a trigger level for one or more of these taxes, you need to monitor carefully actions such as year-end asset sales, distributions from IRAs and annuities, employment bonuses, mutual fund distributions, and the like. Some of these are out of your control, so you have to be careful that the actions you can control don’t trigger higher taxes than you expected.

Leverage charitable gifts. Most people make charitable gifts near year end, and it is a good way to increase itemized deductions and reduce income taxes. But simply writing checks isn’t always the best way to make donations.

You can donate appreciated investments, such as stocks and mutual funds, and deduct the fair market value of the assets. You won’t owe any capital gains taxes on the appreciation during your ownership. Even better, when you have substantial assets and want to make a large donation, is to create a charitable remainder trust or charitable lead trust. These will provide income to you or a designated beneficiary, give you a charitable deduction, and benefit a charity. They also provide estate tax benefits if you need them. For details about these trusts, see our May 2012 visit.

Sell losing investments. Investments that now are worth less than you paid for them and are held in taxable accounts can be valuable tax assets. Sell them, and the loss will offset any capital gains you received this year dollar for dollar. Up to $3,000 of additional losses can be deducted from gross income. That reduces adjusted gross income and can help avoid  those extra taxes and surtaxes already mentioned. Compare any transaction costs with the tax savings before making this move.

You can repurchase the investment after more than 30 days have passed or buy right away an investment that is not substantially identical. For example, sell a mutual fund and buy one with a similar investment style and performance but that is not identical.

Preserve the 0% tax bracket. There’s a 0% tax bracket on long-term capital gains and qualified dividends until your taxable income exceeds $72,500 for a married couple filing jointly and $36,250 for single taxpayers. If you’re close to the line, it’s worthwhile to reduce taxable income to stay in the 0% bracket.

Itemized deductions reduce taxable income, so they can be used to keep you in the 0% tax bracket for gains and dividends, along with the strategies available for reducing AGI.

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