By Michael Bohigian, EA
In part 1 of this series, we looked at the income side of the American Taxpayer Relief Act of 2012. We’ll wrap up with Deductions and some tax-savings tips.
What’s Being Deducted From Your Deductions
Please, No Pease!
At first blush, you may be inclined to utter this lament when learning about the reduction of your itemized deductions due to the Pease Limitation. Fear not: This provision should leave many popular deductions intact for most taxpayers, including deductions for mortgage interest and charitable giving.
Here’s how it works: For a married couple, the Pease Limitation phases out itemized deductions by 3% of the amount that their adjusted gross income is over $300,000 [for individuals, the threshold is $250,000]. A married couple with an AGI of 800,000, for example, loses the right to deduct the first $15,000 of their itemized deductions. Since most of you already deduct more than this amount in state income taxes paid when you itemize, you effectively will still be able to deduct your mortgage interest and charitable giving. Take note that no matter how high your income, your itemized deductions cannot be phased out by more than 80%.
Personal Exemptions Phased Out
Similar to the phase out of itemized deductions, personal exemptions will be phased out at the rate of 2% for each $2,500 above $300,000 in income for married couples and $250,000 in income for individuals, causing high-income taxpayers to lose out on the tax break for themselves, their spouse, and their children and other dependents.
Other Considerations
AMT Permanently “Patched”
You no longer have to worry from year to year whether the government will patch the dreaded AMT. The Act permanently indexes the AMT to inflation, saving millions of people earning somewhere between $150,000 and $750,000 from paying this tax, and reducing the AMT for most other individuals who will end up paying this tax.
Payroll Tax Cuts Expired
The Act restores the pre-2011 Social Security tax rate of 6.2% on all non-government employees, after two years at a reduced rate of 4.2%. Physicians earning more than $113,700 should expect to pay an additional $2,274 in social security taxes in 2013 than in each of the previous two years.
Section 179 Deduction Limit Maintained at Half A Million
For those of you who are practice owners, you will be able to write off up to $500,000 in equipment and machinery purchases under Section 179 in 2013, and this amount is retroactive for 2012 as well. Prior to the legislation, the available Section 179 would have been drastically reduced to a paltry $25,000 in 2013. Under Section 179 of the IRS Tax Code, a taxpayer can elect to write-off the cost of equipment purchased and placed into business use during the year instead of “depreciating” those assets over their useful life of 5 or 7 years, allowing for a much larger upfront tax deduction.
Tax-Savings Tips
With the top marginal tax rate as high as it’s been in several years, and the new Medicare tax on investment income kicking in on January 1st, what can you do to minimize your tax burden?
Invest in retirement
Always a good idea, socking away money in retirement accounts is even more valuable now when it means saving 39.6% in federal income taxes and allowing your investment to grow tax-deferred. You should also consider rebalancing your portfolio, putting less tax-efficient investments in your tax-advantaged accounts while keeping index funds, ETFs, non-dividend paying stocks, and tax-exempt bonds and bond funds in your taxable accounts.
Contribute to a 529 plan
With investment income taxes higher in 2013, take the opportunity to invest in a 529 plan to begin planning for your child’s college education. All earnings in a 529 plan are tax-free, provided that the funds are used to pay for college. And many states even allow you to deduct a 529 contribution on your state tax return. The annual maximum contribution into these tax-advantaged college savings plans is $14,000 per child per year for Gift Tax purposes (or $28,000 for spouses splitting gifts), however, you can frontload five year’s worth of contributions all in one year. Don’t forget to file a Gift Tax Return if you contribute more than $14k ($28k if married) into 529 accounts in one calendar year on behalf of a child.
Purchase needed equipment and machinery for your practice
With the fate of the Section 179 deduction up in the air past 2013, it might be in your best interest to buy big-ticket equipment and machinery during the year to take advantage of the immediate deduction.
Employ your spouse and children
If there’s extra work to be done at your practice, putting your children and spouse on your payroll can be a great way to shift income to a lower tax bracket (in your child’s case) and enable your spouse to put away the maximum ($17,500 for 2013) pre-tax into a 401k retirement fund. Moreover, your child can fund a Roth IRA with the money they earn, up to a maximum of $5,500 in 2013.
Establish a Health Savings Account
If you have a qualified high-deductible health insurance plan, take advantage of the opportunity to pair it with a Health Savings Account (HSA). Contributions to an HSA are tax-deductible, grow tax-deferred, and allow tax-free distributions to cover your family’s health care costs. Plus, any money remaining in the HSA is available penalty-free to supplement your retirement once you reach age 65. The maximum contribution into an HSA for 2013 is $6,450 for married couples and $3,250 for single individuals.
The Big Picture
By and large, the American Taxpayer Relief Act maintained the status quo for most lower and middle-income Americans by extending many provisions into 2013 and making permanent many others. Those of you at the upper end of the income spectrum, however, may not feel as lucky. If that’s the case, perhaps you can take solace in the fact the Act did shunt some of the drastic tax increases set to take place. If there’s little comfort in that, remember that things could be much worse: The top marginal rate, a little more than 30 years ago, was at 70% after all.
Michael Bohigian, EA, is a staff accountant at Schwartz & Schwartz PC with a MS in Accounting and an MBA from Boston College.