As the fourth quarter of 2013 approaches …
It’s time to review your investment portfolio. Make sure that you know the tax rules inside and out so you don’t make a blunder that costs you extra tax.
Be aware of the new 3.8% Medicare surtax. It applies to net investment income of single filers with modified adjusted gross incomes above $200,000 and of couples over $250,000. Marrieds filing separately have a $125,000 threshold. Modified AGI is AGI plus tax free foreign earned income. The tax is due on the smaller of net investment income or the excess of modified AGI over the thresholds. Investment income includes interest, dividends, capital gains, annuities, royalties and passive rental income. But tax-exempt interest and distributions from 401(k)s, IRAs, Roths and pension plans are not covered.
Take steps to minimize the impact of the surtax if you’ll be subject to it or try to keep your income below the thresholds. For example, use an installment sale to spread out a large gain or, if feasible, do a like-kind exchange to defer the gain.
Investors with capital loss carryforwards can cull their portfolios for gains. Any net gains they have this year … up to the carryover amount … aren’t taxed at all.
Don’t forget about the 0% rate on long-term capital gains and dividends. If your income other than gains and dividends is in the 10% or 15% bracket, profits on sales of assets owned for over a year and dividends are tax free until they push you into the 25% bracket. That bracket starts at $72,500 of taxable income for couples and $36,250 for singles. The balance of your long-term gains and dividends is taxed at 15% or possibly 20%. If part of your gains and dividends is taxed in the 0% bracket and the balance is taxed at a higher rate, claiming additional itemized deductions or making a deductible IRA payin gives you two tax breaks: The income tax savings from the deduction. Plus, more gains and dividends will be taxed at the 0% rate.
Think about selling some poor performers. Capital losses offset your gains, plus up to $3,000 of other income. Any excess losses are carried over to next year. Taking losses to offset gains can also reduce the tax bite of the 3.8% Medicare surtax.
But watch the wash-sale rule: If you buy the same security within 30 days before or after the sale, the loss isn’t deductible. Instead, the disallowed loss is added to the basis of the new shares. For example, the rule can apply if you sell a mutual fund at a loss within 30 days of the date a dividend is reinvested, or if you have your IRA purchase shares that you recently sold at a loss out of your taxable account.
A bond “swap” avoids the wash-sale rule … even if the replacement security is from the same issuer … as long as the maturity date or interest rate is different.
Be careful if you buy a mutual fund late in the year. If it pays a dividend in 2013 after your purchase, you owe tax on the payout this year. But financially, you aren’t better off because the fund’s share price falls by a corresponding amount. In effect, you are prepaying your tax to IRS. To avoid this trap, buy the shares after the dividend’s record date. The fund can tell you if it plans to pay a dividend.
Many people will get a refundable credit to help them buy health coverage on the exchanges that are scheduled to open on Oct. 1. To get the credit, household income must be between 100% and 400% of the federal poverty level … currently $11,490 to $45,960 for singles and $23,550 to $94,200 for a family of four. Folks eligible for Medicare or other federal insurance do not qualify for the credit. Nor do those who can get affordable coverage in their employer’s qualified health plan.
The credit can be paid in advance to lower the cost of monthly premiums. The credit amount will be pegged to a percentage of modified adjusted gross income … AGI plus nontaxable Social Security benefits, excluded foreign earned income and tax-exempt interest. The lower a person’s modified AGI, the higher the credit. When applying for coverage on the exchange, an applicant will enter family size and projected household modified AGI, and the credit will then be estimated. Folks who opt for the tax credit to be paid directly to the insurer must reconcile on their tax returns the advance credit payments with the actual credit claimed. Click here for a list of common questions and answers.
Employers get some guidance from IRS on reporting worker health coverage. Beginning in early 2016, larger firms … those with 50 or more full-time employees … must report 2015 health insurance information for each worker. Newly proposed rules set forth what has to be reported, including employees’ monthly health plan coverage and the worker’s share of the lowest-cost monthly premiums for self-only insurance. Employers will also have to certify whether they offered minimum essential coverage.
IRS is considering allowing reporting on W-2s instead of on a separate form, but there are conditions. This simplified option could be used only for employees who are employed the entire year with the firm and for whom the health coverage and their cost remained the same for the whole year. Also, employers that self-insure are subject to multiple reporting rules, so this relief may not be much help to them.
HSAs won’t be disqualified for having deductible-free preventive care benefits, the Revenue Service says. The health reform law mandates that group health plans cover the full cost of preventive care, without any deductible. This rule also applies to HSAs, even though they typically have high deductibles before benefits are paid.
IRS’ simplified per diems for lodging, meals and incidentals inch upward:
In high-cost localities, employees can get up to $251 per day free of tax, up $9. In other areas, their daily stipend is capped at $170 … an increase of $7. Companies that currently use this method have the choice of applying the new rates onOct. 1 or waiting until Jan. 1, 2014.
For meals and incidentals only, the rates remain unchanged … $65 a day in high-cost areas, $52 elsewhere. Self-employeds on travel can use these rates instead of keeping receipts, but their lodging costs must be substantiated separately. They cannot use the full $251/$170 per diem for lodging, meals and incidentals.
The per diem rate solely for incidental expenses remains $5 a day.
Deducting low-cost materials and supplies will be easier, thanks to IRS.
Items costing $200 or less can be written off instead of being depreciated, the Service says in newly issued final regulations. The prior ceiling had been $100. Taxpayers can elect to apply the higher deductibility threshold for 2012 and 2013.
Bigger-ticket assets that aren’t supplies also can be written off in many cases. The limit depends on the policy that a firm uses for its financial books and records and whether it has a certified financial statement. Those with certified statements can elect to deduct items costing the lesser of $5,000 or the amount used for purposes of their financial statements. Firms without audited statements are capped at $500.
Overstating your withholding credit will increase the negligence penalty, the Tax Court says in the case of a musician who didn’t report all his income. He also treated his FICA and Medicare tax withholdings as income tax withholding. IRS hit him with a 20% negligence penalty on the tax due on his unreported income plus the amount of the erroneous refund attributable to the overstated withholding. The Tax Court agreed with IRS’ computation of the penalty.
Help for firms that overwithheld taxes on employees in same-gender marriages. Now that same-gender spouses are able to qualify for tax free employer health coverage, employers aren’t required to impute as additional income to an employee the value of medical coverage for a same-gender spouse. Nor are FICA taxes due on the amount. IRS has now issued guidance for claiming employment tax refunds.
Examinations of exempt groups for political campaign activity are on hold while IRS reviews its internal processes, according to the agency’s acting chief. The reevaluation is part of the fallout from a scathing report by Treasury inspectors that found conservative groups applying for exemption were inappropriately targeted. Charities are barred from participating in political campaigns.Social welfare groups may engage in some political activity, as long as that is not their primary activity.
More innocent spouses will qualify for equitable relief from bills for back taxes under new IRS guidelines. The agency is revising the factors it uses to evaluate claims by filers who argue that it would be inequitable to hold them liable for unpaid taxes attributable to their spouses. More leniency will be shown if a spouse is abused or when the spouse lacks any control over the couple’s finances (Rev. Proc. 2013-34).
Filling out the 1040 will get a tad more complicated for upper-incomers, thanks to two Medicare surtaxes that took effect for 2013: A 3.8% levy on net investment income and a 0.9% levy on wages and self-employment income. Folks subject to these surtaxes will figure what they owe on Forms 8959 and 8960 and then transfer that amount to a separate line on the back of the 1040 form.
Yours very truly,
Shams Khan CPA, CFP