by James B. Gust, Esq., Senior Tax and Trust Editor
Merrill Anderson Co. Inc.
In
contrast to recent years, when clouds of uncertain and various expiration dates
hung over the tax code, this year taxpayers know what the rules are. For those with higher incomes, taxes will be
higher. Period. Top tax rates are
higher; itemized deductions are phased out for some taxpayers; new Medicare
taxes apply.
Even so, there are steps to consider,
as we approach the end of the year, that could make a difference next April 15.
AMT
Upper-income
taxpayers have to calculate their income tax liability, in two ways. The
regular way has a top marginal rate in 2013 of 39.6% and lots of allowable
deductions. The Alternative Minimum Tax
(AMT) has two brackets, 26% and 28%, and it provides for far fewer deductions. Taxpayers pay the higher of the two tax
figures.
Just as taxpayers’ circumstances
vary from year to year, so does their exposure to the AMT. Their deductions and exemptions may trigger
the AMT one year, but not in another. This
fact can lead to some counterintuitive tax strategies.
If a tax review projects that you
will be paying the AMT in 2013, but there is a chance you won’t in 2014, then
you might want to accelerate ordinary income into 2013 to take advantage of the
28% top tax rate, instead of having that income taxed at 39.6% next year. For example, if you own nonqualified stock
options, they could be candidates for a 2013 exercise. However, take care not
to exercise so many options that the AMT no longer applies.
In this situation you also may want
to defer actions that generate ordinary tax deductions until 2014, when the
deductions will be worth more. For example, you might defer payment of state
taxes into the new year or delay some charitable gifts.
On the other hand, if you know that
you will not pay the AMT this year, but you might in 2014, you would reverse
these strategies.
Portfolio moves
Tax
consequences shouldn’t drive portfolio management decisions, but they do need
to be taken into account. Tax efficiency
matters.
Capital gains and losses for the
entire tax year are netted against each other, according to these rules:
1. Short-term losses are netted
against short-term gains.
2. Long-term losses are netted
against long-term gains.
3. If one of these is a gain and the
other is a loss, they are netted.
4. Any resulting short-term gains
are taxed as ordinary income. Any resulting long-term gains from securities
sales are taxed at 15%. At some income
levels, the rate is boosted to 20%, and at still higher levels a 3.8% surtax applies,
for a maximum capital gains tax rate of 23.8%.
5. Up to $3,000 of net capital
losses may be deducted from ordinary income.
Short-term losses are used up first, then long-term losses.
6. Unused capital losses may be
carried to future years until death.
The conventional wisdom resulting
from these rules is that long-term gains are better than short-term, because
they have a lower tax rate. Short-term losses are better than long-term losses,
because they shelter income at a higher tax rate. However true this may be in general, it
shouldn’t be applied to the next transaction until the full range of gains and
losses for the year is understood.
Example. Wes needs to sell $100,000 of securities to
raise cash. He can choose lot A, which
will generate a $20,000 long-term gain, or lot B, which brings with it a
$20,000 short-term gain.
In the absence of any other trading,
Wes would prefer lot A, because the long-term gain brings less taxation. But if
we add one fact the picture changes. Wes already has incurred $20,000 in
capital losses this year, and they will offset his $20,000 gain fully. In that
case he may prefer to realize the short-term gain, and save the long-term gain
for another day.
Wash
sales. When harvesting capital losses, beware of the “wash sale” rule. If you sell a stock at a loss and reacquire
substantially identical securities within 30 days of the sale (either before or
after the sale), the loss will be disallowed.
Instead, the loss will be added to your basis. Note that the rule applies even if the loss
is incurred in a taxable account and the securities are reacquired in your IRA
(traditional or Roth).
No one ever suggested that tax
planning is easy. If you find these
ideas of interest see your tax advisors soon to learn more.
©
2013 M.A. Co. All rights reserved.
