As we slide toward the end of the year, be aware that we actually can do year-end tax planning. Unlike the last few years, we aren’t caught between tax provisions that are set to expire and a Congress that meets through the holiday season trying to cut a deal. It looks like we have some certainty about what the tax law will be for at least 2013 and 2014.
Keep in mind that there are several new or renewed provisions that increase taxes. The Pease limitation on itemized deductions and the phaseout of personal and dependent exemptions are back in the law. High income taxpayers (married couples with adjusted gross income above $300,000 and singles above $250,000) are subject to these.
Also, the top tax rate on long-term capital gains and qualified dividends was raised to 20%. But keep a couple of other points in mind. Only those in the top income tax bracket pay the 20% rate. Most others pay a 15% top rate. Even better, remember that the 0% tax rate on long-term capital gains and qualified dividends was made permanent. Those below the top of the 15% pay 0% on capital gains and dividends. The 0% rate applies to married couples filing jointly with taxable incomes below $72,500 and singles below $36,250.
The newest and more complicated tax is the 3.8% tax on net investment income that was part of Obamacare. Many people still are unaware of this and are likely to trigger the tax inadvertently and end up owing unexpected bills and penalties at tax time.
The 3.8% investment income tax is separate from all other taxes. It kicks in when modified adjusted gross income is above $250,000 for married couples filing jointly or $200,000 for single taxpayers. Modified AGI is regular AGI plus any exempt foreign earned income.
The tax is imposed on the smaller of net investment income or modified AGI that is above those levels. Suppose Max and Rosie Profits, a married couple have adjusted gross income of $225,000, all of it from investment income. They wouldn’t be affected by the investment income tax. But if they had $260,000 of adjusted gross income and $10,000 of it is investment income, they would owe the 3.8% tax on $10,000. If their investment income were less than $10,000, they would owe the 3.8% tax only on amount of net investment income. This tax is in addition to all other income taxes.
Here are the types of income to which the tax applies. Of course, taxable interest, dividends, and both long-term and short-term capital gains are taxed. Also included are royalties and most rental income. Some income from trading commodities is taxed, so if you have that type of income meet with a tax advisor who’s gone through the regulations.
A surprising inclusion in the tax is taxable income from insurance annuities. If you’ve been socking money away in deferred annuities over the years, when you take distributions they’ll face not only ordinary income taxes but also the 3.8% tax if your AGI is high enough.
Income from real estate investment trusts and master limited partnerships also are subject to the tax. But remember only income that is included in gross income is affected by the 3.8% tax. Most distributions from MLPs aren’t taxed. On average, MLP distributions are 15% taxable income and 85% nontaxable returns of capital. But the return of capital portion reduces your basis in the MLP shares, so it increases the capital gain when you eventually sell the shares. On the other hand, you can hold the MLP shares for life. Whoever inherits the shares will be able to increase the basis to current fair market value and avoid taxes on their sale.
Gains from the sale of a principal residence are subject to the tax only when they exceed the tax-free amount of $250,000 for a single taxpayer and $500,000 for married taxpayers filing jointly. But gains from sales of second homes and rental properties are subject to the tax.
A number of types of income aren’t subject to the tax. Interest income from tax-exempt bonds avoids the tax, though capital gains from sales of the bonds do not. Social Security benefits and life insurance benefits aren’t affected.
Pension benefits, including distributions from traditional IRAs and Roth IRAs, are exempt from the tax.
But keep in mind the interplay of tax provisions. Distributions from traditional IRAs are included in AGI. So, large IRA distributions could increase AGI and trigger the 3.8% tax on your investment income, though the distributions themselves aren’t subject to the tax. This is especially likely as you get older and required minimum distributions increase. But Roth IRA distributions aren’t included in gross income. Since they aren’t taxable, they don’t trigger the investment income tax. It’s another factor to consider when deciding whether or not to convert a traditional IRA to a Roth IRA.
Donations of appreciated assets to charity also avoid the tax. That’s another reason to consider making charitable donations in appreciated property held in taxable accounts instead of cash.
Real estate income can be exempt when earned by a real estate professional. To be a professional you must spend a minimum of 750 hours annually managing real estate. That means being involved in the nuts and bolts of managing properties. Those hours also must be more than half of your working hours for the year.
Income and gains earned through pass-through entities such as S corporations, partnerships, and limited liability companies might be exempt. The activity has to qualify as a business for the individual owner. You must pass one of the active involvement tests under the passive activity regulations. The easiest test to pass is to have the activity be your prime source of income, taking 500 hours or more of your time. When none of the tests is passed, the income is passive and subject to the 3.8% tax.
Owners of multiple pass-through entities have a one-time option to either treat each interest separately or group them as one activity. You have to decide if grouping them offers the most tax advantages.
Several strategies to reduce the new tax should be reviewed, and you need to reconsider how old strategies could be affected.
Reduce AGI. This is key to avoiding a number of new taxes, including this one. This tax increases the importance of holding assets in the right accounts, taking capital losses, and planning asset sales and IRA distributions. The tax also might make an IRA conversion more attractive.
Carefully review major events. You might think that your income isn’t near $250,000, so the tax doesn’t affect you. But one-time events could trigger the tax. Suppose you take a large capital gain. That could increase your AGI enough to trigger the tax. Overlooking the potential for the 3.8% tax could result in several thousand dollars of additional taxes one year.
Know the interplay of tax code sections. We already discussed several examples of this. Here another example.
When you sell a capital asset at a loss, for the regular income tax the loss is deducted against gains for the year. Any excess loss offsets up to $3,000 of other income, and any additional excess is carried forward to future years. But for the 3.8% tax, tax losses offset only capital gains for the year. Excess losses aren’t deducted against other investment income to reduce the 3.8% tax.
Track investment expenses. The tax is on net investment income. From your gross investment income you are allowed to deduct certain expenses. The deductible expenses include rental and royalty expenses, margin interest to the extent of interest income and short-term gains, investment advice, broker commissions and fees, and state income taxes attributable to investment income.
Know what’s exempt. You might be able to restructure things if you’re involved in real estate or a small business so that income avoids the 3.8% tax. Some people will shift from taxable bonds to tax-exempt bonds. Others will carefully plan distributions from annuities.
Review trust strategies. As with other special taxes, the 3.8% investment income tax kicks in when the trust’s undistributed investment income exceeds $11,950. Trustees might need to reconsider investment or distribution strategies.
Mark Wilson/Getty ImagesFederal Reserve Chairman Ben Bernanke "Taper talk" could pretty much be dead until next year. Thanks to the dysfunction in Washington, many Fed watchers now see the first taper in the Federal Reserve's bond buying coming sometime later than expected -- certainly not before December but probably in the first quarter. Wall Street had been geared up for the start of a pullback from the easing program sometime this quarter, but a more sluggish economy and fiscal uncertainty make that less likely. "One thing we know for sure, as much as we know anything, is that short-term interest rates are going to stay low for as far as the eye can see," DoubleLine CEO and chief investment officer Jeff Grundlach said on "Squawk on the Street." "Quantitative easing is not even going away. It seems with this budget wrangling, it's going to keep going up." "It means the credit market is really a safer place than it's been for the last few months," he said. Since word of a compromise debt deal came Wednesday, bond yields have fallen and the dollar has tumbled, as traders worried the partisan battling would resume around the next set of deadlines for the budget in January and debt ceiling in February. The 10-year Treasury yield dipped to 2.6 percent from its Wednesday morning high of 2.76 percent, and the dollar index lost a full percent Thursday, trading at a nine-month low of 79.68. The S&P 500 Thursday, after trading lower early in the day, broke through to a new high in the afternoon in a burst of buying. The S&P 500 (^GSPC) closed up 11 at 1,733, topping its Sept. 19 high. The Dow (^DJI), however, finished down 2 at 15,371, dragged down by losses in IBM (IBM). "You don't have to worry about the government anymore. A couple of speed bumps are out of the way. There's no way they're going to taper this month and the odds of them tapering in December are low," said Dan Greenhaus, chief global strategist at BTIG. Greenhaus said the stock market also is being helped by other factors, including the fact it is entering a seasonally favorable time of year. "To the extent you think more [Fed bond] purchases are better than less, and that pushes stock prices higher, then that's supportive," he said. For weeks this summer, markets had been anticipating that the Fed would start to slowly cut back on its quantitative easing program, or the hefty $85 billion in bond purchases it makes each month. Since the spring, Fed officials, in speeches and testimony, had commented repeatedly about the first steps of "tapering" bond purchases if the economy was strong enough. So the first shock to markets was when the Fed decided against announcing tapering in September, citing concerns about financial conditions but also fiscal headwinds. Now those fiscal headwinds have come to bear, with economists saying the 16-day government shutdown likely took a bite out of the economy's already slow growth. "We won't know the economic damage done by the shutdown for a while, and we have the uncertainty of what's going to happen with the budget negotiations through January now, and those are the reasons they said in the first place why they had to delay it," said Diane Swonk, chief economist at Mesirow Financial. Swonk said the economy is showing signs of sluggishness, and it is in part because the Fed talk about winding down bond purchases sent rates higher. "We had less momentum in part because maybe the Fed 'mea culpa' and how they explained tapering. Rates backed up," she said. The 10-year hit 3 percent as traders braced for the Fed to start reducing its purchases of Treasury bonds and mortgage-backed securities. Federal Reserve Chairman Ben Bernanke's final meeting is in January, and Swonk said it's a close call whether the Fed starts to reduce bond buying then. "I think that's something he would like to do ... January at the earliest but I wouldn't be surprised if it's March or later," she said. JPMorgan economists say the government shutdown likely shaved a half percent off of fourth quarter GDP, resulting in growth now of 2 percent. But it should boost first quarter by 0.25 percent. "As far as the Fed goes, we have not really changed our views all that much. While recent events have made 2014 look like the more likely time of the first tightening, we would not rule out December just yet, and think there is about a 30 percent chance the Fed moves then," wrote Michael Feroli, chief U.S. economist at JPMorgan (JPM). He noted that the Fed's decision not to cut back on bond buying in September was a close call. Feroli said the "drop dead" date for the debt ceiling is now likely to be April or May, and the real impediment to a Fed move is the economic data. Many economic reports were unavailable during the government shutdown, and markets still await the key employment report from September, now expected Tuesday. Other data are expected to follow in the next several days. Adrian Miller, GMP fixed income strategist, handicapped the Fed moves this way: Zero chance of tapering at the Oct. 17-18 meeting; 20 percent chance in December; 25 percent in January, and 40 percent at Yellen's first meeting as chair March 18-19. Mohamed El-Erian, CEO and co-CIO of Pimco, said on "Squawk Box" that it makes sense the Fed will now put off tapering until Yellen takes over as Fed Chair, so the Fed may now be more accommodative for longer. "But this notion of taper is less probable now given what has happened," El-Erian said. Fed speakers are once again in the spotlight, now that Washington is taking a temporary back seat for markets. A trio of Fed officials participate in a Washington conference Friday on "Planning for the Orderly Resolution of a Global Systemically Important Bank." Richmond Fed President Jeffrey Lacker speaks at 8 a.m. Eastern time, Fed Gov. Daniel Tarullo speaks at noon, and New York Fed President William Dudley speaks at 3:40 p.m. Chicago Fed President Charles Evans speaks at 2 p.m. on the economy and monetary policy at a lunch in Chicago, and Fed Gov. Jeremy Stein speaks in Washington at 4:30 p.m. at a National Bureau of Economic Research conference on addressing financial imbalances at 4:30 p.m.
In addition to the beer-inspired spa treatments, The Lodge at Woodloch recently expanded its beer and ales menu. Aside from Dogfish Head's craft brewed ale, the new menu includes beer from Troegs, a central Pennsylvania microbrewery, San Diego-based Stone Brewing and Wolaver's in Middlebury, Vt. Depending on their travel date, guests at the spa may also encounter cooking-with-beer demonstrations. They may also find Dogfish Head founder Sam Calagione hosting beer tastings, informal get-togethers and book signings. Calagione wrote Brewing up a Business and Extreme Brewing and co-wrote He Said Beer, She Said Wine. "We think it's just natural to partner with one of the greatest craft beer companies in the country to teach guests about the booming craft ales industry and the growing following of hobbyists that follow the craft ales movement," says Brooke Jennings Roe, director of marketing at The Lodge at Woodloch. According to the Brewers Association, 98% of the more than 2,500 breweries in the U.S. are craft brewers, known for making fuller-flavored ales and lagers. During the first half of 2013, approximately 7.3 million barrels of beer were sold by small and independent craft brewers, up from 6.4 million barrels over the first half of 2012. Luring craft beer lovers, however, is only part of The Lodge at Woodloch's marketing strategy. By introducing beer-infused spa treatments and expanding their beer menu, the spa resort hopes to attract more of the male population who typically shy away from spas.
AFP 