Getting a jumpstart on 2014 tax planning

Advisers should recommend statutory shelters to ease clients' tax bite

Dec 31, 2013 @ 12:01 am

By Darla Mercado

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It's probably too late to do any significant planning for the 2013 tax year, but right now is the perfect time to get a jumpstart on 2014.

Tax gurus note that the top earners — singles with taxable income over $400,000 and married joint filers with income over $450,000 — will be in for a nasty surprise when they confront the 2013 federal tax bills they'll pay in April. They face a top marginal income tax rate of 39.6% and a top marginal tax rate of 20% on long-term capital gains.

The American Taxpayer Relief Act of 2012, enacted close to a year ago, put in place the net investment income tax of 3.8% on annuity income, royalties, dividends and other sources of investment income, as well as the additional Medicare tax of 0.9%. Those levies will affect individuals making upward of $200,000 in modified adjusted gross income and married joint filers with over $250,000 in income.

There have also been phaseouts on personal exemptions and itemized deductions: The so-called PEP and Pease.

“The filing of these 2013 tax returns is going to be an eye-opening experience for many of these clients,” said Gavin Morrissey, vice president of wealth management at Commonwealth Financial Network

It's all the more reason to start laying the groundwork for 2014.

First and foremost, there's the net investment income tax: the 3.8% levy that applies to the amount by which the taxpayer's modified adjusted gross income exceeds $200,000 (if single) or the taxpayer's net investment income — whichever is lesser.

“This 3.8% surtax needs a lot of attention. That means placing more emphasis on portfolio design,” said Robert Keebler, a partner with Keebler & Associates. Kick off the new year by looking at clients' portfolio holdings. Advisers should aim to reduce turnover and look into using statutory shelters, such as life insurance, real estate and master limited partnerships to minimize the tax hit.

Roth conversions will still be in vogue during the 2013 tax season. These conversions require an upfront tax payment, but income from the Roth IRA will be tax-free in the future. “You can still jump on that right out the gates in 2014,” Mr. Keebler said. In fact, jumping on that conversion right away makes sense because the client is maximizing the amount of time for the market to do its work. You have until Oct. 15, 2015, to undo the Roth conversion, which means the client has a year and ten months to watch the market, Mr. Keebler said.

High-net-worth clients who make significant charitable donations may want to consider front-loading a donor-advised fund in the new year. Given the new steep capital gains taxes and the fact that the market appreciated considerably over the course of last year, making a sizable gift of appreciated stock in January will give the client a considerable charitable deduction.

“Let's say you give $5,000 a year to a charity and you have a stock position with a basis of $25,000 — but it's now worth $50,000 because of the appreciation over the last two years,” said Mr. Morrissey. “If you put in the $50,000 in appreciated stock into a donor-advised fund, you're frontloading it for the next 10 years, and you have a nice income tax deduction that you can use today.”

Finally, certain high earners might want to manage their income stream in order to keep themselves from drifting into higher tax brackets. Mr. Morrissey noted that if someone gets paid in stock options, perhaps they can defer them into later years when their income won't be as high. This might make sense if the individual projects that he or she will have a big income year and can have control over when and how that income is received.

“These clients might be getting close to retirement and don't want to trigger all this income at the same time, so they're looking for ways to defer income and stay below their thresholds,” Mr. Morrissey added.

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