Last-minute scramble to save on taxes: A couple oldies-but-goodies and a few interesting new ideas

Decisions clients make in the next four weeks can make a significant difference on their annual tax bill

Dec 3, 2013 @ 1:45 pm

By Darla Mercado

Last-minute cramming is generally not the best idea, but when it comes to year-end tax savings, the decisions clients make in the next four weeks can make a significant difference.

Generally, high-net-worth clients can expect a larger tax bill in April, due to the American Taxpayer Relief Act of 2012. Single filers with taxable income over $400,000 and married-filing-jointly filers with taxable income over $450,000 will be subject to a top marginal income tax rate of 39.6%, plus a top marginal tax rate of 20% on long-term capital gains and a 3.8% surtax on net investment income, as well as a 0.9% Medicare tax on wages. Then there's the phase-out of personal exemptions and itemized deductions, namely the dynamic duo known as the personal-exemption phaseout and Pease.

In fact, income tax planning is taking precedence over estate planning when it comes to last-minute tactics. “Given the season, the income tax side trumps the estate side,” said Charles Douglas, a financial planner and editor of the National Association of Estate Planners and Councils' Journal of Estate & Tax Planning. “The estate planning exemption is so high [at $5.25 million] that many clients don't have an estate tax issue. Rather, they're more concerned with income taxes.”

It might be too late to make elaborate plans to cut down the tax bill, but there are still plenty of areas where advisers can do some damage control and soften the blow for the wealthiest clients. Here are a few ideas:

1. Maximize your retirement plan contributions. Raising the amount a client kicks into retirement plan not only makes sense for the longer-term savings goal, but it also means the client cuts down his or her income. In that sense, stepping up those 401(k) contributions or any salary deferral arrangement is a two-for-one deal. Money that comes out of a 401(k) is not subject to the aforementioned 3.8% surtax on net investment income. “There are multiple goals you're accomplishing: You're saving income taxes but you're also reducing your Medicare surtax in future years,” said J. Christopher Raulston, a wealth strategist at Raymond James Financial Inc.

2. Use the charitable rollover while you still can. ATRA extended the charitable distribution, which allows taxpayers who are over 70.5 to make a contribution to charity without reporting that amount as taxable income. Further, that contribution meets minimum distribution requirements. But hurry: This deduction is to be discontinued at the end of the year. “Go ahead and make that gift [out of the IRA] instead of doing it out of cash flow,” said Mr. Douglas.

3. Double up on tax savings by contributing to a donor-advised fund and performing a Roth conversion. When a client gives to a donor-advised fund, he or she is immediately eligible for an income tax deduction. You can use that income tax deduction to offset the income tax that would be triggered with a Roth conversion. And don't forget: Withdrawals taken from the Roth in future years will be tax-free. “Tax diversification will be as important as asset diversification going forward,” said Gavin Morrissey, vice president of wealth management at Commonwealth Financial Network.

4. Make a gift. “If you're looking at estate and gift tax planning, it's always cheaper to gift than to have the property in your estate,” said Ronni Davidowitz, head of the New York trusts and estates practice at Katten Muchin Rosenman LLP. The annual exclusion for gifts is $14,000 for individuals, $28,000 for a married couple. That money can go toward tuition or medical expenses, but be careful: If you are making a gift to pay for tuition, make your check out to the institution itself. As for medical expenses: Make the check out to the medical provider and make sure the recipient isn't being reimbursed through insurance, Ms. Davidowitz warned.

5. Small business owners: Recover the cost of certain qualifying property through the 179 deduction. Entrepreneurs can take home-office deductions for things like computers, furniture and cars used for the small business, as well as other types of equipment. Typically, entrepreneurs can recover the cost of a qualifying property by taking depreciation deductions over time. The IRS's Section 179 deduction, however, allows a business owner to take that depreciation deduction in one year. For 2013, the deduction at $500,000, but it's scheduled to drop way down to $25,000 next year. “In 2008, Congress raised the deduction [as part of the Economic Stimulus Act that year],” said Mr. Raulston. “This was called the SUV law because lots of people bought SUVs and then wrote them off. This is the last year it's going to be $500,000 — this is something to look out for.”

6. Harvest your tax losses. The equity markets have been good to investors this year, so it's time to think about harvesting tax losses to offset capital gains tax liabilities. A couple of caveats: Mr. Morrissey and Mr. Raulston note that clients shouldn't get sidetracked into believing that tax savings is everything. Rather, tax loss harvesting should be viewed in context of re-balancing and asset allocation. “The focus shouldn't just be on saving taxes. You want to make sure it's a security that you really want to keep or a security that you want to get rid of,” Mr. Raulston said. Beware the wash sale rule: If you sell a security to lock in the loss, you need to wait at least 31 days to buy it back. If you're a big believer in a certain industry and 31 days is too long, you might want to buy an ETF reflective of the industry so that you avoid the wash sale rule but stay invested in that particular sector, Mr. Raulston said.

7. Split an inherited IRA before the year is over. IRA splitting makes sense where there are multiple beneficiaries who would otherwise squabble over the inheritance. But the IRA needs to be split into separate accounts before the end of the year after the year in which the decedent passed away, according to Mr. Douglas. If not, the life expectancy of the oldest beneficiary will be used to calculate the RMDs for all of the beneficiaries.


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