April 15 is fast approaching and the W-2s, 1099s, and other tax documents are starting to appear in your mailbox - it’s almost time to file.
What’s more, with Congress having passed some tax law changes in 2013 - higher top marginal income tax rate (39.6%), higher capital gains rate (20%) for top earners, etc1… - there’s a possibility that your tax bill has increased from 2012. With that in mind, it could make sense to start preparing your taxes early in the event you might owe a bit more than you think. This way you’ll have additional time to decide how you want to pay.
We hope the information below will help make the tax preparation experience a little better by reminding investors of a few ways they may be able to reduce their taxable income for 2013, while also offering a few pointers for thoughtful tax planning in 2014.
It’s too late to make tax deductible contributions to 401(k) plans or other employer-sponsored plans for the 2013 tax year. But, you might still have some alternatives—if you meet some eligibility requirements, you could potentially make a tax deductible contribution to a Traditional IRA, a SEP IRA, or a Health Savings Account, which would reduce the taxable income that you would report for the year.
For Traditional IRAs, the amount you can deduct depends on your income level and whether you’re covered by a retirement plan at work. If you have a retirement plan at work but want to open another IRA, the IRS has an easy-to-use table to help you figure out if you qualify for additional deductions: 2013 IRA Deduction Limits. If you do not have a retirement plan at your work, then use this table: 2013 IRA Deduction Limits - No Retirement Plan at Work.
If you think you might qualify for some of these additional options and that taking action might help reduce your 2013 taxable income, you should speak with your financial advisor or tax professional to establish the next steps.
Before we talk about 2014 tax planning tips, we have one more suggestion you might consider for 2013 filing.
Another tool that may help in the tax filing process is the sales tax deduction calculator. Since 2005, it has been possible to deduct sales tax instead of state and local income tax. However, it can be difficult to keep track of all your sales receipts over the course of the year. To make this easier, the IRS has a developed a calculator to help taxpayers compute this deduction.
When you file this year, if you decide you want to deduct sales taxes instead of state and local tax (perhaps more feasible for someone living in a state with no income tax), consider using the calculator to make your life a bit easier: IRS Sales Tax Deduction Calculator.1
With the whole year ahead, now is a good time to consider a few strategies for estate and tax planning. Every investor’s situation is different, but with the help of your financial advisor you should check your investment plan to see if any of the below strategies might fit into your tax planning for the year.
In 2014, the maximum 401(k) contribution is $17,500, with $5,500 additional for those over 50.2 Your financial advisor can help you determine how much to contribute with each paycheck so you can max out your 401(k) contributions for the year. By doing so, not only can you save more, you’re saving in a tax efficient way.
Even if you have a retirement plan at work, don’t forget about possibly contributing to a Traditional IRA as well to further reduce your taxable income. Additionally, if you have a spouse, you could consider a Spousal IRA to make contributions in your wife or husband’s name—even if they aren’t employed.3
If you’re considering making charitable donations as a way to reduce your taxable income, it could make sense to donate appreciated assets instead of something like cash. If you donate an asset that has appreciated in value, like a stock, you can potentially deduct the fair value of the asset (as long as you’ve owned it for a year) and you could avoid paying capital gains tax.4
A simple example here would be if you own mutual funds in one of your taxable accounts, you should consider using ETFs, or perhaps even hire a money manager to purchase individual stocks and bonds in a separately managed account. ETFs are usually more tax efficient than mutual funds because of the way they are created and redeemed, and they tend to realize fewer capital gains than an actively managed mutual fund. With individual stocks and bonds, you would also have better control over realizing gains and losses over the course of the year.5
Since 2010, there has been no income limit on who can convert their IRA into a Roth IRA, no ceiling on the number of Roth conversions a person can do if they have multiple IRAs, and no limit to the amount of money that can be shifted from an IRA into a Roth IRA.6
As an estate planning strategy, many investors have converted IRA assets into Roth assets, meaning that they pay taxes on the converted amount now, so that they can then spend or pass along those assets at a later date tax-free.
If you have not yet established an investment plan that includes how you want to pass assets along to heirs, you should make it one of your goals for 2014. In its simplest form, this could be setting up trust accounts that have specific instructions on how to distribute assets if you and/or your spouse pass away.
Check out our Estate Planning Checklist with a few reminders of items to consider as you start to plan. Use the guide in that piece as a way to get started.
Aside from the ideas mentioned above, there are other strategies that investors can utilize to make their approach to investing more tax efficient. There are a lot of IRS rules, and they change often, so it’s important to consult a professional when making these decisions.
At WrapManager, we can review your statements, analyze the structure of your investment accounts, and form a relationship with your CPA. Give us a call today at 1-800-541-7774 if you want to discuss your 2013 filing, or if you want to have a conversation about your 2014 investment strategy. You can also get started creating an investment plan by answering a few brief questions here.
1 Fidelity
2 IRS
3 IRS
4 Forbes