Taxes are one of two certainties in life, but how much you owe can depend greatly on your preparedness and your planning, according to Grant Thornton LLP. For business owners, you not only have your returns and your family’s returns to worry about, you also have complex business tax provisions to consider.
2013 marked the first time in years that individual income tax rates rose. Coupled with the new 3.8 percent tax on net investment income, many taxpayers will see a marked increase in their personal tax liability.
“For individuals with trusts, it has often been most advantageous to distribute the trust income to minimize the overall tax burden,” said Donna Witherwax, Tax Practice Leader in Grant Thornton’s Phoenix office. “With the new 3.8 percent tax on investment income it may be beneficial to leave income in the trust. Individuals with trusts should consider modeling out the overall impact.”
Grant Thornton has developed tax tips on what to consider when filing your 2013 tax returns, what you can still do to lower your tax liability and how to make the most of planning for 2014.
What’s new for your 2013 return?
What’s changed since last year? You need to know before you start your 2013 return.
· There are new benefits for same-sex married couples. For the first time ever, the tax law has been harmonized to treat same-sex married couples the same as other married couples. Following the Supreme Court’s landmark decision in U.S. v. Windsor, the IRS issued new rules allowing same-sex married couples to file joint returns and enjoy equivalent treatment in all areas of federal income, gift and estate tax law. In fact, all couples with valid marriages, whether same sex or not, must file as a married couple in 2013, either married filing jointly or married filing separately.
· Higher earning individuals face higher taxes. For the first time in more than a decade, Congress raised individual tax rates. Individuals earning more than $400,000 and couples earning more than $450,000 are now subject to a 39.6 percent top rate. The top capital gains and dividend rates also went up from 15 percent to 20 percent, not including the new Medicare tax. Finally, the personal exemption phaseout (PEP) and “Pease” phaseout of itemized deductions are back in 2013. Both phaseouts complicate tax planning and return preparation while raising taxes.
· A new tax comes due. Another first for your 2013 returns is the calculation and payment of the 3.8 percent Medicare tax on net investment income. The tax became effective at the beginning of 2013 and imposes a 3.8 percent tax on investment income, like dividends, rents, royalties, interest, capital gains and annuities. Passive income from a trade or business in which you do not materially participate is also subject to the tax.
· Alternative Minimum Tax (AMT) indexed for inflation. Congress didn’t eliminate the AMT, as many had hoped. As part of New Year’s Eve legislation in 2012, lawmakers did decide to index the tax for inflation for the first time. Previously, Congress had simply “patched” the AMT for one or two years at a time.
Is it too late to make any changes to my 2013 return?
No, it’s not too late. While the books closed on your income, gain and loss at the end of 2013, there are still ways to reduce your tax liability, such as contributing to a traditional individual retirement account (IRA) or converting to a Roth IRA.
· Contribute to an IRA. You can still get an above-the-line deduction on your 2013 return by contributing to an IRA now, before you file your income tax return. Don’t have an IRA? You can set one up today, fund it, and still take advantage of the deduction. Contribution limits for 2013 are $5,500 plus a $1,000 catch-up for those 50 years old and older. If you were an active participant in your employer’s retirement plan, contributions to an IRA offer deductions only at income levels below $112,000 for joint filers and $68,000 for singles.
· Reconsider a Roth IRA rollover. In 2010, Congress eliminated the $100,000 income limit on rollovers from an IRA or 401(k) to a Roth IRA. Rolling over allows you to pay tax on the conversion in exchange for no taxes in the future (if withdrawals are made properly). These rollovers have been very popular. They should become even more popular in the future because, unlike distributions from a regular IRA, distributions from a Roth IRA do not increase your AGI — which is used in determining the new Medicare tax and the amount of the PEP and “Pease” phaseouts.
· Make a grouping election. The new 3.8 percent Medicare tax on net investment income will generally apply to any income you receive from a business in which you do not materially participate. While it’s too late to go back and change how much you participated in your businesses in 2013, you may be able to make a grouping election when you file your return to combine your activities for various business interests and satisfy the material participation tests.
· Make the 65-day election. Like individuals, most trusts are also subject to the new 3.8 percent tax on net investment income. “Complex trusts” are subject to the new tax in 2013 to the extent their undistributed investment income exceeds $11,950. By making a distribution of the income within 65 days of the end of 2013 (March 6, 2014), the trustee can elect to have the distribution treated as if it were made in 2013, shifting the income for tax purposes to the beneficiary. If the beneficiary is in a lower tax bracket than the trust, the election can reduce the overall tax burden.
How do I avoid filing season hassles?
Tax preparation is complicated, and a transposed number or a forgotten form can make matters worse. Keep these tips in mind when preparing this year’s return so you can avoid common filing season mistakes.
· Organize your receipts. Whether it’s a charitable contribution or a business deduction, the IRS wants to see proof of your expense. These expenses must be documented in order to be deducted. What’s proper documentation? Receipts, bank records, letters from a charity confirming your gift, and even electronic records like emails can be sufficient. Failing to substantiate expenses is a surefire way to lose an audit with the IRS. Proper organization can save you time, money and heartburn.
· Get with the times and file electronically. Filing electronically will not only expedite your refund, but it can also save you from making mistakes. As an additional incentive, the IRS will check your electronic return for commonly made errors. If you did make a mistake, the IRS gives you the chance to correct the problems before it accepts and processes your electronic return.
· Check your numbers twice. Make sure you have the right social security numbers, and, if necessary, employer identification numbers. The IRS may be working with a smaller budget than before, but its computers are still sophisticated enough to automatically match all Social Security numbers and check for simple math mistakes. Lately, the IRS has broadly used its “math error” authority to automatically fix these mistakes, but accidents do happen on their part.
· Don’t miss the deadline for filing an extension. The filing deadline is Tuesday, April 15, 2014. If you can’t make it by then, don’t worry! Filing for an automatic extension with Form 4868 is a painless process that will spare you penalties for missing the deadline. While extending the filing deadline does not extend the time for making a contribution to an IRA or extend the time for payment of any tax due, it will give you some breathing room to properly file your complete tax return. By the filing deadline, you must have paid at least 90 percent of your 2013 tax liability through withholding, estimated payments and any payment made with your extension.
How do I plan for 2014?
The last thing most people want to do immediately after filing their tax returns is to begin tax planning again. But doing so will give you a head start and prepare you for potential tax changes.
· Is tax reform on the horizon? Lawmakers have debated tax reform for years, and 2014 may present the best opportunity for Congress to dramatically change our tax laws. But, will reform be a benefit to individual taxpayers? It’s hard to tell. The top individual rates have risen to 39.6 percent, and Congress has discussed lowering corporate rates from their current peak of 35 percent. That could influence whether a business is organized as a pass-through entity, like a partnership or limited liability company, or as a corporation. After all, the greater the disparity in corporate and individual rates, the more opportunity to change the entity classification of your business.
· Materially participate in your business. The 3.8 percent Medicare tax on net investment income is imposed on passive income. For example, an individual taxpayer who doesn’t “materially participate” in a business will see that income taxed at a higher rate, due to this tax. By materially participating in the business, that investor can eliminate the 3.8 percent tax. Doing so can be tricky, but especially for family businesses that have relatives as owners, it makes sense to look into how to materially participate in the business.
· Understand foreign bank account reporting. The IRS and Department of Justice have, for the last several years, taken a hard look at U.S. taxpayers with unreported offshore financial accounts. Penalties for not reporting offshore income or the existence of those accounts are steep, and can include prison time. The IRS has a voluntary disclosure program for those individuals, which allows for reduced penalties and no prosecution. Keep in mind that the foreign bank account reporting form is not filed with your tax return — rather it must be filed by June 30 of each year with the Financial Crimes Enforcement Network (FinCEN), an agency within the Treasury Department.