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As we approach the end of another year, taxpayers need to be sensitive to year-end tax planning opportunities available to them in order to minimize their 2013 federal income tax liability. Hastening the need for such planning is not only the expiration of several tax benefits on December 31, 2013 (absent a decision by Congress to extend them) but also a new 3.8% excise tax on a taxpayer's "net investment income". In addition, the 2014 retirement benefit limitations recently published by the IRS can also offer year-end tax planning opportunities. These topics are discussed in greater detail below:

I. Expiring Tax Breaks - The following is a list of certain actions based on current tax breaks that may help taxpayers (both individuals and businesses) save taxes if undertaken before January 1, 2014 when these tax breaks are currently scheduled to expire:

  • If the taxpayer is contemplating the purchase of expensive items otherwise subject to state sales taxes, complete the purchase before January 1, 2014 to assure the taxpayer that he can take an itemized deduction on his Schedule A for the sales taxes incurred (in lieu of a deduction for state income taxes).
  • If the taxpayer is a homeowner, make energy-saving improvements to his residence, such as putting in extra insulation or installing energy efficient windows or an energy efficient heater or air conditioning which may qualify for a special tax credit.
  • Consider prepaying higher-education expenses (for a total 2013 expenditure of $4,000) if doing so will increase the taxpayer's tax savings attributable to the above-the-line deduction for the expenses.
  • If the taxpayer is age 70 1/2 or older, has an IRA, and is thinking of making a charitable gift in 2013, arrange for the IRA custodian to transfer up to $100,000 of the IRA balance directly to the charity.
  • Business taxpayers should consider making expenditures that qualify for the special business property expensing deduction permitted under Section 179 of the Internal Revenue Code. For 2013, the expensing limit is $500,000. For tax years beginning in 2014, the annual dollar limitation is scheduled to decrease to $25,000.
  • For those businesses considering the purchase of equipment subject to depreciation, they should seriously consider making the purchase (and placing the equipment in service) before January 1, 2014 to take advantage of the special 50% bonus first year depreciation schedule to expire for purchases after December 31, 2013.
  • Businesses engaged in research and development will no longer receive a research and development income tax credit for these expenses which are made after December 31, 2013. It may, therefore, be beneficial to accelerate any planned R&D expenses into 2013.

  • II. The 3.8% Surtax on Net Investment Income of Individuals, Trusts and Estates - New for 2013, individuals, trusts and estates are subject to a 3.8 surtax on the lesser of (i) the taxpayer's "net investment income", or (ii) the excess of the taxpayer's "modified adjusted gross income" (in many cases, equal to a taxpayer's "adjusted gross income") over a threshold amount. For individuals, this threshold amount is $250,000 for joint filers or surviving spouses, $125,000 for married individuals filing a separate return, or $200,000 for all other individual filers. For trusts and estates, the threshold amount for 2013 is $11,950.

    In general, the term "net investment income" is "investment income" less deductions properly allocable to such income. For this purpose, "investment income" is gross income from interest, dividends, annuities, royalties, rents (unless derived in the ordinary course of an active trade or business), trade or business activities in which the taxpayer does not materially participate (so-called passive activities), and net capital gain (to the extent taken into account in computing taxable income) attributable to the sale or exchange of property other than property held in an active trade or business. Strategies to cope with this new 3.8% surtax include the following:

    • As noted above, the 3.8% surtax applies to income from passive activities, but not from income generated by an activity in which the taxpayer materially participates. Accordingly, if an individual is a "passive" investor, he should consider whether it would be possible and worthwhile to increase his participation in the activity before year-end so as to qualify as a material participant in the activity, thereby preventing the income from the activity being treated as "investment income".
    • If a taxpayer is going to incur a capital gain in 2013 (which, as noted above, is generally treated as "investment income"), consider (i) using the installment method in order to spread out the gain over several years and thereby minimize his 2013 "net investment income", or (ii) using the like-kind exchange rules to defer the gain recognition to a low "net investment income" year.
    • Recognize capital losses to offset any capital gains otherwise being recognized in 2013. This not only reduces 2013 net capital gains but also reduces the taxpayer's "net investment income" attributable to his net capital gain.
    • If the taxpayer needs additional funds in 2013, consider taking these funds from Roth IRAs in the form of "qualified distributions" which are not treated as being part of the taxpayer's "modified adjusted gross income" or "net investment income". For this purpose, a "qualified distribution" is a distribution that has been in the Roth IRA for at least 5 years (measured from January 1 of the year for which the taxpayer first contributed to the Roth IRA the funds being distributed), and the IRA owner is at least 59 1/2 years of age, or disabled, or is using the funds to buy, build, or rebuild the owner's first principal residence.

    • III. Tax-Qualified Retirement Plan Limitations - Several dollar ceilings on tax-qualified retirement plans will be higher in 2014, which may encourage taxpayers to defer 2013 earned income to 2014. For example:

      • The annual contribution limitation for defined contribution plans will increase to $52,000 from the 2013 limitation of $51,000;
      • Retirement plan contributions can be based on compensation of $260,000, up from $255,000 for 2013; and
      • The annual benefit limitation for defined benefit plans will increase to $210,000 from the 2013 limitation of $205,000.
      For additional information regarding this topic, please free free to contact the authors or your local UHY LLP professional.