Reduce the Sting of New Taxes

Many affluent physicians will pay higher income taxes in 2013, thanks to stealth taxes, but taking action now can save money come next April.

The new tax law limits the total amount of itemized deductions and personal exemptions that taxpayers may claim once adjusted gross income (AGI) exceeds $300,000 for married couples filing jointly and $250,000 for single people. Since deductions and exemptions are subtracted from AGI to determine taxable income, the new limitations hike taxes.

One provision cuts itemized deductions by 3% of AGI above the threshold, up to 80% of total deductions. So consider a married couple with $425,000 of AGI and $50,000 in itemized deductions. Their deductions will be reduced by $3,750 (3% x $125,000). They’ll pay about $1,240 more in income tax.

Another provision cuts the total personal exemption by 2% for every $2,500 by which AGI exceeds the threshold. The personal exemption for 2013 is $3,900.

Let’s say our married couple has two young children. Previously, their four exemptions would have cut their taxable income by $15,600. This year they’ll get zero. As a result their income tax will climb about $5,150.

But Uncle Sam isn’t done.

A couple of less-stealthy tax hikes kick in at $250,000 and $200,000 a year for couples and singles respectively.

Under the new Medicare tax, married couples with earned income above $250,000 and single people above $200,000 will pay an additional 0.9% on wages or self-employment income. Let’s say the couple in the example has $375,000 of earned income and $50,000 of investment income. This will increase their taxes by $1,125 (0.9% x $125,000).

Additionally, the Affordable Care Act imposes a 3.8% tax on unearned net investment income, including interest, dividends, annuities, royalties, rents and capital gains. The tax applies to the lesser of net investment income or modified adjusted gross income (MAGI) exceeding the $200,000/$250,000 thresholds for earned income. This will raise the couple’s tax bill by $1,900 (3.8% x $50,000).

Add up all four tax hikes, and the couple faces a total federal tax hike of $9,415 for 2013.

So consider the following moves to reduce your exposure to new stealth taxes.

Maximize contributions to qualified retirement plans

Contributions to plans such as 401(k)s, Simplified Employee Pensions (SEP) IRAs, SIMPLE IRAs, Keogh plans and cash-balance plans reduce your AGI on a dollar-for-dollar basis, no matter how high your income.

While such contributions don’t reduce your MAGI, transferring money from taxable accounts to a retirement account shelters future investment earnings from taxes.

Invest in tax-free bond funds

Municipal bond income does not count toward your AGI or MAGI.

Give securities to charity

Consider donating appreciated securities, especially those that throw off taxable income. Besides getting a deduction, you’ll avoid paying capital gains taxes.

If you’re 70-and-a-half or older, donate your IRA distribution to charity

In 2013, taxpayers can distribute up to $100,000 tax-free from their traditional IRAs to charities. Starting at age 70-and-a-half you must take an annual required minimum distribution (RMD) from your IRA. It counts as taxable income. Instead, you can send part or all of your distribution directly to one or more charities to cut your tax bill.

Give securities to your children or grandchildren

Since they’re probably in a lower tax bracket than you, your heirs may pay little or no tax on the investment income and you will have reduced your AGI and MAGI.

Shomari Hearn is a certified financial planner and vice president of Palisades Hudson Financial Group in Fort Lauderdale. He can be reached at Shomari@palisadeshudson.com. Palisades Hudson is a fee-only financial planning firm and investment advisor.