Tax provisions in the American Taxpayer Relief Act

The American Taxpayer Relief Act, passed by Congress on January 1, 2013, contains many far-reaching tax provisions. In addition to extending many tax items that had expired or were due to expire, the act also made permanent many provisions of previous tax acts. The tax features of this act are too numerous to list here, but the most comprehensive description of these changes I have found is this Journal of Accountancy article.

I highly recommend you read this article or consult a qualified tax professional to assess the impact of this act on your personal situation.

2013 retirement contribution limits

As we near the end of 2012, it’s time to start thinking about your finances for 2013. While some year-end planning might still be needed, it’s not too early to start thinking about next year. Many employers will start having their open enrollment periods over the next few weeks, and this is a great time to review your retirement plan contributions.

The new 2013 retirement contribution limits are as follows:

  • The elective deferral contribution limit for 401(k), 403(b) and most 457 plans increased to $17,500 from $17,000 in 2012.
  • The catch-up contribution limit for employees aged 50 and older into those same plans remains unchanged at $5,500 for 2013.
  • The maximum total contributions into a defined contribution plan rise to $51,000 for 2013 compared to $50,000 for 2012. For those aged 50 and older, the limit is $56,500.
  • If you participate in a Simple IRA plan, the salary reduction contribution limit increases to $12,000 in 2013, up from $11,500 in 2012. The catch-up contribution remains at $2,500.
  • The limit for IRA and Roth contributions increased to $5,500 from $5,000 in 2012. The catch-up contribution remains at $1,000 for 2013.
  • For traditional IRAs, there are a few different scenarios where different income limitations apply. These income limits increased from years prior and need to be looked at in more detail for each specific situation.
  • For Roth IRAs, the AGI phase out range is $178k-$188k for married couples filing jointly. For single and heads of households, the phase-out range is $112,000-$127,000.

If you’d like to learn more, you can read the IRS press release here.

Hedging higher tax rates with Roth conversions

With the Bush-era tax cuts set to expire at the end of 2012, many investors are seeking ways to hedge against a potential increase in tax rates for 2013 and beyond. One option that should not be overlooked is the use of Roth conversions.

A Roth conversion allows you to pay tax on the converted IRA assets now, with those assets then growing tax-free for the rest of your life. It is generally preferable to defer taxes for as long as possible, but in a situation where tax rates may increase in the future, it may be worth locking in the taxes at today’s rates. For example, the top tax rate in 2012 is 35%; In 2013, the top tax rate may be as high as 43.4% (39.6% top marginal rate plus the 3.8% “Medicare surtax”). If tax rates don’t increase, you can always undo the conversion by recharacterizing the Roth back to a traditional IRA. As long as a recharacterization is done by the extended due date of the tax return (October 15th), you’ll just be back to where you started.

It is also important to recognize that a Roth conversion may bump you up into a higher tax bracket in the year of the conversion, depending on the amount converted. In that case, you should consider a partial conversion, where you only convert enough to stay within your current tax bracket. This is where the assistance of a tax professional can be invaluable.

Everyone’s situation is different, and whether a Roth conversion makes sense for you will depend on your particular circumstances and desires. Your financial advisor and CPA can help you weigh the costs and benefits of such a strategy to determine if it is right for you.

Expiring Tax Provisions

It seems like every year there’s a slew of tax breaks in danger of expiring.  Sometimes Congress extends the tax break, other times they actually expire and fall by the wayside. 2011 is no different, with 3 potentially useful tax breaks on the cutting room table.  Those who may be able to benefit from these tax breaks should consider taking advantage of them soon, before it’s too late.

  • Sales Tax Deduction – Individuals who itemize their deductions can elect to deduct their sales tax or their state and local income taxes, whichever is greater.  There are seven states without a state income tax, so those residents would surely elect the sales tax deduction.  Residents of other states may find that they paid very little in state income taxes and may decide to elect the sales tax deduction instead.  For those who are taking the sales tax deduction and considering a large purchase, such as a new car, it may be worthwhile to complete the purchase this year in order to maximize this tax benefit while it’s still available.
  • Energy Efficiency Credit – Individuals can take a credit of up to $500 for making energy efficient improvements to their homes, including upgrades for roofs, doors, insulation, windows, furnaces, air conditioners, and many others.  There are limitations on the amount of eligible credit for the various improvements, and you can find a list of those here. It’s also important to note that unlike many other credits, this one is a lifetime credit–so if you’ve utilized all of the $500 credit in the past, you cannot take any more regardless of your qualified expenditures now.  However, if you haven’t benefited from this tax break yet, and are considering making energy efficient improvements to your home, you may want to do so before year end.
  • Qualified Charitable Distributions from IRAs – Individuals older than 70 ½ can make tax-free distributions from their IRA to qualified charities.  The distribution is not includable in the donor’s income, but it is not deductible as a charitable donation either.  This provision primarily benefits individuals who are charitably inclined but don’t have enough deductions to itemize.  The qualified charitable distributions will count towards an individual’s required minimum distribution (RMD) for the year, allowing those who don’t need the money from their IRA to donate it without being taxed on it.  With year-end fast approaching, individuals who have yet to take their RMD may want to consider this option.

Each of the tax breaks above had been due to expire at some point in the past but was subsequently extended at the last minute.  It is possible that Congress will extend these breaks again, but nothing is certain given the deficit and debt problems currently facing our country.

If you think you may benefit from any of these tax breaks, please be sure to consult with your accountant to see how these tax savings may apply to your specific situation.