A Return to Tax Basics
The more things change, the more they stay the same.
There’s talk, as always, of reforming the tax codes. Although there are attempts by the administration and Congress at major tax reform, if and when that occurs is anyone’s guess. So our focus is on what we know now while we continue to track possible legislative changes.
Major Changes with Major Effects
Tax on Net Investment Income (NII). Likely the most significant change for 2013 is the imposition of the Net Investment Income Tax, used to fund the Affordable Care Act. Beginning with the 2013 tax year, a 3.8% tax is imposed on the lesser of “Net Investment Income” of individuals, trusts, and estates or the excess of the taxpayer’s modified adjusted gross income over a certain threshold amount ($250,000 for joint filers). Estates and Trusts will be subject to the Net Investment Income Tax if they have undistributed Net Investment Income and also have adjusted gross income over $11,950 for 2013, which is much lower than for individuals.
Only proposed regulations have been issued on this tax, and no surprise, have received plenty of reactions from the professional community. What follows is our sense of the planning opportunities based on these proposed regulations:
- By making an installment sale this year with part or all of the proceeds payable next year or later, the gain is spread out and could help minimize your exposure to the NII.
- When selling your home owned and used as a principal residence for at least two of the five years before the sale, you may exclude up to $250,000 in capital gain if single, and $500,000 in capital gain if married. Gain on a sale in excess of the excluded amount will increase NII and net capital gain. If you sell a second residence, the entire gain will potentially be subject to the 3.8% tax.
- The 3.8% surtax applies to income from a passive investment activity, but not income generated by an activity in which the taxpayer is a material participant. Monitoring your level of activity and hours spent could convert any income from a trade or business to non-passive and therefore likely outside of the NII tax. If you are a real estate professional, you should not be subject to the 3.8% surtax on capital gain generated by your real estate activities.
- If you are 70½ or older, you can give a direct gift of up to $100,000 from a traditional IRA to a qualified charity. Your Qualified Charitable Distributions may be counted towards your required minimum distribution amount, which is excluded from your AGI for federal income tax purposes and may help keep your AGI below the threshold amount for the Net Investment Income Tax.
- Balancing the income of estates and trusts can reduce NII. In addition to actual distributions during the calendar year, the trustee of a complex trust can elect to treat certain distributions made within 65 days after the close of the tax year as having been made on the last day of the previous tax year. This election should be considered as a way to possibly use the greater threshold available for individuals.