New U.S. Income Tax Increase Can Be Avoided With Proper Tax Planning
Now is the time to review your tax situation and start your tax planning, because the 3.8% Medicare surtax is at hand this year. Get Tax Planning at http://www.diazconsulting.com. Tax planning moves you make now can limit your exposure to it or prevent you from being ensnared in its tentacles. We’ll take a look at some strategies that you can use.
The surtax applies to net investment income of single filers with modified adjusted gross incomes above $200,000 and of joint filers over $250,000. Marrieds filing separately have a $125,000 threshold. Modified AGI is AGI plus tax free foreign earned income. The tax is due on the smaller of net investment income or the excess of modified AGI over the thresholds. Investment income includes interest, dividends, capital gains, annuities, royalties and passive rental income. But interest on municipal bonds and payouts from 401(k)s, IRAs and pension plans aren’t covered.
If your gains will be subject to the surtax, consider an installment sale, especially if your AGI without including the gain will be below the thresholds. Or think about a like-kind tax-deferred exchange of investment realty in lieu of a taxable sale. The like-kind swap rules are very broad, allowing swaps of raw land for rental real estate and exchanges of nonresidential rental property for residential rental realty. And if you rent out a house you acquired via a swap for a couple of years, you can then convert the property to a personal residence without triggering an income tax bill on the gain that you previously deferred. And remember to take capital losses. They offset gains hit by the surtax. Most gain on the sale of a primary home is exempted from the surtax. Only profit in excess of the $250,000 principal residence exclusion for singles or $500,000 for couples can be hit. But the levy can apply to all gain on a second home.
Filers with passive rental activities get a onetime chance to regroup them to blunt the impact of the surtax. This will help taxpayers with several businesses whose level of involvement in each doesn’t rise to the level of material participation, so the income is passive and subject to the surtax. Regrouping them as one activity makes it easier to satisfy the material participation tests and avoid the surtax.
Another tactic is to take steps to keep your income below the thresholds. Converting taxable compensation into tax free fringes is one way to do it. You can enter into a nonqualified deferred-pay arrangement with your employer. Or negotiate to receive incentive stock options in place of some of your salary. When you exercise an ISO, you don’t have income for purposes of the regular tax or the surtax, although you do have income for alternative minimum tax purposes.
Donating an IRA to charity works particularly well to beat the surtax. Folks age 70½ or older can do a direct distribution of up to $100,000 this year from an IRA to charity. Couples can give up to $100,000 each from their separate IRAs. This allows donors to avoid including required minimum distributions in income, which also lowers their AGI for purposes of determining if they owe the surtax. If you miss out on tax planning, make certain you get a professional tax return preparer to do your taxes.