Steps Toward Financial Fitness, for This Year and Beyond

Reprinted from the NY Times – Jan Rosen 2.7.2014

For a vast majority of Americans, the current tax-filing season will be business as usual, with few changes to the ground rules of recent years. For the very affluent, it may bring sticker shock.

Tax rates have increased and deductions and credits have been reduced for many affluent people. But at nearly every income level, dealing with the tax code is often a frustrating business, and discovering the best way to manage the burdens and benefits can alleviate some of the distress.  Barbara Weltman, a tax lawyer in Vero Beach, Fla., says that some people whose “income looks good on paper are cash-short and will feel socked” when they learn what they owe for 2013. Still, all taxpayers should file their returns on time to avoid a late-filing penalty, and some might consider requesting an installment agreement. If you file Form 9465, such an agreement is automatic up to $25,000, Ms. Weltman said, and almost automatic up to $50,000. A convenience fee and interest are charged, but the cost will generally be less than if you pay by credit card, she said.

Ms. Weltman, the author of “J.K. Lasser’s 1,001 Deductions and Tax Breaks 2014,” as well as a contributing editor to “J.K. Lasser’s Your Income Tax 2014,” (Wiley & Sons), is among the tax experts who cited both opportunities and traps for the current filing season, and who offered some tips for getting personal finances in shape for long-term tax efficiency:

Simpler Home-Office Math

The Small Business Administration says 52 percent of businesses are home-based, but according to Ms. Weltman, many people who qualify fail to take a home-office deduction. In the past, that may have been because the paperwork was too daunting. Now, for 2013 returns, there is an easy alternative: simply deduct $5 a square foot for a home office, up to a maximum of $1,500.

To qualify, a home office must be necessary for a business, and must be used regularly and exclusively for it. But the office does not need to be a separate room, or even partitioned off, Ms. Weltman said, so long as it is a clearly defined space. There must be enough income to offset the deduction; the difference cannot be carried forward to future years.

Medical Deduction Whittled

Feeling pain at tax time? You may feel more. Previously, taxpayers who itemized deductions and had high unreimbursed medical and dental costs could deduct them if they exceeded 7.5 percent of adjusted gross income. But last year, the threshold was raised to 10 percent for people under age 65. Beginning in 2017, the 10 percent threshold will apply to all taxpayers.

The Tax-Break Fog

Altogether, 55 tax breaks that Congress had long renewed annually expired at the end of 2013, Ms. Weltman said, but some may be renewed and made retroactive. She advised people over age 70 1/2 who want to make charitable contributions directly from an I.R.A., for example, as well as business owners who want to take a big upfront write-off for buying equipment, to check whether Congress has renewed those provisions retroactively before doing so. One expired provision that Julian Block, a tax lawyer in Larchmont, N.Y., is confident will be renewed that way is the option to deduct state and local sales taxes instead of income taxes on federal returns. (He noted that Florida and Texas, two states that do not have an income tax, have big Congressional delegations.)

A Free Calculator

One way to get a handle on what you’re likely to owe in April is to use the free and simple Total Tax Insights calculator, offered by the American Institute of Certified Public Accountants at It tells users much more than their projected income-tax bills: By clicking on your state and filling out a form, you can gauge the impact of more than 20 different federal, state and local taxes.

Edward S. Karl, the institute’s vice president for taxation, says the goal is to help people develop “a broad picture of their financial situations.” It isn’t meant for tax preparation, he said, and entries are not saved or stored electronically. Information is cleared when users leave the site or click the “clear data” button.

Harvesting Losses

Larry Krause, president of Tessara Financial Advisors, an independent wealth advisory firm in Larkspur, Calif., notes that many investors hate to sell any holding at a loss, hoping that it will bounce back in price. But capital losses offset capital gains dollar for dollar, so if you are going to recognize a gain, look for an offsetting loss to sell, he said. If you like the investment, you can replace it after 31 days or look for a similar holding now. Many people held gold as a hedge last year, he said, but it lost value, so when they took gains on stocks, he advised them to sell gold as the offset.

Saving for Education

Mr. Krause is enthusiastic about qualified tuition programs, often called Section 529 plans after the section of the tax code that authorized them. These plans are operated by states or educational institutions and offer a wide range of investments. The account owners — typically parents, grandparents or other relatives — retain control over the money. The beneficiary is the prospective student, and, what’s more, the beneficiary can be changed.

The money put into the account is not deductible at the federal level, but some states, including New York and Virginia, offer tax breaks, he said, and the account’s growth is tax-deferred. Money paid out of it for qualified education expenses is exempt from federal taxes. If money is withdrawn for unapproved reasons, the owner will owe taxes and a penalty, but over time the money earned in the account may offset those costs.

Underwater Uncertainty

Many people owe more money on their home than it is now worth and would like to have their mortgages reduced. But a tax problem could loom, according to Mr. Block, the author of several tax books including “Julian Block’s Home Seller’s Guide to Tax Savings.” Normally when a legal debt is forgiven, the amount is deemed taxable income. A special provision from last year, under which qualified home buyers were exempted from that tax obligation, has expired. As a result, anyone seeking to renegotiate a mortgage this year should check into possible tax consequences.

Strategies for Giving

If you’d like to give money to someone, there are no tax consequences for individual gifts of up to $14,000 a recipient, or up to $28,000 if members of a couple give individually to a recipient, because each spouse is counted separately. For higher amounts, it’s necessary to file a gift-tax return on Form 709, but no gift tax is owed until the total exceeds the lifetime credit of $5.25 million, according to Mr. Block.

 How the Rich Are Hit 

Who qualifies as rich? The answers may vary, but provisions of two laws that came into effect for 2013 returns will certainly raise taxes for people at the top of the income distribution. For more than 95 percent of filers, the American Taxpayer Relief Act, passed on New Year’s Day last year, made permanent the Bush-era tax cuts, which had been scheduled to expire after 2012. But the relief act raised the rate for the upper echelon. And that group also faces two increases on 2013 returns from the Affordable Care Act, which was passed in 2010.

The American Taxpayer Relief Act sets a top federal income tax bracket of 39.6 percent for single filers with taxable income above $400,000 and for couples filing jointly with taxable income above $450,000, and it raises their rate on qualifying dividends and long-term capital gains to 20 percent from 15 percent.

In addition, the act limits itemized deductions and personal exemptions. Itemized deductions will be cut for joint filers with adjusted gross income above $300,000 and for single filers above $250,000. The cut will be the smaller of 3 percent of all itemized deductions, or 80 percent of certain itemized deductions — those for medical and dental expenses, investment interest expense, casualty and theft losses of personal-use or income-producing property, and gambling losses. Each personal exemption claimed by a married couple filing jointly is reduced by 2 percent for each $2,500 of adjusted gross income above $300,000. At $425,000, their personal exemptions are completely phased out. The threshold for a single filer is $250,000, and the exemption is completely phased out at $375,000.

The increases related to health care are a surcharge of 0.9 percent on wages and self-employment income above $200,000 for single filers and above $250,000 for joint filers, and a surcharge of 3.8 percent on net investment income for people whose adjusted gross incomes top the $200,000 and $250,000 thresholds. Investment income is broadly defined, including rent and royalty income and passive income, as well as dividends, interest and capital gains.

Sidney Kess, a New York tax lawyer and C.P.A. who acts as counsel to the law firm Kostelanetz & Fink, notes that many upper-income people have trusts, which will be hit especially hard by the two laws. Trusts with undistributed income above $11,950 owe $3,090 in income tax, plus 39.6 percent of the amount above $11,950, as well as the 3.8 percent Medicare surcharge on net investment income.

States Getting Aggressive

Many states are stepping up efforts to collect taxes, Mr. Kess said, and that can have consequences for people who often travel on business. They may need to file multiple state returns, generally claiming a credit for income tax paid to another state against the liability due their home state.

In Fringe Benefits, Audit Flags

While a fringe benefit may seem like a great perk, some can bring tax problems to both employees and employers, especially small-business owners who may not have a separate tax department. Richard C. Farley Jr., a director of PricewaterhouseCoopers in New York, listed what his firm sees as the top five fringe benefits that auditors often found taxable to the people claiming them: company aircraft use for personal travel, spousal accompaniment on business trips, travel away from home for work, trips awarded for attaining performance goals, and company-provided cellphones and tablet devices.

“There is not much guidance” regarding these benefits, Mr. Farley said. “A company needs to look at the facts and circumstances.”

If you can show a legitimate business purpose — if, for example, you have a German-speaking spouse who served as your translator on a business trip to Germany — an auditor may agree that the cost of that spouse’s trip isn’t taxable income to the employee. In such a case, however, the cost is not a deductible business expense to the employer.

Of course, it’s always important to document expenses when incurred, and to keep records in case of an audit.

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