With marginal tax rates rising for higher income levels, the reduction of some tax preference items, and a new Medicare investment income surtax, income tax planning should be a priority.
Here are five strategies that clients can use to mitigate tax obligations today.
1. Invest in municipal bonds for tax-free income
Municipal bonds become more attractive on a relative basis for taxpayers who find themselves subject to the new Medicare surtax and the highest marginal tax rate.
2. Defer taxes with retirement accounts
Contributing to a retirement plan or IRA, funding a flexible spending account (FSA), or deferring compensation income can reduce adjusted gross income and may help a client avoid reaching income thresholds that could result in a higher tax bill.
3. Consider Roth IRA/401(k) contributions or conversions
Roth income is not subject to the Medicare surtax, or included in the calculation of the income threshold triggering the surtax. Younger investors or taxpayers in lower tax brackets may want to use a Roth account to create a source of tax-free income in retirement.
4. Avoid taxes on IRA distributions by using a charitable rollover
Account owners over the age of 70½ may avoid taxes on an IRA distribution if the funds are sent directly to a qualified charity. This provision was reinstated for the 2013 tax year.
5. Make use of the zero percent tax rate on capital gains
The law preserves the 0% dividend and capital gains rate for taxpayers in the 10% or 15% income tax brackets. This means you can look for opportunities to sell appreciated stocks or mutual funds without incurring a gain. Or, clients may want to transfer appreciated assets to other family members in the lowest tax brackets.
For more information and additional planning ideas, read our latest investor education piece, “Ten income and estate tax planning strategies for 2013.”
Capital gains, if any, are taxable for federal and, in most cases, state purposes. For some investors, investment income may be subject to the federal alternative minimum tax. Income from federally tax exempt funds may be subject to state and local taxes.
While all bonds have risks, municipal bonds may have a higher level of credit risk as compared to government bonds and CDs.