Broker Check

Despite Lack of Congressional Drama, Year-End Tax Planning Required

by Howard Hook, CFP®, CPA

As published on the, November 13, 2013

A lack of drama in Congress this year over tax legislation doesn’t eliminate the need for year-end tax planning.

This time last year, politicians debated expiring income and estate tax laws, creating havoc with regard to tax planning. Even though much of the income tax and estate tax issues have been settled (at least for now), complacency and non-action would be financial mistakes. In fact, there are quite a few areas in tax planning to consider. Three are explored here.

Required Distributions

For those required to take distributions from retirement plans, now is a good time to do so, rather than late in December during the holiday crush. The largest class of people with required distributions are those 70½ and older who own IRA accounts or have 401k or 403b accounts with former employers.

However, there are other, less obvious situations where distributions must be taken as well. Beneficiaries who have inherited retirement accounts from others must also take distributions by December 31st. This includes beneficiaries where the original owner died in 2013 prior to taking their required distribution. It also includes spouses who have not elected to have their deceased spouse’s retirement account treated as if it were owned by the living spouse.

The penalty for failure to take the distribution before year-end is 50 percent of the amount that was required to be taken. Those who believe they may be required to take a distribution should contact their financial advisor or tax preparer right away to make sure. Be sure to ask if they are familiar with these distribution rules as they are complicated, confusing, and contain certain nuances with which not all tax preparers or advisors are familiar.

Holding Periods

When selling an investment, it is important to be aware of how long it has been owned since that will determine whether any gain on the sale of the investment will be taxed at ordinary income tax rates or more favorable, long-term rates. Gains on the sale of investments that have been held for less than one year are taxed at ordinary income tax rates, which can be as high as 43.4 percent (including the tax on net investment income). If the asset was owned for more than a year, the maximum tax on the gain drops to 23.8 percent and for some people, it drops to zero. A careful review of how long the investment has been held is important, but secondary to the number one priority: The risk that waiting to sell an investment will result in a material declinin the price of that investment. Potentially, that decline would most likely far outweigh the tax benefits of holding the asset.

Out-of-Pocket Medical Expenses

The American Taxpayer Relief Act of 2012 included a change in the calculation of deductible medical expenses. Beginning in 2013, taxpayers must have out-of-pocket medical expenses in excess of 10 percent of their Adjusted Gross Income (AGI) in order to deduct medical expenses. Prior tax law disallowed the first 7.5 percent of AGI. The change in the law only applies to taxpayers under age 65 until 2017, when all taxpayers, regardless of age, will be subject to the higher phase-out percentage.

Those who are going to come close to the 10 percent threshold may want to pre-pay some of their medical expenses before the end of the year. Conversely those who believe they will meet the threshold next year may want to defer paying medical expenses in December and wait until January 2014 to pay them, thus increasing the deduction next year.