Plan Now to Avoid Paying More in Taxes Next Year
Small business owners understand the value of good planning and thinking ahead. One area where that is especially true is this year’s post-tax season review. New tax changes that start in 2013 could generate a higher tax bill next year, even if your situation otherwise stays the same. Taking action now will hopefully help to make next year’s tax bite less painful.
The higher taxes that start in 2013 include an additional 0.9 Medicare surtax on wages and self-employment income, a new 3.8 percent Medicare tax on net investment income, and income tax and capital gains tax rates of 39.6 and 20 percent, respectively, for higher-income taxpayers. Many of these 2013 tax pitfalls are triggered by certain income-related thresholds. For example, the 0.9 Medicare surtax sets in at $200,000 for single filers ($250,000 for married filing jointly; $125,000 for married filing separately). The 3.8 percent Medicare tax on net investment income has similar thresholds of modified adjusted gross income. The 39.6 top income tax rate, and the 20 percent capital gains tax rate, affect those with taxable incomes above $400,000 for single filers ($450,000 for joint filers; $225,000 for married filing separately). That’s why, this year, it is especially important to assess your tax planning strategies as early as possible.
A significant portion of tax planning in 2013 and beyond will focus on trying to keep relevant income below certain thresholds or trying to find tax-favored types of income.
Here is a list of post-tax season tips to consider. As they say, it’s never too early to sit down with your advisor and plan your taxes.
Review your choice of business entity. Despite the “Scarlett D” of Double-Taxation that C corporations have worn for many years, recent tax changes could make the C corporation more attractive for business owners. Depending on your situation, a C corporation or S corporation might actually be a tax-saving entity choice (yes, you read that correctly: tax-saving). For more information, including some illustrative number-crunching, review our complimentary Business Toolkit webinar.
Plan for your business deductions and credits. Reviewing where you spent money last year will help you assess your financial situation this year. Also, when making plans for this year, note that many items that were supposed to expire by the end of 2012 have been extended into 2013.
As you go through the year, keep your business and personal income and expenses separate. Use your personal card for only personal items and your business card for only business items. This will help track your business income and expenses for the year. Keep in mind that your business expenses must be ordinary and necessary expenses in order to be deductible come tax time.
For tax years starting in 2013, the IRS is allowing a simplified home office deduction as an alternative to this otherwise complex deduction. In order to qualify, under either the simplified or the standard method, you’ll need to plan now to ensure you have taken the right actions by the time next year’s tax season rolls around.
Plan for your itemized deductions. The amount of itemized deductions and personal exemptions is reduced for higher income taxpayers, starting in 2013. This reduction affects those with adjusted gross income (AGI) above the following thresholds:
- $300,000 for joint filers and surviving spouses
- $150,000 for married individuals filing separately
- $275,000 for heads of households
- $250,000 for single filers
Another change for 2013 is the threshold for deducting medical expenses. Many taxpayers will be able to deduct these expenses only to the extent they exceed 10 percent of adjusted gross income (AGI) in 2013, up from 7.5 percent in 2012.
Consider funding retirement accounts. Retirement accounts traditionally provide helpful tax advantages. You will want to discuss with your advisor which type is best for you. Pre-tax contributions could help you stay below the thresholds that trigger the various new tax pitfalls. This could be especially helpful in avoiding the 0.9 percent Medicare surtax on higher wage income.
Although a distribution from a traditional IRA or 401(k) plan is not considered “net investment income” for purposes of the 3.8 percent tax, it does increase your modified adjusted gross income. This could cause your other unearned income to be subject to the tax, if you trigger the relevant threshold.
Distributions from a Roth IRA do not increase modified adjusted gross income for purposes of the 3.8 percent tax on net investment income. However, contributions to a Roth IRA are not deductible and are subject to income limitations.
If you have a retirement account, review your asset allocation with your investment advisor. Some assets are better held in a taxable account while others should be in a nontaxable account.
Consider charitable donations. If you have been thinking of donating to your favorite charity, now may be a good time to do so, in light of the income tax deduction it provides. Also, the charitable remainder trust may prove to be very attractive to donors with highly appreciated assets.
Consider your state tax situation. You’ll also want to consider your state tax situation. Each state taxes business income and individual income differently.
Stay on top of your estimated tax payments. The various additional taxes starting this year may translate into a need for some people to increase withholding from their wages or to make higher estimated tax payments. This especially true if you have a combination of wage and self-employment income, or if you have wage income from more than one employer. An employer does not withhold for the 0.9 percent additional Medicare tax until the wages the employer pays you exceed $200,000 – even if you know in advance that you will be underwithheld due to a spouse’s earnings or a second job. It’s painful enough to have to pay tax – you don’t want to have to also pay penalties and interest that could easily have been avoided.
Have a system for recordkeeping. Keeping good records is imperative for any small business owner, and it truly helps at tax time. Before stuffing away all of this year’s tax documentation, make sure you have an organized system in place for storing your tax-related documentation as you acquire it throughout the year. One way to get organized is to use the return that you just filed to create a list of the documents that were needed to prepare it (e.g., any property tax bills, mortgage interest statements, stocks bought and sold, receipts and invoices, brokerage statements, bank statements, each W-2, each 1099, each Schedule K-1, etc). Keep this list as an ongoing guide for what you will likely need every tax season in order to complete your return.
Not sure if you’ll need a document? Follow this rule: When in doubt, save it. Tax return preparation held up by missing documents risks late-filing and payment penalties. It is much easier to discard an unnecessary document later, than to search endlessly for a missing document.
You could use your list to create categories, or labels, for a standing folder that stores your documents and receipts as you acquire them throughout the year.
Filing receipts and documents on an ongoing basis throughout the year saves a tremendous amount of time come tax season. By doing so, you won’t have to sort through mounds of paper and “try to remember” what each was for. This frees you up to focus on what you do best – running your business.
In addition, various apps and programs are available at little or no cost to help you with your bookkeeping and accounting needs. Some will even pull data from your email, your various online accounts, or other sources, and organize it for you. If you decide to use this type of system, make sure ahead of time that it will meet your needs come tax time.