FA Playbook

Happy Holidays, now start tax planning

Shelly K. Schwartz, Special to CNBC.com
Now is the time to start tax planning
Now is the time to start tax planning

The last few months of the year may have everyone thinking about holiday cheer and pumpkin pies, but it's also prime time for investors to put tax-planning strategies into place that can help reduce their liability for 2013.

Indeed, Dec. 31 marks the cutoff date for delaying income, accelerating deductions, gifting appreciated assets and dumping investment dogs for the current filing year.

Such moves, however, require careful consideration of an investor's current and projected financial picture, said Melissa Labant, the director of tax advocacy for the American Institute of Certified Public Accountants. Labant, a CPA, is also a certified financial planner.

"Anywhere from September through November, taxpayers should be thinking about year-end (tax) planning," she said. "To be able to plan ahead, you have to know where you are."

(Read more: Year-end financial checklist)

The advice is even more crucial this year for high-income earners, said Labant, who pointed out that the Bush-era tax cuts expired this year for those in the highest tax brackets.

For 2013, married couples filing jointly with taxable income greater than $450,000 will face a new 39.6 percent top marginal income tax rate, plus a bump to 20 percent, up from 15 percent, on qualified dividend and long-term capital gains.

Joint filers earning more than $250,000 will also be subject to a new 3.8 percent Medicare surtax on net investment income.

"Taxpayers tend to look at their liability for prior years and assume that it will be the same for the current year, but when you have a year with significant tax law changes you can't assume your tax bill will stay the same," Labant said.

Taxpayers looking to keep more of their money from Uncle Sam this year need to start with a forecast, said John Napolitano, chairman of U.S. Wealth Management in Braintree, Mass.

Chris Bernard | E+ | Getty Images

Indeed, financial advisors say that taxpayers need to pay special attention if their income threshold has changed.

For example: Did an income change land you in a higher (or lower) tax bracket? Or, did it trigger the alternative minimum tax? The AMT is a parallel tax system that has impacted a growing number of middle-income Americans.

"Take out your 2012 tax return, put 2013 in a column next to it and go through it line-by-line to estimate the numbers," Napolitano said. "That gives you a first look at any issues that need to be handled over the next three months."

This year, for example, mutual fund distributions of dividends and capital gains are likely to be higher.

"It's been a pretty good year in the market and I expect fund managers will lock in returns for the year and that could have a pretty meaningful impact on distributions," Napolitano said.

(Read more: What you should ask your advisor)

Generally speaking, if a taxpayer expects to be in the same or a lower tax bracket next year it's best to defer as much income as possible until after the year-end, explains Edward Wacks, a financial planner and CPA with Ameriprise Financial in Fort Lauderdale, Fla.

Strategies that work include deferring year-end bonuses until January 2014, delaying the exercise of incentive stock options and postponing receipt of distributions beyond the required minimum from individual retirement accounts.

Such taxpayers should also consider accelerating deductions, he said.

This can occur by using various strategies, including: taking advantage of flexible spending accounts; maximizing pretax contributions to a 401(k) plan; prepaying deductible mortgage interest, real estate taxes and charitable contributions; making alimony payments early and paying out-of-pocket medical expenses to the extent they are deductible in December rather than January.

Conversely, those likely to be in a higher tax bracket next year should accelerate income and defer deductions.

Investors can also minimize their capital gains tax bite by selling stocks and mutual funds that have lost in value before the end of the year. The Internal Revenue Service allows investors to offset capital gains with capital losses dollar for dollar.

Financial experts stress that any excess capital loss can be used to offset other income, up to $3,000 per year. Leftover capital losses beyond that can be carried forward to offset gains and income in future years.

If an investor is selling shares that they wanted to keep, however, for the sole purpose of offsetting gains, be mindful of the wash-sale rule. That IRS rule prevents investors from claiming a loss on shares they repurchase within 30 days after, or before, the date of the sale.

Additionally, advisors are alerting their clients to the new tax rules for estate planning. Instead of an emphasis on avoiding estate taxes, some advisors are looking at plans that focus on trimming income taxes.

If someone is planning to leave an estate to their heirs, they can also reduce and potentially eliminate the tax bill this year by gifting appreciated stocks to someone in a lower tax bracket, like a child, Napolitano said.

For example, if a child is in the lowest (10 percent or 15 percent) tax bracket with little earned income, they'll pay no tax when they sell the stock.

Everyone, however, should be mindful of the kiddie tax, whereby part of a child's interest, dividends and other investment income totaling more than $1,900 may be taxed at their parent's tax rate instead of the child's.

The kiddie tax applies to a child if either of the following two conditions are true: The child has not reached age 19 by the end of the taxable year or the child has not reached age 24 and their earned income is not more than one-half of their support.

The kiddie tax does not apply unless all three of the following conditions are true: The child is required to file a return for the year; the child has at least one parent alive at the close of the taxable year; and the child will not file a joint return for the taxable year.

(Read more: How to pick the right college tax break for you)

Advisors are also talking to clients about the tax breaks they can receive from charitable donations.

Investors can donate appreciated property instead of cash to a charity, which yields double the bang for the buck. This occurs because an individual can deduct the property's fair market value on the date it gifts and avoid paying capital gains tax on the appreciation.

Before making a donation, however, investors are urged to check and ensure they are eligible to claim charitable donations as a deduction.

One of the impacts from the fiscal cliff legislation to be felt by high-income earners is the reintroduction of the Pease limitation.

While the American Taxpayer Relief Act of 2012 reduced the impact of the Pease limitation it can greatly limit itemized deductions.

The Pease limitation reduces the amount of itemized deductions like mortgage interest and charitable gifts, that married taxpayers filing jointly and earning more than $300,000 can claim. (The income threshold for single filers is $250,000.)

Labant stressed that year-end planning is a must for taxpayers in every income tax bracket. And it's never too soon to start, she said.

(Read more: Year-end planning is key)

Those who find they would benefit from harvesting capital losses, for example, or wish to avoid an estimated tax payment penalty need to take the time to execute their financial plan.

"Even if you are likely to have a large tax bill next April, you need to plan ahead for that," Labant said.

—Shelly K. Schwartz, Special to CNBC.com.

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