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A Few 2013 Tax Law Changes You Should Know About

May 30, 2013

These are some of the more mainstream changes in the tax law for 2013. They cast a fairly wide net and snare most of us in it. We'll try and offer some insight on each one to see how or why it may impact you.

By the way, these are not even close to being all the changes--think of the Raid commercial that shows you the one cockroach in your kitchen and then they show you the x-ray view of your walls with dozens more in there...or if that's too unpleasant, think of the magician who stuffs one colorful handkerchief into his closed fist and then magically pulls out dozens of brightly-colored ones from where there seemed to be only one...ahh, much better.

By the way, we had already discussed most of these when they were in a proposed stage (remember the fiscal cliff fiasco) in our 09/05/12 blog here:

Anyway, without further ado, here are a few things for you to read, ponder, and most importantly, remember.

* The threshold for deducting medical expenses increases to 10% of Adjusted Gross Incoma (AGI). Over the age of 65, the threshold stays at 7.5% of AGI. *

This one is bad. It was already tough to get a deduction when the threshold we had to exceed was 7.5% of the AGI, now it's been increased to 10%!

So, a married couple grossing about $52,000/yr would now be able to claim a medical deduction for any medical expenses that exceed $5200, whereas before they would have been able to claim any medical expenses exceeding $3900. That $1300 they lost translates to $195 more in taxes they'll have to pay (15% tax bracket).

A second family grossing $95,000/yr ends up losing $2375 of medical deductions and it's costing them an additional $594 in taxes (25% tax bracket).

A single parent making $32,000 now loses $800 of medical deductions and ends up paying $120 more in taxes.

* 401k max contribution is $17,500 and taxpayers born before 1964 can contribute up to $23,000 *

This one's good. If you're not too sure about whether or not putting money into your 401(k) is a good strategy for you, keep in mind a few things (and read more about it or talk to your company's 401(k) rep).

First, your contributions to the plan reduce your taxable income. This is what makes it so appealing. Spoke with a couple the other day who are in a position to "max out" their 401(k) contributions (kids are grown, mortgage is paid), and they're at that "catch-up" age where they can contribute up to $23,000 each. Imagine the tax savings of at least $6,900 (if in 15% bracket). Okay, so not too many people can afford to "max out" their 401(k), but you may be able to afford a $20 or $30 deduction every paycheck--you spend that much just going to the movies or ordering a pizza!

Second, the money you set aside can not be taken out without paying a 10% "early withdrawal penalty" until you're at least 59 1/2 (there are very few exceptions). Thirdly...okay, okay, here are the exceptions, per IRS site:

"Distributions that are not taxable, such as distributions that you roll over to another qualified retirement plan are not subject to this 10% additional tax. For more information on rollovers, refer to Topic 413.

There [a few other] exceptions to this 10% additional tax. The following six exceptions apply to distributions from any qualified retirement plan:

1. Distributions made to your beneficiary or estate on or after your death.
2. Distributions made because you are totally and permanently disabled.
3. Distributions made as part of a series of substantially equal periodic payments over your life expectancy or the life expectancies of you and your designated beneficiary. If these distributions are from a qualified plan other than an IRA, you must separate from service with this employer before the payments begin for this exception to apply.
4. Distributions to the extent you have deductible medical expenses (medical expenses that exceed 7.5% of your adjusted gross income), whether or not you itemize your deductions for the year. For more information on medical expenses, refer to Topic 502.
5. Distributions made due to an IRS levy of the plan under section 6331.
6. Distributions that are qualified reservist distributions. Generally, these are distributions made to individuals that are called to active duty for at least 180 days after September 11, 2001.

The following additional exceptions apply only to distributions from a qualified retirement plan other than an IRA:

1. Distributions made to you after you separated from service with your employer if the separation occurred in or after the year you reached age 55, or distributions made from a qualified governmental defined benefit plan if you were a qualified public safety employee (State or local government) who separated from service on or after you reached age 50.
2. Distributions made to an alternate payee under a qualified domestic relations order, and
3. Distributions of dividends from employee stock ownership plans."

( Yes, we copied-and-pasted that list---it was way too much to type! You can read even more about it at )

Third, if you do withdraw money--whether you meet an exception or not--it will be taxed at whatever your income tax rate is. So, for goodness sake, tell the plan administrator to withhold federal AND state taxes on all 401(k) distributions. You would be surprised how many people find out--at our desk when the money's been spent and the tax due is staring at them on page 2 of the 1040 return--that 401(k) distributions are counted as income. We're talking about owing thousands of dollars, not just a couple of hundred extra.

* IRA and Roth IRA contribution limit is $5,500. Taxpayers born before 1964 can contribute an additional $1,000 *

Basically the same rules as 401(k)'s above with a few differences. One notable difference is that you can withdraw up to $10,000 from an IRA for a first-time home purchase, without having to pay the 10% early withdrawal penalty (still must include it as taxable income, though).

For other IRA stuff, read our blog dated 12/05/12. Check it out:

* Standard mileage allowance for business miles is 56.5 cents *

This is for those who are self employed or for those employees who use their vehicles for their job and they are not reimbursed for mileage. The awesome thing about being able to take mileage is that you don't need to keep all of your vehicle gas & repair receipts, you don't have to worry about depreciating your vehicle (it's already figured in the mileage rate), and it is a much simpler method of taking the deduction.

The thing that you absolutely, positively have to do is keep a vehicle mileage log. You can paraphrase the familiar saying with, "a few seconds are worth a good deduction" when speaking of the log. No need to get fancy or expensive here. A 15-cent notebook and a pencil work just as well as a GPS-aided computarized printout does. Just make sure you have the following columns across the top of the page (and fill out the information, of course!): Date|Destination|Odometer Starting|Odometer Ending|Total Miles|Business Purpose.

Check out our no frills 100% free Excel Vehicle Mileage Log in the "as seen in our blog" section in the Files link above. Copy it, save it to your hard drive, give or e-mail it to your friends, print it, fill out the boxes to make a pattern and then crumple it up to get your frustrations out...whatever, it's free!!!

FYI, in case you're wondering, medical and moving mileage (if qualified) got an extra penny and are now 24 cents per mile. Charitable mileage stays at 14 cents per mile.

* Health Savings Account limit is $6,450 for family coverage and $3,250 for singles. Taxpayers born before 1959 can contribute an additional $1,000 *

This one's also good to do, if you can do it. You must be enrolled in a High Deductible Health Plan to be able to open up an HSA. It basically works like a retirement account in the sense that whatever you contribute into it reduces your taxable income. If you're not familiar with what an HSA is, it's basically a checking account that you set up to pay for your medical expenses for the year. You always pray for a healthy year, but let's say that you know you'll have to pay for the kids' braces ($1200), your prescriptions ($300), your contacts ($300) and a few doctor visits ($200), then why on earth would you not contribute $2000 into your HSA? Even at 15%, this represents a $300 tax savings.

You know what else is cool about the HSA? Let's say the kids didn't need braces because once a tooth got pulled, all the other teeth realigned themselves. That extra $1200 that you now have in the HSA because you didn't need to spend it stays in the account making money for you and it basically turns into another retirement vehicle for you.

Please note that on an HSA, any money taken out for non-medical use will be taxed like regular, ordinary income and will also be subject to a 10% surtax if you are not 65 years old when you take the distribution.

Here is IRS publication 507, it's super detailed as to what they consider medical expenses:

Equally as important is a list such as this one, which also lists some expenses that are not qualified:

A final word on HSA, note that medical expenses have to be incurred after the HSA was established, not before. In other words, don't go set up an HSA account a week after you've had $6000 in dental work and expect to pay for it with HSA funds. Go set up the HSA first and then schedule your dental appointment once you receive your checks and debit card for the account.

* 39.6% rate now applies to taxable income over $400,000 for singles, $425,000 for head of household, and $450,000 for married couples filing jointly *

This is a brand new tax bracket created for those "lucky ones" who "lucked out" and "get" more than $400,000 per year (I didn't know "luck" was a synonym for "hard work"). They get to pay 39.6% of tax on amounts over $400,000/year.

Well, at least we're not in France, where they're thinking of doing something to the effect of 60% or 70% income tax--I even read the other day that somewhere in Europe, they're thinking of a 100% income tax rate (not a typo--100%!!)

* 2013 standard deduction increased to $12,200 for married filing joint, $6,100 for single, and $8,950 for head of household *

Nothing really to say here...seems to increase slightly every year. As the standard deduction continues to increase, those who are past the halfway point in their mortgages and whose mortgage interest deduction is barely helping them itemize should really consider just paying off that mortgage. I just spoke to a gentleman who only owed about $6000 to the mortgage company--interest was only about $500/yr at about 5%. I told him to pay it off--where else is he going to get a 5% return on his money? Certainly not a savings account or CD's.

* 2013 personal exemption increases to $3,900 *

Not much to say here. Goes up a little each year.

* 2013 Social Security wage base increases to $113,700 and the amount needed to qualify for coverage goes to $1,160 per quarter *

This is a $3600 increase from 2012. That's a $223 increase in Social Security tax per taxpayer. A married couple, then, is now paying $446 more in Social Security. Also, keep in mind that the Medicare component of 1.45% is payable on all earnings--whether you make $10,000 or $10,000,000 per year.

If you want to get a kick and check out how this tax has progressed (base began at $3,000--now almost $114,000), check out the Social Security website:

* Estate and gift tax exemption increases to $5,250,000. The tax rate jumps to 40% and the annual gift exclusion is $14,000 per donee.

First, let's establish that if any of you are feeling so generous and want to send gifts our way...who are we to quash your generosity? Just keep it at under $14,000 and we won't have any problems! But seriously, if you have been "lucky" and amassed at least $5,250,000 ($5.25M), read on:

As of 2013, every person has a lifetime gift exclusion of $5.25M This means that they can give away that much without having to pay gift taxes. Now, there are many more people than you'd think with that kind of money out there--of course you factor in their cash, but also the cost of their homes, jewelry, furniture, retirement accounts, art, perhaps their spouse was insured for $1 million, etc.

Anyway, the gift tax basically works this way: You can give anyone in the world up to $14,000 with no one having to report anything.

You can also give someone more than $14,000. In that case, only you fill out a gift tax return. The recipient of the money doesn't have to do anything but spend it. In the return you file, you will document the excess that you gifted over the $14,000 that is normally allowed. That excess will decrease your lifetime exclusion of $5.25M. Rinse and repeat year after year until you die.

So, for example, you transfer one of your houses to your oldest child, "Junior", free of charge (he didn't even pay the attorney fees), because that apartment he lives in isn't big enough for him, his wife, and the triplets that are on the way. The house is worth $124,000. Then you gave your daughter $54,000 that she "needed" to pay for her wedding expenses. "The Baby" graduated college and you hate to see the "poor boy" and his stay at home wife owing student loans, especially with your two grandchildren just starting school, so you give him $104,000 to pay down his loans. Finally, you just finished reading this blog and you were moved to donate $24,000 to the author.

If you did this all without consulting your spouse, then you just reduced your lifetime exclusion by $250,000 ($110K on the house, $40K on the wedding, $90K on student loans, and $10K on the author). No big deal---you still have $5M left to go.

But wouldn't it be a better deal if you still had the full $5.25M left to give? "But how? Tell me more," you ask (as you dream about having to face this problem some day).

The answer is your spouse. Remember that each of you can give each person $14,000 per year. This means that between you and your spouse, you can give each person up to $28,000 without having to report, pay, or reduce anything.

Junior needs a bigger place? No problem. Once the triplets are born, Mom and Dad come to the rescue and gift up to $140,000 ($28,000 for each of the five family members)--more than the house is worth, so no reduction in the exclusion.

Your princess wants a nice wedding? No problem, have them pay for the wedding, earn points on their cards, and after the wedding has been a success--and before the payments are due--give them up to $56,000 ($28,000 for each). Again no effect on exclusion amount.

The Baby's getting smothered by student loans? Hey, what are parents for, right? Since you guys can give him, his wife and the two newest academics in the family $28,000 each, for a total of $112,000--it more than covers the student loan balances and no exclusion is lost.

And finally, the author--again you are so moved by the information presented in the blog, that instead of giving him $24,000, you and your spouse "max out" and give him the full $28,000 (hey--I can dream, too!).

Category: Bookkeeping