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Give away your tax bill


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With the American Taxpayer Relief Act of 2012, individuals earning over $400,000 per year or married couples earning more than $450,000 are now subject to higher tax rates including a new long-term capital gains tax rate of 20 percent. 

Single taxpayers earning $250,000 and married couples earning more than $300,000 are also subject to phased-out exemptions and deductions. Even individuals with taxable income of more than $200,000 and married couples with taxable income exceeding $250,000 will likely find that they are paying more taxes on both earned income and capital gains in 2013.

The 2009 Affordable Care Act (ACA) provides for an additional 3.8 percent Medicare tax on all investment income, when total taxable income is above $200,000 for an individual or $250,000 for a married couple.  Once a married couple’s combined taxable income exceeds $250,000,  they will pay a minimum of 18.8 percent on long term capital gains and qualified dividends and 36.8 percent on short-term capital gains as well as “non qualified” dividends or interest.

With the market up dramatically in 2013 and the possibility of a coming correction, many investors would like to lower their equity exposure but do not wish to pay the new higher taxes. Here are three ways that higher earners can “give away” some of their tax bill.

1. Contribute to a donor advised fund.  By contributing appreciated long term stock to a donor advised fund, the donor may take a charitable tax deduction of the full value of the donated stock in 2013.  A donor advised fund is similar to a small “family foundation”, where the owner can contribute to their favorite charities now or at any time in the future.  Setting up a charitable giving fund, with most brokers, is a simple process. Once established, donate highly appreciated long term capital gain stock instead of selling it.  Not only will the 15-25 percent long term capital gains taxes be saved, a charitable deduction for the full value of the stock donated can be taken.

2. Minimizing taxable required distributions. Retired taxpayers, over age 70½, with an IRA, 401(k), or other retirement plan must pay taxes on their Required Minimum Distribution (RMD).  These taxes can be eliminated if the RMD (up to $100,000) is given directly to one or more charitable organizations.  While there is no charitable deduction for the gift, no income taxes are paid on the RMD.  This gift must be given directly to a qualified charitable organization.

3. Gifts to children and/or grandchildren. A single person can gift $14,000 to any recipient and a married couple can gift up to $28,000 to each recipient.  Thus, a couple with three children and seven grandchildren could gift $280,000 each year without the gift being recognized under the gift tax rules. To maximize the tax benefits, gift short term capital gain stocks that you may wish to sell but do not want to take the significant income tax consequences required.

As an example, for a married couple with taxable income over $146,000, any short term stock sale would be federally taxed at 28 percent.  However, if a child with low income receives the stock as a gift, the child could sell this stock and likely pay only 10 percent-15 percent in federal taxes.  This strategy will only work if the gift recipient is over the age of 23 or is no longer a dependant, as this will avoid the “kiddie tax.”.

Gifting of appreciated stocks to charities and/or individuals can lower an individual’s tax liabilities. The rules for gifting are somewhat complex and if not precisely followed, could negate the gifting tax advantages.  Before making a gift, take the time to study the rules of your proposed gifting strategy or have a qualified financial planner help you through the arcane gifting rules.

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Wayne Farlow

Wayne Farlow is the founder of Financial Abundance, LLC, a Registered Investment Advisor firm.  He is a Certified Financial Planner (CFP®), focusing on Retirement Planning, Investment Management, Small Business Owner Planning and Sudden Wealth/Inheritance Planning.  His book, “Financial Abundance Guide,” is available free at www.farlowfinancial.com .  He can be reached at wayne@farlowfinancial.com or at 303-554-0309.

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