How to prepare
To lessen the pain, LePley says most high-income taxpayers will want to maximize tax deductions, including charitable donations, but warns that both the PEP and Pease limitations are difficult to avoid, and should be considered with a comprehensive wealth-management strategy.
Shauna Wekherlien, owner of Tax Goddess Business Services, says high-income taxpayers may want to bundle medical expenses in 2013 because they must exceed 10% of adjusted gross income to qualify. "Taxpayers that are considering elective medical procedures will want try to schedule them all in one year to maximize the value of the deductions," she said.
LePley suggests that high-income households consider taking advantage of the federal estate and gift tax exemption of up to $5.25 million over a lifetime. Taxpayers who used the full exemption in 2012 still have an additional $130,000 to gift tax-free this year due to inflation adjustments.
A recent JPMorgan Chase paper from a team of wealth advisers and investment specialists recommends that wealthy taxpayers who own several homes also may want to consider switching their main domicile to the home in the state with the lowest state income tax burden.
The report also suggests tax-advantaged investment strategies such as purchasing tax-exempt municipal bonds, annuities and life insurance policies.
"There are certainly esoteric investments out there, such as structured notes and private equity, but those tend to be fraught with risk," says Karen Kruse, the president of First Tennessee Advisory services.
Kruse said dividend-paying stocks and solid blue chips should be held in tax-advantaged accounts, such as individual retirement accounts. "Outside of your tax-exempt accounts, you would tend to go towards growth-oriented stocks that typically don't throw off income," she said. "You buy and hold them, and your gains become long-term gains."
She is not advising clients to invest in long-term bonds: "You might want to invest in municipal bonds, but you'd really want to stay short," she said. "I think the market is waiting for the first sign of inflation." Kruse recommends investing in assets that will rise with inflation such as real estate investment trusts, real estate, utilities and commodities.
According to LePley, retirees will be in the best position to save, since they have more flexibility with their annual distributions. "Most working people are not going to be able to manage what they make," he said. "But, for retirees, that's where we can manage a little better."
Taxpayers older than 70 1/2 can also give up to $100,000 per year from IRAs to qualified charities for the 2012 and 2013 tax years only. These donations meet minimum distribution requirements and limit taxable income.
A quick guide to deductions
The big three:
- Charitable deductions. Contributions to charitable organizations may be deducted up to 50% of adjusted gross income. Contributions to certain private foundations, veterans organizations, fraternal societies and cemetery organizations are limited to 30% of adjusted gross income.
- Mortgage interest. Any interest on a mortgage is deductible, but filers can't deduct interest on mortgages that exceed $1 million. If you have a second loan or a home equity line of credit, the filer can deduct interest only on loans up to $100,000.
- State, local and property taxes. A handful of states have no state income tax, but for filers in high-income tax states, this deduction prevents residents from being taxed twice.
Other miscellaneous deductions:
- Gambling. Gambling winnings are fully taxable and must be reported on a tax return, however taxpayers can limit the amount of winnings taxed by deducting their gambling losses.
- Investment and advisory fees. Certain investment management and advisory fees also are deductible.
- Alimony. All payments that qualify as alimony are also deductible under the U.S. tax code. However, child support, noncash property settlements and use of a filer's property do not qualify.
- Job-related moving expenses. If you moved due to a new job, you may be able to deduct your moving expenses. The new workplace must be at least 50 miles than your previous place of employment was, and the job must be full time.
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