Stay Out of the Surtax Zone with Year-End Tax Planning

10/1/2012 | Written by: Karen Reed

Tax planning can make a big difference in the amount of taxes you are legally required to pay, especially in a year that may mark the end of an era of lower tax rates. Beginning in 2013, taxpayers with modified adjusted gross incomes (MAGI) above certain thresholds will be subject to a 3.8% surtax. In addition, if Congress does not extend the “Bush Tax Cuts,” rates on investment income will increase for all taxpayers.

The new surtax will apply to the lesser of net investment income or the amount by which your income exceeds the threshold amount. The threshold amount is $250,000 for joint filers, $125,000 for married taxpayers filing separately from their spouses, and $200,000 for single and head of household filers. Even if your income tends to be far below these amounts, you could find yourself unexpectedly in the surtax zone without careful planning of your retirement plan distributions and investment sales.

Plan Your Retirement Distributions

Before you take a retirement plan distribution, consider all of your other sources of income as well as your spending needs. Retirement distributions from traditional IRAs and 401ks are added to your MAGI, so if you are close to the threshold amount, you may be able to adjust your distribution to stay under the threshold. Alternatively, you may want to consider taking a greater distribution in 2012 in order to plan ahead for 2013.

Qualified Roth distributions are tax-free and do not increase your MAGI. If you have Roth accounts, and expect to be near the income threshold for the surtax, plan your distribution amounts from your various accounts so that you stay under the threshold.

If you are currently putting money aside for your future retirement, the new surtax strengthens the case for choosing Roth accounts, especially if you expect to be in a high income bracket when you retire.

Conversion to a Roth Now Instead of Later

If you are planning to convert your traditional IRA accounts to Roth IRAs, you may benefit by completing your conversions this year instead of next if your Roth conversions have the potential to push your MAGI over the threshold for the surtax.

Sell your home in 2012 instead of in 2013

The taxable gain on the sale of a home is considered investment income, and amounts not excludable from income under section 121 may subject you to the surtax if your home has appreciated a great deal since you purchased it. In addition, if the “Bush Tax Cuts” expire, you’ll pay a higher tax rate on the gain in 2013. If you were thinking about selling your principal residence or vacation home in 2013, it might be worthwhile to consider the possible tax advantages of selling it in 2012 rather than next year.