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Using your 2012 tax-year return to plan for the future


Andrew Presti

Did you owe tax on your 2012 tax return? Did you receive a sizeable refund? Or, conversely, did you receive a smaller refund than you expected? If so, take another look at your tax return from this past year. It is quite possible that by making a few changes, you could put more money in your pocket in the short term. And by examining your investments as they are reported on your tax return, you may be able to strategize for the long-term future. Trying to implement this type of plan may seem difficult at first. However, just by looking at your tax return, you can start the critical planning that can lead you to broader goals of financial independence and a comfortable retirement.

Federal withholding

If you received a large tax refund, it might be time for you to adjust the amount of tax the federal government withholds from your paycheck. Although next year your refund check may not be as large, you will have the advantage of seeing a larger sum deposited directly into your pocket every month. To adjust your withholding, fill out and sign a Form W-4, and submit it to your employer. You would want to do this in cases where your adjustments to income, exemptions, and deductions remain relatively steady from year-to-year, and where the government consistently is required to give you a large refund.

If you do not change your withholding allowances, the government essentially is holding your money for a year without paying any interest on it. You may lose some potential investment opportunity or, at the very least, the ability to increase your monthly discretionary income. On the other hand, many taxpayers prefer to receive the large refund check after tax filing season because it is a no-hassle way to ensure large savings at the end of the year.

Conversely, many taxpayers may want to change their withholding allowances because they owe the government a significant amount of money at the end of the year. Taxpayers who expect to owe at least $1,000 in tax for the 2013 tax year, after subtracting withholding and any refundable credits, and who also expect their 2013 withholding and credits to be significantly less than the projected tax owed for 2013, may need to file estimated taxes. Failure to do so could result in penalties. Alternatively, taxpayers should consider making quarterly estimated tax payments, especially if they anticipate a significant amount of investment gains for the year or other income unrelated to wage compensation.

State withholding

Some people are entirely exempt from state tax, but it is withheld from their paychecks nevertheless. At the end of each year, they may include the amount of their state taxes in their itemized deductions, but then receive a refund which they have to declare as income in the next year. This problem particularly applies to active duty military families, many of whom are posted in states other than their state of residency. Military families can check with their state income tax authority to see if there is an appropriate form that can be completed and filed, which would exempt them from withholding. A higher adjusted gross income (AGI), even if it is subsequently reduced by itemized deductions, can erode other adjustments to income, such as a deduction for student loans, IRA contributions, higher education expenses, and more because of certain AGI caps on these benefits.

Tax rates and adjusted gross income

As you may have heard, Congress allowed the Bush-era tax cuts to expire for higher-income earners. That means joint filers with more than $450,000 of adjusted gross income ($400,000 for single individuals) are now in the 39.6-percent tax bracket. Taxpayers at this level of income or above are also subject to a higher long-term capital gains tax rate: 20 percent, up from 15 percent paid by other taxpayers.

In addition, for tax years beginning in 2013, the 33-percent tax bracket for individual taxpayers ends at $398,350 for married individuals filing joint returns, heads of households, and single individuals. If you were hovering near the bottom of the 35-percent bracket for the 2012 tax year, then you might want to see if you can readjust your income so that you fall within the 33-percent category.

Higher-income taxpayers also have two new taxes to worry about for 2013 and beyond. Joint-filing taxpayers with modified adjusted gross income of $250,000 ($200,000 for single filers) are also subject to the 3.8-percent surtax on net investment income and a .9-percent Additional Medicare Tax. Look at your adjusted gross income for last year. Does it approach these figures? Is it on the edge of the income brackets? Will stock market increases this year put you over the top of those income thresholds? If so, it may be time to find ways to reduce your income for 2013.

Investments

At some point in your efforts over the years to accumulate a savings nest egg, you will need to consider diversification, the process of putting your money in the right kind of investment vehicles to satisfy your personal risk strategy and achieve your goals. Looking at your tax return will help you decide whether the investments you now have are the right ones for you. For example, if you are in a high tax bracket and need to diversify away from common stocks, investing in tax-exempt bonds might help, especially if you have state income taxes to worry about, too.

Reviewing the Schedule D and Form 8949, which cover Capital Gains and Losses from last year’s return and from the past three or four years, can be an eye-opener for many. Did you hold stocks long enough to be entitled to the long-term capital gains rate? Did you try to balance short-term gains with short-term losses? Are you bouncing from one investment trend to another without a long-term investment plan that achieves long-term needs? Are your mutual funds “tax smart”? Become familiar with different types of banking institutions and their products. Find out about CDs, money-market funds, government securities, mutual funds, index funds, and sector funds and how they interrelate with the determination of your tax liability each year. You may want to put that knowledge to work in your investment strategy.

Medical costs

Should you be taking advantage of the medical expense deduction? Many people assume that with the 10 percent adjusted gross income floor on medical expenses now imposed for tax years starting in 2013 (7.5 percent for seniors) that it doesn’t pay for them to keep track of expenses to test whether they are entitled to itemize. But with the premiums for certain long-term care insurance contracts now counted as a medical expense, some individuals are discovering that along with other health insurance premiums, deductibles and timing of elective treatments, the medical tax deduction may be theirs for the taking.

Retirement planning

Don’t forget to protect for eventualities. Are you maximizing the amount that Uncle Sam allows you to save tax-free for retirement? A look at your W-2 for the year, and at the retirement contribution deductions allowed in determining adjusted gross income should tell you a lot. Should your spouse set up his or her own retirement fund, too? Are you over-invested in tax-deferred retirement plans? If so, you may lose a significant amount of your nest egg to tax after retirement.

When you are reviewing last year’s tax return, it may help to review some of what you’ve learned from it. This could foster an important conversation with your tax advisor about how to establish or modify your plan for your financial future. If you would like to review last year’s completed tax return with future planning in mind, please feel free to give us a call and set up a time when we can meet and discuss this matter.