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Smart tax planning doesn't stop on April 15

April 22, 2014

With the tax-filing deadline behind us, it's a good time to look ahead for ways to minimize your tax bite in 2014—and beyond—while keeping recent federal tax law changes in mind.

"The number of new taxes and regulations need not cause a radical change in your strategy," said Sarah Hammer, a senior analyst with Vanguard Investment Strategy Group. "Vanguard's thinking on the best way to tax-optimize your portfolio remains the same as it was last year."

Instead, we encourage you to focus on smart tax moves that can maximize your after-tax investment returns, including:

With a few exceptions, the tax rules introduced in 2013 still apply in 2014. Here are highlights of tax-law changes to help you plan for the year ahead. Because some of the rules are fairly complex, we suggest that you consult a professional financial or tax advisor about your situation.

Federal income tax changes

The top tax bracket increased in 2013 from 35% to 39.6% for single filers above $400,000 in adjusted gross income (AGI) and married couples above $450,000. While the rates haven't changed for the 2014 tax year, the income brackets have widened and exemptions have been raised to adjust for inflation. For more information, visit IRS.gov.

2013 and 2014 tax rules at a glance

Federal marginal income tax brackets
2013
(for taxes due in April 2014)
2014
(for taxes due in April 2015)
Single:
  • 10% ($0–$8,925)
  • 15% ($8,926–$36,250)
  • 25% ($36,251–$87,850)
  • 28% ($87,851–183,250)
  • 33% ($183,251–$398,350)
  • 35% ($398,351–$400,000)
  • 39.6% ($400,000+)
Married filing jointly:
  • 10% ($0–$17,850)
  • 15% ($17,851–$72,500)
  • 25% ($72,501–$146,400)
  • 28% ($146,401–$223,050)
  • 33% ($223,051–$398,350)
  • 35% ($398,351–$450,000)
  • 39.6% ($450,000+)
Single:
  • 10% ($0–$9,075)
  • 15% ($9,076–$36,900)
  • 25% ($36,901–$89,350)
  • 28% ($89,351–$186,350)
  • 33% ($186,351–$405,100)
  • 35% ($405,101–$406,750)
  • 39.6% ($406,751+)
Married filing jointly:
  • 10% ($0–$18,150)
  • 15% ($18,151–$73,800)
  • 25% ($73,801–$148,850)
  • 28% ($148,851–$226,850)
  • 33% ($226,851–$405,100)
  • 35% ($405,101–$457,600)
  • 39.6% ($457,601+)
Personal exemptions and itemized deductions
(see below for more information)

2013

2014

PEP and Pease limitations: Reinstated for higher-income taxpayers. Remain repealed for income at or below $250,000 (individual filers), $275,000 (heads of households), and $300,000 (married filing jointly) for tax years beginning after December 31, 2012. PEP and Pease limitations: Remains repealed for income at or below $254,200 (individual filers), $275,000 (heads of households), and $305,050 (married filing jointly).
Capital gains and dividend taxes 
2013 and 2014
Short-term gains taxed as ordinary income.

Long-term gains taxed based on your top marginal income tax rate:

  • 0% if you're in the 10% or 15% brackets.
  • 15% if you're in the 25%, 28%, 33%, or 35% brackets.
  • 20% if you're in the 39.6% bracket.
Qualifying dividends continue to be taxed at the same level as capital gains.

Additional Medicare tax on investment income explained below.
Medicare taxes 
2013 and 2014
Additional 0.9% tax on salary and/or self-employment income (only for higher-income taxpayers):

  • Above $200,000, if single.
  • Above $250,000 (combined), if married filing jointly.
  • Above $125,000, if married filing separately.
Additional 3.8% tax on net investment income (including long-term capital gains and dividends) if your modified adjusted gross income exceeds:
  • $200,000 (single).
  • $250,000 (married filing jointly).
  • $125,000 (married filing separately).
The surtax was created to fund Medicare expansion as part of the Affordable Care Act and is reportable on IRS Form 8960.
Estate, gift, and generation-skipping taxes
(see below for more information)
2013  2014 
Exemption: $5.25 million for individuals.

Tax rate: 40% on amounts above the exemption.

Estate and gift tax regimes remain unified, and spouses can continue to access unused estate tax exemption amounts.
Exemption: $5.34 million for individuals.
Tax rate: 40% on amounts above the exemption.

Estate and gift tax regimes remain unified, and spouses can continue to access unused estate tax exemption amounts.
Qualified charitable distributions
2013 and 2014
If you're 70½ or older, all or part of your annual required minimum distribution (RMD) could be made directly from an IRA (but not a Roth) to a qualified charity, up to $100,000 per year, without the distribution being treated as taxable income. However, Congress did not extend this provision beyond its expiration date of December 31, 2013.
Social Security payroll tax
2013  2014 
Flat 6.2% withholding rate on income up to $113,700 (applies to both employers and employees). Flat 6.2% withholding rate on income up to $117,000 (applies to both employers and employees).


Pease limitation and personal-exemption phase-out

The Pease limitation on itemized deductions continues to apply in 2014. This limitation reduces many itemized deductions (such as mortgage interest expense, charitable contributions, and state and local taxes) by 3% of the AGI that exceeds $254,200/$305,050 for single/married filers, but up to a maximum of 80% of what the itemized deductions would be without the new restrictions.

Sarah HammerThe personal-exemption phase-out continues to apply at a 2% reduction in personal and dependent exemptions for each $2,500 over the threshold of $254,200/$305,050, up to the complete elimination of exemptions.

According to Ms. Hammer, the Pease limitation does not necessarily affect the tax deductibility of charitable giving.

"If your Pease limitation is already met by other deductions such as state and local taxes or mortgage interest, then you'll likely still enjoy the full benefit of charitable deductions," she said.

We realize these rules can be quite complex and urge you to consult a tax planning professional before filing your taxes.

Alternative minimum tax exemption increases in 2014

The exemption thresholds increase for 2014. Married couples filing jointly will be exempt up to $82,100 and single filers up to $52,800. The alternative minimum tax (AMT) is a federal income tax calculated separately from the regular federal income tax. It is designed to prevent taxpayers—particularly those with high incomes—from using certain deductions and credits (called tax-preference items) to pay little or no taxes.

Tax rules for kids

In 2014, children under age 19 will pay no federal income tax on their first $1,000 of "unearned income"—that is, capital gains or interest. They'll also be taxed at their individual rate on the next $1,000. For income above $2,000, they will be taxed at their parents' rate, unchanged from 2013.

The same rules apply for full-time students under age 24, unless their earned income (wages, tips, and other pay derived from employment) is greater than half of their parents'. Individuals age 19 and older and dependent full-time students age 24 and older pay taxes at their own individual rate.

Retirement savings action items

Retirement plan contributions present another important source and opportunity for tax optimization. For the 2014 tax year, the federal contribution limit to a 401(k), 403(b), and 457 is $17,500, the same as in 2013. If you're age 50 or older, you're permitted to make a "catch-up" contribution of $5,500.

For IRAs, whether traditional or Roth, the maximum contribution for those under age 50 is $5,500. If you're 50 or older, you can contribute an additional $1,000. Contributions to a traditional IRA are generally tax-deductible. Certain IRS restrictions apply if you're an active participant in your company's retirement plan, such as a 401(k).

Gifts and estate planning

The gift tax annual exclusion amount for 2014 is $14,000—the same as 2013. In other words, an individual who gives a gift of up to $14,000 every year to any number of people will generally not be taxed. Married spouses filing jointly can give twice that amount—$28,000—and there's no limit for gifts paid toward tuition or medical expenses if paid directly to the provider.

Gifts beyond those amounts would then count toward the lifetime gift and estate tax exemption, which would require filing a gift tax return on IRS Form 709. The gift and estate tax exemption (amount exempt from gift and estate tax) was made permanent in 2013 and is inflation-adjusted. For 2014 the gift and estate tax exemption is $5.34 million. Gifts above the exemption amount will be taxed at 40% to the giver.

According to Ms. Hammer, "the gift and estate tax regimes are 'unified,' which means that a gift made during your lifetime above the exclusion reduces your estate tax exemption, dollar for dollar. The unification feature creates opportunities for smarter gifting strategies that could benefit income and estate taxes concurrently."

The bottom line? Smart tax planning need not be a seasonal event. Understanding the rules and following some fairly simple steps can help you develop a sound tax-planning strategy for years to come.

Notes:

  • All investing is subject to risk, including the possible loss of the money you invest.
  • Tax-loss harvesting involves certain risks, including, among others, the risk that the new investment could perform worse than the original investment, and that transaction costs could offset the tax benefit. There may also be unintended tax implications. We recommend that you consult a tax advisor before taking action.
  • Links to third-party websites will open new browser windows. Except where noted, Vanguard accepts no responsibility for content on third-party sites.
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