Investing and Backdoor Taxes

It’s been a pretty good year so far for the stock market, and you may have locked in some nice capital gains on investment sales, and/or received some hefty dividends from mutual funds (or may yet receive year end fund distributions). While all of this is good stuff (more money in your pocket), the additional gains and income could put you in the position of paying even higher taxes than you may anticipate.

In my practice, this past tax season was a “perfect storm” for a bunch of my clients, who got hit with additional/higher taxes, as well as the loss of various deductions. Let me run down a few things from last year that are still lurking out there this year.

Net Investment Income Tax – this was a new tax in 2013, and is a 3.8% tax on income such as capital gains, dividends, interest, and a few other items. Once income goes above certain levels, this additional tax will kick in.

Personal Exemption Phaseout – while this isn’t an additional tax per se, the fact that personal exemptions (for self, spouse, dependents) can be reduced literally to zero if income is high enough, which has the effect of raising taxable income, obviously creating a higher tax.

Itemized Deduction Phaseout – this works similarly to the exemption phaseout, in that when income is high enough, itemized deductions will be reduced. And as with the exemption phaseout, this exposes more income to taxation.

Higher Long-Term Capital Gains Rate – for taxpayers in the top tax bracket, long-term capital gains will be taxed at 20% and not 15% for most other taxpayers.

Alternative Minimum Tax – I’ve covered this in previous articles, but it’s something that’s also still hanging around, and shouldn’t be forgotten.

From a tax planning perspective, if you feel some or all of these could be applicable to you in 2014, and you don’t want surprises at tax time, I recommend that you contact your favorite CPA (maybe one whose name starts with “Jay The…”?) to crunch some numbers and get some additional guidance on ways to reduce the sting of some of these stealth taxes.

Holidays and Tax Planning

Thanksgiving is history. Black Friday’s gone. Cyber Monday’s in the books. What’s there to look forward to? The second half of Hanukkah? Christmas? Are you kidding, we’re talking tax planning, people!

That’s right, rather than thinking about ways to spend money, think about ways to save money, especially on taxes. Since there’s about a month left in 2013, you still have a little time to save a few dollars in tax before the ball drops in Times Square.

Net Investment Income Tax – starting with the 2013 tax year, taxpayers with adjusted gross income (AGI) over $200K single/$250K married filing jointly are subject to an additional tax of 3.8% on net investment income above the threshold amounts. This tax applies to income that includes capital gains, interest, dividends, rents, and others. While some of these items may be beyond your control (such as how much dividend is paid on a stock or mutual fund), you may be able to control your AGI, to keep it below the threshold where the 3.8% tax kicks in. One way is if you’re taking retirement plan (IRA etc) distributions. If you’re considering taking more than a minimum distribution, consider whether a higher distribution would put you above the level where the 3.8% tax kicks in.

Personal Exemption Phase-out – this “gem” has been (thankfully) missing from tax returns for the last three years, but has come roaring back for 2013. For AGI over $250K single/$300K joint, the deduction for personal exemptions reduces (phases out), and goes down to zero with AGI of about $372K single/$422K joint. Taxpayers closing in on the phase-out range of AGI should consider if there are ways to push off 2013 income to 2014, to keep personal exemptions intact.

Itemized Deduction Phase-out – similar to the personal exemption phase-out, the reduction of itemized deductions returns in 2013. Common itemized deductions are mortgage interest, real estate tax, charitable contributions, and others. As with the exemption phase-out, when AGI goes above the thresholds, the total allowed itemized deductions begin to reduce. Note that reduced deductions and exemptions have the effect of subjecting more income to tax, which has the effect of increasing your overall net tax rate.

As you may have concluded, the tax and phase-outs I mentioned above are driven by your level of AGI, so it’s important to look at ways to reduce your adjusted gross income. The best way to address this is to look at page 1 of your 2012 tax return, since the page 1 ends at AGI. Consider if there are ways of delaying income, taking losses on investments (which would reduce income/AGI up to $3K), switch investments to tax free municipal bonds/funds, and increasing retirement plan contributions, among other things.

While increasing itemized deductions won’t reduce your AGI, they will still probably net you some tax savings. Making additional charitable contributions could help, as would bunching medical or miscellaneous itemized deductions, both of which are subject to AGI related “floors”.

So while you’re in the middle of a tug of war with that jerk at Walmart over the last Xbox 360 on the shelf, just think about how much more fun it would be to save some money on your taxes!

How are you planning on saving on your taxes this year? Or next? Leave a comment and let me know what you’re thinking. And please forward this article to a friend or family member who might (tax) benefit from it.


Once upon a time, high income taxpayers were able to pay little or no income tax, because they were able to take deductions and credits for things that the average taxpayer couldn’t. IRS created the Alternative Minimum Tax (AMT) in 1969, in attempt to eliminate some of the benefits of all the deductions that high income taxpayers were getting, and generate at least some amount of tax.

The major problem with the AMT (and IRS recognizes it) is that it’s not indexed for inflation, so over the years, more and more middle-income taxpayers are finding that they’re owing more tax based on the AMT. I’ve seen this countless times over the years with my clients, and have had the same conversation with many people, often with the conversation starting out with the title of this article!

The AMT is computed on Form 6251. Generally, the computation starts with your adjusted gross income (AGI) less your total itemized deductions (line 41 of Form 1040). From this number, “alternative minimum taxable income” (AMTI) is computed, generally by adding back certain deductions that are allowable for the regular tax computation. For most taxpayers, the ones that come up most often are the itemized deductions for taxes and the miscellaneous itemized deductions. There’s a long list of other deductions and “tax preference” items that need to be added back to arrive at AMTI, but they’re beyond the scope of this article.

After arriving at AMTI, taxpayers are allowed an exemption amount, and the remaining amount will generally be subject to a tax rate of 26 or 28% to come up with the tentative minimum tax. Once this tax is computed, the amount is compared to the regular tax on the Form 1040, and if the minimum tax is higher, than bingo, you lose, and wind up with the AMT.

The 2011 AMT exemption amounts are $74,450 for married filing joint taxpayers, $48,450 for single and ‘head of household’ taxpayers, and $37,225 for married filing separately taxpayers. If your taxable income for regular tax purposes is higher than these exemption amounts, the AMT may apply to you, and you need to fill out Form 6251 to see if you are in the AMT.

I’ve attempted to make this as understandable as possible. If you think you might be in the AMT, it would probably be a good idea to have a tax professional prepare your taxes. Please pass this article along to your fellow taxpayers, and leave a comment if you’ve had a ‘run-in’ with the AMT.

I Started a Nonprofit, and Now I Have to Do What??

You just formed a nonprofit organization. Congratulations on your altruism, and your chutzpah! Most people would’ve just made a donation to the charity of their choice, and considered that to be doing their part to help humanity, or the environment, or the planet, or something else. You’ve taken a step past that; a BIG step. You’re going to personally help further a cause that’s near and dear to you, and that’s beyond commendable, because you’re about to sacrifice yourself in ways that you may not have considered.

This is a brief discussion of some things that you’ve hopefully thought of, when you decided to form your nonprofit. For those of you considering starting your own nonprofit, think about these things before you take the big leap. The following issues have all arisen in discussions with clients, over the years.

I’m in business for myself?

In a word, yes! Starting a nonprofit is the same as starting your own for-profit business, except you’re using the public’s money. Until you’re large enough to have your own staff, you’re going to be the program director, development director/fundraiser, bookkeeper, and other positions, all rolled into one. Taking into consideration other ‘adult’ duties (i.e. spouse, parent, ”real job”, soccer practices, etc), when you add the responsibilities of managing a nonprofit business, you may run out of hours in a day.

I have to file what with IRS?

Just because you filed with the Virginia State Corporation Commission (SCC) to be a non-stock corporation, doesn’t mean that you’re done with the formation. When most people think of forming a ‘nonprofit’, they’re thinking of a 501(c)(3) public charity, as recognized by IRS. That doesn’t come automatically with your SCC filing. To be recognized as a public charity, Form 1023 “Application for Recognition of Exemption…” must be filed with (and approved by) IRS. The application is fairly rigorous, and is not rubber stamped, so make sure all the information is completely and accurately filled out, before submitting.

I need to be a bookkeeper too?

For us CPAs, this part is a breeze, but for the general public, maintaining accounting records can be a real drag. If you’re going to be a public charity using public funds (contributions), you will be accountable to the public as to how you used their money. By some means (yourself, a bookkeeper, etc) you will need to keep books and records of the organization’s finances, for different purposes, one of which follows, next.

I have to file what with IRS?

I know, you’ve heard that already. The issue is, filing that original application for tax exemption with IRS doesn’t fulfill your obligations to them forever. A report of one length or another must be filed with IRS annually. It can be as detailed and complicated as the Form 990 (Return of Organization Exempt From Income Tax), which is the “long form” 990, or can be the 990-EZ “short form”, or even the 990-N “e-postcard”. Which form you file is dependent on how much your gross receipts and total assets were for each tax year.

This article barely scratches the surface of things that you need to consider when you form a nonprofit organization (or think of forming one). Remember, you’ll be using other peoples’ money, and will be held to a higher standard than if you were in business for yourself. Be prepared!