Investment-Related Taxes: Must-Knows for 2013

As 2012 wound down, fairly decent-sized tax hikes loomed for 2013, and tax-savvy investors and their advisors were scrambling. Dividends were set to once again be taxed at ordinary income tax rates, long-term capital gains were to jump to 20%, and estates of more than $1 million would be taxable at a 55% rate.

In the end, however, the changes that did pass through Congress were much more modest; few individuals will have to completely rework their financial plans to avoid much higher tax bills next year. That said, tax planning is one of the few categories that investors have a fair amount of control over: Maximizing tax-sheltered accounts, putting the right types of assets in tax-sheltered and taxable accounts, and properly sequencing withdrawals in retirement can all help improve your aftertax returns.

Here's an overview of some of the key tax-related changes that are taking effect with the 2013 tax year; note that I've focused on those that intersect in some fashion with your investment plan.

Dividend Tax
Although the impending hike in the dividend tax rate had led to a lot of hand-wringing, the modest increase that passed through Congress won't affect most investors. As in the past, investors in the 10% and 15% tax brackets will pay nothing on qualified dividends, and those in the 25%, 28%, 33%, and 35% tax brackets will pay a 15% rate on their qualified dividend income. The only change is for single filers earning more than $400,000 and married couples filing jointly who earn more than $450,000; for them, a new 20% dividend tax rate will kick in starting this year.

Even if you're not in the highest tax bracket, it still makes sense to consider parking dividend payers in your tax-sheltered accounts and reserving your taxable account for holdings that don't pay dividends. The key reason is loss of control. If a company that you hold in your taxable account pays a dividend, that's a taxable event for you, whether you wanted that dividend or not. (If you hold a dividend-paying fund, you'll owe taxes on any dividends paid out, even if you've reinvested those dividends back into the fund.) By holding nondividend payers in your taxable accounts, by contrast, you won't be on the hook for taxes unless you take action and sell shares.

Tax on Long-Term Capital Gains
As with dividend taxes, much is staying the same with long-term capital gains rates. Those in the 10% and 15% brackets will not owe capital gains tax on securities held for more than a year, while those in the 25%-35% brackets will see their long-term capital gains taxed at a 15% rate. The 20% capital gains rate will kick in for the same taxpayers who are seeing a dividend tax hike: single filers earning more than $400,000 and married couples filing jointly who earn more than $450,000.

Medicare Surtax
An outgrowth of the new health-care law, this new tax was moving full steam ahead regardless of what happened with the fiscal cliff negotiations. The 3.8% tax will be imposed on the lesser of an individual's net investment income for the year or adjusted gross income in excess of $200,000 for single filers and $250,000 for married taxpayers filing jointly. (Note that investment income is included in adjusted gross income.) What counts as net investment income? Short- and long-term capital gains, the taxable portion of annuity income, royalties, and rents. In addition, net investment income includes trading of financial instruments and commodities and income from passive activities (earnings from a business in which you have limited involvement). Net investment income does not include municipal-bond income, distributions from IRAs or other qualified retirement plans, pension and Social Security income, or capital gains from the sale of a principal residence, assuming the gains don't exceed $250,000 for individuals and $500,000 for couples and meet the other requirements to qualify for the Section 121 exclusion. This article discusses the new surtax in depth.

IRA Contribution and Income Limits
Contribution limits for IRAs are going up, at least a little. Investors under age 50 will be able to contribute $5,500 to their IRAs--either Roth or traditional--starting with the 2013 tax year, whereas individuals over age 50 can contribute $6,500. However, if you're squeaking in a contribution for the 2012 tax year, earlier limits ($5,000 for those under 50 and $6,000 for those over it) will apply.

Income limits for IRA contributions have also bumped up a bit. Individuals earning less than $69,000 in 2013 who are covered by a company retirement plan can make at least a partially deductible contribution to a traditional IRA. (Contributions phase out, or are reduced, for individuals who make between $59,000 and $69,000.) Married couples filing jointly can make at least a partially deductible IRA contribution if they earn less than $115,000. (Contributions begin to phase out for couples who make between $95,000 and $115,000.)

Roth IRA income limits have also increased. Individuals filing singly and making less than $127,000 will be able to make at least a partial Roth IRA contribution in 2013. (The amount you can contribute is phased out, or reduced, for single filers who make between $112,000 and $127,000 a year.) Married couples filing jointly can make at least a partial contribution if they earn less than $188,000 per year in 2013. (Contributions begin to phase out for joint filers earning between $178,000 and $188,000.) Individuals of any age can make a Roth IRA contribution, as long as they have eligible compensation, such as wages, salaries, tips, and commissions.

Roth IRA Conversions
The current Roth IRA income limits are little more than a formality because the so-called backdoor IRA maneuver, whereby a person funds a traditional nondeductible IRA and converts it to a Roth shortly thereafter, is alive and well. This strategy is a good one for investors looking to get some assets over into the tax-free withdrawal column, but not such a good one with large pools of traditional IRA assets, as I discussed in this article.

401(k) Contribution Limits
The maximum 401(k) contribution has jumped slightly in 2013: It's $17,500 for those under age 50 and $23,000 for savers over 50. (Contribution limits for 403(b) and 457 plan participants are the same.) If you're just turning 50 this year, note that you can start contributing extra catch-up amounts at the beginning of the year; you don't need to wait until your birthday.

401(k) In-Plan Conversions
In an effort to raise revenues, the fiscal cliff deal allows employees with traditional 401(k) balances to convert them to Roth 401(k)s, provided their 401(k) plan allows for such a conversion and includes a Roth 401(k) feature. Whereas the Small Business Jobs and Credit Act of 2010 enabled a limited subset of individuals--those who have left or retired from their former employers, are age 59 1/2, or are disabled or dead--to convert their 401(k) balances from traditional to Roth, the new laws enable people of all ages to do so. Partial conversions will also be available. In general, such in-plan conversions will be less attractive than other methods of garnering Roth treatment for your assets, including outright Roth 401(k) contributions, backdoor Roth IRAs (discussed above), and conversions of traditional IRAs to Roth. This article discusses key questions to ask when pondering whether to undertake an in-plan 401(k) conversion.

Estate Tax
Although the estate tax was poised to affect many more estates starting in 2013, the estate tax exemption will remain over $5 million ($5.25 million, to be exact) per individual, and the top estate tax rate will increase to 40% from 35% last year.

The very high exemption amount, as well as the concept of portability of exclusion amounts between spouses, makes the creation of bypass trusts arguably less essential than it once was, as estate-planning expert Deborah Jacobs discussed in this video. Yet generous estate-tax laws notwithstanding, everyone needs to mind basic estate-planning matters, including properly drafted beneficiary designations, guardianships for minor children, and powers of attorney for financial and health-care matters. This article details some of the key estate-planning steps people at all income levels should take.

Gift Tax
The annual gift tax exclusion amount jumps to $14,000 for 2013. That means you can gift $14,000 apiece to an unlimited number of people this year without having to worry about a gift tax or even fill out the gift tax paperwork. Savers in 529 college-savings plans can actually gift $70,000 to a single individual in a single year without triggering a gift tax, assuming they make no further contributions to the same individual's college plan in the subsequent four years. In that case, the Internal Revenue Service assumes that your contribution is spread over five years. Married couples can actually contribute $140,000 to one child's college-savings plan in 2013--assuming they make no further gifts from 2014 through 2017--without getting into gift tax terrain.

Also, if you're gifting to pay educational or medical expenses, you can circumvent the gift tax system altogether by making payments directly to the educational or medical institution.

See More Articles by Christine Benz

		Register Free for Individual Investor Conference
	Discover how to secure stronger returns in a challenging market at Morningstar Individual Investor Conference 2013, starting at 9 a.m. CDT Saturday, March 23. The live online event is tailored to a variety of financial goals: Learn how to improve your investment mix, build your income stream, optimize your long-term benefits, and much more.
	Click below to check out the full day's sessions and speakers--and register absolutely FREE.