Every year most U.S. citizens are obligated to file income tax returns. Taxpayers try frantically to figure out ways to pay what they still owe — hopefully before the filing deadline — even though feelings of frustration linger as they consider the federal deficit. It's especially frustrating when they realize income taxes for small-business owners and their employees are rising with health care and Social Security costs.
The divided U.S. Congress and re-elected President Barack Obama averted the "fiscal cliff" a few weeks ago, but the country's enormous national debt is still a potential problem. If the federal deficit — created by lawmakers seemingly spending perpetually above taxation proceeds — keeps rising, why doesn’t Congress figure a way to cut expenditures? Raising tax rates, reducing deductions and adding new surcharges are ways to increase revenue, but will likely promote higher unemployment.
What are hard-working taxpayers or thriving business owners to do about this impending tax burden? A good start, in my opinion, would be to re-position yourself with a tax saving plan that will also allow you to put more away in your retirement with a pension plan that has defined contribution attributes. This type of retirement plan allows you to keep more of your earnings under your control and realize retirement earlier than planned.
Undoubtedly, many of you have set up or are contributing to an IRA or 401(k) Plan. Although these are typical options for employees, a business owner or independent contractor has more options to consider. Depending on your particular income, age and employee demographics, the right retirement plan could produce an additional $50,000 to $200,000 deduction per year and reduce your tax burden by perhaps $15,000 to $100,000.
In 2013 there will be at least two new surtaxes as a result of the Taxpayer Relief Act of 2012:
No. 1, there will be an investment income surtax — a new 3.8 percent surtax on investment income for those with modified adjusted gross income of more than $250,000 (filing married) or $200,000 (filing single). Investment income includes dividends, interest, capital gains, annuities, royalties, rents and passive activity income. It does not include distributions from IRAs or other retirement accounts.
No. 2, for high-income earners (with modified AGI listed above), there will be a higher Medicare tax rate. Households with modified AGI above the thresholds mentioned above will incur a Medicare rate of 2.35 percent assessed on incomes above $450,000 (filing married) and $400,000 (filing single) thresholds.
Other things to note are long-term capital gains and qualifying dividend rates. High-income earners (taxpayers filing married with incomes exceeding $450,000 and single filers with incomes exceeding $400,000) will have capital gain and qualifying dividend income tax rates increase from 15 percent to 20 percent. Non high-income earners below the above-stated income thresholds will have capital gain/dividend income tax rates at the 2012 level (15 percent).
Now back to the all-important defined contribution pension plan: The focus must be on current-year deductions with future year benefits for your retirement account. In a defined contribution plan an employee can set aside up to $17,000 of their salary as a deferral; meaning they don’t pay taxes on it now. If age 50 or above you can contribute an additional $5,500. With full employer participation, $55,500 can be put into a pension plan that's tax deductible.
Let’s assume you as a business owner can put $55,000 into your retirement account and you are in the 40 percent combined federal and state tax bracket. Under this assumption, your $55,000 contribution would be funded with $33,000 from your business income and $22,000 in lower tax payments since the aggregate $55,000 retirement plan contribution isn’t subject to taxation.
In summary, higher taxes are coming. Tax-planning strategies need your attention today, I feel. Here is my advice: Take a serious look at adopting a defined contribution pension plan for your business. Get help from a professional adviser and realize “taxation with representation.” Plan now and you could realize significant tax savings and by doing so make your retirement a reality sooner.
Author's note: Examples shown, including different percentages and tax brackets, are provided for illustration purposes only and may not be representative of your specific tax situation. Tax services provided by Vonderharr Wagner Associates, LLC, a Utah CPA firm. Advisory services through Valued Wealth Advisers, LLC a Registered Investment Adviser. Securities offered through Independent Financial Group, LLC. Member FINRA/SIPC. Vonderharr Wagner Associates, LLC and Valued Wealth Advisers are not affiliated entities of IFG. Visit them at www.vwapro.com.
Bob Vonderharr, a licensed CPA, is a tax and investment advisor. If you would like more ideas on protecting, saving and growing your retirement accounts, call him at 801-633-4321 or email him at [email protected].