As the year-end quickly approaches, there is still time to do year-end tax planning to generate significant tax savings. As many of you know, changes to the tax laws in 2013 made many tax rates (subject to cost of living adjustments) and certain tax breaks permanent.
But some tax breaks expired in 2013 (discussed in more detail below) and Congress has not as yet revived them making year-end planning more complicated and frustrating.
The President has signed the Protecting Americans from Tax Hikes Act of 2015 (the PATH Act). Some tax breaks have been made permanent, some have been extended through 2016, and some have been extended through 2019. See Expired Tax Provisions below for more details.
This 2014 tax year will again be challenging as taxpayers will have to deal with the following recent tax law changes:
It is important to know that this year-end tax guide only provides an overview of various tax strategies and some of the more important tax provisions and by no means covers all tax minimization techniques. Each taxpayer situation is unique and as a result tax strategies and projections should be developed for each client for the greatest results.
As a starting point, it is essential to know the customary year-end planning techniques that can cut income taxes. It all starts with a tax projection of whether you will be in a higher or lower tax bracket next year. In some cases it is imperative to project income and expenses for multiple years to smooth income out over time to avoid higher tax brackets over an extended period. This type of planning is beyond the scope of this discussion and should be explored directly with tax counsel.
Once your tax bracket for this year and next year are known, there are two basic income tax planning considerations:
However, life is never that simple. Tax laws always make for some real guesswork. As discussed below, when it comes to certain deductions that have tax threshold limitations, bunching of deductions to one year may force these deductions into a tax year where the tax bracket is lower than the other tax year in question. This may be the only way to get a tax break for these deductions.
As a further irritant, year-end tax projections must take into account the maddening alternative minimum tax and the new parallel universe of the 3.8% Medicare tax.
For discussion purposes, the following strategies assume that the taxpayer’s income will be higher next year. Where income will be taxed at a higher tax bracket next year, accelerating income to this year results in less taxes being paid. At the same time, deductions and tax credits deferred into next year will become more valuable as they offset income taxed at a higher marginal bracket.
Usually accelerating income to the current year and deferring deductions must take into account the impact on cash flow and the time value of money when paying taxes on income a year earlier. However, due to our current low-interest rate environment, time value of money implications are quite minimal and may not be a significant consideration.
If a taxpayer expects income to decrease next year they should use the opposite approach.
Important: Be sure to remember that the following lays out the basic ideas for income acceleration and deduction/credit deferral where income projects to be taxed at a higher level next year.
For taxpayers who think that they will be in a higher tax bracket next year, here are some targeted forms of income to consider accelerating into this year.
Example: Mr. Appreciation has low basis stock that has appreciated in value. The rate for capital gains can rise as taxable income increases. Before selling any securities he needs to run the numbers to see if it makes sense to sell this year or next year or spread such sales between the two years.
He also needs to consider in the 3.8% Medicare tax on capital gains and how such decision impacts itemized deduction limitations.
Important Planning Point: If a taxpayer is in the 10% or 15% tax bracket in the current year, it would make sense to sell appreciated assets in this year since a zero tax rate would apply to such long-term capital gain. This special treatment does not apply to sales of collectibles (28% rate) and recapture property (25% rate).
Important Planning Point: If a taxpayer is in the 25%, 28%, 33% or 35% tax bracket, it would make sense to sell appreciated assets this year to be taxed at 15% on capital gains instead of next year when it is expected that the taxpayer will be in the 39.6% bracket and be subject to capital gain tax rates of 20%. This special treatment does not apply to sales of collectibles (28% rate) and recapture property (25% rate).
Important Planning Point: For an older taxpayer or one in ill-health, this strategy may not make income tax sense. When a person dies their assets get a step up in basis to the date of death value. As a result, when the estate sells such assets there is no capital gain. So a sale right before death would trigger a needless capital gain tax. For an extensive discussion of this issue readers may want to explore The Biggest (Tax) Loser: Misguided Gifts of Real Estate By Uninformed Do It Yourselfers, Realtors & Attorneys
Wash Sale Planning Note: The wash sale rules do not apply when selling at a gain, so taxpayers can cash out their gains and then repurchase identical securities immediately afterwards. For more on wash sale rules and how to avoid them, please see the discussion below.
For taxpayers who think that they will be in a higher tax bracket next year, here are some actions to consider in deferring deductions into next year. Remember, we are assuming that income will be higher next year, so deductions are more valuable next year. (Obviously, if income is higher this year, it is better to have deductions accelerated into this year). With any tax strategy, taxpayers must take into account the impact of the alternative minimum tax.
Planning Note: If your AGI is close to the threshold, strategies such as making retirement plan and health savings account (HSA) contributions may allow you to stay below the threshold. When covered under a high deductible health plan, HSA contributions are $3,300 for self-only coverage and $6,550 for family coverage for 2014. In addition, if you are age 55 or older an extra $1,000 is available.
Example and Important Warning: Do not prepay state and local income taxes or property taxes if subject to the AMT. It will generate no income tax savings and you will have made these payments without gaining a tax benefit.
Warning: If you want to buy back the same security beware of the so-called “wash sale” rules. These rules are complex but with proper planning losses can be taken while avoiding the wash loss limitation rules.
Avoiding Wash Sale Rules: To avoid the wash sale rules, a taxpayer can (1) immediately buy securities of a different company in the same industry, (2) immediately buy shares in a mutual fund that holds securities much like the one sold, or (3) simply wait 31 days to repurchase the same security.
Use Credit Cards To Claim Deductions: Expenses charged to credit cards before year-end are deductible this year even though paid next year. Use credit cards to pay:
Increase Withholding Taxes: Many taxpayers pay both estimated income taxes and withholding taxes. If you have fallen behind on quarterly estimated taxes, it is a good idea to increase withholding on your remaining wages to avoid underpayment penalties.
Key Tax Planning Point: The IRS treats withheld taxes as if spread out evenly throughout the year. This strategy can cut or even eliminate penalties for the failure to pay timely.
Be Careful When Investing in Mutual Funds at Year-end: Many mutual funds pay accumulated dividends and capital gains in November and December. This will result in a needless tax bill and a rude surprise come tax time for the unknowing investor.
Cost Segregation Study: A taxpayer who recently purchased or built a building or remodeled existing space should consider a cost segregation study. It breaks down the improvements into divisible parts allowing faster depreciation, thus increasing current year deductions.
The President has signed the Protecting Americans from Tax Hikes Act of 2015 (the PATH Act). Here is a list of key provisions.
Extended through 2016:
Extended through 2019:
The following provides more details of some of these provisions:
Sales Tax Deductions: The deduction for state and local sales taxes in lieu of state and local income taxes is now available for 2015. This provision is especially important to taxpayers in states such as Texas and Florida where there is no state income tax.
Section 179 write-offs for Equipment, Machinery and Other Depreciable Assets: Under the extender legislation, the limit for this write off is $500,000 and phases out dollar for dollar when total asset purchases for the tax year exceed $2,000,000.
Qualified Leasehold Improvement, Restaurant and Retail Improvement Property: Accelerated depreciation for qualified leasehold improvement, restaurant and retail improvement property that allowed a shortened recovery period of 15 year is now available for 2015.
Section 179 For Qualified Leasehold Improvement, Restaurant and Retail Improvement Property: The Section 179 write-off of up to $250,000 for qualified leasehold improvement, restaurant and retail improvement property has now been extended to 2015.
The 50% Bonus Depreciation Allowance: The 50% bonus depreciation allowance is extended to 2015.
IRA Distributions To Charity: The tax-free IRA distributions to charities has now been extended to 2015. This tax provision allows those age 70 ½ and older to make required distributions directly to charity avoiding income tax on such distributions. Note: They do not also get a charitable deduction for such contribution.
Conservation Easements: Enhancements to the rules for donating real property for conservation that encourage farmers, ranchers and other modest-income landowners to make donations to charitable organizations for land conservation purposes.
Discharge of Principal Residence Debt: Previously taxpayers who got discharged from debt on their home could avoid being taxed on this form of income. Congress has now extended this provision to 2015.
Mortgage Insurance Premiums: The deduction for mortgage insurance premiums has been reinstated for 2015.
Mass Transit and Van Pooling: Parity for employer-provided mass transit and parking benefits ($250 a month, up from $130 a month). Transit commuters who run all their commuting costs through their employer’s transit plan should get a retroactive true up—a potential $576 extra tax savings for 2015.
The Research Tax Credit: Available in 2015.
The Work Opportunity Tax Credit: This credit designed to encourage hiring of certain disadvantaged employees (certain veterans, ex-felons and food stamp recipients, etc.) is now available for 2015.
Various Energy-related Tax Incentives: Energy-efficient home improvements tax credit has been reinstated. Taxpayers can get a tax credit (that’s a dollar for dollar reduction in your tax liability) of up to $500 for making energy-efficient home improvement like new windows or upgraded heating and air conditioning equipment.
Tuition and Fees Deduction: Taxpayers can deduct up to $4,000 in qualified higher education and fees but this provision is available only for 2015.
Teacher Supplies: A $250 above-the-line deduction for school teachers for supplies is available for 2015.
While this discussion offers some major year-end income tax strategies, it is not all-encompassing nor is it intended to fit every taxpayer situation. Ultimately, year-end tax strategies depend on the specific income and expenses of each taxpayer and their overall income, gift and estate tax situation.
Taxpayers must stay alert for possible last-minute tax laws enacted before year-end and tax law changes for next year that may impact their short and long-range tax planning .
The one certainty in this uncertain tax environment is to “run the numbers” for your particular tax and financial situation with tax counsel to craft specific tax strategies to cut taxes owed.
I hope this article has been of value to my readers. Please feel free to contact me for help, ask a question or make comments below.
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