2014 Year-End Tax Planning for Individuals and Business Entities
Year-end tax planning is especially challenging this year because Congress has yet to act on a host of tax breaks that expired at the end of 2013. Some of these tax breaks may be retroactively reinstated and extended, but Congress may not decide the fate of these tax breaks until the very end of this year (and, possibly, not until next year).
For individuals, expired tax breaks for potential reinstatement and extension include:
- the option to deduct state and local sales and use taxes instead of state and local income taxes;
- the above-the-line-deduction for qualified higher education expenses;
- tax-free IRA distributions for charitable purposes by those age 70-1/2 or older; and
- the exclusion for up-to-$2 million of mortgage debt forgiveness on a principal residence.
For businesses, tax breaks that expired at the end of last year and may be retroactively reinstated and extended include:
- The 50% bonus first year depreciation for most new machinery, equipment and software;
- the $500,000 annual expensing limitation;
- the research tax credit; and
- the 15-year write-off for qualified leasehold improvements, qualified restaurant buildings and improvements and qualified retail improvements.
We have compiled a checklist of Year-End Tax Planning Moves for Individuals and Business Entities, based on current tax rules that may help you save tax dollars if you act before year-end. Not all tax planning moves will apply to your particular situation, but you or your business will likely benefit from many of them. Both individual and business taxpayers can narrow down the specific actions to take by projecting potential tax scenarios for the year. The time to do this is soon, to allow a few weeks before December 31st to execute transactions, process payroll adjustments, or to evaluate strategies that require the balancing of tax, investment, and cash flow decision-making. We recommend that you establish tax planning moves in order of priority, so that potential late tax legislation can be considered before finalizing certain transactions just prior to December 31st.
Please review the following lists at your earliest convenience, and we invite you to contact us to assist in your planning decisions:
Year-End Tax Planning Moves for Individuals
1. Income and Deduction Timing – Postpone income until 2015 and accelerate deductions into 2014 to lower your 2014 tax bill. This strategy may enable you to claim larger deductions, credits, and other tax breaks for 2014 that are phased out over varying levels of adjusted gross income (AGI). These include child tax credits, higher education tax credits, and deductions for student loan interest. Postponing income also is desirable for those taxpayers who anticipate being in a lower tax bracket next year due to changed financial circumstances. It may be advantageous to try to arrange with your employer to defer a bonus that may be coming your way until 2015. Note, however, that in some cases, it may pay to actually accelerate income into 2014. For example, this may be the case where a person’s marginal tax rate is much lower this year than it will be next year or where lower income in 2015 will result in a higher tax credit for an individual who plans to purchase health insurance on a health exchange and is eligible for a premium assistance credit. Consider using a credit card to pay deductible expenses before the end of the year. Doing so will increase your 2014 deductions even if you don’t pay your credit card bill until after the end of the year. You may be able to save taxes this year and next by applying a bunching strategy to “miscellaneous” itemized deductions, medical expenses and other itemized deductions. You may want to pay contested taxes to be able to deduct them this year while continuing to contest them next year. You may want to settle an insurance or damage claim in order to maximize your casualty loss deduction this year.
2. Capital Gains and Losses - Determine your year-to-date net gains and losses, to assess potential tax liability, or tax losses. Matching of losses with gains before year-end may be advisable. Realize losses on stock while substantially preserving your investment position. There are several ways this can be done. For example, you can sell the original holding, then buy back the same securities at least 31 days later. Review your portfolio and consult your investment advisor regarding potential trades or asset transactions.
3. Additional Medicare Tax and Unearned Income Surtax - Higher-income-earners have unique concerns to address when mapping out year-end plans. They must be wary of the 3.8% surtax on certain unearned income and the additional 0.9% Medicare tax that applies to individuals receiving wages with respect to employment in excess of $200,000 ($250,000 for married couples filing jointly and $125,000 for married couples filing separately).
The surtax on unearned income is 3.8% of the lesser of:
- net investment income (NII), or
- the excess of modified adjusted gross income (MAGI) over an unindexed threshold amount of $250,000 for joint filers or surviving spouses, $125,000 for a married individual filing a separate return, and $200,000 in any other case.
As year-end nears, a taxpayer’s approach to minimizing or eliminating the 3.8% surtax will depend on his estimated MAGI and net investment income (NII) for the year. Some taxpayers should consider ways to minimize (e.g., through deferral) additional NII for the balance of the year, others should try to see if they can reduce MAGI other than net investment income, and other individuals will need to consider ways to minimize both NII and other types of MAGI.
The additional Medicare tax may require year-end actions. Employers must withhold the additional Medicare tax from wages in excess of $200,000 regardless of filing status or other income. Self-employed persons must take it into account in figuring estimated tax. There could be situations where an employee may need to have more withheld toward year end to cover the tax.
For example, an individual earns $200,000 from one employer during the first half of the year and a like amount from another employer during the balance of the year. He would owe the additional Medicare tax, but there would be no withholding by either employer for the additional Medicare tax since wages from each employer don’t exceed $200,000.
Also, in determining whether they may need to make adjustments to avoid a penalty for underpayment of estimated tax, individuals also should be mindful that the additional Medicare tax may be over-withheld. This could occur, for example, where only one of two married spouses works and reaches the threshold for the employer to withhold, but the couple’s income won’t be high enough to actually cause the tax to be owed.
4. Traditional to Roth IRA Recharacterization – If you believe a Roth IRA is better than a traditional IRA, and want to remain in the market for the long term, consider converting traditional-IRA money invested in beaten-down stocks (or mutual funds) into a Roth IRA if eligible to do so. Keep in mind, however, that such a conversion will increase your adjusted gross income for 2014.
5. Roth to Traditional IRA Recharacterization - If you converted assets in a traditional IRA to a Roth IRA earlier in the year, the assets in the Roth IRA account may have declined in value, and if you leave things as is, you will wind up paying a higher tax than is necessary. You can back out of the transaction by recharacterizing the conversion, that is, by transferring the converted amount (plus earnings, or minus losses) from the Roth IRA back to a traditional IRA via a trustee-to-trustee transfer. You can later reconvert to a Roth IRA.
6. State Tax Payment Timing - If you expect to owe state and local income taxes when you file your return next year, consider asking your employer to increase withholding of state and local taxes (or pay estimated tax payments of state and local taxes) before year-end to pull the deduction of those taxes into 2014 if doing so won’t create an alternative minimum tax (AMT) problem.
7. Withholding Tax Payment Timing – Take an eligible rollover distribution from a qualified retirement plan before the end of 2014 if you are facing a penalty for underpayment of estimated tax and having your employer increase your withholding is unavailable or won’t sufficiently address the problem. Income tax will be withheld from the distribution and will be applied toward the taxes owed for 2014. You can then timely roll over the gross amount of the distribution, i.e., the net amount you received plus the amount of withheld tax, to a traditional IRA. No part of the distribution will be includible in income for 2014, but the withheld tax will be applied pro rata over the full 2014 tax year to reduce previous underpayments of estimated tax.
8. Alternative Minimum Tax Considerations – Estimate the effect of any year-end planning moves on the alternative minimum tax (AMT) for 2014, keeping in mind that many tax breaks allowed for purposes of calculating regular taxes are disallowed for AMT purposes. These include the deduction for state property taxes on your residence, state income taxes, miscellaneous itemized deductions, and personal exemption deductions. Other deductions, such as for medical expenses, are calculated in a more restrictive way for AMT purposes than for regular tax purposes in the case of a taxpayer who is over age 65 or whose spouse is over age 65 as of the close of the tax year. As a result, in some cases, deductions should not be accelerated.
9. Retirement Account Required Minimum Distributions – Take required minimum distributions (RMDs) from your IRA or 401(k) plan (or other employer-sponsored retired plan) if you have reached age 70-1/2. Failure to take a required withdrawal can result in a penalty of 50% of the amount of the RMD not withdrawn. If you turned age 70-1/2 in 2014, you can delay the first required distribution to 2015, but if you do, you will have to take a double distribution in 2015-the amount required for 2014 plus the amount required for 2015. Think twice before delaying 2014 distributions to 2015-bunching income into 2015 might push you into a higher tax bracket or have a detrimental impact on various income tax deductions that are reduced at higher income levels. However, it could be beneficial to take both distributions in 2015 if you will be in a substantially lower bracket that year
10. Flexible Spending Account Contributions – Increase the amount you set aside for next year in your employer’s health flexible spending account (FSA) if you set aside too little for this year.
11. Health Savings Account Contributions – If you are eligible to make health savings account (HSA) contributions in December of this year, you can make a full year’s worth of deductible HSA contributions for 2014. This is so even if you first became eligible on Dec. 1, 2014.
12. Estate Tax Planning – Estate taxes are levied on a taxpayer’s estate at the time of death. For 2014, the estate tax has a $5.34 million lifetime exemption and a top rate of 40%. Inherited assets enjoy a full step-up in basis to their fair market value at the decedent’s death. The estate tax allows unlimited marital deductions for transfers between spouses. Your estate generally can deduct the value of all assets passed to your spouse at death if your spouse is a U.S. citizen, and no gift tax is due if you gave the assets while alive. There is also no limit on estate and gift tax charitable deductions. If you bequeath your entire estate to charity or give it all to charity while you are alive, no estate or gift tax will be due. The estate tax exemption is now also fully portable between spouses. To use a predeceased spouse’s unused estate tax exemption amount, the executor must file an estate tax return that computes the unused estate tax exemption amount and makes an election on the return that allows the surviving spouse to use the predeceased spouse’s unused estate tax exemption amount.
13. Gift Tax Planning – Gift taxes are applied on gifts made during a taxpayer’s lifetime. The gift tax also offers both a lifetime exemption and an annual exclusion. Giving remains one of the best estate planning strategies. You may want to formulate a giving plan to take advantage of the annual gift tax exclusion. The annual exclusion is indexed for inflation in $1,000 increments but remained at $14,000 per recipient in 2014. You can double this exclusion to $28,000 by electing to split gifts with your spouse. So even if you want to give to just four individuals, you and your spouse could give a total of $112,000 this year with no gift tax consequences. If you have more people you’d like to benefit, you can remove even more money from your estate every year. For 2014, the gift and estate tax are reunified, with a $5.34 million lifetime exemption and a 40% rate. Any gift tax exemption used during a taxpayer’s lifetime will effectively reduce the taxpayer’s estate tax exemption. Choose your gifts wisely. Give property with the greatest potential to appreciate. Don’t give property that has declined in value. Instead, sell the property so that you can take the tax loss and give the sale proceeds. When deciding which assets to give, keep in mind the step up in basis at death. If it’s likely that the loved ones to whom you give property won’t sell it before you die, you need to analyze the situation. If it stays in your estate, the property gets an automatic step up in basis to fair market value at the time of your death. This could generate significant income tax savings for your heirs upon later sale, but must be balanced against the fact that the property could appreciate during your life and add to your estate at death. You can also avoid gift taxes by paying tuition and medical expenses for a loved one. As long as you make payments directly to the provider, you can pay these expenses gift tax-free without using up your annual exclusion.
Year-End Tax Planning Moves for Business Entities:
1. New Asset Purchases - Businesses should buy machinery and equipment before year end and, under the generally applicable “half-year convention,” thereby secure a half-years’ worth of depreciation deductions for the first ownership year
2. Maximize New Asset Expensing Option - Although the business property expensing option is greatly reduced in 2014 (unless legislation changes this option for 2014), don’t neglect to make expenditures that qualify for this option. For tax years beginning in 2014, the expensing limit is $25,000, and the investment-based reduction in the dollar limitation starts to take effect when property placed in service in the tax year exceeds $200,000.
3. Asset Acquisition Election Policy – Businesses may be able to take advantage of the “de minimis safe harbor election” (also known as the book-tax conformity election) to expense the costs of inexpensive assets and materials and supplies, assuming the costs don’t have to be capitalized under the Code Sec. 263A uniform capitalization (UNICAP) rules. To qualify for the election, the cost of a unit-of-property can’t exceed $5,000 if the taxpayer has an applicable financial statement (AFS; e.g., a certified audited financial statement along with an independent CPA’s report). If there’s no AFS, the cost of a unit of property can’t exceed $500. Where the UNICAP rules aren’t an issue, purchase such qualifying items before the end of 2014.
4. Income Timing and Tax Brackets – A corporation should consider accelerating income from 2015 to 2014 where doing so will prevent the corporation from moving into a higher bracket next year. Conversely, it should consider deferring income until 2015 where doing so will prevent the corporation from moving into a higher bracket this year. To reduce 2014 taxable income, consider deferring a debt-cancellation event until 2015, or disposing of a passive activity in 2014 if doing so will allow you to deduct suspended passive activity losses.
5. Corporate Alternative Minimum Tax Planning - A corporation should consider deferring income until next year if doing so will preserve the corporation’s qualification for the small corporation alternative minimum tax (AMT) exemption for 2014. Note that there is never a reason to accelerate income for purposes of the small corporation AMT exemption because if a corporation doesn’t qualify for the exemption for any given tax year, it will not qualify for the exemption for any later tax year.
6. Estimated Tax Requirements - A corporation (other than a “large” corporation) that anticipates a small net operating loss (NOL) for 2014 (and substantial net income in 2015) may find it worthwhile to accelerate just enough of its 2015 income (or to defer just enough of its 2014 deductions) to create a small amount of net income for 2014. This will permit the corporation to base its 2015 estimated tax installments on the relatively small amount of income shown on its 2014 return, rather than having to pay estimated taxes based on 100% of its much larger 2015 taxable income.
7. Home Office Deduction Safe Harbor - The IRS has offered administrative relief for one of the trickiest tax issues faced by small business owners and the self-employed who work out of their own homes. You are generally entitled to a home office deduction if you use part of your home for business and it is one of the following:
- Your principal place of business
- Where you meet clients or customers in the normal course of business
- A separate structure not attached to your home
Taxpayers have often struggled to determine allowable depreciation under the home office deduction and the amount of home expenses such as rent, mortgage interest, taxes or utilities they can deduct. The issue has long created controversy between the IRS and taxpayers. Late in 2013, the IRS offered a new safe harbor that allows taxpayers to deduct $5 for each square foot of home office space up to a maximum safe harbor deduction of $1,500 per year. If you use this safe harbor, you won’t need to reduce your normal itemized deductions for any assignment to the home office of items like mortgage interest or taxes.
8. Employer Health Care Mandate Relief – The IRS has offered employers additional relief from excise taxes for a failure to meet health care coverage requirements. Two separate excise taxes were originally scheduled to take effect in 2014 and are imposed for the following:
- Failing to offer coverage to 95% of employees
- Offering coverage to 95% of employees, but failing minimum value and affordability requirements
The IRS initially offered transition relief delaying both taxes in full for 2014. The new transition relief will fully postpone the excise taxes until 2016 for employers with 50 to 99 full-time and full-time equivalent (FTE) employees. Employers with 100 or more full-time and FTE employees can avoid the first tax in 2015 by offering coverage to just 70% of employees instead of 95%. However, these employers can still be subject to the second excise tax if the coverage does not meet affordability and minimum value requirements. There are also ongoing legal challenges regarding individual taxpayers’ ability to receive premium assistance credits to purchase health coverage on federal exchanges. This will eventually be important for employers, because the employer excise taxes don’t apply if an employer has no employees who qualify for tax credits. The Supreme Court may ultimately have to make a decision on this issue, which could come sometime next year.
9. Domestic Production Activities Deduction - If your business qualifies for the domestic production activities deduction for its 2014 tax year, consider whether the 50%-of-W-2 wages limitation on that deduction applies. If it does, consider ways to increase 2014 W-2 income, e.g., by bonuses to owner-shareholders whose compensation is allocable to domestic production gross receipts. Note that the limitation applies to amounts paid with respect to employment in calendar year 2014, even if the business has a fiscal year.
10. Pass-Through Entity Basis – If you own an interest in a partnership or S corporation consider whether you need to increase your basis in the entity so you can deduct a loss from it for this year.
These are just some of the year-end steps that can be taken to save taxes. Again, by contacting us, we can tailor a particular plan that will work best for you. We also will need to stay in close touch in the event Congress revives expired tax breaks, to assure that you don’t miss out on any resuscitated tax saving opportunities.