Dear Clients & Friends:
The holiday season is for spending time with family and friends and also to spend time considering year-end tax planning! All of us at Howe, Riley & Howe wish you a wonderful holiday season. We also want to let you know about tax issues that may affect you. Year-end tax planning could be especially challenging this year as Congress has not yet renewed several tax breaks that expired after the 2013 tax year. Some of these decisions will not be made until the very end of this year, or possibly not until early 2015, with retroactive effective dates.
Expiring Tax Breaks
The expiring tax breaks for individuals include:
- The above-the-line deduction for qualified higher education expenses;
- tax-free distributions by those age 70-1/2 or older from IRAs to charities;
- the exclusion of up to $2,000,000 of mortgage debt forgiveness on a principal residence; and
- the option to deduct state and local sales and use taxes instead of state and local income taxes.
For businesses, the expiring tax breaks include:
- 50% bonus first year depreciation for most new machinery, equipment and software;
- an extraordinarily high $500,000 Section 179 expensing limitation;
- the R&D and Work Opportunity tax credit; and
- the 15-year write-off for qualified leasehold improvements, qualified restaurant buildings and improvements and qualified retail improvements.
Income Tax Rates
Income tax rates are not scheduled to change for tax year 2015. However, high-income-earners have unique concerns to address when mapping out year-end plans. They must be wary of the 3.8% tax surtax on certain unearned income and the additional 0.9% Medicare tax that applies to individuals receiving wages in excess of $200,000 ($250,000 for married couples filing jointly and $125,000 for married couples filing separately).
The surtax is 3.8% of the lesser of: (1) net investment income (NII), or (2) the excess of modified adjusted gross income (MAGI) over an unindexed threshold amount ($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 or her 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 unearned income, and others will need to consider ways to minimize both NII and other types of MAGI.
The additional Medicare tax on earned income 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 their estimated tax payments. There could be situations where an employee may need to have more withheld toward year end to cover the tax. For example, if 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 or she 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.
Below is a list of additional actions, based on current tax rules, which may help you save tax dollars if you act before year-end. Not all actions will apply in your particular situation, but you may benefit from many of them. Please review the following list and contact us if you would like us to advise you on which tax saving moves to make:
Year-End Tax Planning Moves for Individuals
- Realize losses on stocks 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 (to avoid wash sale exclusions) or you can immediately buy securities in other companies that are in the same industry as the company whose securities you sold. This strategy is particularly effective when used to reduce the tax impact on short term capital gains which could be taxed at up to 43.4% (or 55.4% in Massachusetts).
- 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. 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, those already in the alternative minimum tax, 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.
- 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.
- 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 undo a Roth IRA conversion transaction by recharacterizing the rollover or conversion, 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 if it makes sense at that time.
- It may be advantageous to try to arrange with your employer to defer a bonus that may be coming your way until 2015.
- Consider prepaying expenses that can generate deductions for this year.
- Donate appreciated stock held for more than one year to a charitable organization and obtain a double tax benefit of not realizing the gain on the stock while still receiving a charitable deduction. However, the tax benefits of this strategy may be limited if your income is too high due to the Pease limitation (which may phase out some of your itemized deductions).
- If you expect to owe state and local income taxes when you file your return next year, consider making a 4th quarter estimated tax payment by December 31 or asking your employer to increase withholding of state and local taxes before year-end to bring the deduction of those taxes into 2014 if doing so won’t create an alternative minimum tax (AMT) problem.
- 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 isn’t viable 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.
- Estimate the effect of any year-end planning moves on the 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 (or state sales tax if you elect this deduction option), 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.
- 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. However, higher income taxpayers should be careful that they donגt limit the benefit of this strategy due to the Pease limitation (which may phase out some of your itemized deductions).
- 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, because, for example, you plan to retire in late 2014 or early 2015.
- For those who are over 70-1/2, consider making year-end charitable gifts directly from your IRA RMD. If the expiring tax break is extended, the distribution will be tax free.
- Make gifts sheltered by the annual gift tax exclusion before the end of the year and thereby potentially save gift and estate taxes. You can give $14,000 in 2014 to each of an unlimited number of individuals but you can’t carry over unused exclusions from one year to the next. The transfers also may save family income taxes where income-earning property is given to family members in lower income tax brackets who are not subject to the kiddie tax.
- If you become 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.
Year-End Tax- Planning Moves for Businesses & Business Owners
- C and S Corporations should consider year end strategies to minimize entity level taxes such as the 8.5% New Hampshire Business Profits tax. Paying out any taxable profit as a shareholder bonus is one strategy however one must be careful that the reasonable compensation rules are satisfied.
- Businesses should consider buying needed machinery and equipment before year end and, under the generally applicable “half-year convention,” thereby securing a half-years’ worth of depreciation deductions for the first year of ownership with the possibility to claim additional bonus depreciation or Section 179 expense if Congress extends these provisions. Although the Section 179 business property expensing option is greatly reduced in 2014 (unless legislation extends this option for 2014), consider making expenditures that qualify for this option. For tax years beginning in 2014, the expensing limit is currently $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. Some of the “extender” proposals being discussed in Congress will increase the expensing limit back to pre-2014 levels of $500,000.
- 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 uniform capitalization (UNICAP) rules. To qualify for the election, the cost of a unit-of-property cannot exceed $5,000 if the taxpayer has an applicable financial statement (e.g. an audited financial statement). If there are no applicable financial statements, the cost of a unit-of-property cannot exceed $500. Where the UNICAP rules aren’t an issue, purchase such qualifying items before the end of 2014.
- If you are self-employed and haven’t done so yet, set up a self-employed retirement plan. 401(k) plans are required to be setup by the end of the calendar year however they might be eligible to be funded after year end. SEP IRAs can be setup and funded by the due date of the return, including extensions.
- 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.
Affordable Care Act – Individuals
Effective January 1, 2014, individuals are required to have minimum essential healthcare coverage during the 2014 calendar year (except those who belong to an exempt group). The individual who claims a child on his or her tax return is responsible for the child’s coverage as well as their own. If the required coverage was not maintained throughout the year, certain penalties may apply. The penalty amount will be the greater of:
- 1% of your household income that is above the filing threshold for your filing status (single, married filing jointly/separately, head of household, etc.) This penalty will be capped at the national average premium amount for a bronze level health plan (approximately $2,450 according to Revenue Procedure 2014-46).
- $95 per adult plus $47.50 per child, limited to a family maximum of $285.
Affordable Care Act – Businesses
Beginning January 1,2015, the employer mandate will take effect for employers who have 50 or more full-time equivalents:
- For employers with 100 or more full time equivalents, penalties for noncompliance will begin in 2015.
- For employers with 50-99 employees, penalties for noncompliance will not begin until January 1, 2016.
Currently there is no employer mandate for businesses that have less than 50 full time equivalents. Business owners should take the time to determine which size employer group they belong to and take the necessary steps to be in compliance with the employer mandate as it applies to them. The penalties for noncompliance can be rather hefty. Please be aware that the calculation of full-time equivalents is strictly defined and miscalculation could result in extensive noncompliance penalties.
Employers are still permitted to provide group health insurance plans on a pre-tax basis. However, beginning January 1, 2014, employers can no longer “reimburse” employees for individual health insurance plans on a pre-tax basis. This includes both reimbursing employees for premiums they paid to maintain an individual health insurance plan and paying the health insurance companies directly for an individual health insurance plan of one of the employees. This also includes supplemental plans such as Medicare Supplement Insurance and plans purchased through the Federal and state Marketplaces. The penalties for continuing these practices are severe. If you currently have an arrangement with your employees to provide this form of reimbursement, please contact us immediately as we may be able to assist in avoiding these costly penalties.
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 will also need to stay in touch in the event that Congress revives expired tax breaks to assure that you don’t miss out on any of the returning tax saving opportunities.
This information presented is only of a general nature, may omit many details and special rules, is current only as of its published date, and accordingly cannot be regarded as legal or tax advice. Any tax advice contained in this communication is not intended or written to be used and cannot be used by any taxpayer for the purpose of avoiding tax penalties. Please contact our office (603-627-3838) for more information on this subject and how it pertains to your specific tax or financial situation. Howe, Riley & Howe, PLLC would be happy to answer your tax and financial questions regarding these issues or other matters that may be of interest to you or your business.