2014 Year-End Planning for Individuals and Businesses
by Gregory S. Dowell and Maria C. Blair
Each year our office issues a year-end newsletter as a way to encourage our clients to stop and consider key tax and financial issues before the year expires. The following is the letter that was issued for year-end 2014:
A number of tax breaks expired at the end of 2013. Ultimately, some may be retroactively reinstated, but Congress may not take action until very late in 2014. For individuals and businesses, these expired breaks included:
- Option to deduct state and local sales and use taxes instead of state and local income taxes
- Above-the-line deduction for qualified higher education expenses of up to $4,000
- Tax-free distributions by those age 70-1/2 or older directly from IRAs for charitable purposes
- Cancellation of indebtedness of up to $2 million on a qualified principal residence
- 50% bonus first-year depreciation for most new machinery, equipment and software
- $500,000 expensing limitation
- Research tax credit
- 15-year write-off for qualified leasehold improvements, qualified restaurant buildings and improvements and qualified retail improvements.
As was the case for 2013, individuals in higher income brackets in 2014 will have to consider the effects of two additional taxes: 1) the 3.8% surtax on unearned income, and 2) the 0.9% Medicare (hospital insurance) tax. These taxes apply 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), as follows:
- The 3.8% surtax is imposed on individuals, trusts, and estates. The 3.8% tax is based on the lesser of: (1) net investment income (NII), or (2) the excess of modified adjusted gross income over an unindexed threshold amount ($250,000 for joint filers or surviving spouses, $125,000 for a married individual filing a separate return, $200,000 in any other individual case and $11,950 for trusts).
- The 0.9% Medicare tax is imposed on earned income in excess of $200,000 for singles, $250,000 for married filing jointly, and $125,000 for married filing separately. Note that 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 estimate tax.
While the inertia in Congress has made tax planning this year particularly difficult, we don’t have the luxury of inaction. It is important that we take whatever action possible to plan for our taxes. To help you cut through the clutter at the end of the year, we have included the following three checklists with this letter:
- Individuals – Year-End Tax Planning
- Individuals – Other Planning Reminders
- Business – Year-End Tax Planning
Even if Congress decides to take action before the end of the year and passes a flurry of new laws, many of the items on the enclosed checklists are basic fundamentals that will not be affected. We encourage you to read through the appropriate checklists and, if you have any questions, please give us a call or an email.
Very truly yours,
Bass, Solomon & Dowell, LLP
Individuals – Year-End Tax Planning
- Flexible Spending Account – 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.
- Health Savings Account – 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.
- Check the year-to-date capital gains and losses – Determine the net short and long-term capital gains and losses recognized thus far. Bear in mind any significant capital gain distributions you might receive from mutual funds or partnership investments, and take into account any capital loss carryovers. Understanding the overall net gain or loss positions is the first step in understanding and managing the impact of income taxes. You might want to take more long term or short term gains to offset losses or if you may want to harvest tax losses.
- Realizing capital losses – Look at your portfolio and determine if there is any benefit to realizing capital losses. You may 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. Discuss this with your financial advisor.
- Check withholding – If you might face a penalty for not having enough tax withheld or for paying too little in estimates, increase the amount of Federal and State income taxes withheld from your wages.
- Postpone income and accelerate deductions – This strategy may enable you to claim larger deductions, credits, and other tax breaks for 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. 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.
- Charitable contributions – Consider making any additional charitable gifts by cash, credit card, or appreciated securities by the end of the year. Making charitable gifts by donating appreciated securities remains an effective way of meeting the desire to support a charity while minimizing the economic impact on the donor.
- Non-cash charitable contributions – Consider making additional noncash charitable gifts by the end of the year, but pay particular attention this year to the substantiation rules if you are claiming that the fair market value of your gifts exceeded $250. See an article dated October 9, 2014 on our website at www.bsd-cpa.com, under Resources, Client Bulletins, Tax – Individual, for more information.
- Roth conversion – 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.
- Roth 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 could wind up paying a higher tax. You can back out of the transaction by re-characterizing the rollover, 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.
- Defer bonus – It may be advantageous to try to arrange with your employer to defer a bonus that may be coming your way until 2015.
- Prepay expenses – Consider using a credit card to prepay expenses that can generate deductions for this year (charitable and medical expenses are good examples).
- If you will likely owe State income taxes – 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.
- Penalty for underpayment of estimated tax – If you are facing a large penalty for underpayment of estimated tax and the increased withholding option is unavailable or won’t sufficiently address the problem, take an eligible rollover distribution from a qualified retirement plan before the end of 2014. 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, as increased by 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.
- AMT – 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 property taxes, state income or sales 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. As a result, in some cases, deductions should not be accelerated.
- Bunching deductions in one year – Saving tax over a 2-year period may be achieved by “bunching” miscellaneous itemized deductions and medical expenses in a single tax year. Because these are subject to phase-outs, bunching the deductions in a single year might allow the largest deduction possible.
- Contested State income taxes -You may want to pay any contested State income taxes to be able to deduct them this year while continuing to contest them next year.
- Insurance claims – You may want to settle an insurance or damage claim in order to maximize your casualty loss deduction this year.
- Required Minimum Distributions (RMDs) – RMDs must be taken from your IRA, 401(k) plan, or other employer-sponsored retirement 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 next year, for example, because you plan to retire late this year.
- Gifts to family or friends – Make gifts sheltered by the annual gift tax exclusion before the end of the year. You can give $14,000 in 2014 to each of an unlimited number of individuals. Note that you cannot 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.
- Education funding –If educational funding is an issue in your family, consider funding 529 plans by the end of the year.
Individuals – Other Planning Reminders
- Review your portfolio – On your own or with your investment adviser, analyze your holdings and determine if the risk tolerances and asset allocations are still appropriate for your investment objectives.
- Review the beneficiary designations – Review the beneficiaries named on retirement accounts or insurance policies; consider if assets are titled correctly; determine if a family member should be added as a signer on an account.
- Wills and Trusts –If you have not set up wills and trusts, then contact your attorney; call us if you need a reference. If it has been many years since you had your wills and trusts drafted, set up a meeting with your attorney or CPA to review the documents, including the named beneficiaries, guardians, and executors.
- Power of Attorney – As part of the review of wills and trusts, also consider powers-of-attorney and health care powers-of-attorney you have in force (or should have in force) for all of your family members.
- Insurance – Review the various types of insurance you have in place and re-examine your needs. In addition to homeowner’s and auto insurance, you should consider life, health, umbrella liability, and long-term care.
- Family meeting – Consider having a family meeting to give everyone an overview of your investments and objectives, charitable giving strategies and desires, the location of key documents, and names of your key advisors (CPAs, attorneys, bankers, insurance agents, investment advisors, etc.).
- Safe deposit box –Make a special point to visit your safe deposit box and inventory (and organize) the contents.
Businesses – Year-End Tax Planning
- Expenses – Businesses should consider making expenditures that qualify for the business property expensing option; this allows businesses to immediately expense (rather than depreciate) the cost of new equipment. One of the most significant questions for business owners is whether Congress will take action by December 31st to increase the expensing limit. As it stands at the present, the expensing limit is $25,000 for 2014, and the limit starts to phase-out when property placed in service in 2014 exceeds $200,000 (for comparison, the first $500,000 could be expensed in 2013 and the limit before the phase-out took effect was $2,000,000). Unlike 2013, in 2014 off-the-shelf software and certain qualified real property will not qualify for the expensing election.
- Bonus depreciation – 2013 was also the end of 50% bonus depreciation, unless Congress takes action by December 31st. While purchases of machinery and equipment made in 2014 will not be eligible for the 50% bonus depreciation, there is still some incentive to consider buying any necessary equipment before the end of the year. Equipment purchased before the end of the year will likely qualify for the half-year convention, which allows a half-year’s depreciation for the first year of ownership.
- Consider if the business should have audited financial statements – CPAs often prepare certified audits of financial statements because banks or investors want a higher level of comfort about the financial results. Because of a change in expensing rules for tax purposes, however, businesses with a large volume of smaller equipment purchases will have another incentive to have a certified audit performed. The new rule is called 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 Section 263A 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 (an “AFS” is a certified audited financial statement along with an independent CPA’s report). If there is no AFS, the cost of the unit of property cannot exceed $500. Where the UNICAP rules are not an issue and where the business has a certified audit, a business should consider purchasing such qualifying items before the end of 2014.
- Income timing – Consider accelerating income from 2015 to 2014, if doing so will prevent the business from moving into a higher tax bracket in 2015. Conversely, the business should defer income until 2015 when doing so will prevent the business from moving into a higher tax bracket in 2014.
- AMT – A corporation should consider deferring income until 2015 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.
- Tax planning to minimize estimated tax payments – A corporation (other than a “large” corporation) that anticipates a small net operating loss (NOL) for 2014 (and substantial net income for 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 allow the corporation to base its 2015 estimated tax payments on the smaller amount of income shown on its 2014 return, rather than having to pay estimates based on 100% of its larger 2015 taxable income.
- Reasonable compensation – Shareholder-employees must take reasonable compensation for their services, and this is a focus of the IRS. See our website (www.bsd-cpa.com) for more information.
- SEP – If you are self-employed and haven’t done so yet, set up a self-employed retirement plan.
- Cancellation of debt – Analyze the specific facts and consider the effect on income if debt is cancelled in 2014 or 2015.
- Dispose of passive activities – The owner of a business should consider disposing of a passive activity in 2014 if doing so will allow the owner to deduct suspended passive activity losses.
- Increase basis –The owner of an interest in a partnership or an S corporation may need to increase the basis in the entity so that the owner can deduct a loss from it for 2014.