Once again, tax
planning for the year ahead presents more challenges than usual, this time due
to the numerous tax extenders that expired at the end of 2013.
These tax extenders,
which include nonbusiness energy credits and the sales tax deduction that
allows taxpayers to deduct state and local general sales taxes instead of state
and local income taxes, may or may not be reauthorized by Congress and made retroactive
to the beginning of the year.
More significant
however, is taxable income in relation to threshold amounts that might bump a
taxpayer into a higher or lower tax bracket, thus, subjecting taxpayers to
additional taxes such as the Net Investment Income Tax (NIIT) or an additional
Medicare tax.
In the meantime, let's
take a look at some of the tax strategies that you can use right now, given the
current tax situation.
Tax planningstrategies for individuals this year include postponing income and accelerating
deductions, as well as careful consideration of timing related investments,
charitable gifts, and retirement planning. General tax planning strategies that
taxpayers might consider include the following:
Sell any investments
on which you have a gain or loss this year. For more on this, see Investment
Gains and Losses, below.
If you anticipate an
increase in taxable income in 2015 and are expecting a bonus at year-end, try
to get it before December 31. Keep in mind, however, that contractual bonuses
are different, in that they are typically not paid out until the first quarter
of the following year. Therefore, any taxes owed on a contractual bonus would
not be due until you file a tax return for tax year 2015.
Prepay deductible
expenses such as charitable contributions and medical expenses this year using
a credit card. This strategy works because deductions may be taken based on
when the expense was charged on the credit card, not when the bill was paid.
For example, if you charge a medical expense in December, but pay the bill in
January, assuming it's an eligible medical expense, it can be taken as a
deduction on your 2014 tax return.
If your company grants
stock options, you may want to exercise the option or sell stock acquired by
exercise of an option this year if you think your tax bracket will be higher in
2015. Exercise of the option is often but not always a taxable event; sale of
the stock is almost always a taxable event.
If you're
self-employed, send invoices or bills to clients or customers this year in
order to be paid in full by the end of December.
Caution: Keep an eye
on the estimated tax requirements.
Accelerating income
into 2014 is an especially good idea for taxpayers who anticipate being in a
higher tax bracket next year or whose earnings are close to threshold amounts
($200,000 for single filers and $250,000 for married filing jointly) that make
them liable for additional Medicare tax or Net Investment Income Tax (see
below).
Here are several
examples of what a taxpayer might do to accelerate deductions:
Pay a state estimated
tax installment in December instead of at the January due date. However, make
sure the payment is based on a reasonable estimate of your state tax.
Pay your entire
property tax bill, including installments due in year 2015, by year-end. This
does not apply to mortgage escrow accounts.
It may be beneficial
to pay 2015 tuition in 2014 to take full advantage of the American Opportunity
Tax Credit, an above the line deduction worth up to $2,500 per student to cover
the cost of tuition, fees and course materials paid during the taxable year.
Forty percent of the credit (up to $1,000) is refundable, which means you can
get it even if you owe no tax.
Try to bunch
"threshold" expenses, such as medical and dental expenses (10 percent
of AGI starting in 2013) and miscellaneous itemized deductions. For example,
you might pay medical bills and dues and subscriptions in whichever year they
would do you the most tax good.
Threshold expenses are
deductible only to the extent they exceed a certain percentage of adjusted
gross income (AGI). By bunching these expenses into one year, rather than
spreading them out over two years, you have a better chance of exceeding the
thresholds, thereby maximizing your deduction.
In cases where tax
benefits are phased out over a certain adjusted gross income (AGI) amount, a
strategy of accelerating income and deductions might allow you to claim larger
deductions, credits, and other tax breaks for 2014, depending on your
situation.
The latter benefits
include Roth IRA contributions, conversions of regular IRAs to Roth IRAs, child
credits, higher education tax credits and deductions for student loan interest.
Caution: Taxpayers
close to threshold amounts for the Net Investment Income Tax (3.8 percent of
net investment income) should pay close attention to "one-time"
income spikes such as those associated with Roth conversions, sale of a home or
other large assets that may be subject to tax.
Tip: If you know you
have a set amount of income coming in this year that is not covered by
withholding taxes, increasing your withholding before year-end can avoid or
reduce any estimated tax penalty that might otherwise be due.
Tip: On the other
hand, the penalty could be avoided by covering the extra tax in your final
estimated tax payment and computing the penalty using the annualized income
method.
Healthcare Reform
If you haven't signed
up for health insurance this year, it's not too late to do so--and avoid or
reduce any penalty you might be subject to. Healthcare subsidies are also a
potential tax planning issue. Please contact us if you need assistance with
this.
Additional Medicare
Tax
Taxpayers whose income
exceeds certain threshold amounts ($200,000 single filers and $250,000 married
filing jointly) are liable for an additional Medicare tax of 0.9 percent on
their tax returns, but may request that their employers withhold additional
income tax from their pay to be applied against their tax liability when filing
their 2014 tax return next April.
High net worth
individuals should consider contributing to Roth IRAs and 401(k) because
distributions are not subject to the Medicare Tax.
If you're a taxpayer
close to the threshold for the Medicare Tax, it might make sense to switch Roth
retirement contributions to a traditional IRA plan, thereby avoiding the 3.8
percent Net Investment Income Tax as well (more about the NIIT below).
Alternate Minimum Tax
The Alternative
Minimum Tax (AMT) exemption "patch" was made permanent by the
American Taxpayer Relief Act (ATRA) and is indexed for inflation. It's
important not to overlook the effect of any year-end planning moves on the AMT
for 2014 and 2015.
Items that may affect
AMT include deductions for state property taxes and state income taxes,
miscellaneous itemized deductions, and personal exemptions.
Note: AMT exemption
amounts for 2014 are as follows:
$52,800 for single and
head of household filers,
$82,100 for married
people filing jointly and for qualifying widows or widowers,
$41,050 for married
people filing separately.
Please call us if
you'd like more information or if you're not sure whether AMT applies to you.
We're happy to assist you.
Residential Energy Tax
Credits
Non-Business Energy
Credits
ATRA extended the
non-business energy credit, which expired in 2011, through 2013 (retroactive to
2012); however, it has not been reauthorized by Congress. For years prior to
2014, taxpayers could claim a credit of 10 percent of the cost of certain
energy-saving property that was added to their main home.
Residential Energy
Efficient Property Credits
The Residential Energy
Efficient Property Credit is available to individual taxpayers to help pay for
qualified residential alternative energy equipment, such as solar hot water
heaters, solar electricity equipment and residential wind turbines. In
addition, taxpayers are allowed to take the credit against the alternative
minimum tax (AMT), subject to certain limitations.
Qualifying equipment
must have been installed on or in connection with your home located in the
United States.
Geothermal pumps,
solar energy systems, and residential wind turbines can be installed in both
principal residences and second homes (existing homes and new construction),
but not rentals. Fuel cell property qualifies for the tax credit only when it
is installed in your principal residence (new construction or existing home).
Rentals and second homes do not qualify.
The tax credit is 30
percent of the cost of the qualified property, with no cap on the amount of
credit available, except for fuel cell property.
Generally, labor costs
can be included when figuring the credit. Any unused portions of this credit
can be carried forward. Not all energy-efficient improvements qualify so be
sure you have the manufacturer's tax credit certification statement, which can
usually be found on the manufacturer's website or with the product packaging.
What's included in
this tax credit?
Geothermal Heat Pumps.
Must meet the requirements of the ENERGY STAR program that are in effect at the
time of the expenditure.
Small Residential Wind
Turbines. Must have a nameplate capacity of no more than 100 kilowatts (kW).
Solar Water Heaters.
At least half of the energy generated by the "qualifying property"
must come from the sun. The system must be certified by the Solar Rating and
Certification Corporation (SRCC) or a comparable entity endorsed by the
government of the state in which the property is installed. The credit is not
available for expenses for swimming pools or hot tubs. The water must be used
in the dwelling. Photovoltaic systems must provide electricity for the
residence and must meet applicable fire and electrical code requirement.
Solar Panels
(Photovoltaic Systems). Photovoltaic systems must provide electricity for the
residence and must meet applicable fire and electrical code requirement.
Fuel Cell (Residential
Fuel Cell and Microturbine System.) Efficiency of at least 30 percent and must
have a capacity of at least 0.5 kW.
Charitable
Contributions
Property, as well as
money, can be donated to a charity. You can generally take a deduction for the
fair market value of the property; however, for certain property, the deduction
is limited to your cost basis. While you can also donate your services to
charity, you may not deduct the value of these services. You may also be able
to deduct charity-related travel expenses and some out-of-pocket expenses,
however.
Keep in mind that a
written record of your charitable contributions is required in order to qualify
for a deduction. A donor may not claim a deduction for any contribution of
cash, a check or other monetary gift unless the donor maintains a record of the
contribution in the form of either a bank record (such as a cancelled check) or
written communication from the charity (such as a receipt or a letter) showing
the name of the charity, the date of the contribution, and the amount of the
contribution.
Tip: Contributions of appreciated
property (i.e. stock) provide an additional benefit because you avoid paying
capital gains on any profit.
Investment Gains and
Losses
This year, and in the
coming years, investment decisions are likely to be more about managing capital
gains than about minimizing taxes per se. For example, taxpayers below
threshold amounts in 2014 might want to take gains; whereas taxpayers above
threshold amounts might want to take losses.
If your tax bracket is
either 10 or 15 percent (married couples making less than $73,800 or single
filers making less than $36,900), then you might want to take advantage of the
zero percent tax rate on qualified dividends and long-term capital gains. If
you fall into the highest tax bracket (39.6 percent), the maximum tax rate on
long-term capital gains is capped at 20 percent for tax years 2013 and beyond.
Minimize taxes on
investments by judicious matching of gains and losses. Where appropriate, try
to avoid short-term capital gains, which are usually taxed at a much higher tax
rate than long-term gains--up to 39.6 percent in 2014 for high-income earners ($406,750
single filers, $457,600 married filing jointly).
Where feasible, reduce
all capital gains and generate short-term capital losses up to $3,000.
Tip: As a general
rule, if you have a large capital gain this year, consider selling an
investment on which you have an accumulated loss. Capital losses up to the
amount of your capital gains plus $3,000 per year ($1,500 if married filing
separately) can be claimed as a deduction against income.
Tip: After selling
securities investment to generate a capital loss, you can repurchase it after
30 days. If you buy it back within 30 days, the loss will be disallowed. Or you
can immediately repurchase a similar (but not the same) investment, e.g.,
another mutual fund with the same objectives as the one you sold.
Tip: If you have
losses, you might consider selling securities at a gain and then immediately
repurchasing them, since the 30-day rule does not apply to gains. That way,
your gain will be tax-free; your original investment is restored, and you have
a higher cost basis for your new investment (i.e., any future gain will be
lower).
Net Investment Income
Tax (NIIT)
The Net Investment
Income Tax, which went into effect in 2013, is a 3.8 percent tax that is
applied to investment income such as long-term capital gains for earners above
certain threshold amounts ($200,000 for single filers and $250,000 for married
taxpayers filing jointly). Short-term capital gains are subject to ordinary
income tax rates as well as the 3.8 percent NIIT. This information is something
to think about as you plan your long term investments. Business income is not
considered subject to the NIIT provided the individual business owner is
materially active in the business.
Please call us if you
need assistance with any of your long term tax planning goals.
Mutual Fund
Investments
Before investing in a
mutual fund, ask whether a dividend is paid at the end of the year or whether a
dividend will be paid early in the next year but be deemed paid this year. The
year-end dividend could make a substantial difference in the tax you pay.
Example: You invest
$20,000 in a mutual fund at the end of 2014. You opt for automatic reinvestment
of dividends. In late December of 2014, the fund pays a $1,000 dividend on the
shares you bought. The $1,000 is automatically reinvested.
Result: You must pay
tax on the $1,000 dividend. You will have to take funds from another source to
pay that tax because of the automatic reinvestment feature. The mutual fund's
long-term capital gains pass through to you as capital gains dividends taxed at
long-term rates, however long or short your holding period.
The mutual fund's
distributions to you of dividends it receives generally qualify for the same
tax relief as long-term capital gains. If the mutual fund passes through its
short-term capital gains, these will be reported to you as "ordinary
dividends" that don't qualify for relief.
Depending on your
financial circumstances, it may or may not be a good idea to buy shares right
before the fund goes ex-dividend. For instance, the distribution could be
relatively small, with only minor tax consequences. Or the market could be
moving up, with share prices expected to be higher after the ex-dividend date.
Tip: To find out a
fund's ex-dividend date, call the fund directly.
Be sure to call us if
you'd like more information on how dividends paid out by mutual funds affect
your taxes this year and next.
Year-End Giving To
Reduce Your Potential Estate Tax
The federal gift and
estate tax exemption, which is currently set at $5.340 million is projected to
increase to $5.43 million in 2015 (Bloomberg BNA). ATRA set the maximum estate
tax rate set at 40 percent.
Gift Tax. For many,
sound estate planning begins with lifetime gifts to family members. In other
words, gifts that reduce the donor's assets subject to future estate tax. Such
gifts are often made at year-end, during the holiday season, in ways that
qualify for exemption from federal gift tax.
Gifts to a donee are
exempt from the gift tax for amounts up to $14,000 a year per donee.
Caution: An unused
annual exemption doesn't carry over to later years. To make use of the
exemption for 2014, you must make your gift by December 31.
Husband-wife joint gifts
to any third person are exempt from gift tax for amounts up to $28,000 ($14,000
each). Though what's given may come from either you or your spouse or both of
you, both of you must consent to such "split gifts".
Gifts of "future
interests", assets that the donee can only enjoy at some future time such
as certain gifts in trust, generally don't qualify for exemption; however,
gifts for the benefit of a minor child can be made to qualify.
Tip: If you're
considering adopting a plan of lifetime giving to reduce future estate tax,
then don't hesitate to call us. We can help you set it up.
Cash or publicly
traded securities raise the fewest problems. You may choose to give property
you expect to increase substantially in value later. Shifting future appreciation
to your heirs keeps that value out of your estate. But this can trigger IRS
questions about the gift's true value when given.
You may choose to give
property that has already appreciated. The idea here is that the donee, not
you, will realize and pay income tax on future earnings and built-in gain on
sale.
Gift tax returns for
2014 are due the same date as your income tax return. Returns are required for
gifts over $14,000 (including husband-wife split gifts totaling more than
$14,000) and gifts of future interests. Though you are not required to file if
your gifts do not exceed $14,000, you might consider filing anyway as a
tactical move to block a future IRS challenge about gifts not "adequately
disclosed."
Tip: Call us if you're
considering making a gift of property whose value isn't unquestionably less
than $14,000.
Income earned on
investments you give to children or other family members are generally taxed to
them, not to you. In the case of dividends paid on stock given to your
children, they may qualify for the reduced child tax rate, generally 10
percent, where the first $1,000 in investment income is exempt from tax and the
next $1,000 is subject to a child's tax rate of 10 percent (0 percent tax rate
on long-term capital gains and qualified dividends).
Caution: In 2014,
investment income for a child (under age 18 at the end of the tax year or a
full-time student under age 24) that is in excess of $2,000 is taxed at the
parent's tax rate.
Other Year-End Moves
Retirement Plan
Contributions. Maximize your retirement plan contributions. If you own an
incorporated or unincorporated business, consider setting up a retirement plan
if you don't already have one. It doesn't actually need to be funded until you
pay your taxes, but allowable contributions will be deductible on this year's
return.
If you are an employee
and your employer has a 401(k), contribute the maximum amount ($17,500 for
2014), plus an additional catch-up contribution of $5,500 if age 50 or over, assuming
the plan allows this much and income restrictions don't apply.
If you are employed or
self-employed with no retirement plan, you can make a deductible contribution
of up to $5,500 a year to a traditional IRA (deduction is sometimes allowed
even if you have a plan). Further, there is also an additional catch-up
contribution of $1,000 if age 50 or over.
Health Savings
Accounts. Consider setting up a health savings account (HSA). You can deduct
contributions to the account, investment earnings are tax-deferred until
withdrawn, and amounts you withdraw are tax-free when used to pay medical
bills.
In effect, medical
expenses paid from the account are deductible from the first dollar (unlike the
usual rule limiting such deductions to the excess over 10 percent of AGI). For
amounts withdrawn at age 65 or later, and not used for medical bills, the HSA
functions much like an IRA.
To be eligible, you
must have a high-deductible health plan (HDHP), and only such insurance,
subject to numerous exceptions, and must not be enrolled in Medicare. For 2014,
to qualify for the HSA, your minimum deductible in your HDHP must be at least
$1,250 for single coverage or $2,500 for a family.
Summary
These are just a few
of the steps you might take. Please contact us for help in implementing these
or other year-end planning strategies that might be suitable to your particular
situation.
I
am here to help! If you have any
question call me today!
Amare Berhie
Cell 612-282-3200
Office (651)
621-5777,
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