Whether considering your own personal tax situation or that of your business, as we near the end the year, tax considerations and planning should be on your mind. Certain decisions and actions are imperative this year to help minimize your tax situation for 2014.
Year-end tax planning for 2014 will be challenging in many respects due to tax incentives that expired at the end of the 2013 year. Although Congress could still act on some of these expired incentives and retroactively reinstate these, it is unclear as to whether the political climate will exist to support this. The end result is that there could be some truly last minute tax opportunities that open up if these tax breaks are extended.
Tax breaks which expired for individuals included: opportunity to deduct state and local sales and use tax instead of state and local income taxes; an above-the-line deduction for qualified higher education expenses; tax-free IRA distributions for charitable purposes by individuals 70 ½ or older;, and the exclusion for up to $2 million of mortgage debt forgiveness on a principal residence.
Tax breaks which expired for businesses included: 50% bonus first year depreciation for most new machinery, equipment and software; the $500,000 annual section 179 depreciation expensing limitation; the research tax credit; and the 15 year write-off for qualified leasehold improvement property, qualified restaurant property and qualified retail improvement property.
2014 will also have unique consideration for higher income earners when mapping out year-end tax plans. The 3.8% surtax on certain unearned income and the additional 0.9% Medicare (hospital insurance, or HI) tax that applies to individuals receiving wages from employment in excess of $200,000 ($250,000 for married filing jointly and $125,000 for married filing separately) must be planned for.
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 married filing joint or surviving spouses, $125,000 for married individual filing separate, and $200,000 for all others). Strategies to minimize this surtax depend upon the estimated NII and MAGI for the year. Taxpayers with high NII should consider ways to minimize additional NII balances for the year (possibly through income deferral). Or if high MAGI is the concern, it should be looked at how to reduce 2014 MAGI; or consider ways to reduce both NII and MAGI.
For the additional 0.9% Medicare tax (HI) year-end planning may require action. Employers must withhold the additional Medicare tax from wages in excess of $200,000 regardless of filing status or other income. However, self-employment individuals must take it into account when projecting their estimated tax for 2014. Also, there could be situations where an individual needs to have an additional amount withheld near the end of the tax year to cover this tax. This situation could occur if an employee worked at more than one employer in 2014 and cumulatively earned over $200,000 (but was under the $200,000 at each employer separately). In this case, the employee would owe the HI tax, but neither employer would have had to withhold this tax amount since neither met the thresholds.
Below is a list of many tax action items that should be considered for the 2014 tax year that may help to minimize your tax burden for the 2014 tax year if acted upon before the end of this year. Although 2014 is shaping up as a fairly hard year to plan for in many respects, there are actions that you can and should take now to help minimize your ending tax bill:
Year-end tax planning actions for individuals:
- Postponing Income & Accelerating Deductions – For higher income individuals, postponing income until 2015 or accelerating deductions could lower your 2014 tax bill and help you be able to take advantage of other tax breaks 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 would be most desirable to individuals who anticipate lower income levels for the 2015 tax year. Also, for those individuals who anticipate higher income for 2015, the opposite of this strategy may make sense to help minimize the overall tax burden between the tax years.
- Traditional IRA Conversion to Roth IRA Considerations- If you converted assets held in a traditional IRA to a Roth IRA earlier in the year and the assets in the Roth IRA have declined in value, if you leave it as is you may end up paying higher tax than is necessary. You can back out of the transaction by recharacterizing the conversion (transferring the converted amount plus earnings/loss back to a traditional IRA via a trustee-to-trustee transfer). You can reconvert later to a Roth IRA if doing so proves advantageous.
- End of Year Bonus – It may be advantageous to arrange with your employer to defer a bonus that you may be receiving until 2015.
- State & Local Tax Withholding – If you anticipate owing state and local income taxes when you file your return next year, consider asking your employer to increase your withholding of state and local taxes (or make an estimated payment to the state) before year end to pull the deduction of taxes into 2014 if doing so will not create alternative minimum tax (AMT) issues.
- AMT Considerations – Talk with your tax professional to estimate the effect of any year-end planning moves on the alternative minimum tax (AMT) for 2014 – many tax breaks allowed for purposes of calculating regular taxes on your residence, state income taxes, miscellaneous itemized deductions and personal exemption deductions are not allowed for AMT purposes.
- 70 ½? Take RMD – Make sure to take required minimum distributions (RMDs) from your IRA or 401(k) plan if you have reached age 70 ½ . Failure to take the RMD can result in a penalty of 50% for the amount of the RMD not taken.
- Retirement Contributions – One of the best ways to save on taxes is to make contributions into a retirement account including 401(k), SEP or IRA. Maximizing your contribution not only saves money for retirement, but decreases your taxable income for the current tax year.
- HSA Contribution – 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 will be the case even if you became eligible on December 1.
- Gifting Strategies – Making gifts sheltered by the annual tax exclusion before the end of the year could save taxes in the future for gift and estate taxes. You can give up to $14,000 in 2014 to each of an unlimited number of individuals ($28,000 for married couples) but you cannot carry over used exclusions from one year to the next. The transfers may also 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.
Year-end tax planning actions for businesses:
- Depreciation & New Capitalization Regulations – Although the expiration of the bonus 50% depreciation expense on new equipment additions and the decrease in the section 179 dollar limitation (from $500,000 limit with beginning of phase-out amount of $2 million to $25,000 limit with beginning of phase-out amount of $200,000) will be a hard hit to business taxable income, businesses could benefit from the new “de minimus” safe harbor election in the new capitalization regulations and the provisions for expensing certain regular repair or maintenance costs which in the past may have been required to be capitalized. Business controllers and managers should become familiar with the new IRS capitalization regulations and make sure they are in compliance and maximizing their business’s benefit.
Business should make sure they have adopted a capitalization policy as required by the new regulations effective as of the end of 2013 to ensure that they are able to set the capitalization threshold which applies to their business at the highest possible level. For businesses that have annual financial audits, this threshold is $5,000, however if the business did not have an audit, the maximum of this threshold is $500. If no policy is in place or adopted, however, the automatic threshold assigned under the new capitalization thresholds is only $200.
- Half-Year Depreciation Convention – If machinery and equipment is purchased before year end, the “half-year convention” should be utilized for tax purposes which secures a half-year worth of depreciation deduction for the first ownership year.
- Acceleration & Deferral of Income – A corporation should consider accelerating income from 2015 to 2014 where doing so will prevent the corporation from moving into a higher tax bracket next year. Conversely, it should be considered to defer income until 2015 when doing so will prevent the corporation from moving into a higher tax bracket this year.
- Business AMT – If income and expense deferral or acceleration options will be considered by your business for 2014, a determination for the alternative minimum tax (AMT) consequence should be considered to determine if the taxpayer would be subjected to additional AMT.
- Pay by Credit Card- 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.
With careful proactive and reactionary tax planning (if Congress takes action on certain tax extender legislation) and coordination with your tax advisor, you should be able to customize your tax planning to take advantage of many positive tax strategies and help minimize your tax burden for 2014.