We have as much certainty in year-end tax planning as we did this time last year. Congress just passed the “Extender Bill” (discussed below) but only for the short-term, retroactive to January 1, 2014 through December 31, 2014. We go into 2015 not knowing whether these provisions along with more drastic tax reform proposals will be the law in 2015. We have had time to lament over the new rules that began in 2013 involving phase-outs of itemized deductions and personal exemptions, increased income tax rates and the new Medicare surtaxes. It should leave us less surprised when the numbers hit the tax returns this coming filing season. WBL is always happy to “run the numbers” as part of year-end planning for our clients, so please contact us. In the meantime, here are some thoughts that you might find useful:
“Extenders” Arrive and Disappear: As noted above, Congress has extended more than 50 temporary tax provisions through 2014 that are currently set to expire in 2015. For individual filers, these include (among others): Child tax credit, dependent care credit, certain tuition credits and deductions, exclusion of income from cancellation of mortgage debt, IRA distributions for charity for those older than 70-1/2 years old, state and local sales tax deduction and certain energy credits. For business filers, the extenders currently available in 2014 but possibly not in 2015 include: the research tax credit, work opportunity tax credit, 100% exclusion for gain on sale of qualified small business stock and the reduced recognition period to 5 years for S Corporation built-in gains tax.
Depreciation Provisions: As part of the “Extenders Bill,” the Section 179 expensing deduction for certain fixed asset acquisitions has been increased to $500k from $25k for 2014, subject to a $2 million investment limit. In addition, the 50% bonus depreciation rule is back for many other fixed asset acquisitions placed in service in calendar year 2014. There is no guarantee how these rules will fare during 2015 and beyond with the new Congress, so the race is on to place fixed assets into service by year-end.
Ordinary Income Tax Rates: In 2014, ordinary income tax rates will be comparable to 2013. That means for those with taxable income of over $406,750 ($457,600 for joint filers; $432,200 for heads of households), the federal tax rate on ordinary income over those thresholds will be 39.6%. Clearly if one can manage to keep taxable income under the thresholds in 2014 and 2015, the impact of this top tax rate can be avoided. Please let us know if you believe you will be close to these thresholds and we can discuss strategies.
Capital Gains/Qualified Dividends: For taxpayers above the same $406,750/$432,200/$457,600 thresholds noted above, the top federal rate for long-term capital gains and qualified dividends will be 20% in 2014. For those under these thresholds, the maximum federal rate is 15%. Again, managing income to stay under the thresholds if possible might be beneficial. Also, selling investment assets to realize capital losses before year-end and managing holding periods to avoid short-term gains remain good strategies for many.
As a reminder, dividends are generally eligible for the lower tax rates as “qualified dividends” if they are received from a domestic corporation or a qualified foreign corporation, on which the underlying stock is held for at least 61 days within a specified 121-day period.
The 25% tax rate for certain real estate gains and the 28% tax rate for sales of collectibles remain unchanged.
Medicare Surtax on Investment Income: As in 2013, the Affordable Care Act (ACA) retains the 3.8% Medicare surtax on net investment income (NII) for those with AGI of $200,000 ($250,000 joint filers). The tax equals 3.8% of the lesser of NII or the excess of modified AGI over the $200,000/$250,000 thresholds.
NII generally includes most capital gains, interest, dividends and income from passive activities (including real estate income for those not considered “real estate professionals”). Gains from a trade or business are generally excluded from NII as is tax-free income such as interest income on municipal bonds. Taxpayers with multiple businesses/activities who are subject to the Medicare surtax can continue with the re-grouping of activities done this year. Those who didn’t take advantage of the regulations to regroup certain 2013 businesses/activities can do so this year to aggregate the hours spent on such businesses/activities and convert potential passive activities to non-passive. The passive activity rules are complicated; therefore an election must be made with caution given its possible impact on future dispositions.
Limitation on Itemized Deductions and Exemptions: High income taxpayers have to reduce certain otherwise allowable itemized deductions by 3% of the amount by which their adjusted gross income (AGI) exceeds an applicable threshold. They also have their personal exemptions phased out by 2% for each $2,500 of AGI in excess of the applicable threshold. The applicable AGI thresholds for 2014 are: $305k for joint filers, $280k for heads of households and $254k for singles. For those affected, this is a hidden tax increase.
Gift Giving: To reduce your estate, you can give up to $14,000 tax-free in 2014 to as many donees as you want without reducing your estate and lifetime gift tax exclusion amount. In addition, because spouses may combine their exemptions in a single gift from either spouse, married givers may double the amount of the exclusion to $28,000 per donee. Qualifying tuition payments and medical payments do not count against this limit. The annual exclusion will be $14,000 in 2015 as well. Plus, the lifetime exclusion will increase to $5.43 million in 2015 from $5.34 million, enabling those who had previously gifted the lifetime maximum to gift another $90k in addition to the annual exclusion amounts.
Certain Healthcare Provisions: Beginning in 2014, the individual mandate kicks in requiring individuals to have health insurance that meets minimum coverage or pay a penalty, unless otherwise exempt. 2014 tax returns will need to disclose whether you are in compliance. For lower-income individuals who obtain health insurance through an “Exchange,” a premium tax credit and cost-sharing reductions may be available to offset the costs. Cafeteria plans are still available and employees may elect to contribute up to $2,500 to a health flexible savings account pre-tax to reduce salary. Health savings accounts (HSAs) also remain available for deductible contributions for those with “high deductible health plans.”
Final Repair/Capitalization Regulations: The IRS has issued final regulations explaining when taxpayers must capitalize costs and when they can deduct expenses for acquiring, maintaining, repairing and replacing tangible business property. This will complicate most business tax returns we prepare for the 2014 tax year. It is possible that a “change in accounting method” will have to be requested to put our business clients in compliance with these rules. See our summary of these regulations with other important information at www.wblcpa.com.
Other “Typical” Tax Savings Strategies: Given that income tax rates for 2015 will be comparable to 2014, most taxpayers will generally benefit from the typical tax strategies we have discussed in previous years. For example, strategies for deferring income and accelerating expenses for cash basis businesses, taking advantage of one or more of the many retirement vehicles available, paying state income taxes before year-end if beneficial and “bunching” certain expenses such as medical expenses into one year if doing so will put you over the limits to enable a tax benefit. For taxpayers who plan to make charitable contributions before year end, consider donating appreciated securities rather than cash. You reap the benefit of the same charitable contribution deduction, subject to certain limitations, without recognizing the gain on securities for tax purposes. Also, it continues to be important to monitor the impact of the alternative minimum tax (AMT) with its parallel tax system that disallows certain expenses such as real estate taxes while taxing certain otherwise tax-free income such as interest from municipal private activity bonds. Investments in strategies that provide charitable deductions for conservation easements and other land donations continue to create a buzz among some taxpayers. Your WBL professionals are available to explain all of these in more detail, help weigh the applicable risks and run the numbers.
A Race for Georgia Incentives: Because Georgia has capped the total amount of certain tax credits that it will provide, taxpayers are encouraged to get applications filed as soon as possible before the credits get used up in 2015. These include the credit for contributions made to Student Scholarship Organizations (SSO) and the gaming film credit if applicable. Contact WBL or see our website at www.wblcpa.com for more information about these and other tax incentives.
2015 Standard Mileage Rates: The business standard mileage rate will increase to 57.5 cents-per-mile for 2015, up from 56 cents. The rate for medical and moving expenses will decrease to 23 cents-per-mile.
New Savings Account for 2015 Planning: The Achieving a Better Life Experience (ABLE) Act creates tax-favored savings account for individuals with disabilities for tax years beginning after December 31, 2014. Contributions would be limited to $14k for 2015. https://wblcpa.com/2014-year-end-tax-planning-briefing/Distributions can be used to cover medical expenses as well as transportation and housing with no tax effect. More information from IRS is forthcoming.
IRS Budget Gets Cut: The ominibus funding bill recently passed by Congress funds the IRS at $11 billion for fiscal year 2015, $346 million less than the 2014 budget. Enforcement funds were reduced to “only” $4.86 billion, but there will be a boost in funding for identity theft protection. The IRS has warned of a hiring freeze and the likelihood of diminished service and responsiveness.
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There are other year-end strategies that might be more specific to your situation. If you have any questions or if we can help in any way, please contact us. In the meantime, we will continue to monitor the tax impact of what goes on in Washington.