2014 Year-End Tax Planning
As December rolls in, we may have visions of sugar plums and holiday merriment dancing in our heads but, like it or not, it's also the time of year when we need to be getting our tax-planning ducks in a row. Indeed, end-of-year tax planning can be a challenge for both individuals and businesses. This seems especially so this year, as we are waiting for Congress to act on a number of tax breaks that expired in 2013. Some may be reinstated and extended retroactively, but we may not find out until the very end of the year (or, more troubling, not until next year).
For individuals, these breaks include deductions for qualified higher education expenses and tax-free individual retirement accounts (IRAs). For businesses, tax breaks that expired in 2013 and may be reinstated include a 50 percent bonus first-year depreciation for new machinery and equipment, as well as a $500,000 annual expensing limitation. In addition, all taxpayers need to be prepared for the how the Patient Protection and Affordable Care Act (PPACA) will affect them.
Based on the November's election results, the Republicans' majority in the House and the Senate means there may be an opportunity for comprehensive tax reform. The impact of the elections on the 2014 year-end tax planning was primarily on the so-called "tax extenders" package that includes various expired individual and business tax breaks. It is not yet decided whether the final passage will happen in December or January next year when the new Congress meets and whether it will be retroactively restated to the beginning of 2014.
Here is a checklist of tax strategies to consider, based on current tax rules, which may help you save tax dollars if you act before Dec. 31. Not all actions will apply, but you may benefit from many of them. Be sure to speak with a certified tax professional for full information.
Businesses looking to maximize tax benefits through 2014 year-end tax planning may want to consider the following general strategies:
- Use the traditional timing techniques for income and deductions
- Understand the tax incentives that expired at the end of 2013 but may be extended through 2014
- Consider adopting a qualified retirement plan before year-end.
- React to recent tax developments that may present either new tax-saving opportunities or pitfalls
Section 179 Expensing and Bonus Depreciation
Many business owners are familiar with the benefits of Section 179 expensing and bonus depreciation.
After Dec. 31, 2013, enhanced Section 179 expensing expired, which is significant. The expensing and investment limitations were reduced from $500,000 and $2 million to $25,000 and $200,000.
Uncertainty over the ultimate fate Section 179 expensing and bonus depreciation impacts 2014 year-end planning, particularly as business owners consider purchases of equipment and supplies. Businesses considering qualified purchases need to weigh the benefits of making these purchases before year-end or postponing them until 2015.
In addition, businesses should consider purchasing machinery and equipment before year-end as, under the generally applicable half-year's convention, a half-year worth of depreciation deduction is allowed for the first ownership year.
When it comes to treating costs related to real property (the so-called "repair regulations"), regulations may open tax planning opportunities for some taxpayers. For tangible property acquisition, businesses may be able to take advantage of the "de minimis safe harbor election" (also known as the book-tax conformity election) to deduct the costs. The safe harbor applies to items that cost $5,000 or less (per item or invoice) and that are deducted on the company's applicable financial statement (AFS) in accordance with a written accounting procedure. The de minimis limit is $500 per item or invoice for companies without an AFS.
Small Business Stock
A full 100 percent gain exclusion is allowed for qualified small business stock that is acquired after Sept. 27, 2010, and before Jan. 1, 2014, and held for more than five years. Under current law, the percentage that is excluded is 50 percent (60 percent for empowerment zone stock) for qualifying stock acquired after Dec. 31, 2013. Even with the reduced gain exclusion, it is still a worthwhile strategy. Taxpayers should consider making investments before year-end so that the required five-year holding period begins to run.
Small business healthcare tax credit
Owners of small businesses should not overlook a tax credit under IRC Section 45R that helps offset the cost of providing health insurance to employees. To be eligible for the tax credit, the small employer must have fewer than 25 full-time equivalent employees (FTEs). In addition, the average annual wages it pays to its employees for the year must be less than $50,000 per FTE.
The Treasury Department is expected to unveil a new retirement savings arrangement before the end of 2014. The new accounts are called myRA. These accounts will be offered through employers that elect to participate. Account holders will build savings for 30 years or until their myRA reaches $15,000, whichever comes first. After that, myRA balances will transfer to private-sector Roth IRAs. Small business owners should explore the benefits of offering myRAs to their employees.
Net Investment Income (NII) Tax For some individuals, the new net investment income tax has become part of their year-end tax planning.
There are three categories of net investment income:
- Category 1: gross income from interest, dividends, annuities, royalties and rents, if the income is not derived in a trade or business
- Category 2: income from a "trade or business" that is a passive activity, as determined under IRC Section 469, or is from a business as a financial trader
- Category 3: net gains from the sale of property, unless the property is held in a non-passive trade or business.
Under IRC Section 469, individuals may group multiple activities into a single activity. Generally, an individual must meet the material participation standard for each activity. Grouping into a single activity can make it easier for a taxpayer to meet the standard by combining the taxpayer's hours and participation. By grouping activities, a taxpayer may be able to avoid having income treated as net investment income.
The income thresholds for triggering the net investment income tax: $200,000 for single taxpayers; $250,000 for married couples filing a joint return; and $125,000 for married couples filing separately. All net investment income should be monitored for exposure to the NII tax. Taxpayers with potential NII tax liability should consider keeping income below their respective thresholds if possible by spreading income out over a number of years or offsetting the income with both above-the-line and itemized deductions.
Additional Medicare Tax
The additional Medicare tax increases the employee share by an additional 0.9 percent of covered wages in excess of certain threshold amounts. The tax also increases Medicare tax on self-employment income by an additional 0.9 percent of income in excess of the threshold amounts. The threshold amounts are $200,000 for single individuals (and heads of household); $250,000 for married couples filing a joint return; and $125,000 for married individuals filing returns.
This is the second year for the additional Medicare tax. Taxpayers who now realize that they have had insufficient income tax withholding may require that their employer(s) take out an additional amount of income tax withholding, which would be applied against taxes shown on their individual income tax returns, including any additional Medicare tax liability. Taxpayers may also want to consider making estimated tax payments to avoid the penalties.
Alternative Minimum Tax (AMT)
The AMT is now permanently "patched." The patch provides for increased exemption amounts and allows taxpayers to take all the non-refundable personal credits against regular and AMT liability. Even with the permanent patch, taxpayers should continue to review their AMT liabilities versus regular tax liabilities.
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 back out of the transaction by recharacterizing the rollover or conversion, 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. Roth conversions may also be available in 401(k) accounts (check with your plan administrator).
Individual Tax Extenders
Prospects for permanent extension of many of the so-called tax extenders also appear dim before yearend.
However, there will likely be an extension of the extenders, probably for two years. That means extensions will be retroactive to Jan. 1, 2014, because many of the extenders expired after Dec. 31, 2013. For planning purposes, individuals should consider their tax strategies under one scenario that includes extension of the extenders and another that does not. Keep in mind that some of the extenders impact other provisions of the Tax Code. The list of expired extenders is long so talking to a certified tax professional is encouraged.
New Considerations from PPACA
As of Jan. 1, 2014, PPACA requires all individuals to carry health insurance or make a shared responsibility payment, unless exempt. For many, employer-provided health insurance will satisfy the individual mandate. Others will satisfy the individual mandate if they are covered by Medicare or Medicaid. Individuals who are not exempt will need to make a shared responsibility payment when they file their 2014 returns in 2015.
Generally, the shared responsibility payment amount is either a percentage of the individual's income or a flat dollar amount, whichever is greater. The amount owed is 1/12 of the annual payment for each month that a person or the person's dependents are not covered and are not exempt. The individual shared responsibility payment is capped at the cost of the national average premium for the bronze level health plan available through the Affordable Care Act Marketplace (Marketplace) in 2014.
Estate and Gift Planning
The maximum federal unified estate and gift tax rate is 40 percent, with an inflation-adjusted $5 million exclusion for gifts made and estates of decedents dying after Dec. 31, 2012. The annual gift tax exclusion allows taxpayers to give up to an inflation-adjusted $14,000 to any individual, gift tax-free, and without counting the amount of the gift toward the lifetime $5 million exclusion, adjusted for inflation.
Gifts made before the end of the year can be sheltered by the annual gift tax exclusion and thereby save gift and estate taxes. 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.
As you head into your year-end tax planning, remember that every tax situation is different and requires a careful and comprehensive plan. A tax professional can assist you in aligning traditional year-end techniques with strategies for dealing with the regulatory uncertainties.