By Mark G. Kmiecik
The final months of 2014 are a great time to finalize your tax planning opportunities and set the stage for minimizing your tax outlay in 2015.
As a business owner, please be aware that in the wake of the election, sources indicate tax extenders are likely to pass, with some differences between the two houses in Congress being characterized as “easily resolvable” — one house leaning toward passing tax extenders as one bill, the other addressing tax extenders as six separate bills. Broad tax reform, even if put on a fast track would not likely take effect until late 2015 or early 2016, and the tax policy arm of the Treasury Department will need to process some very weighty subjects, like tax inversions, before moving in haste. With this as a backdrop, the following tax provisions are currently in play as we cross over into a new year:
- Bonus Depreciation and Section 179 Elections. As legislated, the days of six-figure elections to expense capital assets (Section 179) and bonus depreciation benefits are gone. (Please note this was put in place to help the economy recover). Although a retroactive extension of the prior years’ higher limits is possible, a final decision is not required until a tax return is filed. However, the transactions need to be completed in accordance with treasury regulations by the end of the year.
- The Underutilized Domestic Production Activities (Section 199) Deduction. This deduction expired at the end of 2013. Known as one of the more underutilized deductions, and fraught with complex computations, if extended, it could benefit many individuals and business owners.
- Affordable Care Act. January 1st, 2015 is the first effective date of the law’s employer mandate. There are, however, a number of carve outs from this law. Your business should establish a proactive plan to deal with the exemptions, and to comply with the mandate, which begins January 1, 2015.
- Repair Regulations. While there is a de minimus safe harbor for certain acquisitions of tangible personal property at up to $5,000, most businesses should have a written policy in place by the end of 2014 to qualify for the new regulation opportunities beginning in 2015.
Second, individual taxpayers should be aware of income tax planning opportunities, health care coverage considerations and the expiration of some important tax deductions. Some recent dramatic changes made to the tax law for individuals include:
- The highest income tax bracket on ordinary income and short-term capital gains increased from 35% to 39.6%. An individual income tax rate of 39.6% applies for single taxpayers whose income exceeds $413,200 (increased from $406,750) and $464,850 for married taxpayers filing a joint return (increased from $457,600). Estates and trusts reach the same rate when income exceeds $12,300.
- The highest income tax bracket on long-term capital gains increased from 15% to 20%.
- A new 3.8% net investment income tax (“NIIT”) went into effect.
- When the NIIT is added to the top income tax brackets, the tax rates could be as high as 43.4% for ordinary income and short-term capital gains and 23.8% for long-term capital gains.
- In addition to the 3.8% NIIT, Congress added a 0.9% Additional Medicare Tax on earned income.
- The personal exemption is subject to a phase-out that begins with adjusted gross incomes of $258,250 ($309,900 for married couples filing jointly) and phases out completely at $380,750 ($432,400 for married couples filing jointly.) Furthermore, when taking into account the phase-out of personal exemptions (PEP) and limitations on itemized deductions (Pease) as income rises above the applicable threshold amounts, the tax rates increase even further.
- The gift, estate and generation-skipping transfer tax exclusion amounts were made permanent and provided for inflation adjustments (the exclusion amount is $5,340,000 in 2014 and increases to $5,430,000 in 2015).
More than ever before, effective tax planning is required because nearly every financial decision now needs to be analyzed, taking into account the regular income tax, the AMT, the PEP and Pease limitations, the NIIT, and the new higher tax brackets for high-income taxpayers. We urge you to contact us to discuss your tax situation and develop an approach that will work best for you. The tax-savings and compliance actions we can explore with you include:
Make Planning and Income Minimization a Priority (High-Income Taxpayers)
High-income taxpayers have many incentives for proper tax planning. In addition to recent hikes in income tax, dividend and long-term capital gains taxes, the 3.8% NIIT became effective in 2013. This tax applies to single filers with modified adjusted gross income (MAGI) of more than $200,000 and joint filers whose modified MAGI exceeds $250,000.
NIIT generally applies to most trusts and estates as well. Because the threshold for trusts and estates in 2014 is an adjusted gross income (AGI) exceeding $12,150 (increases to $12,300 in 2015), many trusts and estates retaining income at the trust or estate level are subject to the new 3.8% tax. An individual beneficiary of the trust, however, is not subject to the tax until his or her MAGI exceeds $250,000 if married filing jointly, or $200,000 if filing as a single individual.
The range of investment income subject to the 3.8% tax is broad and includes interest, dividends, capital gains, rental and royalty income, non-qualified annuities and businesses that are considered “passive activities.” We can help you find ways to minimize taxable income and to avoid generating passive income.
Consider New Developments in Health Care
- Following the rollout of the Affordable Care Act, some taxpayers may be eligible for a premium tax credit if they buy health care coverage through the government’s Health Insurance Marketplace, fall within certain income limits or meet other qualifications.
- If you did not have minimum essential health care coverage in 2014, you may have to pay either $95 per person ($47.50 for a child under 18) limited to a family maximum of $285 or 1% of your yearly household income that is above a certain filing threshold. This penalty will rise in 2015.
- Flexible spending accounts (FSA) can help you lower taxes by setting aside pretax dollars to cover medical bills. In the past, you may have been reluctant to contribute to FSAs because you risked losing money you did not spend by year-end. You can now contribute up to $2,500 to an FSA in any year, and new rules allow you to carry over as much as $500 from one year to the next. The annual dollar limit on employee contributions to employer-sponsored healthcare flexible spending arrangements (FSA) rises to $2,550, up $50 dollars from the amount for 2014.
Beware the Alternative Minimum Tax (AMT)
The AMT is a separate tax calculation that is aimed at ensuring high-income taxpayers pay a minimum amount of tax. However, it increasingly affects middle-income taxpayers. And you may be surprised at some of the triggers that subject you to the AMT. These triggers generally include items that can provide you with substantial deductions, such as:
- paying high state or local taxes;
- cashing in stock options;
- spending home equity line dollars on something other than a home improvement;
- reporting business depreciation on your return;
- reporting many miscellaneous deductions; or
- even having a large number of dependents
The AMT exemption did increase for 2014, to $52,800 for single taxpayers (increases to $53,600 in 2015) and to $82,100 for married couples filing jointly (increases to $83,400 in 2015). There are several ways to plan for the AMT; for example, you can lower taxable income through retirement account contributions or by managing the capital gains or dividends you receive.
Seize Retirement Plan Opportunities
There is still time to make contributions to retirement accounts. Consider taking full advantage of your retirement contribution options for the possible tax benefits now , as well as, the income security later. In 2014 and 2015, you can contribute up to a total of $15,500 ($6,500 if you’re 50 or older) to a traditional or Roth IRA. Contributions to a traditional IRA may be tax-deductible, depending on your income and whether you’re covered by an employer’s retirement plan.
In addition, there are income limits for contributing to a Roth IRA. For those who are self-employed or own a small business, the contribution limits are significantly higher.
Anticipate Expiring Tax Benefits
Beneficial tax provisions that expired at the end of 2013 include a deduction for state and local general sales taxes, one for teachers’ out-of-pocket expenses, and an above-the-line deduction for tuition and some related expenses. Those over age 70½ can no longer exclude from income any distributions made from individual retirement accounts to qualified charitable organizations.
In addition, if your home has gone through a foreclosure or short sale, you will now have to pay taxes on the amount of any mortgage forgiveness. (This rule may not apply if you are insolvent, however, so contact us for more information.)
Experts are divided on whether or not Congress will act to renew these laws this year, so it is best to prepare for any contingency to help reduce your tax bill. Now is the optimum time to engage in short- and long-term planning to meet your financial goals. We can help you understand your tax situation and determine the best steps to address your tax challenges and any other financial concerns. Please don’t hesitate to contact us today to schedule an appointment.
Estate Planning, Gifts and High Transfer Tax Exclusion Amounts
There are new rules on estate taxes as a result of the new tax law enacted in early 2013. Effective Jan. 1, 2013, the top tax rate on estates rose to 39.6% from 35%, but no tax will be imposed on the first $5.34 million of an estate (adjusted for inflation to $5.43 million in 2015).
While this sounds high, and you may think that the estate tax doesn’t affect you or your family, you may be surprised. Estate planning should definitely be a priority. There is no assurance that they will stay at these high levels. Thus, taxpayers may want to make lifetime wealth transfers now.
For 2015, the exclusion from tax on a gift to a spouse who is not a U.S. citizen is $147,000 (up from $145,000 for 2014). The annual exclusion for gifts remains at $14,000 for 2015.
Got Foreign Assets? FBAR May Apply to To You.
Are you aware of the nature of all your investments both domestic and international? Do you know if you have foreign accounts with an aggregate value higher than $10,000 at any time during the calendar year? U.S. taxpayers (including individuals and business entities) are required to report on foreign assets or investments they hold in offshore accounts. Under the Bank Secrecy Act, you may be required to e-file what is known as the FBAR directly with the Financial Crimes Enforcement Network (FinCEN), a bureau of the Treasury Department. Given the diversity of assets that many people hold, do not assume that the FBAR rules do not apply to you. If you are not sure, we can help you determine the answers.
Tax Planning Opportunities
Fortunately, there are a number of effective tax planning strategies that can be used to reduce or eliminate the impact these new tax changes will have on you or to enable you to take advantage of the high transfer tax exclusion amounts. A list of some of the strategies that we are prepared to discuss with you include:
- Bracket Management
- Harvesting Capital Gains and Losses
- Non-Grantor Charitable Lead Annuity Trusts
- Charitable Remainder Trusts
- Roth IRA Conversions
- Installment Sales
- Tax-Aware Investing
- Intra-Family Loans
- Grantor Retained Annuity Trusts
- Intentionally Defective Grantor Trust Sales
- Trusts as S Corporation Shareholders
- Family Limited Partnerships (or Family LLCs)
- Borrowing from Life Insurance Policies
- Grouping Business Activities to Create Material Participation
- Choice of Filing Status
- Trust Decanting
- IRAs as Trust Beneficiaries
- S-Election to Save on Employment Taxes
You will be surprised at the potential tax savings that some of the strategies mentioned above can have on your business. However, keep in mind that some of these strategies are a major undertaking and should begin as soon as possible. We are prepared to assist you in your tax planning and discuss what strategies may be right for you. Please do not hesitate to call your Davis & Kuelthau attorney or the authors, Mark G. Kmiecik, at 414.225.1406 / email@example.com to schedule a tax planning conference to begin discussing your options and potential tax savings.