As the end of the year approaches, it is a good time to think of planning moves that will help lower your tax bill for this year and next. Factors that make this a challenge include the up and down stock market, overall economic uncertainty, and the continued failure of Congress to act on a number of important tax breaks that expired at the end of 2014. Some of these tax breaks might ultimately be reinstated retroactively as they have been in the past. But Congress may not make the decision to extend these tax breaks until very late in 2015 or thereafter.
The individual tax breaks include: (1) the option to deduct state and local sales and use taxes instead of state and local income taxes; (2) the above-the-line-deduction for qualified higher education expenses; (3) tax-free IRA distributions for charitable purposes by those age 70-1/2 or older; and the (4) the exclusion for up-to-$2 million of mortgage debt forgiveness on a principal residence. The businesses tax breaks include: (1) the 50% bonus first-year depreciation for most new machinery, equipment and software; (2) the $500,000 annual expensing limitation; (3) the research tax credit; and (4) the 15-year write-off for qualified leasehold improvements, qualified restaurant buildings and improvements, and qualified retail improvements.
Higher-income earners have additional concerns to address when mapping out their year-end plans. These taxpayers must be wary of the 3.8% surtax on certain unearned income and the additional 0.9% Medicare tax. This latter tax applies to individuals for whom the sum of wages and self-employment income is in excess of a specified threshold amount ($250,000 for joint filers, $125,000 for married couples filing separately, and $200,000 in any other case).
The 3.8% surtax is calculated on the lesser of: (1) net investment income (NII), or (2) the excess of modified adjusted gross income (MAGI) over a threshold amount ($250,000 for joint filers or surviving spouses, $125,000 for a married individual filing a separate return, and $200,000 in any other case). As the end of the year nears, a taxpayer’s approach to reducing the 3.8% surtax will depend on the amount of his estimated MAGI and NII for the year. Taxpayers should consider ways to defer income in the next year.
The 0.9% additional Medicare tax also may require yearend actions. Employers must withhold the additional Medicare tax from wages in excess of $200,000 regardless of filing status or other income. Self-employed persons should take it into account in figuring estimated tax. There could well be situations where an employee may need to have more withheld toward the end of the year to cover the tax. For example, if an individual earns $200,000 from one employer during the first half of the year and a like amount from another employer during the balance of the year, he would owe the additional Medicare tax, but there would be no withholding by either employer for the additional Medicare tax since wages from each employer do not exceed $200,000.
Below is a checklist of certain actions based on current tax rules that may help you save tax dollars if you act before yearend. Not all actions will apply in every taxpayer’s particular situation.
Year-End Tax Planning Moves for Individuals
- Realize losses on stock while substantially preserving your investment position. There are several ways this can be done. For example, you can sell the original holding, then buy back the same securities at least 31 days later.
- Defer income until 2016 and accelerate deductions into 2015 to lower your 2015 tax bill. This strategy may enable you to claim larger deductions, credits, and other tax breaks for 2015 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 also is desirable for those taxpayers who anticipate being in a lower tax bracket next year due to changed financial circumstances.
- In some cases, it may pay to actually accelerate income into 2015. For example, this may be the case where a person’s marginal tax rate is much lower this year than it will be next year or where lower income in 2016 will result in a higher tax credit for an individual who plans to purchase health insurance on a health exchange and is eligible for a premium assistance credit.
- If you believe a Roth IRA is better than a traditional IRA, consider converting traditional-IRA money invested in beaten-down stocks (or mutual funds) into a Roth IRA if eligible to do so. Such a conversion will increase your AGI for 2015, but may save dollars down the road when the Roth IRA investments are distributed.
- If you converted assets in a traditional IRA to a Roth IRA earlier in the year and the assets in the Roth IRA account declined in value, you could wind up paying a higher tax than is necessary if you leave things as is. You can back out of the transaction by recharacterizing the conversion. This can be done by transferring the converted amount (plus earnings and losses) from the Roth IRA back to a traditional IRA via a trustee-to-trustee transfer.
- Use a credit card to pay deductible expenses before the end of the year. Doing so will increase your 2015 deductions even if you don’t pay your credit card bill until after the end of the year.
- If you expect to owe state and local income taxes when you file your return next year, increase your withholding of state and local taxes (or pay estimated tax payments of state and local taxes) before year-end to pull the deduction of those taxes into 2015.
- You may be able to save taxes this year and next by bunching “miscellaneous” itemized deductions, medical expenses and other itemized deductions into one tax year.
- You may want to pay contested taxes to be able to deduct them this year while continuing to contest them next year.
- You may want to settle an insurance or damage claim in order to maximize your casualty loss deduction this year.
- Increase the amount you set aside for next year in your employer’s health flexible spending account (FSA) or Health savings Account (HSA).
- Make gifts sheltered by the annual gift tax exclusion before the end of the year and thereby save on future gift and estate taxes. The exclusion applies to gifts of up to $14,000 made in 2015 to each of an unlimited number of individuals. You cannot carry over unused exclusions from one year to the next. 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.
Year-End Tax-Planning Moves for Businesses & Business Owners
- Businesses should buy machinery and equipment before year end and, under the generally applicable “half-year convention,” thereby secure a half years’ worth of depreciation deductions in 2015.
- Although the business property expensing option is greatly reduced in 2015 (unless retroactively changed by Congress), making expenditures that qualify for this option can still get you significant current deductions that you would not otherwise get. For tax years beginning in 2015, the expensing limit is $25,000, and the investment-based reduction in the dollar limitation starts to take effect when property placed in service in the tax year exceeds $200,000.
- Businesses may be able to take advantage of the “de minimis safe harbor election” (also known as the book-tax conformity election) to expense the costs of inexpensive assets and materials and supplies, assuming the costs don’t have to be capitalized. To qualify for the election, the cost of a unit of property can’t exceed $5,000 if the taxpayer has an applicable financial statement (AFS). If there is no AFS, the cost of a unit of property cannot exceed $500.
- A corporation should consider accelerating income from 2016 to 2015 if it will be in a higher bracket next year. Conversely, it should consider deferring income until 2016 if it will be in a higher bracket this year.
- A corporation should consider deferring income until next year if doing so will preserve the corporation’s qualification for the small corporation AMT exemption for 2015. There is never a reason to accelerate income for purposes of the small corporation AMT exemption because if a corporation doesn’t qualify for the exemption for any given tax year, it will not qualify for the exemption for any later tax year.
- A corporation (other than a “large” corporation) that anticipates a small net operating loss (NOL) for 2015 (and substantial net income in 2016) should consider accelerating just enough of its 2016 income (or to defer just enough of its 2015 deductions) to create a small amount of net income for 2015. This will permit the corporation to base its 2016 estimated tax installments on the relatively small amount of income shown on its 2015 return, rather than having to pay estimated taxes based on 100% of its much larger 2016 taxable income.
- If your business qualifies for the domestic production activities deduction for its 2015 tax year, consider whether the 50%-of-W-2 wages limitation on that deduction applies. If it does, consider ways to increase 2015 W-2 income such as paying additional bonuses to owner-shareholders whose compensation is allocable to domestic production gross receipts. Note that the limitation applies to amounts paid with respect to employment in calendar year 2015, even if the business has a fiscal year.
- To reduce 2015 taxable income, if you are a debtor, consider deferring a debt-cancellation event until 2016.
- To reduce 2015 taxable income, consider disposing of a passive activity in 2015 if doing so will allow you to deduct suspended passive activity losses.
- If you own an interest in a partnership or S corporation, consider whether you need to increase your basis in the entity so you can deduct a loss from it for this year.
Please contact one of our tax and business attorneys at 937-223-1130 or Jsenney@pselaw.com if you would like to talk about the tax break extensions or any of the individual or business tax strategies suggested above.