Tax Extenders, Year-End Tax Planning & Portability – Oh My!
There is nothing like a last minute tax extenders bill from Congress to affect your year-end planning.
This past Friday, President Obama signed into law the Tax Increase Prevention Act of 2014 (HR 5771). This law breathes life into the so-called “tax extenders” and applies them retroactively for the 2014 calendar year. This law also includes the Achieving a Better Life Experience (ABLE) Act, which creates tax-favored savings accounts for individuals with disabilities and has some tax-related offsets.
What does this mean for you?
There are over 50 items in this tax bill and over 500 changes to the Internal Revenue Code. And all of the “tax extenders” will again expire on or before January 1, 2015.
For individual taxpayers, some of the more important provisions renewed include:
- Deduction for state and local sales tax
ACTION TO CONSIDER: Potential large purchases between now and year‘s end
- Deduction for qualified tuition and related expenses
- Deduction for teacher classroom expense deduction
- Exclusion of mortgage debt cancellation income
- Charitable distributions from IRA’s for individuals over age 70 ½
ACTION TO CONSIDER: A charitable rollover transaction between now and year‘s end.
Below are some of the key provisions renewed for the benefit of business taxpayers:
R&D Tax Credit
Generally allows taxpayers a 20 percent credit for qualified research expenses, and 14 percent for alternative simplified credit.
ACTION TO CONSIDER: This credit can have significant effects on estimated tax strategies, so consider the necessary adjustment. Also, consider the need to gather necessary information now for this credit.
Bonus Depreciation & §179 Expensing provisions
Taxpayers may claim a 50 percent first year bonus depreciation deduction for new, qualified property placed in service before January 1, 2015 (January 1, 2016 for certain property). The §179 expensing limit is raised from $25,000 to $500,000 for 2014, with a $2 million investment limit.
ACTION TO CONSIDER: Potential large purchases between now and year‘s end. These deductions can also have significant effects on estimated tax strategies.
15-year Depreciable Life for Qualified Real Property
Applies to qualified leasehold improvement property, qualified restaurant property, and qualified retail improvement property placed in service in 2014. Taxpayers may elect to expense up to $250,000 of these qualified improvements under §179.
Work Opportunity Tax Credit
Credits for portions of first year wages paid to new, qualifying employees.
§179D Energy Efficiency Deductions for Commercial & Government Buildings
A deduction of up to $1.80 per square foot for energy efficient improvements to commercial and government buildings. Governments can allocate this deduction to an architect, engineer, contractor, environmental consultant or energy services provider involved in creating the energy saving technical specifications for the building.
ACTION TO CONSIDER: This deduction can have a significant impact on estimated tax remittances, so consider whether an adjustment is appropriate. Also, consider the need to gather necessary information now for this deduction.
- New Markets Credit
- 100 percent exclusion of gain for sale of qualified small business stock
- Tax incentives for business investments in empowerment zones
- Basis adjustments for S corporations making charitable donations of property
- . . . and many more
While contemplating the benefits of the tax extenders and potential related actions, individual taxpayers should also consider the following traditional year-end tax planning strategies:
Bracket management is one of the principal planning strategies you should consider. This term refers to minimizing the tax rate that your income will be subject to under the five different taxing schedules now in effect:
- Ordinary income tax;
- Capital gains tax;
- Personal Exemption Phase-out (PEP) and the Pease Limitation (limitation on itemized deductions based on a percentage of adjusted gross income);
- Alternative Minimum Tax; and
- Net Investment Income Tax.
The strategy is to receive the income or claim a deduction in the year that will result in the lowest tax.
Defer Income – Accelerate Deductions?
In some cases, accelerating income could be to your benefit. How? If your current year adjusted gross income is below the threshold that triggers the net investment income tax, but next year this income would push you over the threshold for net investment income tax, it might be better to accelerate income into the current year.
What type of income can be accelerated or deferred? Capital gains and losses, gains from sales of other assets, discretionary IRA distributions and Roth IRA conversions all qualify. Small businesses that use the cash method of accounting may also defer billing so that payments are received in January rather than December.
Similarly, taxpayers can plan for when to benefit most from certain deductions. If you are already subject to the alternative minimum tax (AMT) or close to it, you may not realize any benefit by accelerating itemized deductions. Alternatively, if you are not subject to AMT, then consider accelerating deductions that you were planning on paying in early 2015 by paying them in 2014. Some deductions frequently accelerated are charitable contributions, state and local income taxes (both fourth quarter-estimated tax payments and anticipated balances due on 2014 returns to be filed in 2015), real estate taxes, accountants’ fees, medical expenses and your January 2015 mortgage interest payment. Business owners may also consider the timing of payments to qualified retirement plans, SEPs, and IRAs.
The topic of charitable giving is very important not only to the charities and the valuable work they do, but also to your tax bill.
Perhaps you are considering making a charitable contribution, but don’t know the best way to do that given your current situation. You may have assets, such as marketable securities, that have appreciated in value. Rather than selling them and donating the proceeds, consider donating the asset to a qualified charity. By doing this, you can claim a deduction for the value of the asset (to the extent you would have qualified for long-term capital gain treatment had you sold it) in calculating your taxes for the year, plus avoid having to recognize and pay tax on the gain. This strategy may work particularly well for a business owner who is selling the business and plans to donate a portion of the proceeds to a favorite charity. However, if your assets have decreased in value, consider selling them, (recognizing the loss) and then donating the proceeds.
We mentioned above that it may make sense to accelerate charitable deductions. Perhaps you would like to support a favorite charity over a period of years, but you anticipate that your income will be significantly lower in future years due to retirement or other factors. In this case, consider donating in the current year to a donor advised fund with instructions to make distributions from the fund to your favorite charities in future years. This technique would produce a deduction for you in the current year, and also benefit your favorite charities in future years.
Review your investments with your investment advisors. Evaluate whether it would be beneficial to harvest unrealized gains or losses in 2014. Again, watch your tax bracket. A realized gain in 2014 will usually result in a real cash outlay for the year. Unless you are in a 10 percent or 15 percent tax bracket (zero capital gains tax), or you have net realized capital losses for the year, accelerating gains may not be a wise choice.
Check Your Withholding/Estimated Tax
Consider how much tax you will owe next April. Have you paid in enough tax to avoid the penalty for underpayment of estimated tax? Individuals can reduce a potential underpayment penalty by increasing year-end withholding or fourth quarter-estimated tax payments. Do you know how much you could owe for taxes in March or April?
Finally, don’t forget the annual gift exclusion amount. In 2014, the amount is $14,000. A married couple with two married children can give up to $112,000 each year to their children and their children’s’ spouses without using any of their lifetime exemption amounts. Further, the lifetime exemption for gifts and estates is at a record level; $5.34 million for 2014, increasing to $5.43 million in 2015. With these exemption levels, business owners should consider strategies to transfer ownership of those businesses to the next generation. Individuals might consider establishing trusts for their heirs to encourage them to pursue education or entrepreneurial goals.
And while gifting is on your mind, think about whether portability affects you and if you need to take action before year end.
Rev. Proc. 2014-18 allows an extension of time to make a portability election in the case of decedents’ executors who are not required to file an estate tax return for estate tax purposes and who did not file an estate tax return for a decedent dying in 2011, 2012 or 2013.
Portability allows the surviving spouse to receive any unused exclusion amount from the deceased spouse (currently at $5.34 million).
For example, a decedent dies in 2013 and previously made taxable gifts of $1,250,000 and at death left $500,000 to the children. The applicable exclusion amount available to the decedent’s estate would be $4,000,000 ($5.25M – $1.25M), while the unused amount portable to the surviving spouse would be $3,500,000 ($4.00M – $500K).
An estate tax return is not required to be filed unless the gross estate exceeds the basic exclusion amount less any certain taxable gifts. However, if the value of the surviving spouse’s estate is expected to exceed the exclusion amount, a case could be made for filing a return for the first deceased spouse in order to obtain the unused exclusion for the surviving spouse.
Rev. Proc. 2014-18 does not provide relief for any decedent dying in 2014 or later.
With Rev. Proc. 2014-18, there may be opportunities for our clients with year 2011, 2012 and 2013 estates to now file an estate tax return and elect portability.
These are just a few of the many topics and planning strategies that should be considered before year’s end. It is essential to “run the numbers” to determine which strategies will work best for you.
Your Cherry Bekaert Tax Professional can help by doing the necessary calculations, considering various alternative scenarios and recommending strategies that will work best for you not only for this year, but also in the years to come. Please call us. It is our pleasure to serve you. We wish you a happy and healthy holiday season!