In recent years, end of year tax planning has been complicated by uncertainty over the future availability of many tax incentives. The 2015 year-end is no different. While certain tax provisions were extended at the last minute for 2014 tax returns, these extenders have not yet been approved for the current year. While taxpayers await the announcement of final regulations for 2015, let’s take a look at some of the tax strategies that you can use right now, given the current tax situation.
Basic Numbers You Need to Know
Individual marginal tax rates have remained the same. However, due to inflation, the top rate of 39.6% has now been imposed on taxable income over $413,200 for single filers and $464,850 for married taxpayers filing jointly.
To minimize the impact of the higher tax brackets, taxpayers should consider taking steps to keep their income below the various threshold levels, if possible, by spreading income over a number of years or offsetting the income with above-the-line deductions. In particular, spikes in income should be carefully managed – keeping a close eye on transactions such as retirement account withdrawals, taxable sales of assets, and the timing of income earned from pass through S-corporations or partnerships. On the flip side, taxpayers who find themselves in the lower tax brackets should consider recognizing any long-term capital gain available to fully utilize these lower brackets and take advantage of the related reduced rates.
A number of deductions, brackets, and limitations have been adjusted, as follows:
· The standard deduction rises to $6,300 for singles as well as those who are married filing separately. The standard deduction for married couples filing jointly has increased to $12,600. The standard deduction for heads of household rises to $9,250.
· The personal exemption rises to $4,000, up from the 2014 exemption of $3,950. However, the exemption is subject to a phase-out that begins with adjusted gross incomes of $258,250 ($309,900 for married couples filing jointly). It phases out completely at $380,750 ($432,400 for married couples filing jointly.)
While higher income earners will experience a decrease in the deductibility of their personal exemptions and itemized deductions, they can consider the following:
o Prepay deductible expenses such as charitable contributions and medical expenses this year using a credit card. The expense is still deductible this year even if the credit card balance is paid in the following year.
o Take full advantage of health insurance deductions for business owners. If you are either self-employed or own more than 2% of the stock of an S corporation and the S corporation established the plan, you can deduct 100% of the premiums paid for medical and dental insurance, and qualified long-term care insurance for yourself, your spouse, and your dependents. This deduction is not subject to the typical adjusted gross income limitation and is available even if you do not itemize your deductions.
o Keep good records. In particular, make sure you have the required documentation for charitable contributions. For cash donations of more than $250, be sure you have a copy of your canceled check and the receipt from the charitable organization. For donated property, a detailed listing, with the fair market value of each item, along with the receipt from the organization will be needed. You will also need to be able to demonstrate that the donated property was in “good” shape for your deduction to count. Additional documentation is required for noncash donations of more than $5,000 — including a qualified written appraisal along with acknowledgments from the appraiser and the charitable organization.
o Consider establishing a charitable fund. Donor-advised funds allow givers to make immediate deductible charitable contributions without having to choose a specific charity at the time that the donation is made. These funds are much simpler to use than private foundations and require much less paperwork and have lower administrative costs. Keep in mind that donations of appreciated stock that you have owned for more than one year provide you some unique benefits. You can generally deduct the full fair market value of those shares without paying tax on the appreciation. As an added bonus, donations of publicly-traded securities are exempt from the requirement to obtain a written appraisal – which saves the cost of obtaining the appraisal.
o Subject to limitations that could be imposed due to the Alternative Minimum Tax rules, you might also benefit from the following:
o Pay state estimated tax installments in December instead of at the January due date. However, make sure the payments are based on a reasonable estimate of your state taxes.
o Pay your entire property tax bill, including installments due in year 2016, by year-end. This does not apply to mortgage escrow accounts, which are prepayments of your “reserve” rather than actual property tax assessments.
Miscellaneous Itemized Deductions, such as expenses for financial planning, tax preparation, and unreimbursed employee business expenses, are deductible only if the total of these items exceeds two percent of your adjusted gross income. Grouping these deductions in alternating years can be an effective tax-planning strategy to reach the threshold level.
Other Tax Considerations
As required by the Affordable Care Act, individuals who fail to carry “adequate” health insurance will face a penalty. More specifically, nonexempt taxpayers will owe the penalty if they don’t have so-called minimum essential coverage. There are a number of exceptions to the penalty, including concessions for lower-income individuals as well as those who had previous coverage that was no longer available under the Affordable Health Care Act.
Contributions to health flexible spending arrangements (FSA’s) are capped at $2,550 for 2015. In recent years, the IRS announced a new exception to the dreaded “use-or-lose” rule for these accounts. Under the exception, employers can allow their employees to carry forward up to $500 of any unused balance to the subsequent year. The new carry forward exception is in lieu of allowing a grace period through March 15 of the following year to incur enough expenses to use up your unused balance from the previous year. In other words, your company’s health care FSA plan can allow either the $500 carry forward OR the grace period, not both.
The annual exclusion for gifts remains at $14,000 for 2015, ($28,000 for husband-wife joint gifts to any third person). Gifts at or below this threshold can be made tax free without counting this toward the lifetime estate exclusion. There is no limit on the number of individuals to whom the gifts can be made, but you can’t carry over unused exclusions from one year to the next. Those gifts are not tax deductible, but these transfers can minimize future taxable investment earnings and can help achieve estate planning goals. Qualifying tuition payments and medical payments do not count against this limit.
Keep an eye on the estimated tax requirements. The tax changes that came into effect last year may already have resulted in an increased tax liability, and possibly a balance due. If your tax situation is expected to be similar in 2016, an increase in tax payments is required. Submitting estimated tax vouchers and payments is on an option to get your payment levels up to the required levels. Increasing your withholding before year-end is another option and can avoid or reduce any estimated tax penalty that might otherwise be due. On the other hand, the penalty could be avoided by covering the extra tax in your final estimated tax payment and computing the penalty using the annualized income method.
Expired Individual Tax Provisions
Previously expired tax breaks include: the option to deduct state and local sales and use taxes instead of state and local income taxes, tax-free distributions by those age 70-1/2 or older from IRAs for charitable purposes, deduction for expenses of elementary and secondary school teachers, “above the line” deduction for higher education tuition and related fees (keep in mind that education tax credits were previously extended), tax-free treatment for forgiven mortgage debt, deductibility of mortgage insurance premiums on a personal residence, and a tax credit for energy-saving home improvements. In the past, it was not uncommon for certain provisions to be retroactively reinstated.
Planning Strategies for Businesses
Bonus Depreciation and Code Sec. 179 Expense Deductions
In prior years, 50-percent bonus depreciation was available to accelerate depreciation deductions. Because this bonus depreciation, if and when the provision is extended, can be elected on the 2015 return when it is filed in 2016, business owners do not have to make an immediate decision if they will use this accelerated method. Bonus depreciation is optional and businesses can elect not to use it – which may be appropriate in certain circumstances if deductions need to be spread more evenly over future years. What is important, is that any qualifying property must be purchased and placed in service by the end of 2015. To be prepared to take advantage of this provision, if it is extended, businesses should evaluate their equipment needs now and take action to acquire qualified property while there is still time.
Under enhanced Code Section 179 expensing rules in prior years, businesses could write off up to $500,000 in qualifying expenditures, and would not reduce this amount unless total purchases of related equipment exceeded $2 million. Unless the tax provisions are extended, this Section 179 deduction is limited to $25,000 and is reduced if total purchases exceed $200,000.
Proper Classification of Property and Repair Costs
The IRS previously issued final regulations on the treatment to acquire, produce or improve tangible property. These rules are generally applicable to tax years beginning on or after January 1, 2014. These regulations were designed to clarify:
• Distinctions between fixed assets versus material and supplies
• What cost must be capitalized on the acquisition of tangible property
• Whether expenditures related to the property’s operation are deductible repairs or have to be capitalized as improvements
• When to recognize dispositions
Certain safe harbor thresholds are included in the regulations. The safe harbor enables taxpayers to routinely deduct items whose cost is below those levels. These safe harbor levels allow deductions for items costing less than $500 or $5,000, depending on the businesses financial reporting requirements and other factors.
Businesses should evaluate and document their capitalization policy. Taking advantage of the ability to deduct the cost of qualified items rather than including them in their capitalized property costs, will prevent businesses from having to use up their Sec. 179 and bonus depreciation limits.
Deducting Routine Service Costs
The IRS has provided a new safe harbor for accrual-basis taxpayers that could prove useful in year-end planning. If an accrual-basis taxpayer is currently negotiating contracts for services that extend into 2016, ensuring that the contract meets the specifications of this rule would allow the business to take a full deduction for certain 2015 payments, even for services not yet performed until 2016.
Expired Business Tax Provisions
Previously expired tax breaks include: tax credits such as the Research and Development credit, New Market tax credit, Low Income Housing tax credits for subsidized new buildings, and the Work Opportunity tax credit, the exclusion of gain from the disposition of qualified small business stock, and a reduction in the recognition period for reporting of built-in gains taxes, among other provisions. These items, along with the other areas discussed above, could be subject to a last-minute reprieve depending on what action Congress takes by the end of the year.
Tax planning involves making wise tax decisions for the current year, but also decisions that will provide benefits for years to come. Obviously, taxes are not the only issue to consider when making decisions about your financial plans. And, in many cases, tax strategies need to be evaluated to determine the effect on your specific set of facts and circumstances. Either way now may be the time to call your advisor at MarksNelson to discuss the tax planning strategies that may benefit you.
About the author
For Linda Freeman, tax season is every season. Linda works with her clients year-round to minimize their tax liability as much as possible. She uses a holistic approach to tax planning that takes into account their current financial picture as well as their future goals.