To Our Clients and Friends:
Year-end planning will be challenging again this year. Unless Congress acts, a number of popular deductions and credits that expired at the end of 2014 won’t be available for 2015. Deductions not available this year include, for example, the election to deduct state and local sales taxes instead of state and local income taxes and the above-the-line deductions for tuition and educator expenses, generous bonus depreciation and expensing allowances for business property, and qualified charitable distributions that allow taxpayers over age 701/2 to make tax-free transfers from their IRAs directly to charities.
Of course, Congress could revive some or all of the favorable tax rules that have expired, like they have done in the past. However, which actions Congress will take and when they will be taken remains to be seen.
Despite the current uncertainties, keeping an eye on your taxable income is more important than ever given today’s high top tax rates and additional taxes on net investment income. But, keep in mind that effective tax planning requires considering both this year and next year—at least. Without a multiyear outlook, you can’t be sure maneuvers intended to save taxes on your 2015 return won’t backfire and cost additional money in the future.
Here are a few tax-saving ideas to get you started. As always, you can call on us to help you sort through the options and implement strategies that make sense for you.
Ideas for Your Business
Evaluate Inventory for Damaged or Obsolete Items. Inventory is normally valued for tax purposes at cost or the lower of cost or market value. Regardless of which of these methods is used, the end-of-the-year inventory should be reviewed to detect obsolete or damaged items. The carrying cost of any such items may be written down to their probable selling price (net of selling expenses). (This rule does not apply to businesses that use the Last in, First out (LIFO) method because LIFO does not distinguish between goods that have been written down and those that have not).
To claim a deduction for a write-down of obsolete inventory, you are not required to scrap the item. However, in a period ending not later than 30 days after the inventory date, the item must be actually offered for sale at the price to which the inventory is reduced.
Set up Tax-favored Retirement Plan. If your business doesn’t already have a retirement plan, now might be the time to take the plunge. Current retirement plan rules allow for significant deductible contributions. Even if your business is only part-time or something you do on the side, contributing to a SEP-IRA or SIMPLE-IRA can enable you to reduce your current tax load while increasing your retirement savings. With a SEP-IRA, you generally can contribute up to 20% of your self-employment earnings, with a maximum contribution of $53,000 for 2015. A SIMPLE-IRA, on the other hand, allows you to set aside up to $12,500 for 2015 plus an employer match that could potentially be the same amount. In addition, if you will be age 50 or older as of year-end, you can contribute an additional $3,000 to a SIMPLE-IRA. If you’re age 50 or older as of year-end and your business has no employees, a solo 401(k) can allow for a contribution of up to $59,000.
Check Your Partnership and S Corporation Stock Basis. If you own an interest in a partnership or S corporation, your ability to deduct any losses it passes through is limited to your basis. Although any unused loss can be carried forward indefinitely, the time value of money diminishes the usefulness of these suspended deductions. Thus, if you expect the partnership or S corporation to generate a loss this year and you lack sufficient basis to claim a full deduction, you may want to make a capital contribution (or in the case of an S corporation, loan it additional funds) before year end.
Accelerating and Maximizing Deductions. Business taxpayers should be looking to maximize deductions and depreciation. The first step is to identify purchases and money that can be spent on deductible expenses, such as equipment repair, this year instead of waiting until 2016.
Cash-method businesses should consider paying bonuses before year end. Accrual-method taxpayers can also possibly deduct bonus payments made to unrelated employees within 2 1/2 months of year-end. However, for these bonus payments after year-end to be deductible in 2015, the liability to pay the bonus must be fixed and determinable by the end of the year.
Businesses should, as much as possible, try to take advantage of the opportunity under Sec. 179 to currently deduct expenses for purchases of tangible property. This can be beneficial, even though the Sec. 179 limits are lower this year (currently the maximum amount that can be deducted under Sec. 179 is $25,000 and the expensing amount is reduced, dollar for dollar, when the amount of Sec. 179 property placed in service exceeds $200,000).
If a portion of an asset was replaced during the year (e.g. the roof of a building was replaced), a business should consider making a partial disposition election. Under the election, the replacement of the portion of the asset is treated as a partial disposition of the asset, allowing the business to recognize a loss on the disposition of that portion of the asset.
Absent the retroactive increase in the Sec. 179 deduction for the purchase of business property, businesses can still take advantage of some favorable provisions in the new repair regulations. First, businesses should try take advantage of the tangible property regulations’ de minimis safe harbor. Small businesses (without applicable financial statements) can take advantage of the annual election to deduct small purchases of $500 or less per invoice or per purchase. Businesses with applicable financial statements can deduct purchases of up to $5,000 each.
Small businesses (those with average gross receipts of less than $10 million) can also take advantage of safe harbor for repairs, maintenance, or improvements to eligible buildings (buildings with an unadjusted basis of less than $1 million). Under the safe harbor, expenses for repairs, maintenance, or improvements to an eligible building are currently deductible if their cost does not exceed the lesser of $10,000 or 2% of the building’s unadjusted basis.
Prepare your Information Reporting. You should start gathering information early this year to make sure you can complete your mandatory reporting on time. Congress has enacted new legislation that more than doubles most penalties for late or incorrect information returns. This includes the Form W-2 employers must provide to all employees and the Form 1099 a business must provide to any contractor it pays at least $600 for services. These returns are due to recipients by February 1.
Remember your State and Local Tax Obligations. Don’t forget that state and local governments impose their own filing and payment responsibilities with various income, sales and property taxes. Recently, states have become more aggressive in taxing corporations that are not physically present in their states, but have significant sales to customers in those states. While there may be exceptions for limited business activities in particular states, it is wise to check on your activities of your salespeople that often travel to different states to ensure you are filing all state corporate tax returns as needed.
Ideas for Increasing Non-Business Deductions
Make Charitable Gifts of Appreciated Stock. If you have appreciated stock (or mutual fund shares) that you’ve held more than a year and you plan to make significant charitable contributions before year-end, consider keeping your cash and donating the stock instead. You’ll avoid paying tax on the appreciation, but will still be able to deduct the donated property’s full value. If you want to maintain a position in the donated securities, you can immediately buy back a like number of shares. (This idea works especially well with no load mutual funds because there are no transaction fees involved.)
However, if the stock is now worth less than when you acquired it, sell the stock, take the loss, and then give the cash to the charity. If you give the stock to the charity, your charitable deduction will equal the stock’s current depressed value and no capital loss will be available. However, if you sell the stock at a loss, you have to wait 31 days to buy it back. Otherwise, you will trigger the wash sale rules, which means your loss won’t be deductible, but instead will be added to the basis in the new shares.
Don’t Lose a Charitable Deduction for Lack of Paperwork. Charitable contributions are only deductible if you have proper documentation. For cash contributions of less than $250, this means you must have either a bank record that supports the donation (such as a cancelled check or credit card receipt) or a written statement from the charity that meets tax-law requirements. For cash donations of $250 or more, a bank record is not enough. You must obtain, by the time your tax return is filed, a charity-provided statement that shows the amount of the donation and lists any significant goods or services received in return for the donation (other than intangible religious benefits) or specifically states that you received no goods or services from the charity.
If you claim a charitable deduction of more than $500 in donated property, you must attach Form 8283. If you are claiming a deduction of $250 or more for a car donation, you will need a written acknowledgement from the charity that includes a description of the car. Remember, you cannot deduct donations to individuals, social clubs, political groups or foreign organizations.
Ideas for the Office
Maximize Contributions to 401(k) Plans. If you have a 401(k) plan at work, it’s just about time to tell your company how much you want to set aside on a tax-free basis for next year. Contribute as much as you can stand, especially if your employer makes matching contributions. You give up “free money” when you fail to participate to the max for the match.
Adjust Your Federal Income Tax Withholding. Check your withholdings and estimated tax payments now while you have time to fix a problem. If it looks like you are going to owe income taxes for 2015, consider bumping up the federal income taxes withheld from your paychecks now through the end of the year. When you file your return, you will have to pay any taxes due less the amount paid in and/or withheld. However, as long as your total tax payments (estimated payments plus withholdings) equal at least 90% of your 2015 liability or, if smaller, 100% of your 2014 liability (110% if your 2014 adjusted gross income exceeded $150,000; $75,000 for married individuals who filed separate returns), penalties will be minimized.
Making the Most of Year-end Securities Transactions
Harvest Capital Losses. There are a number of year-end investment strategies that can help lower your tax bill. Perhaps the simplest is reviewing your securities portfolio for any losers that can be sold before year-end to offset gains you have already recognized this year or to get you to the $3,000 ($1,500 married filing separate) net capital loss that’s deductible each year. Be aware that these capital losses cannot be used against other kinds of income so if your net loss for the year exceeds $3,000, the excess carries over indefinitely to future tax years. Be mindful, however, of the wash sale rule when you jettison losers—your loss is deferred if you purchase substantially identical stock or securities within the period beginning 30 days before and ending 30 days after the sale date.
Secure a Deduction for Nearly Worthless Securities. If you own any securities that are all but worthless with little hope of recovery, you might consider selling them before the end of the year so you can capitalize on the loss this year. You can deduct a loss on worthless securities only if you can prove the investment is completely worthless. Thus, a deduction is not available, as long as you own the security and it has any value at all. Total worthlessness can be very difficult to establish with any certainty. To avoid the issue, it may be easier just to sell the security if it has any marketable value. As long as the sale is not to a family member, this allows you to claim a loss for the difference between your tax basis and the proceeds (subject to the normal capital loss and wash sale rules previously discussed).
Review Your Health Insurance Costs and Coverage
Make Sure You Have Adequate Health Insurance Coverage. If you and your family don’t have adequate medical coverage (referred to as minimum essential coverage), you may be subject to a penalty. Medical insurance provided by your employer or through an individual plan purchased through a state insurance marketplace generally qualifies for adequate coverage. The penalty amount varies based on the number of uninsured members of your household and your household income. If you have three or more uninsured household members, the penalty may be $975 or more for 2015 ($2,085 or more for 2016), depending on your household income.
Consider a Health Savings Account (HSA). If you are enrolled in a high-deductible health plan and don’t have any other coverage, you may be eligible to make pre-tax or tax deductible contributions to an HSA of up to $6,650 for a family coverage or $3,350 for individual coverage. Distributions from the HSA will be tax free as long as the funds are used to pay unreimbursed qualified medical expenses. Furthermore, there’s no time limit on when you can use your contributions to cover expenses. Unlike a healthcare FSA, amounts remaining in the HSA at the end of the year can be carried over indefinitely.
Take a Look at Your State Residency Status. For individuals who split their time in two different states throughout the year, now is an excellent time to consider where you may be taxed as a resident for 2015. To make it more likely that the high-tax jurisdiction will respect the move and not continue to tax you as a resident, you should track the number of days you are spending in each jurisdiction. Generally, if you reside in a state for 183 days or more, that state will assert residency and the ability to tax all of your income. Furthermore, if you move to a new state but you maintain significant contacts with the old state (including driver’s license, residences, bank accounts and the like), you could run the risk of being taxed as a resident in the old state.
Year-end Moves for Seniors Age 70½ Plus
Take Your Required Retirement Distributions. The tax laws generally require individuals with retirement accounts to take withdrawals based on the size of their account and their age beginning with the year they reach age 701/2. Failure to take a required withdrawal can result in a penalty of 50% of the amount not withdrawn. If you turned age 701/2 in 2015, you can delay your 2015 required distribution to 2016 if you choose. But, waiting until 2016 will result in two distributions in 2016—the amount required for 2015 plus the amount required for 2016. While deferring income is normally a sound tax strategy, here it results in bunching income into 2016. Thus, think twice before delaying your 2015 distribution to 2016—bunching income into 2016 might throw you into a higher tax bracket or bring you above the modified AGI level that will trigger the 3.8% net investment income tax. However, it could be beneficial to take both distributions in 2016 if you expect to be in a substantially lower bracket in 2016.
It May Pay to Wait until the End of the Year to Take Your Distributions. If you plan on making additional charitable contributions this year and you have not yet received your 2015 required distribution from your IRA, you might want to wait until the very end of the year to do both. It is possible that the Congress will bring back the popular Qualified Charitable Distributions (QCDs) that expired at the end of 2014. If so, IRA owners and beneficiaries who have reached age 70½ will be able to make cash donations totaling up to $100,000 to IRS-approved public charities directly out of their IRAs. QCDs are federal-income-tax-free to you and they can qualify as part of your required distribution, but you get no itemized charitable write-off on your Form 1040. That’s okay because the tax-free treatment of QCDs equates to an immediate 100% federal income tax deduction without having to itemize your deductions or worry about restrictions that can reduce or delay itemized charitable write-offs. However, to qualify for this special tax break, the funds must be transferred directly from your IRA to the charity. Once you receive the cash, the distribution is not a QCD and won’t qualify for this tax break.
Watch out for Alternative Minimum Tax
Be on the alert for the AMT in all of your planning because what may be a great move for regular tax purposes may create or increase an AMT problem. There’s a good chance you’ll be hit with AMT if you deduct a significant amount of state and local taxes, claim multiple dependents, exercised incentive stock options, or recognized a large capital gain this year.
Don’t Overlook Estate Planning
For 2015, the unified federal gift and estate tax exemption is a generous $5.43 million, and the federal estate tax rate is a historically reasonable 40%. Even if you already have an estate plan, it may need updating to reflect the current estate and gift tax rules. Also, you may need to make some changes that have nothing to do with taxes. Contact us if you think you could use an estate planning tune-up.
Through careful planning, it’s possible your 2015 tax liability can be significantly reduced, but don’t delay. The longer you wait, the less likely it is that you’ll be able to achieve a meaningful reduction. The ideas discussed in this letter are a good way to get you started with year-end planning, but they’re no substitute for personalized professional assistance. Please don’t hesitate to call us with questions or for additional strategies on reducing your tax bill. We’d be glad to set up a planning meeting or assist you in any other way that we can.