2015 Year End Tax Planning
POSTPONING INCOME, ACCELERATING DEDUCTIONS
Typically, if you are expected to be in a lower tax bracket in the future, it generally makes sense to defer income into later years and accelerate deductions into the current year. This strategy can help you move into a lower tax bracket in the current year. It can also help to avoid crossing the threshold at which you are subject to the net investment income tax or subject to losing all or part of certain deductions (e.g., the dependency exemption). In addition, lowering your income and accelerating expenses into the current year can make it easier to deduct expenses subject to the 2%-of adjusted- gross income threshold.
Some actions to consider in postponing income are:
- Pushing the sale of a gain-generating asset into the next year;
- Structuring the sale of a gain-generating asset as an installment sale;
- Deferring any year-end bonuses;
- Using the like-kind exchange provisions to defer recognizing gain on dispositions of business or investment property; and
- Delaying the collection of outstanding accounts receivables until the following year.
Some actions to consider in accelerating deductions are:
- Making fourth-quarter state estimated tax payments in the current year;
- Prepaying property taxes due the following year;
- Bunching medical and dental expenses into the current year if it’s expected that those expenses for the current and following year will exceed the AGI floor limitation applicable to such expenses;
- Moving future charitable donations into the current year; and
- Harvesting losses from stocks or other assets by selling them before year-end.
Note that, because short-term capital gains are taxed at ordinary income rates, if your income includes such gains, then harvesting short-term capital losses first to offset those gains is advisable.
ACCELERATING INCOME, POSTPONING DEDUCTIONS
Alternatively, if you expect a substantial increase in income or anticipates using a less favorable tax filing status in the next year, accelerating income into the current year or deferring deductions to the following year may be an appropriate strategy to lessen your tax bill next year.
Actions to consider for accelerating income are:
- Creating incentives for customers or clients to pay outstanding receivables in the current year;
- Advance billing of clients;
- Moving up planned retirement plan distributions to the current year rather than taking them in the next year (assuming the 10% penalty tax on early distributions to individuals under 59½ years old does not apply);
- If installment payments are being received, moving more installment income into the current year by either selling the installment note, having the debtor pay off the note, or using the note as collateral on a loan;
- Settling any legal disputes that might result in taxable income before next year;
- Selling gain-generating assets this year; and
- If government bonds on which interest income is being deferred are owned, making the election to recognize interest income currently, including interest deferred from prior years.
Strategies to consider for deferring deductions include:
- Delaying the purchase of business property that will generate depreciation and Sec. 179 deductions;
- Bunching deductions (e.g., charitable contributions, expenses for medical and dental visits and surgery(to the extent they exceed the applicable limitation), property taxes, etc.) into the following year;
- Delaying the payment of state estimated tax payments to the following year, but taking into consideration any late-payment penalties;
- Delaying any actions that might establish the worthlessness of a debt until the following year when a bad debt deduction can be taken; and
- Postponing the sale of the loss-generating property.
NET INVESTMENT INCOME TAX
Additionally, you must consider the impact of the net investment income tax, which applies to individuals, estates, and trusts with income over a specified threshold.
The tax is 3.8% on the lesser of net investment income or the amount by which the taxpayer’s modified adjusted gross income (MAGI) exceeds a threshold amount. That threshold amount is $250,000 for married filing jointly and surviving spouses, $125,000 for married filing separately, $200,000 for all others. To lessen exposure to the net investment income tax and if it otherwise makes good financial sense, you should consider moving income-producing investments to tax-exempt bonds, thereby lowering their MAGI and avoiding the net investment income tax. Because dividends are subject to the net investment income tax, pursuing growth stocks over dividend-paying stocks may be appropriate. The capital gains won’t be subject to the net investment income tax until the stocks are sold, and capital gains, unlike dividends, can be offset by capital losses.
Additionally, because the net investment income tax applies to income from passive activities, it is worth seeing if anything can be done to reclassify a passive activity to a nonpassive activity. One of the biggest sources of passive activity income is rental income, which is per se passive income. However, such income is not automatically considered passive if you qualify as a real estate professional and the taxpayer materially participates in the activity, the income from the activity is not passive income.
Material participation is determined for each rental activity separately unless you make the election to treat all rental activities as a single activity. If the separate or grouped activities qualify as a trade or business, the income from them is excluded from the net investment income tax under the “ordinary course of a business” exception. In addition, under a special safe harbor, a real estate professional taxpayer as defined in the passive loss rules can exclude income from a rental activity from net investment income if he or she participates in the rental activity for more than 500 hours per year, or for more than 500 hours or more in any five tax years out of the past 10 tax years.
If a real estate professional taxpayer makes an election to group all rental activities as a single rental activity under the passive loss rules, the election applies for net investment income tax purposes. You should ensure that being eligible to group rental activities together do so because it will generally make it easier to qualify as a real estate professional and easier to offset nonpassive income with rental activity losses while avoiding the net investment income tax.
Distributions from a qualified plan are not subject to the net investment income tax. If you own your business you may start a qualified retirement plan.
CHARITABLE DONATION PLANNING
If you own a stock portfolio you may consider making charitable contributions using appreciated corporate stock. Assuming you itemizes deductions, not only is the cost of the stock deductible, but the appreciation of the stock is deductible as well. Otherwise, if the stock is sold, the appreciation may be subject to capital gains tax and the net investment income tax.
Do not forget the tax savings associated with maxing out their retirement plan contributions. For 2015, the limitations on 401(k), 403(b), and 457(b) plan contributions is $18,000. If you are in the 25% tax bracket, that equals a tax savings of $4,500. The catch-up contribution limitation for individuals age 50 and older is $6,000. That translates into another $1,500 of savings for an individual in the 25% tax bracket for a total tax savings of $6,000.
If your employer provides a 401(k) match, it’s especially important that you contribute the maximum amount required to get the full match from the employer. Otherwise, you are leaving free money on the table. For individual retirement arrangements (IRAs), the maximum deductible contribution is $5,500, with a catchup contribution of $1,000.
Additionally, for high-income individuals covered by an employer’s retirement plan, there is always the option of investing in a nondeductible IRA. While this option is not right for most people, the tax deferral may still be worth something, depending on your situation and the type of assets funding the IRA.
First, the downside. Putting money in a nondeductible IRA rather than a taxable account means that you can’t reach the money until he or she turns 59½ without incurring a penalty. Additionally, capital gains in a taxable account, as opposed to in an IRA, are taxed at the reduced capital gain rates, whereas money withdrawn from an IRA is taxed at the your regular tax rate. However, if the IRA is funded with 30-year bonds instead, the net amount at the end of the 30 years will yield more income you even after paying taxes on the IRA withdrawal as a result of compounding the interest income and not having to currently pay taxes on that interest.
Finally, it may be advantageous to convert their IRA to a Roth IRA. While paying tax on the amount of deductible contributions that have been made to the IRA and all the appreciation that has taken place in it up to that point, the future appreciation in the account will be tax-free if certain requirements are met (i.e., a five-year waiting period has passed and the account owner is age 59½ or over, disabled, or deceased).
Whether such a conversion is the right path for you depends on several factors.
First, since you will have to include the amounts converted, other than nondeductible contributions to the account, in income, converting an IRA during a year you are in a lower tax bracket makes more sense that if you are in a higher tax bracket.
Second, you should consider when you are going to need the money in the account. The benefits of a Roth IRA account increase the longer the money is in the account. So if in your time horizon for keeping the money in the account is short, converting to a Roth IRA may not be in your best interest.
Finally, because there are no required minimum distributions from a Roth IRA as there are from a traditional IRA, if your tax rate will be the same or higher in years when an RMD is required, then converting to a Roth IRA may make sense.
This article appeared originally as a pdf document in Accountants World. Clik next to see it 2015 Year End Tax Planning.
Fulton Abraham Sanchez, CPA, founder of FAS CPA & Consultants of Miami, FL, is a Certified Public Accountant specializing in Tax Planning. You can email him to email@example.com or follow us on Facebook: FAS CPA & Consultants
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