Last Minute 2014 Personal Tax Planning

Consider implementing the following strategies by December 31^st to save income taxes.  The income tax laws are now so complex that it is difficult to know whether any of these general recommendations will actually save you tax without undertaking a computerized tax projection.  You should consult your tax advisor before implementing these ideas.

·       If you are in the upper tax brackets, harvest capital losses as necessary to reduce capital gains tax, and to lower the Obamacare tax on net investment income.  Generally, short-term losses are preferred over long-term losses because short-term gains bear a higher tax rate than long-term gains.  Be sure to specifically identify the block of securities you are selling to your broker.  Don’t trigger capital losses if you are in a low tax bracket.  Be sure to avoid the “wash sale” rule that applies if you purchase substantially identical replacement securities within 30 days before or 30 days after the date of sale.  See my prior blog post for more details.

·       If you are in the lower tax brackets, harvest long-term capital gains as necessary to fill in the lower tax brackets.  For example, a zero percent long-term capital gain tax rate applies through $73,800 of taxable income!  However, ordinary income fills up the low brackets first, so some coordination is necessary to achieve a zero percent tax rate.

·       Be sure that any year-end charitable donations are either delivered or mailed and postmarked by December 31^st.  Be sure that you obtain the required tax-qualified receipt early next year so that documentation is available when preparation of your income tax return begins.  If you want a charitable deduction but are not prepared to actually give the funds to a charity at this time, consider using a donor advised fund (DAF) to claim the deduction now.  You can select the charity later and “advise” the DAF to contribute to the charity then.

·       For those at least age 70 ½, consider using your traditional IRA to make a direct charitable donation of up to $100,000 to a public charity (but not a DAF).  This provision had expired at the end of 2013 but was just retroactively reinstated for 2014 donations.  It expires again after 2014!  The charitable IRA donation is also considered a distribution for purposes of your 2014 minimum required distribution.  Coupled with the phase out of itemized deductions, personal exemptions, and the net investment income tax, the charitable IRA donation can be effective in lowering your overall income tax.

·       Consider donating any long-term appreciated securities to charity.  You can claim a tax deduction equal to the fair market value of the securities without triggering tax on the capital gain.

·       For those at least age 70 ½, and for those who have inherited an IRA, don’t forget to take your minimum required distribution by December 31^st to avoid a 50% penalty.

·       Prepay state income tax unless you are subject to the alternative minimum tax (AMT) because taxes are not deductible for the AMT.

·       Consider accelerating ordinary income into 2014 if you are subject to the AMT and may not be in 2015.  The top AMT tax rate is lower than the top ordinary tax rate.

·       If you exercised incentive stock options (ISOs) in 2014 and the value of the stock has dropped, consider selling the ISO stock by year-end in order to purge the AMT ISO adjustment so that you don’t pay tax on value that has disappeared.

·       Consider making a Roth IRA conversion if you are in a low tax bracket this year.

·       Keep a focus on your adjusted gross income (AGI).  Many deductions and credits are lost, and additional taxes can apply, depending on the size of your AGI.  These include the deduction of personal exemptions, itemized deductions, some IRA deductions, the ability to contribute to a Roth IRA, educational credits, taxation of Social Security benefits, and Obamacare taxes.  Therefore, it generally makes sense to keep your AGI as low as possible.

·       For purposes of gift and estate tax planning, don’t forget to use the $14,000 annual exclusion.  Giving cashier checks is advisable when cash gifts are made at year end to be sure that the gift is completed in the 2014 calendar year.

Last Minute 2014 Business Tax Planning

Now that the Senate has passed the Tax Prevention Act of 2014, and with the expected signature of the President, taxpayers have less than two weeks until December 31, 2014, to implement any “last minute” income tax planning strategies.  The Act basically extends for one-year the various tax items that had expired at the end of 2013.  Here is a checklist of several strategies applicable to businesses:

·       50% first-year bonus depreciation has been extended to include qualified property acquired and placed in service by December 31, 2014 (previously expired after 2013 and expiring once more after 2014).  The property’s original use must begin with the taxpayer (new property).

·       The higher Section 179 business expensing limits have been extended to include property (new or used) acquired and placed in service in tax years beginning in 2014 (previously expired for tax years beginning after 2013 and expiring once more for tax years beginning after 2014).  The expensing limit is restored to $500,000; phasing out dollar for dollar as purchases exceed $2,000,000.  Previously these limits would have been $25,000 and $200,000 respectively.

·       Adopt a qualified retirement plan, such as a profit sharing plan, a 401(k) plan, or a defined benefit plan by December 31^st.  Alternatively, a simplified employee pension (SEP) plan can be adopted by the due date of the tax return (with extensions).

·       Estimate the business’ marginal income tax rate for 2014 and 2015 and shift income and deductions as appropriate to allow more income to be taxed at lower tax rates, or to allow more deductions to be claimed at higher tax rates.

·       Cash basis taxpayers should pay and mail all outstanding bills and payroll by December 31^st.

·       Accrual basis corporations should declare and accrue bonuses by December 31^st as long as actual payment occurs no later than March 15, 2015.  Special rules apply to shareholders owning directly or indirectly more than 50% of the corporation’s stock.  Bonuses to such shareholder-employees must be paid by December 31^st to be deductible in 2014.

·       If you own an interest in a partnership or an S corporation, you may need to increase your tax basis in the entity in order to deduct a loss from it for this year.

·       If you do not already have an existing policy, be sure that a written capitalization policy is in place by December 31, 2014 for the 2015 tax year.  This policy permits low-cost asset purchases ($500 or up to $5,000 for audited financial statements) to be expensed in the income statement instead of capitalized on to the balance sheet and depreciated.  Your financial accounting records must also treat these low-cost asset purchases as expenses.  While an annual election in the income tax return must be made each year to claim the deduction, it does not appear that a new capitalization policy must be adopted each year.  Rather, a written capitalization policy simply must be in place before the start of the tax year for which you are making the tax return election.

Employer Reimbursement of Employee Health Insurance Premiums

Historically, many small employers haven’t directly offered group health insurance policies, but instead have reimbursed or directly paid some or all of the premium expense of policies purchased by their employees.  Beginning in 2014, the Affordable Care Act (ACA) presents at least two large problems with these arrangements.

1.     First, if more than one current employee is involved in the expense reimbursement plan, the government says the employer has established a group health plan.  The ACA prohibits group health plans from limiting the amount of medical benefits provided under the plan.  By design, reimbursement arrangements are limited to the cost of the premium.  Now, under the ACA, the reimbursement plan exposes the employer to potentially unlimited liability for employee medical costs.

2.     Second, if the employee purchases his or her policy on the health insurance marketplace or exchange, the employer’s reimbursement or payment of the premium is a violation of the ACA.  It does not matter whether or not the reimbursement or payment is treated as taxable wages or as a non-taxable, pre-tax reimbursement to the employee.  Plans that violate the ACA are subject to a $100 per day per employee penalty under IRC §4980D.

Another pitfall deals with more-than-2% S corporation shareholder employees.  IRS Notice 2008-1 permits the shareholder-employee to purchase an individual policy and to either be reimbursed by the S corporation or to have the S corporation directly pay the premium.  If the premium is included as income taxable wages on the W-2 (it isn’t subject to FICA or Medicare tax), the shareholder-employee may deduct the premium cost as self-employed health insurance.  However, this Notice 2008-1 pre-dates the ACA.  So if more than one employee is involved, the problems listed above apply.

What can be done to avoid these problems?  The employer should offer an ACA-compliant group health insurance policy for the employees instead of reimbursing the costs of individual policies.  The employer could also consider the small business health options program (SHOP), known as Avenue H in Utah.  Avenue H permits an employer to provide a sum of money for an employee to use to purchase a policy on that exchange.  Alternatively, the employer could simply increase their employees’ wages and let the employees purchase their own health insurance.  The wage increase should not refer to health insurance premiums.  As a small employer, there is no requirement to offer health insurance, so there is no penalty for increasing employee wages and letting them purchase their own insurance.  The downside, of course, is that increasing wages is not a tax efficient way for the employee to purchase insurance.  A better approach for tax purposes would be to use Avenue H which permits pre-tax money to be used to purchase health insurance.

For further guidance on these issues, see IRS Notice 2013-54 and a DOL FAQ on the subject.

General Documentation Guidelines for Deductible Charitable Contributions

As the year comes to a close, many people consider making charitable contributions to their favorite organizations by year end.  The following chart outlines in general the required documentation.  Without timely documentation, the tax deduction is lost.  IRS form instructions should be consulted for special rules.

Required Documentation for Charitable Deductions
	Amount	Required Records
Cash	Single cash contribution of less than $250.	Cancelled check, bank record, credit card statement or written acknowledgment from the charity.
	Single cash contribution of $250 or more.	A tax qualified receipt that contains the following elements: ·        Amount of the contribution, ·        Name of the donor, ·        States that either:  i) no goods or services were provided by the charity in consideration for the contribution, or ii) provides a description and good faith estimate of the value of any goods or services provided by the charity, ·        If only “intangible religious benefits,” were received, then the receipt must explicitly state this, and ·        The donor must receive the receipt no later than the due date of the original federal tax return (including any extensions obtained).
	Payroll Deduction	Pledge card, W-2, Paystub etc.
Non-Cash	Non-cash contributions of less than $250.	Written acknowledgment from the charity or other record showing the details of the donation.  Complete Form 8283 Section A Part 1, if the total of such donations exceeds $500 but is $5,000 or less.
	Non-cash contribution of $250 or more.	Tax qualified receipt from the charity.  Complete Form 8283 Section A Part 1, if the total of such donations exceeds $500 but is $5,000 or less.
	Non-cash contribution of publicly traded securities.	Tax qualified receipt from the charity.  Complete Form 8283 Section A Part I even if over $5,000.
	Non-cash contribution of non-publicly traded securities and other property over $5,000.	Tax qualified receipt from the charity.  Complete Form 8283 Section B and obtain a qualified appraisal.

If you are considering donating a vehicle to a charitable organization, consult IRS Publication 4303 which provides specific guidelines on vehicle donations.

The amount of any deductible contribution must be reduced by the fair market value (FMV) of any goods or services received.  If the FMV of the goods received exceeds the amount of the contribution, none of the contribution is deductible.  Many organizations host charitable events which include auctions.  At many auctions the FMV is listed on the bid sheets.  Occasionally individuals will bid on an item simply because they wish to donate to the organization but do not have any intention of ever using the item.  In such a case, the individual should simply donate cash instead of bidding on an item, in order to deduct the full amount of the donation.

For individuals who volunteer for charitable organizations, the cost of the individual’s time and and value of his or her services are not deductible.  However, a volunteer may deduct mileage (at 14 cents per mile) and any unreimbursed out-of-pocket expenses directly connected with services provided.  Documentation of the time, place, date, amount and nature of the expenses is required.

If you are unsure whether or not an organization is eligible to receive tax-deductible charitable contributions, verify the organization’s status by using the IRS’ Exempt Organizations Select Check tool.