Last Minute 2013 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.

1.      Harvest capital losses as necessary to reduce capital gains tax, and to lower the Obamacare tax on net investment income.  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.

2.      Be sure that any year-end charitable donations are either delivered or mailed and postmarked by the 31^st.

3.      For those at least age 70 ½, consider using your traditional IRA to make a direct charitable donation.  This can satisfy your 2013 minimum required distribution and lower your overall income tax.

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

5.      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 the 31^st in order to avoid a 50% penalty.

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

7.      Consider accelerating ordinary income into 2013 if you are subject to the AMT and may not be in 2014.

8.      Consider making a Roth IRA conversion if you are in a lower tax bracket this year.

9.      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 2013 calendar year.

10.  Many upper-income individuals will suffer dramatic 2013 tax increases from the combination of income tax rate hikes and the start of Obamacare taxes.  Such taxpayers should consider estimating these tax increases in order to avoid surprises at April 15^th and to be sure sufficient cash is on hand to pay the additional tax on time, in order to avoid late payment penalties and interest.

Last Minute 2013 Business Tax Planning

Although, the IRS has delayed the start of tax filing season to January 31, 2014, taxpayers have less than two weeks until December 31, 2013, to implement any “last minute” income tax planning strategies.  Here is a checklist of several strategies applicable to businesses:

1.      Purchase and “place in service” any necessary equipment or furnishings by December 31^st to take advantage of  the 50% bonus depreciation that goes away after 2013 and to utilize the higher Section 179 business expensing limit of up to $500,000 that drops to only $25,000 for tax years beginning in 2014.

2.      Adopt a qualified retirement plan, such as a profit sharing plan, a 401(k) plan, or a defined benefit plan.  Unlike a qualified plan, a simplified employee pension (SEP) plan does not need to be adopted by December 31^st.

3.      Purchase stock directly from a qualified small business C corporation to be eligible for a potential 100% gain exclusion upon a future qualifying sale of the stock.  The exclusion drops to 50% for stock purchased after 2013.

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

5.      Accrual basis corporations may declare and accrue bonuses by December 31^st as long as actual payment occurs no later than March 15, 2014.  Special rules exist for 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.

6.      Estimate the business’ marginal income tax rate for 2013 and 2014 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.

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

 

Written Capitalization Policy Statement Required by December 31, 2013!

The Federal government recently published final regulations concerning the acquisition, production, and improvement of tangible property.  The regulations are effective for tax years beginning on or after January 1, 2014.  These regulations have been in the works for about 10 years and will change how businesses have historically accounted for repairs, maintenance, and asset purchases.  One of the provisions requires prompt action by all businesses.  This blog post is limited to this provision.  Future posts will cover other aspects of the final regulations.

The regulations provide for an annual "de minimis" safe harbor election for expensing the cost of tangible property equal to or less than a certain threshold amount.  The threshold amount is $5,000 for businesses that file financial statements with the SEC or with a state or local government, or that have a certified audited financial statement (reviewed or complied statements don't qualify).  These financial statements are termed, "applicable financial statements." The threshold is only $500 for businesses without applicable financial statements.  The safe harbor expensing election also applies to tangible property having an economic useful life of 12 months or less.  Note that this de minimis safe harbor election is different from, and is in addition to, bonus depreciation, and expensing under Section 179.

The safe harbor election requires that the business have a written capitalization policy for their financial accounting records BEFORE the start of the tax year for which the expensing will be taken.  Be sure that you have a written policy in place by December 31, 2013 if your tax year starts January 1, 2014.  Without a timely written policy, you can't elect the safe harbor, and asset purchases you choose to expense will be subject to challenge by the IRS, even if under the threshold amount.  The capitalization policy should refer to the dollar threshold amount, and also state whether property having an economic useful life of 12 months or less is also required to be expensed.

In brief, the requirements of the safe harbor election are as follows:

• A written capitalization policy statement is in place before the start of the tax year,
• The purchased items are actually expensed in the financial statements,
• The invoice total, or the cost of each asset purchased as itemized on the invoice, is equal to or less than $5,000 or $500 as applicable, and
• An election statement is made on a timely filed, original income tax return for each tax year.

The expensing ceiling is an all or nothing approach.  For example, if an item cost $5,001 (or $501 if no applicable financial statement), none of its cost can be expensed.

Social Security Benefits Increase for 2014

The Social Security Administration (SSA) announced a benefit increase of 1.5% for 2014.  Social Security benefits are indexed for inflation.  Average retirement benefits will increase by $19 a month to $1,294.  Fortunately, given the small increase, Medicare Part B premiums do not increase in 2014 and consume the increased benefit.

The inflation standard used by the SSA is CPI-W, the Consumer Price Index for Urban Wage Earners and Clerical Workers.  Notice that these are wage earners and there are no retirees in this index.  Retired persons spend more on health care, and those costs have been rising faster than overall inflation.  So over time, retirees who depend on Social Security benefits will suffer a lower standard of living because of the mismatch between the CPI-W and the cost of actual goods and services consumed by retired persons.  Furthermore, discussions for scaling back the cost of the Social Security program have considered replacing CPI-W with so-called “chained CPI.”  Chained CPI grows at a slower pace than CPI-W because it presumes that when prices increase, people will purchase less expensive items by substituting items of lesser quality.  If adopted, chained CPI will further erode retirees’ standard of living.  Therefore, it is imperative for people who wish for a comfortable retirement to save and invest for their future, rather than relying upon Social Security benefits to be the primary source of their retirement income.

Separately, the Social Security wage base, upon which the Social Security tax of 6.2% is imposed, rises from $113,700 in 2013 to $117,000 in 2014.  This is an increase of 2.9%.  The inflation increase for the taxable wage base uses a different index than CPI-W.  The 2014 increase is based upon the national average wage index for 2012 ($44,321.67) as related to the index for 1992 ($22,935.42), then multiplied by the 1994 Social Security wage base of $60,600.00.  The computation is as follows:  $44,321.67 / $22,935.42 X $60,600.00 = $117,106.78; rounded to the nearest multiple of $300.00 or $117,000.00.  See http://www.ssa.gov/oact/cola/cbbdet.html.

Medicare Open Enrollment Period Ends December 7, 2013

With the current confusion regarding health insurance marketplace exchanges, it is important for Americans turning age 65 to remember to enroll in Medicare.  Medicare is not purchased through the Affordable Care Act's individual exchanges, but rather with the Federal government at www.medicare.gov.

Your initial Medicare enrollment period begins three months before the month you turn age 65 and ends three months after the month you turn age 65.  If you are still working for an employer with 20 or more employees, and are covered by health insurance, you may delay enrollment until you stop working.  If you do not enroll on time, your Medicare premiums will be higher by 10% times the number of years you are late in signing up.

If you are already enrolled in Medicare, you do not need to re-enroll, nor do you have to worry about the ACA's health insurance exchanges.  However, during Medicare's annual open enrollment period, you can make changes your Medicare plans.  Medicare's open enrollment began on October 15, 2013 and ends on December 7, 2013.

Medicare is federal health insurance for those age 65 and older.  If you apply for Social Security benefits early, at age 62, it does not make Medicare available to you any earlier than age 65.  Medicare is a self-only policy and does not include family members.  There is no pre-existing condition exclusion.  Medicare insurance consists of several parts, and it is important to enroll in all of the parts for which you desire coverage.
 

·       Part A:  coverage for hospital stays, home health services, and hospice care.

·       Part B:  coverage for doctor services, outpatient care, and medical equipment.

·       Part C:  known as Medicare Advantage, are policies from insurance companies rather than from the Federal government, that provide Part A and B coverage, and often Part D.

·       Part D:  prescription drug coverage, offered through private stand-alone drug plans or by Medicare Advantage plans.

·       Medigap:  private supplemental insurance that covers many of traditional Medicare's (Parts A & B) out-of-pocket expenses.  Medigap is inappropriate for Medicare Advantage plans.

You are not charged premiums for Part A if you or your spouse are eligible for Social Security benefits, otherwise the premiums will be $426.00 per month in 2014.

Premiums are charged for Parts B and D.  The amount of the 2014 premiums vary and are based upon the amount of your adjusted gross income reported on your Federal income tax return for 2012, according to the following table.

If your yearly income in 2012 was			You pay Part B premiums in 2014 of	You pay Part D premiums in 2014 of
File individual tax return	File joint tax return	File married & separate tax return
$85,000 or less	$170,000 or less	$85,000 or less	$104.90	Your plan premium
above $85,000 up to $107,000	above $170,000 up to $214,000	Not applicable	$146.90	$12.10 + your plan premium
above $107,000 up to $160,000	above $214,000 up to $320,000	Not applicable	$209.80	$31.10 + your plan premium
above $160,000 up to $214,000	above $320,000 up to $428,000	above $85,000 and up to $129,000	$272.70	$50.20 + your plan premium
above $214,000	above $428,000	above $129,000	$335.70	$69.30 + your plan premium

Deducting HSA Contributions Made by Someone Else

A Health Savings Account (HSA) is a special financial account to which deductible contributions can be made.  The deduction is an adjustment to arrive at adjusted gross income (AGI), meaning that the account owner does not have to itemize deductions to claim the benefit.  HSA distributions used to pay medical expenses, or to reimburse medical expenses paid by the account owner, are not subject to income tax.  HSA payments of non-medical expenses are subject to income tax plus a 20% penalty.  If the account owner is 65 or older, the penalty disappears but non-qualifying payments remain taxable.

An HSA is only permitted when established in connection with high-deductible health insurance plans (HDHP).  An HDHP, which covers you but not your family, is a plan which has an annual deductible of at least $1,250 in 2013 or 2014, and limits total out-of-pocket expenses to $6,250 in 2013 and $6,350 in 2014.  In the case of family coverage, the plan must have an annual deductible of at least $2,500 in 2013 or 2014 and limit total out-of-pocket expenses to $12,500 in 2013 and $12,700 for 2014.

Contributions for a tax year may be made as late as April 15^th of the subsequent year.  Contributions may not exceed the following amounts: 

	2013	2014
Individual Plan	$3,250	$3,300
Family Plan	$6,450	$6,550
Age 55 catch-up	$1,000	$1,000

An interesting planning idea is that contributions to the account owner’s HSA can be made by anyone.  If a contribution is made by the employer, the contribution is excluded from wages.  If the contribution is made by a parent, the contribution is a gift to the child and the contribution is deductible by the child.  See IRS Publication 969, pages 2 & 4.  In the case of where parents might want to financially assist their children by paying modest amounts of out-of-pocket medical expenses, the parent should consider making a contribution to their child’s HSA instead of directly paying the medical expense.  The child can then use the HSA money to pay the expense.  This enables the child to receive an income tax deduction that would otherwise go to waste if the parent paid the medical expense directly to the service provider.  Reducing the child’s AGI could also open up other tax benefits that are limited by the amount of AGI.

 

This planning idea applies to the following fact pattern:  the child has an HSA in connection with a HDHP, the child is not a tax dependent of the parent, the amount of medical expense to be paid is modest and fits within the parent’s gift tax annual exclusion amount (whereas the direct payment of medical expenses is not counted as a gift for gift tax purposes), and the gift to the HSA, when aggregated with all other contributions, does not exceed the HSA maximum for the year.

Looming Change to Section 179 Expensing Amounts

Under current tax law, certain purchases of new or used property may be “expensed” for income tax purposes under Section 179 of the tax code, in the year of purchase, instead of being depreciated over a number of years.  The amount that taxpayers can expense is currently $500,000 for tax years beginning in 2013.  After 2013 the amount drops to $25,000.  The expensing limit is reduced dollar for dollar as total eligible Section 179 property purchases during the year exceed $2 million.  After 2014 the beginning of the phase-out starts at only $200,000. 

In addition to changes in these limits, the provisions permitting Section 179 to apply to the cost of qualified leasehold improvements, qualified restaurant improvements, new restaurant buildings, qualified retail improvements, and to off-the-shelf computer software will no longer apply in years beginning after 2013. 

While considering year-end business tax planning, you should take note of these changes.  There is a chance that Congress will restore the higher limits for years after 2013, but nothing is certain about what Congress will do. 

Fiscal-year partnerships, limited liability companies, and S corporations (known as “pass-through entities” because their owners pay the tax on company profits) should be careful of a potential trap that could waste part of their Section 179 expensing election.  For fiscal years beginning in 2013, the full amount of the expensing limits is available.  However, since Section 179 deductions of pass-through entities are allocated to owners in the calendar year in which the fiscal year ends (by Schedule K-1), the owners must contend with 2014 limitations.  For example, assume an S corporation whose fiscal year starts November 1, 2013, elects to expense $200,000 of equipment under Section 179.  Assume further that the S corporation is owned by two 50% owners.  The tax result is that only $50,000 of the $200,000 expense is deductible ($25,000 for each owner).  The excess $150,000 is lost!  In this case, the S corporation should wait to make the Section 179 election on its tax return until it learns of any potential tax law extensions.  If the law isn’t extended, then the S corporation should elect to expense only $50,000 and depreciate the balance of the cost to avoid wasting any deductions.