Year-end tax planning – how to minimize the total tax paid in 2015 and 2016

To act or not to act? That is the question.

You still have time as year-end approaches to finalize your tax planning for 2015. With that in mind, this post separates areas where you may be able to act and provides more detail on the rules affecting how you act. If any of this is not clear, just ask questions, please.

  • Look through the list below to see if there are any items in your 2015 and 2016 finances that you can change in any way – moving from one year to the other, or delaying further.
  • Determine what impact each of these has and then the impact of all of them in concert:
    • This includes the alternative minimum tax (“AMT”), which is the 28% flat rate as opposed to the marginal rate of up to 39.6%.
    • If your deductions bring the regular tax down too low, the AMT kicks in, so that the deductions are wasted and need to be moved to another year, if possible, or income for that year increased to “pull you out of the AMT.” The AMT exemptions amounts for 2015 are $53,600 for individuals and $83,400 for married couples filing jointly.
  • Be sure to prepare tax projections for both tax years to determine which changes have the best results so that the total tax paid in the two years is minimized.

Not easy!

What do you act on?
To get started, it is helpful to know the current tax rates. Here are the new rates for 2015: Federal Tax Rates for 2015. Also, note that the Standard Deductions rises to $6,300 for single taxpayers and married taxpayers filing separately, $12,600 for married couples filing jointly, and $9,250 for heads of household.

3.8% Medicare surtax
This affects all income for 2015 and beyond, but only to the extent of the lesser of:

  • Net investment income, or
  • The excess of modified adjusted gross income (“AGI”) over the threshold, which is $250,000 ($200,000 for single taxpayers).

Investment income includes interest, dividends, capital gains, annuities, royalties and passive rental income but excludes pensions and IRA distributions.

N.B. – the 3.8% surtax must be covered with your withholdings and estimated payments. See our post Update on the impact of the 3.8% Medicare surtax .

Wages – Can you defer or accelerate between years or even convert income into deferred income, such as stock options, or income to be received at retirement? Can you convert compensation into tax-free fringe benefits?

Stock options – can you exercise a non-qualified option (“NQ”), which is treated as ordinary income, or instead of as an ISO, which can be investment income? Disqualifying an ISO converts it into a NQ, so that you have control over the type and timing of the income.

Schedule C income and expenses – can you defer or accelerate income and deductions between years so that the net income falls in the best year?

Schedule A itemized deductions – like income, can you deductions for the maximum benefit, given the income-based deduction thresholds?

Medical – only the amount above 7.5% (10% above certain income levels) of qualified medical expenses, which include amounts paid for prescriptions, doctor co-pays, long-term care insurance premiums, and glasses, are allowed on Schedule A.

Miscellaneous – only the amount above 2% is allowed on Schedule A. Miscellaneous expenses include unreimbursed employee expenses, tax preparation fees and investment-related expenses.

Deductions – certain itemized deductions are phased out once your AGI exceeds $305,050 for married filing jointly ($254,200 for singles), so that your itemized deductions are reduced by 3%, on up to 80% of the deduction, for the excess of your AGI above $305,050 ($254,200 for single filers).

N.B. – many of the deductions affected by the phase-out are the ones not allowed in the AMT calculation. Also, investment interest expenses are not subject to reduction on Schedule A.

Investment income – can you shift interest, dividends, and capital gains? Can you use an installment sale to spread out a large gain or, if feasible, a like-kind exchange to defer the gain?

(An installment sale that spreads gain over several years; a like-kind exchanges involve investment property, which means you can swap, rent and later convert to residential.)

The tax rate on capital gains was as low as 0% in 2014, with a cap at 20% and those rates remained in place for 2015. The 20% rate applies in 2015 for AGI over:

  • Married filing jointly – $464,850;
  • Head of Household – $439,000;
  • Single – $413,200;
  • Married Filing Separately – $232,426; and
  • Trusts and Estates – $12,300.

You net losses against gains. If you have a loss, with up to $3,000 of the loss is allowed to shelter other income, with any remaining losses carried to the next year.

Investment Loss – Take advantage of tax-saving losses by selling depreciated stocks or mutual funds that are in a taxable account, not your 401(k) or IRA. However, if your traditional IRA has declined in value, you may want to consider converting some or all of the funds in it to a Roth.

Caution:

  • Purchasing mutual funds late in the year can lead to dividend and capital gains distributions where the mutual fund price changes but your investment does not. This means that you have no economic gain for the distribution on which you pay taxes – you are effectively pre-paying taxes because you did not purchase after the declared distribution date.
  • If you sell to recognize a loss, and want to hold the stock again, be aware of the wash sale rule which bars recognition of the loss if you re-purchase substantially the same security within 30 days – which applies to different accounts you own, including repurchasing in your IRA. An example of what works: a bond swap with the same issuer, where the maturity or interest rate is different, is a way to recognize a loss without being affected by the rule.

Investment income also includes passive income and losses (rental property, limited partnerships and LLCs).

If you can re-characterize any activities as material participation rather than passive by grouping together to meet the material participation rules, you have a one-time election to regroup.

N.B. – Gains include the sale of a primary residence (above the $250,000 per owner shelter).

Roth conversions – can you convert an IRA to a Roth IRA, so that future distributions are not subject to tax? Be sure to pay the tax with funds outside of the IRA so that the conversion has maximum benefit.

Health Insurance – It’s the time of year to choose your health insurance for next year and your decision could affect your 2015 tax filing:

  • Choosing to opt out of buying health insurance could be a costly decision. The new penalty is $695 per adult and $347.50 per child, with a family maximum of $2,085. Those whose income is too low or for whom insurance is too costly may qualify for an exemption from this penalty;
  • If you purchase insurance on an exchange, you may qualify for a tax subsidy if your income is between 100% and 400% of the federal poverty level; and
  • The subsidy will be based on your expected 2016 income. However, if your income is higher than the estimated income, your credit may factor into your tax filing for that year.

Required Minimum Distribution (RMD) – If you are 70 ½ or older, you must take a withdrawal by the end of the year from your traditional IRA or face a significant penalty. To calculate your RMD, take your year-end IRA balances as of December 31, 2014, and divide each one by the factor for your age, which can be found in IRS Pub. 590-B. If you turned 70 ½ this year, you can delay your payout until April 1, 2016. If you opt to take your distribution 2016, you will be taxed on two IRA distributions in 2016.

Federal Estate Tax Exemption – the exclusion amount for estates of decedents who die in 2015 is $5,430,000, up from a total of $5,340,000 in 2014.

Gifting – can you shift assets by gifting within the $14,000 per year/per person annual gift tax exclusion, or even by filing a gift tax return to use some of your unified credit now, so that income is in the lower tax bracket of new owner?

If you’re looking to shift more than $14,000 per year per person, amounts directly paid to college tuition and medical services are exempt from gift-tax rules.

Inherited IRA – be sure to divide an inherited IRA among beneficiaries to get the maximum life expectancy for RMD calculations for each

If you made it this far, I hope you have a good idea of your 2015-2016 tax plan, or else a set of questions to ask so we can help devise one for you! Please Contact Us.

Plan now to avoid surprises from the Affordable Care Act when filing 2014 taxes

2014 was the first year Americans had access to health insurance options through the Affordable Care Act (the “ACA”). With this new access to insurance came the obligation to purchase it or face new tax consequences. If you opted not to buy health insurance in 2014, you may be faced with a penalty when you file your 2014 tax returns. Even if you did buy insurance through one of the insurance marketplaces, you may have new tax forms to complete and some surprises when it comes to your refund or tax bill.

For most taxpayers, the impact on their tax filing will be minimal, requiring those who were covered to simply check a box indicating they had insurance throughout the year. Those who received subsidies to purchase insurance and who later had increases in their 2014 salary may be required to pay back some of that subsidy. Those whose salary decreased may receive a larger than expected refund.

As these provisions are new to everyone, there may be confusion for taxpayers and tax preparers alike. Unfortunately, due to recent budget cuts, the IRS expects to be able to speak with only half of the people who call in for assistance.

While gearing up for the 2014 tax season, it’s helpful to understand some the most important provisions of the ACA:

  • 1. Exemptions: The ACA provided some exemptions that allow taxpayers to opt out of purchasing insurance without any penalties, including hardship, affordability and religion. There are different methods for applying for an exemption depending on the type of exemption you are requesting. To learn more, go to: https://www.healthcare.gov/fees-exemptions/apply-for-exemption/
  • 2. Penalties: Those who do not qualify for an exemption, were insured for only part of the year, or remain uninsured will be required to pay a penalty called “The Individual Shared Responsibility Payment.” The penalty is set to increase over the coming years, so compare not to see if it is more beneficial for you to pay the penalty or buy insurance. The Tax Policy Center has designed a calculator to help you determine your penalty is you opt to remain uninsured: http://taxpolicycenter.org/taxfacts/acacalculator.cfm.
  • 3. Reconciling: Those who purchased subsidized insurance on the exchanges received an advance on a tax credit. At the time of requesting the subsidy for insurance in 2014, the amount of the subsidy was calculated based on the taxpayer’s 2012 income. The amount of the subsidy granted will be reconciled in the taxpayer’s 2014 filing using the taxpayer’s actual 2014 income and that will affect the taxpayer’s refund or bill. Changes in an individual’s personal circumstances, such as divorce, marriage or a new child can also impact those numbers.
  • There’s still time to plan. Taxpayers facing a loss in premium subsidies because of an increase in income can reduce their income to qualify for the credits. For example, they can contribute to an IRA by April 15, 2015, for the 2014 tax year.

    Comments on health insurance, tax changes and asset allocation (not even having all investments in cash is safe)

    Investing
    Starting with my reoccurring theme of asset allocation, I post below two comments on investing.

    The first short comment from Morningstar reaffirms that you need to diversify by class, as well as in each class, of investment.

    The second comment from Merrill Lynch provides a year to date summary of returns, showing that the people who tried to market time, by going to cash last year, missed out on substantial returns by being out of the stock markets in 2009.

    Finally, as another example on diversifying, we had some clients invest in Euro bonds. They made over 20% in the last two years, which is much having gone to cash.

    So, again, I urge anyone who has not reviewed their allocation to do so now …..

    Tax impact of Health Care Reform
    On the health care reform and its impact on your taxes, I reprint a section from the Kiplinger’s Tax Letter below.

    As with many other sources, they believe a bill will pass and that it will have an impact on taxes.

    The impact is likely to be predominately on people with income in excess of $250,000, but not beginning until 2011. When we know more on this, we will give you an update.

    Estate Taxes
    Kiplinger’s expects Congress to keep the estate tax much like it is today, rushing to avert the year of no estate tax and the year after or a $1 million credit (we now have a $3.5 million credit)…

    Kiplinger’s also has comments on the “cash for clunkers” and changes likely in 401(k) plans…..

    Let me know if any of this raises questions or comments please. Thanks,

    Steven

    From Morningstar:
    Theoretical and empirical research, as well as long-term data from financial markets, confirms that risk is minimized significantly and performance can be enhanced when a portfolio holds, for long periods of time, different asset classes with dissimilar price movements. This approach, which fulfills the fundamental underlying objective of modern portfolio theory, is also in accord with the standards of modern prudent fiduciary investing.

    From Merrill Lynch:
    …. In the meantime the S&P 500 Index had its best quarterly return since 1998, rising almost 16%. Most US equities rose sharply in the second quarter as investors regained their appetite for risk; investors bid up stocks beginning in March after it appeared that the financial sector had stabilized and this momentum continued through the second quarter. Investors seized upon indicators such as retail sales, industrial production and ISM survey data that suggested economic growth, although weak, was showing improvement. Indeed, retail sales and durable goods orders were higher than expected and employment figures showed a moderation in worsening trends. After the strong end to the first quarter, analyst estimates for company earnings were on average revised higher as the depression scenario faded into memory. During the quarter, the riskiest assets were bid up the most, with the Russell 2000 Small Cap Index returning more than 20%.
    Outside the US, the story was similar: markets improved sharply on the turn in economic data. The MSCI Emerging Markets Index had its best quarter in U.S. dollar terms since it was launched in 1988 – rising almost 35% in the second quarter…..

    The Kiplinger Tax Letter (ISSN 0023-1762)
    Health care reform may seem stalled for now, with both the House and Senate missing the deadline that Obama set for action on a bill…early August.
    But work still goes on behind the scenes, so Democratic leaders can make a final push this fall.
    Readers are asking what’s going to happen to the legislation and what it will mean for taxes.
    We’ll share our answers to those questions.
    What are the chances that no bill will pass?
    Very unlikely, given all the political capital that the president has spent on this issue. He’s sure to insist Congress keep at it.
    But if gridlock continues, Obama may have to accept a scaled down bill… a lesser expansion of the government’s role in providing coverage to the uninsured.
    A smaller bill would lower the price tag, reducing the need for tax hikes. The odds of a big-ticket tax increase such as an income surtax would go way down. It wouldn’t be needed to offset higher federal spending from revamping health care.
    Does a smaller bill mean no employer mandate? No, although the number of small businesses that would be covered by the mandate and the tax penalties for failing to provide coverage to employees would be smaller than originally thought. The tax would be somewhat less than the $750 per worker proposed in the Senate, and would be phased in for those businesses with payrolls that exceed $500,000. As first proposed, the tax would have covered firms with payrolls over $250,000.
    Would a mandate apply beyond the private sector? Yes. The coverage rule and tax penalty are sure to cover nonprofit groups and state and local governments.
    Could employers avoid the mandate by classifying workers as contractors?
    Theoretically. However, it’s a risky move. Tax pros predict that a mandate would spur many firms to consider reclassifying employees to avoid covering them, forcing them to buy their own coverage. But you can expect that angry workers will squawk to the IRS, giving the agency lots of leads for employment tax exams.
    Are middle incomers likely to see higher taxes to fund the overhaul?
    Don’t rule it out. Lawmakers are considering, for example, a new tax on gold plated insurance plans. Those policies aren’t owned just by upper incomers. They are included in the contracts of many union members…police, firefighters, etc.
    Would Congress consider making tax hikes start in 2010? Definitely not. Figure that 2011 would still be the earliest year that hikes would become effective.
    Will continuing delays on health care push estate tax changes into 2010?
    Not very likely. Lawmakers still intend to act before the end of the year to prevent the estate tax rate from dropping to zero in 2010. The exemption amount for 2010 will be kept at $3.5 million and the rate will stay at 45% for another year. The estate tax bill is sure to include extensions beyond 2009 of popular tax breaks, such as tax free IRA payouts to charity and the deductions for tuition and sales tax.

    The “cash for clunkers” program has tax angles for people and businesses. Vouchers are tax free for individuals. Therefore, if you trade in a vehicle for a more fuel efficient one and get a $3,500 or $4,500 dealer credit on the trade-in, you owe no tax, even if the amount of the credit far exceeds the trade-in’s value. And if you purchase a qualifying hybrid or a lean diesel vehicle as a replacement, you still can claim the hybrid or diesel credit, even though the voucher isn’t taxed.
    But car dealerships don’t benefit from the tax break, IRS officials say. The voucher amount is included in the gross receipts from the sale of the vehicle.

    Many 401(k) plans will have a different look a couple of years from now. The economic downturn is prompting changes that firms will implement to reduce plan expenses and to prompt their employees to save more for retirement.
    More employer payins will be discretionary. Although most plan sponsors that suspended matching contributions during the downturn will reinstate them, those payins won’t return before 2011, and they’ll probably be in a different form. Fewer firms will automatically match a set percentage of pay. More contributions will be tied to company performance. And many firms will stop obligating themselves to a contribution level at the start of the year but will wait until year-end to decide.
    Companies will try to get more 401(k) accounts on autopilot to help workers boost savings. One idea: Having employee payins increase automatically each year until reaching a preset level…around 10% of pay…if the employee selects this option. The number of companies adopting automatic enrollment will continue to grow, though some will limit it to employees with at least two years of service. That way, firms can avoid incurring the administrative hassle and expense for short-timers.

    Another subject:
    Bad news from IRS for exchange-traded funds that invest in metals: Those funds do not qualify for the 15% rate on long–term capital gains. Instead, their top tax rate is 28%. It applies if the fund owned the metal for more than one year and the investor owned fund shares for over a year, IRS says privately.
    The fund’s investors are deemed to own a share of the metal, such as gold, silver or platinum. The gain is treated as coming from the sale of a collectible.
    The Service takes a different stance for IRAs investing in these funds. If the metal is held by an independent trustee, the Service will not treat the IRA as owning a share of the fund’s underlying metal. This favorable interpretation keeps the IRA from running afoul of the rule barring direct investments in bullion.