Year-end tax planning – how to minimize the total tax paid in 2014 and 2015

This year, when projecting your potential taxes, you have to factor in the changes from 2013 that affect 2014 and 2015, which can be daunting. That is:

  • You have the standard plan: “defer income/accelerate deductions unless you are in the alternative minimum tax (“AMT”)” (see below).
  • But then you also have the new 3.8% surtax, with rules that do not play well with the others!
  • Finally, the tax rates changed again for 2014 (see the table below).

If any of this is not clear, please ask questions.

Can you act?
To make your review of 2014 planning less daunting, take these separate steps: (1) ask “can you act?” – determine what you can do reviewing the “what can you act on” list below; then (2), if you can act on any of the items in 2014 or 2015 – moving from one year to the other, or delaying further – then ask “what impact does your acting have?” ; and finally, ask “what happens if I take all of these actions?” – determine the impact of all possible moves in concert, especially vis a vis the AMT. Preparing tax projections for both years is the best way to find out how to act most effectively to reduce taxes. It permits you to see which moves have the best results in which years, so that the total tax paid in the two years is minimized.

What can you act on?
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 fringes?

AMT – the AMT is the 28% flat rate calculated differently than 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. Otherwise, you will want to increase income for that year to “pull yourself out of the AMT.” The AMT exemptions amounts for 2014 are $52,800 for individuals and $82,100 for married couples filing jointly.

The 3.8% Medicare surtax – This affects all income for 2014 and beyond, but only to the extent of the lesser of (a) net investment income or (b) 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. The 3.8% surtax must be covered with your withholdings and estimated payments to avoid penalties and interest. See our post at Update on the impact of the 3.8% Medicare surtax .

Standard Deduction – up in 2014 to $6,200 for single taxpayers and married taxpayers filing separately, $12,400 for married couples filing jointly, and $9,100 for heads of household.

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

  • //Miscellaneous// – only the amount above 2% is allowed on Schedule A. Miscellaneous expenses include items such as unreimbursed employee expenses, tax preparation fees and investment-related expenses.
  • //Other 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. – (a) many of the deductions affected by the phase-out are the ones not allowed in the AMT calculation and (b) investment interest is not subject to reduction on Schedule A.

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

Investment income – can you shift interest, dividends, and capital gains? The tax rate on capital gains was as low as 0% in 2013, with a cap at 15%. However, that cap went up to 20% in 2014 for AGI over $457,600, for married filing jointly ($406,750 for single; $12,150 for trusts and estates). You net losses against gains, with up to $3,000 of an excess loss over gains being allowed to shelter other income and losses you do not use carry to the next year.

Notes

  • (a) capital gains include the sale of a primary residence (above the $250,000 per owner shelter);
  • (b) 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, even if it is in different accounts you own, including repurchasing in your IRA;
  • (c) 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; and
  • (d) 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, such 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.

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 (see final regulations on when and how you elect issued early in 2014).

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.

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

Required minimum distributions (“RMD”) – If you turned age 70½ in 2014, you can take a distribution in 2014 instead of next year to decrease your 2015 income – but the IRA distribution is not subject to the surtax so this would be done for the Schedule A phase outs (see below).
A direct distribution from an IRA to a charity allows you to give up to $100,000 (per person) of your RMD and lower your AGI for purposes of determining taxes.

Estate taxes – Federal Estate Tax Exemption for estates of decedents who die in 2014 is $5,340,000, up from $5,250,000 for 2013.

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? You may want to combine this estate tax savings strategy with income tax savings ideas so that you shift an income-producing asset to someone in a lower tax bracket.

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 2014-2015 tax plan, or else a set of questions to ask so we can help devise one for you! //Please contact us//.

Federal Tax Rates for 2014:
[[image:2014-federal-tax-rates.jpg|large|link=source]][[file:2014-federal-tax-rates.pdf]]

Finances and need for planning for young people or “millennials”

For many, when they hear the term millennial, they conjure up the image of an underemployed, tech-savvy twenty-something living in his parents’ basement. Many unfavorable stereotypes have been given to them, such as: entitled, lazy, and delusional.
In fact, millennials face many more financial challenges than previous generations. The average student loan debt of a 2012 college graduate is $29,400, while finding a decent paying job is difficult at best.
Just because you do not have great wealth, that does not mean you do not need sound financial planning and advice. No matter what your resources are, good financial planning and education are essential to long-term financial stability.
Unfortunately, millennials have not gotten this message. A study in the June issue of Kiplinger’s Finance Magazine found that only 40% of millennials have a retirement account and only 25% are willing to take investment risks in setting up a savings account. Many lack fundamental financial literacy, with little understanding of basic concepts like mortgage financing or inflation. More than 50% of millennials have used costly services, such as payday advances and pawnshops to obtain loans.
The good news is that there are many apps and online services available to help users plan and budget.
Spending and budgets: The Mint app tracks a user’s spending and income and provides an up-to-date snapshot of their current finances. There are also many budgeting websites, such as www.LearnVest.com and www.Mvelopes.com, which categorize expenditures and set target spending limits.
Saving and banking: There are apps available to help users save money and avoid ATM fees. SavedPlus.com, for example, automatically sweeps money from your checking account into your savings account every time you make a purchase. The MasterCard Nearby app allows you to search for nearby ATMs and filter your search based on criteria such as fees and 24-hr availability.
While there are many online resources available, none we found are comprehensive, and none actually provide the needed planning advice. Meeting with a trusted financial planner is always recommended.
As you read this, did think of your friends, your children, or your children’s friends, that is, does this apply to them? We hope to be addressing this with a dedicated site so all feedback is welcome.

Some interesting statistics on risk of an IRS audit, from The Kiplinger Tax Letter, 1-17-14

“IRS is struggling on the enforcement front. 2013’s individual audit rate fell to 0.96%… one out of every 104 filed returns. It’s the first time in seven years that this key statistic dipped below 1%. And we expect this figure to sink even lower for 2014 as the agency’s resources continue to shrink. The number of enforcement personnel has decreased to its lowest level in years, partly due to budget cuts and reassigning agents to work identity theft cases.”

The Tax Letter breaks down to .88% for below $200,000 of income, 2.7% for above that level but below $1 million, and 10.85% for over $1 million of income (down from 12.14%)

The Tax Letter indicates certain red flags (some text omitted)
“Claiming 100% business use of a vehicle. They know that it’s extremely rare for an individual to actually use a vehicle 100% of the time for business, especially if no other vehicle is available for personal use.
“Deducting business meals, travel and entertainment on Schedule C.
Big deductions here are always ripe for audit. A large write-off will set off alarm bells, especially if the amount seems too high for the business. Agents are on the lookout for personal meals or claims that don’t satisfy the strict substantiation requirements.
“Writing off a hobby loss. Chances of losing the audit lottery increase if you have wage income and file a Schedule C with large losses. And if the activity sounds like a hobby…dog breeding, car racing and such…IRS’ antennas go up higher.
“Failing to report a foreign bank account. The agency is intensely interested in people with offshore accounts, especially those in tax havens, and tax authorities have had success in getting foreign banks to disclose account owner information. This is a top IRS priority. Keeping mum about the accounts can lead to harsh fines.
“Taking higher-than-average deductions. IRS may pull a return for review if the deductions shown are disproportionately large compared with reported income. But folks who have proper documentation shouldn’t be afraid to claim the write-offs.”

The last phrase is the key: if you have a proper reporting position with full documentation, then the risk of any adverse determination is drastically reduced (but you have the time lost responding if the IRS does raise a question).

Let me know if this raises questions for you.

Massachusetts enacts the Massachusetts Uniform Probate Code (“MUPC”) Many other states have or will do the same

(While the following applies to Massachusetts, there are many other states that have recently made the same changes)
Massachusetts adopted the “MUPC” on March 31, 2012. It affects almost every aspect of the law of wills and the administration of estates including changes outlined below:
• Personal Representative: The law does away with classifications of executors, temporary executors, administrators, special administrators and the like by adopting the one-size-fits-all title of “personal representative.” The personal representative acts for people with a will (“testate”) or people without (“intestate”).
• Descendants: Any portion of the estate which passes to the decedent’s descendants will pass under a new system of distribution called “per capita at each generation.” Under this rule, living children inherit equally. If a child pre-deceases the parents, and has living children, the shares of all deceased children are combined and divided equally among all the surviving children.
• Effect of Divorce on the Estate Plan: The impact of divorce is broadened from partially revoking wills and unfunded revocable trusts to expressly apply to non-probate transfers, such as life insurance policies and trusts, whether funded or unfunded, in the case where an individual has the sole power to make certain changes to at the time of the divorce or annulment. The new law also operates to revoke bequests to relatives of the ex-spouse, as well as appointments of such relatives of executor or trustee under certain situations.
• Effect of Marriage on Will: Where marriage used to automatically revokes a prior will, the MUPC does not provide for such automatic revocation. Instead, the will survives, and any legacy to descendants of the decedent (who are not descendants of the new spouse) is preserved. If any part of the estate is left to persons other than such descendants, the new spouse would receive his or her intestate share under law, to be satisfied from the assets left to such other persons (and from any bequests made to the surviving spouse, if any, in the premarital will). The testator’s choice of personal representative and guardian of minor children is also preserved. Note that this rule can be avoided by updating the will after marriage.
Because of these changes to the MUPC, it is important that your estate planning documents are up to date. If you have not updated your estate plan recently, be sure to do so as soon as possible.

Tax Law Changes Coming, including raised capital gains and dividend tax rates

This month, President Obama released his proposed FY 2014 budget which contains new taxes, limits on deductions, and other changes intended to meet the goal of raising more than $580 billion in revenue.
The most significant of these is the termination of capital gains breaks and qualified dividend treatment, causing them both to be taxed as ordinary income. The Kiplinger Tax Letter suggests taking capital gains before 2015 to lock in the lower rate. However, as always, do not let a tax strategy override a good investment plan.
Here is a summary of other changes that may affect you:
The 28% Limitation:
• Affects married taxpayers filing jointly with income over $250,000 and single taxpayers with income over $200,000.
• Limits the tax rate at which these taxpayers can reduce their tax liability to a maximum of 28%.
• Applies to all itemized deduction including charitable contributions, mortgage interest, employer provided health insurance, interest income on state and local bonds, foreign excluded income, tax-exempt interest, retirement contributions and certain above-the-line deductions.
The “Buffet Rule”
• Households with income over $1 million pay at least 30% of their income (after charitable donations) in tax.
• Implements a “Fair Share Tax,” which would equal 30% of the taxpayer’s adjusted gross income, less a charitable donation credit equal to 28% of itemized charitable contributions allowed after the overall limitation on itemized deductions. The Fair Share Tax would be phased in, starting at adjusted gross incomes of $1 million, and would be fully phased in at adjusted gross incomes of $2 million.
Estate, gift, and generation-skipping transfer (GST) Tax
• Reintroduce rules that were in effect in 2009, except that portability of the estate tax exclusion between spouses would be retained.
• This change would take effect in 2018.
• Top tax rate would be 45% and the exclusion amount would be $3.5 million for estate and GST taxes, and $1 million for gift taxes.
The Kiplinger Tax Letter anticipates the changes being acted on as early as 2014. On April 23, 2013, Max Baucus (D-MT), the head of the Senate Finance Committee, announced he would retire from the U.S. Senate at the end of his term in 2015. In The Kiplinger Tax Latter, Vol. 88, No. 9, Kiplinger predicts that “he’ll push to make revamping the tax code his legacy.”
You may feel as though you are done with taxes and do not need address them for another year. Resist that urge and schedule a meeting with us so we can review the potential impact of proposed tax changes on your portfolio and investments. We can also discuss the best strategies for saving money on your 2013 and 2014 tax returns.