As the end of 2015 approaches, now is a good time to consider planning moves that will help lower your tax bill for this year and into the future. Tax planning is a proactive and on-going process, this time of the year can be one of the most fruitful times to comprehensively review where you stand.
As we have come to expect over the past several years, year-end tax planning for 2015 has to incorporate the uncertainty as to whether the so-called “tax extenders” will be extended once again by Congress. All of the following “temporary” tax provisions have expired and may or may not be retroactively reinstated and/or extended before year-end:
- 50% “bonus” first year depreciation deductions for qualifying new purchases
- The $500,000 (rather than $25,000) limit on the election to expense depreciable property under Section 179 of the Code
- The research and development tax credit
- The 15 year (rather than 39 year) write-off for qualified leasehold improvements, qualified restaurant buildings and equipment, and qualified retail improvements
- The election to claim state and local sales and use taxes as an itemized deduction instead of state and local income taxes
- The “above-the-line” deduction for qualified higher education expenses
- The exclusion of up to $2 million on cancellation of indebtedness income on a principal residence
- The ability to exclude up to $100,000 from gross income for charitable distributions from IRAs by those age 70 ½ and older
Although the nuances of planning seem to change each year, some general principles always apply. Year-end tax planning principles and moves for businesses and business owners include:
- Although the election to expense depreciable property used in a trade or business is greatly reduced for 2015 (unless retroactively changed by legislation), making expenditures that qualify for this option can still result in current year tax savings. Under current law the Section 179 expensing limit for 2015 is $25,000 and begins to be phased out when total property placed in service for the year exceeds $200,000.
- Businesses can take advantage of a de minimis safe harbor election rule concerning capitalization decisions assuming that costs don’t have to be otherwise capitalized under the Code Sec. 263A UNICAP rules. To qualify, the costs of a unit of property cannot exceed $5,000 if the taxpayer has an applicable financial statement (generally an audited financial statement). If the taxpayer does not have an applicable financial statement, the cost of a unit of property cannot exceed $2,500.
- If your business qualifies for the domestic production activities deduction (DPAD) for the 2015 tax year, consider whether the 50% of W-2 wage limitation applies, and if so, whether 2015 W-2 wages can be increased to increase the deduction.
- If you own an interest in a partnership or S corporation, consider basis limitations and whether basis needs to be increased in order to deduct current year losses.
- Analyze passive activities versus non-passive activities to keep non-deductible losses to a minimum. Make sure that any “self-rentals” do not result in non-deductible passive losses.
- Choice of entity can affect tax results as well as cash basis versus accrual basis options. These options should be reviewed to optimize income and tax savings.
- Ohio businesses structured as sole proprietorships and pass-through entities should make sure they take advantage of the Ohio small business investor income deduction. For 2015 the deduction is again 75% of the first $250,000 of business income for those who do not file separate returns. There is a flat 3% tax on remaining business income. In 2016 the deduction based on current law is 100% of the first $250,000 of business income.
- Businesses with activity in multiple states should carefully analyze which states the business has “nexus” in for both income tax and sales and use tax purposes. Businesses also need to watch for new “bright-line” nexus rules in states that can trigger filing requirements based on arbitrary thresholds such as the amount of sales in a particular state.
- Businesses should make sure they are incorporating various aspects of the Affordable Care Act (ACA) to avoid unnecessary penalties and to correctly report employer-sponsored insurance. The rules vary depending on the number of persons the business employs.
Some of the more common planning principles for individuals include:
- Postpone income until 2016 and/or accelerate deductions into 2015 while keeping in mind the various phase-outs for many deductions at certain levels of income. Note that depending on varying individual circumstances there may be times when the opposite strategy is appropriate, such as when you expect to be in a higher tax bracket the following year.
- Consider a traditional to Roth IRA conversion if you expect to be in a higher tax bracket when eventually taking distributions from the Roth, you do not expect to take distributions from the account for a substantial period of time, and/or your income was much lower in 2015 than is typical. Roth IRA conversion will increase your AGI in the year converted absent a unique tax attribute such as a net operating loss (NOL).
- Consider using a credit card to pay deductible expenses before the end of the year. The credit card charges are considered to be a 2015 deduction even when the charges are paid in a future year.
- If you expect to owe state and local income taxes consider increasing your withholding of these taxes (or pay estimates of these taxes) before the end of the year to pull the deduction into 2015. However, this is only advantageous if you’re not subject to alternative minimum tax (AMT) in 2015.
- Your exposure to alternative minimum tax (AMT) must be kept in mind as many tax breaks allowed for regular income taxes are disallowed for AMT purposes. These include the deduction for property taxes on your residence, state and local income taxes, miscellaneous itemized deductions, and personal exemptions.
- If you are just under a threshold for the allowance of a deduction such as miscellaneous itemized deductions or medical expenses consider “bunching” these expenses into one year to get over the threshold.
- Remember to take into account the required minimum distributions (RMD) from your IRA or 401(k)/403(b) account(s) if you are over age 70 ½ at the end of 2015. The penalty is 50% of the RMD amount for failure to take the distribution during the year.
- Consider ways to maximize income taxed at lower capital gain and qualified dividend tax rates. Consult your investment advisor to develop a strategy to match capital gains and losses and to make investments that pay income as qualified dividends.
- Shelter gifts by using the annual gift tax exclusion before the end of the year to reduce possible gift and estate taxes. The annual exclusion applies to gifts of up to $14,000 made in 2015 to each of an unlimited number of individuals.
Unique aspects of planning for higher-income earners include:
- Higher-income individuals must take into account the 3.8% net investment income tax on certain unearned income. The tax applies to individuals with income over $250,000 who use the filing status of married filing jointly or qualifying widow, $125,000 for the married filing separately status, and $200,000 for any other filing status. Strategies to minimize the tax include having investments like municipal bonds where the interest income is tax-exempt and maximizing investments in qualified retirement plans where the income is also tax-exempt. Income from activities in which you materially participate is not subject to the tax and your business activities should be carefully analyzed in classifying the income as net investment income versus income from an active trade or business.
- Like the 3.8% net investment income tax, the 0.9% Medicare tax applies to individuals for whom the sum of their wages and self-employment income is in excess of $250,000 for joint filers (or the qualifying widow filing status), $125,000 for those with the filing status married filing separate, and $200,000 for any other filing status. Self-employed individuals must take this into account in figuring quarterly estimated taxes due. Also, individuals and married couples who have two or more employers may have a disparity in their withholding if one or more W-2’s are under $200,000 (the amount where employers must withhold the tax) but combined with the other earned wages the total wages exceed the threshold. Alternatively, tax may also be over withheld where, for instance, a couple files married filing jointly but one spouse has wages over $200,000 and is required to withhold but the combined income does not exceed $250,000.
- Plan for estate taxes based on current law, but be alert for possible changes from legislation. The current effective estate tax exemption due to the unified credit is $5.43 million and a married couple can pass an estate valued at $10.86 million to their heirs without paying federal estate tax because of a provision allowing for the unlimited portability between spouses of a deceased spouse’s unused exclusion amount.
Other more general considerations:
- Identity theft continues to be an issue for both the IRS and state tax departments as many false returns and refund claims have been and continue to be filed. Consider how well you safeguard your personal information and ID numbers and take care not to email or fax them unless the method is secure. The IRS will only contact you only via mail and if you are contacted by either email or telephone, it is likely to be a scam.
- Taxpayers should be aware of new rules for filing Ohio city tax returns that go into effect January 1, 2016 due to the passage of HB 5 in the 130th General Assembly. HB 5 was passed to make the income tax provisions of various Ohio municipalities more uniform. For example, there are new rules for when to apply withholding to employees working in another city (occasional entrant treatment), for the filing of pass-through entity returns, and for handling NOL carryforwards.
- Contact your tax advisor immediately regarding any notices received from the IRS or other tax departments. They are often incorrect and assessments should not be paid automatically.
The above is a generalized synopsis of some of the various strategies and ideas to consider in tax planning. Tax planning issues seem to become more complex with each passing year. Please contact us if you have any questions so that we can assist you.
Very truly yours,
Certified Public Accountants – Akron, Ohio