Taxpayers are always on the hunt looking for ways to reduce their tax bills. Even with the looming year-end tax legislation sessions that can result in tax provisions being changed, extended, extinguished, or reinstated, it is never too early to start year-end tax planning. While some of the following suggestions may not be feasible for a taxpayer’s given tax situation, many can still be employed.
One thing many individual taxpayers look forward to every year is their expected annual year-end bonuses. If asked, your employer may hold off paying it until January of the following year instead of December in the current year. This way the additional pay will show on the following year’s income-tax return. This strategy is especially helpful when this added pay would push you into the next tax bracket.
Taxpayers are able to adjust their withholdings at any point during the year. The ideal situation is for a taxpayer’s withholdings to be approximately the same as their tax bill for the year. By not withholding enough money taxpayers often panic, unsure of where to come up with the money to pay their tax balance due. By withholding too much, it means the government received a tax-free loan of your money that you could have invested sooner, earning you more money. Identity theft through the filing of fraudulent tax returns has been hitting all-time highs, so large refunds also represent a security risk. For taxpayers that make estimated payments, an increase in withholdings can help to avoid underpayment penalties as the withholdings are deemed to have been made evenly throughout the year.
One of the easiest ways to put money into your own pocket, while lowering the amount of current taxes you owe the government, is to put as much money into your company’s retirement plan as possible to help reach your retirement goals. Most retirement plans allow for tax-free contributions that lower the taxable amount the government can touch (an exception is a Roth 401(k) plan, which utilizes after-tax dollars). The earnings are allowed to grow tax-free. If you are a sole proprietor, you are allowed a deduction on your tax return for your self-employed retirement contributions.
If you do not already have one, another option may be to open a traditional individual retirement account (IRA) that will allow earnings to grow tax-free until you withdraw money from the account. Whether you open one, or have an existing IRA, a portion of your contributions may be deductible, subject to limits. With IRA accounts, taxpayers need to be aware of the year in which required minimum distributions must begin, as the penalties for failure to comply are high.
Roth IRAs funded with after-tax dollars can be advantageous because withdrawals can be tax-free if you are at least 59 ½ years old. There is a five-year holding requirement on the initial contribution for the distributions to be completely tax–free. Roth IRA conversions, or setting up a new one, make sense if it is anticipated that your tax rate will be going up in the future.
Now is the time to start reviewing your Flexible Spending Accounts (FSA), if you have one. Money is contributed to FSAs tax-free and money remaining in the account at year-end can be lost for good. Recent IRS rules allow employers the choice of allowing their employees to carry over $500 in their FSA to the next year, but it is not required. Some employers allow a grace period after year-end of a few months to allow for additional medical spending if too much money was put in the account. Check with your plan administrator to see what your plan allows. See IRS Publication 502 for a list of medical-related deductions allowed to be paid through your FSA account as changes have recently been made to over-the-counter items.
If you would like to lower the amount in your estate while avoiding gift and estate taxes, you can gift up to $14,000 each year per person to an unlimited number of people. The amount increases to $28,000 if you decide to split gifts with your spouse. Gifts can include cash, stocks, bonds, vehicles, jewelry, real estate, and even ownership in companies.
Regular investment accounts (non-retirement ones) should be reviewed prior to year-end. If you expect capital gains, you should scour the investment portfolio for non-performing investments that are no longer in tune with your investment strategy. You could sell these for losses, which will help offset your capital gains. If capital losses exceed capital gains, you can use up to $3,000 to lower your income taxed at ordinary rates. You may carry over any excess capital losses over $3,000 indefinitely. Capital losses can also help lower the income for high-income taxpayers encountering the 3.8 percent Net Investment Income Tax.
Education expenses offer another way to save on taxes. Normally, the spring semester’s tuition bill is not due until January. Depending on your income level and ability to pay the tuition expenses, you could pay the spring bill by Dec. 31. The American Opportunity Credit can be as high as $2,500 for taxpayers with the opportunity for up to $1,000 as a refundable credit. New York residents may contribute money to a New York 529 college plan, allowing taxpayers up to a $5,000 deduction on their state tax return ($10,000 for married filing joint returns). Amounts contributed to state 529 plans typically are removed from an estate. Educational institutions also allow you to make payments directly to them with no gift-tax consequences.
The majority of taxpayers make charitable contributions during the year. Keep the receipts for every contribution you make, not only those over $250. Contributions can be made with cash, clothing, household goods, securities, and vehicles to name a few. By donating securities, you avoid the capital-gains tax that you would have had to report for selling the securities, and get the benefit of being able to deduct the fair market value as a donation. Donor-advised funds are becoming more popular where taxpayers make a charitable contribution receiving an immediate tax benefit, and then get to recommend disbursements of the fund over time. Another option is a charitable-gift annuity where some of the money donated is allowed as a current-year donation and you then get a fixed monthly income payment for life.
Another way to increase itemized deductions is to bunch deductions or accelerate payments. Medical expenses subject to the 7.5 percent threshold, or 10 percent, depending on your tax situation, can be consolidated and taken every other year as itemized deductions to try and get over the limitation (miscellaneous itemized deduction subject to the 2 percent threshold can be handled the same way). You may claim additional mortgage-interest expense if the January payment is paid by Dec. 31. The real-estate tax bill due in the first few months of the following year can be paid by Dec. 31. Fourth-quarter state estimated income-tax payments due in January can also be paid by Dec. 31. If you are subject to the Alternative Minimum Tax (AMT) however, some of these deductions will be disallowed.
The AMT tax usually sneaks up on taxpayers unaware. While the original goal of the AMT was to force high-income taxpayers to pay some tax, the AMT now hits many middle-class taxpayers as well. It is important to recognize some of the factors that can generate the AMT which include:
- Large capital gains
- Large state income-tax deductions
- Interest from certain private-activity municipal bonds
- Exercising incentive stock options
- Higher than average number of dependency exemptions
Here is a list of life events that sometimes taxpayers inadvertently forget to tell their accountant:
- Changes in filing status (marriage, divorce, death)
- - Birth of a child
- Daycare expenses for children and summer camps
- Changes in dependents (moved out, graduated college, disabled, death)
- Significant medical expenses (watch for nursing-home expenses too as there may be a possible New York credit)
- Long-term care insurance premiums (possible federal itemized deduction and a New York credit)
- Recent or anticipated large inheritances
- Bankruptcy or discharge of indebtedness
- Employment changes and related relocation
- Purchase of a new home or a refinancing
The Affordable Care Act’s impact
It is important not to forget the Affordable Care Act. Individuals in 2014 risk facing a penalty if they do not carry minimum essential health-insurance coverage. Regarding employers, those with fewer than 50 full-time equivalent employees are exempt from having to offer employees health coverage. Employers with 100 or more full-time equivalent employees are required to offer full-time employees minimum essential coverage starting in 2015. Employers with at least 50 and less than 100 full-time equivalent employees are required to offer full-time employees minimum essential coverage starting 2016.
The new tangible property regulations, required for tax years beginning on or after Jan. 1, 2014, are very important for businesses. De minimus regulations allow $500 per item or invoice for companies without an applicable financial statement and $5,000 for those who have it. It is recommended that companies have a fixed-asset capitalization policy on file spelling out the dollar threshold for which they will expense items under it instead of capitalizing. Most companies will have to review their past fixed assets and depreciation methods to make sure allowed methods were being used. Companies will need to correct improper prior depreciation and adopt the new repair regulations by filing Form 3115.
With December here, there is no better time to start tax planning if you have not done so yet. The new tax year will be upon us before you know it and certain tax-planning strategies will need to be completed by Dec. 31.
Michael C. Burt, CPA, MBA, is a tax senior associate with Dermody, Burke & Brown, CPAs, LLC in Syracuse. Contact him at (315) 471-9171 or email: MCB@dbbllc.com. This viewpoint article is drawn from the accounting firm’s November 2014 tax e-newsletter.