Year-end tax planning this year will be just as complicated as it was last year due in a large part to uncertainty surrounding many expired tax breaks for individuals and businesses. Tax legislation signed into law last December extended several expired breaks but only through the end of 2014.
While Congress considers the passage of legislation to renew expiring tax provisions, there are year-end tax-planning strategies that can be implemented now and do not need to wait for tax legislation to be signed into law.
Strategies for Individuals
If certain expired tax breaks are extended before the end of the year, you may have some planning opportunities. Some of the popular expired provisions for individuals include tax-free IRA distributions to charity for taxpayers age 70½ and older, the deduction for state and local sales taxes, the mortgage debt forgiveness exclusion, and the above-the-line deduction for qualified tuition and related expenses. In the meantime, traditional tax planning continues.
Individual tax planning generally involves managing the timing of income and deductions. For example, deferring or accelerating income can be achieved depending upon when employee bonuses are paid. Similarly, the acceleration of deductions or pretax contributions can be achieved by paying certain property taxes or making charitable contributions before the end of the year or by increasing your IRA or qualified retirement plan contributions to the extent that they qualify as allowable deductions or are treated as pretax contributions in 2015. Certain qualified retirement plan contributions, such as IRAs, provide even greater flexibility because you can make 2015 contributions after the end of the year. And charitable contributions charged to your credit card in 2015 and paid with your credit card statement in 2016 will be treated as a charitable contribution for 2015. If deferring deductions is more beneficial, consider delaying the payment of deduction items, such as state and local taxes, until 2016, especially if you are subject to the alternative minimum tax (AMT) or the limitation of itemized deductions due to income thresholds (Pease limitation).
Other year-end tax plans to consider include these strategies:
Offsetting capital gains: If you sold stocks or other investments at a gain this year – or plan to do so – consider offsetting those gains by selling some poorly performing investments at a loss. This so-called “loss harvesting” is an important year-end tax-planning strategy, allowing capital gain income to be offset dollar for dollar with capital losses. Excess capital loss up to $3,000 may offset other income, and any remainder is carried over into future years.
Reducing capital gains is particularly important if you are subject to the net investment income (NII) tax. This 3.8 percent tax applies to taxpayers with modified adjusted gross income (MAGI) over $200,000 ($250,000 for married couples filing jointly). In addition to reducing your net investment income by generating capital losses to offset capital gains, you may have opportunities to bring your MAGI below the applicable NII threshold by deferring income or accelerating certain deductions.
Tax bracket management: The IRS publishes adjustments to a number of tax provisions, including graduated individual income tax rates. For 2015, the rates in percentages are 10 percent, 15 percent, 25 percent, 28 percent, 33 percent, 35 percent and 39.6 percent. Long-term capital gain and dividend rates have not changed and range from 0 to 20 percent, depending on your income threshold. Short-term capital gains enjoy no tax rate benefit and are taxed similarly to ordinary income tax rates. For tax planning, the goal is to allocate as much income as possible to low-bracket tax years. If 2015 is a low-bracket tax year, this may be an optimal time to sell assets for a profit or to convert a traditional IRA into a Roth IRA, pay the conversion tax at ordinary rates and enjoy tax-free distributions from the Roth IRA at retirement.
Business Tax Planning
Year-end tax planning for businesses has become increasingly less certain because of expired tax breaks, as well as an increased regulatory environment. Several important business tax breaks expired on December 31, 2014, including the immediate expensing of up to $500,000 related to new or used tangible property (Section 179 expensing) and the 50 percent bonus depreciation for qualified asset costs (generally new tangible assets). Other expired business tax provisions include the following deductions:
- Research tax credit
- Work opportunity tax credit
- New markets tax credit
- Empowerment Zone incentives
- Wage credit for active military reservists
- Indian employment credit
- Low-income credit for new subsidized buildings and military housing
- Reduced S corporation built-in gain recognition period
- S corporation stock basis reduction for charitable donations
- Gain exclusion for sale of small business stock
Year-End Strategies for Businesses
Traditional year-end business planning strategies remain important, such as deferring income to 2016 and accelerating deductible expenses into 2015. If your business uses the cash method of accounting, income from 2015 invoices that are paid in 2016 will not be recognized in 2015. If your business uses the accrual method of accounting, you may be able to defer the tax on certain advance payments you receive this year. You may also be able to deduct year-end bonuses accrued in 2015 even if not paid until 2016 (provided they are paid within 2½ months after the end of the tax year).
Deferring income and accelerating deductions may not be the best strategy in all circumstances. If you expect your business’s marginal tax rate to be higher next year, it may be more beneficial to accelerate income now and defer deductions until 2016. This strategy will likely increase your 2015 tax liability, but it can reduce your overall tax liability over a two-year period.
Finally, consider switching your tax accounting method from accrual to cash or vice versa if your business is eligible and such a change would provide tangible benefits. Other tax accounting method changes should also be considered if appropriate. Recent guidance published by the IRS provides important clarity and procedures with respect to several specific and overall accounting methods.
Expired or expiring tax breaks remain a thorny source of uncertainty that can negatively impact year-end tax planning for both individuals and businesses. Traditional tax planning and competent tax advice is essential, as is planning for the passage of tax extender legislation. Prudent taxpayers should evaluate their entire financial situation, perform accurate modeling and obtain compliance advice that will guide them through the steps that must be taken before year end in order to take full advantage of tax benefits.
Mark R. Baran, Principal in the tax department at Marks Paneth LLP. [email protected]
Published November 28, 2015.
