The tax landscape for the year ahead has been settled for some time, with one big exception - the extenders. And most observers agree that they will be acted on by Congress in the lame duck session before the year's end.
Most taxpayers will find their rates virtually unchanged from last year, so that once again, traditional last-minute moves - accelerating deductions and deferring income - will be on many advisors' playlists as we close out 2014.
"Looking at 2015, it's important to start with a projection of what 2014 will look like," said Greg Rosica, tax partner at Big Four firm Ernst & Young. "Most of 2014 is behind us, so sketch out what it will look like, and compare it to your projection for 2015. Look at different types of income, consider itemized deductions that might get phased out, and which new taxes, such as the Net Investment Income Tax or Medicare surtax, the taxpayer might be subject to. Some of your planning will be a function of which tax year is going to be more advantageous to you in terms of whether to defer income or accelerate deductions."
"Once you have that landscape to examine, look for ways to defer income until next year, or accelerate deductions to this year, or deflect income to lower-income family members. If the taxpayer is deferring, they might want to sell an asset that has gains associated with it such as stocks or bonds, or losses that they might take this year," he said. "And since bonuses are controllable as to when they're received, they might push the bonus off until next year. If stock options are involved, they can control the timing of the income, so they should look to see whether it makes sense to exercise them this year or next year."
Likewise, there are various ways to accelerate deductions, Rosica noted. "Charitable deductions can be moved in or out of a particular tax year," he suggested. "Consider making the donation not of cash but of appreciated stock. If it was held long-term - more than 12 months - you get the full value of the deduction without being liable for the gain. And real estate taxes offer some flexibility as to when they're paid, depending on the state you live in."
To deflect income to lower tax brackets, Rosica suggests that advisors engage in "holistic" family planning. "The taxpayer may be able to gift certain assets to young adults in the family. They can sell the assets and generate gain, taking advantage of the lower tax bracket that they may be in."
Finally, Rosica recommends considering asset allocation. "A lot of people inadvertently change their tax rate from 20 percent to 40 percent because they buy stocks inside their retirement account," he said. "Even though normally they would be taxed at the capital gain rate when they're sold, if they come out of a traditional IRA or 401(k) plan, they come out subject to the ordinary income rate. Look at where the taxpayer has stocks and bonds that generate interest income and consider what the appropriate asset allocation is so they can get the best tax benefit out of the tax rate differential."
"The extenders are the unknown," said George Farrah, executive editor of tax and accounting at Bloomberg BNA. "But people in Congress understand they need to get passed, and it needs to be done before the end of the year so that the IRS has time to adjust. Anything later would interfere with the whole filing season."
"The only real unknown is whether to expect a bill before the end of the year. It's not like two years ago, when there were also tax rate changes. That had more of an impact because there were different rates in different years. Here the rates will be about the same in 2015 as in 2014," he added.
This leaves us with the traditional menu of tax planning, Farrah observed. "Depending on the tax bracket and income projection over the next year, you can make the decision to accelerate deductions and expenses and defer income."
For taxpayers on the cusp of the standard deduction, Farrah recommends accelerating deductions one year, then taking the standard deduction the next year.
For a taxpayer subject to the 15 percent capital gains tax, it's important to review investments and determine if it would be advantageous to sell appreciated securities to recognize gain this year, if next year the taxpayer might be in a higher bracket, according to Karen Fickes, managing editor for federal tax at Bloomberg BNA. "The same is true with losses - they might be more beneficial this year than next year," she said.
"You can convert a traditional IRA to a Roth IRA if you expect to be in a higher tax bracket or expect tax rates to go up," she said. "If you take funds out of an IRA this year you will incur tax, but in subsequent years when you pull out of the Roth IRA, you won't pay tax."
The Affordable Care Act goes into effect next year for companies, but this year it's in effect for individuals, Fickes noted. "If the taxpayer didn't get insurance, they may have to pay a penalty," she said. "That's another reason not to over-withhold, because the ACA penalty is capped at the amount of the refund due the taxpayer. If you over-withheld, and have a large refund due, there is more money available for the penalty. The IRS can't come after the taxpayer for the penalty, but they can grab the refund."
"The IRS will be very tied up with FACTCA and ACA compliance," observed Farrah. "They will have a limited amount of resources to answer questions, so get ready for longer wait times, slower responses and fewer answers from the IRS."
PITFALLS TO LOOK OUT FOR
For taxpayers engaging in traditional year-end harvesting of losses on securities, make sure that the wash sale rules are not triggered by buying back the assets within 30 days, advised Wenli Wang, tax partner and partner-in-charge at Moss Adams' San Francisco office.
"Because the regular tax rates increased in 2013, there is a bigger differential now between the regular tax rate of 39.6 percent and the AMT rate of 28 percent," Wang observed. She suggested the possibility of lightening the effect of the Alternative Minimum Tax in years when regular tax and the AMT would be the same. "When deciding whether or not to prepay state or property taxes, keep in mind that they are not deductible for the AMT but they are for regular tax," she said.
"This is the second year of the NIIT," she noted. "People are still fine-tuning their strategies to deal with it. For clients whose main activity is real estate, they should consider making an election to qualify as a real estate professional; this will get them out of the NIIT on the income generated from rental properties."
Taxpayers with projected estates over $10 million should be making gifts to their children, she indicated. "And a revocable family trust, although not an income tax-saving tool, will help with the preservation and protection of wealth from one generation to the next."
When analyzing whether to prepay state income tax, note that an allocable portion is deductible for NIIT purposes, cautioned Richard Bloom, a tax partner at WeiserMazars. "And whether or not the taxpayer is prepaying, the deduction will create AMT liability for those subject to the AMT," he said.
"Self-employed individuals or partners should consider setting up a retirement plan if they don't have one already," he said. "Some need to be established before the year end, although they don't have to be funded until the return is actually due."
In addition to the normal charitable giving of appreciated assets, Bloom recommends that taxpayers that don't want to make a donation to a specific charity consider making a contribution to a private foundation or a donor-advised fund. "The taxpayer would receive a charitable contribution this year for the entire amount given to the donor-advised fund or private foundation, and then over time it can be given out to specific charities," he said.
"Advisors should review estate planning documents with their tax return clients every few years. A lot can change. They may want to name new guardians for their children, or check who they named as trustees and executors," he said. "They should also check the beneficiary designations of retirement plans and life insurance policies. This is often overlooked and it can result in an unintended windfall for an ex-spouse."
Bloom noted that the estate tax lifetime exemption has changed every year based on the cost of living index. "If it was used up in the past, there may be more to use now as a result of the increase," he said. "For 2014, it's $5,340,000. In 2015, it will be $5,430,000 per donor."
The NIIT is new and often overlooked, Bloom said. "One of the ways to reduce it is to rebalance an investment portfolio - municipal bond interest income is not subject to the tax. You can also shift away from dividend-paying stocks to more growth-oriented stocks."
"While everyone is talking about getting to the extenders during the lame duck session of Congress, the question is when," said Roger Harris, president of Padgett Business Services. "The IRS still needs time to react, particularly if there is something surprising in the bill. Hopefully Congress will make it a priority and the IRS will have time to do what they have to do to get the forms ready, and we can start tax season on the normal start date."
Employers who are close to the 50-employee threshold for purposes of the Affordable Care Act will have to offer insurance or be subject to a penalty if they are at that threshold, Harris cautioned. "If they wait until after the first of the year they will have a problem because they should have been offering health insurance beginning January 1. They need to address it now in order to select a plan, give employees time to make a decision and have them enrolled by January 1."
Mike Campbell, a tax partner at BDO USA LLP, advises preparers to train their clients to be organized. "They should keep up to date on tax-relevant matters throughout the year by putting a system in place for organizing their deductions," he said. Taking time to do this on a weekly or monthly basis will not only save them time, it will make the preparer's life easier, he suggested.
"Self-employed or contractors will not be paid like an employee," he noted. "They will not have tax withholding taken against their income. They should be aware of their impending liability at tax time, and should set aside funds to cover the payment due at filing."
Now is the time to hire any additional help that may be necessary for tax season, according to Gene Holzer, a CPA and managing partner at staffing firm Ascendo Resources. "A lot of firms reach out to us between now and mid-January," he said. "They're looking for professionals who are looking for tax and audit career opportunities."
Most firms are more interested in permanent candidates, according to Holzer. "Not so many are interested in seasonal. It could be costly for them. If they can hire someone to work 60 to 80 hours per week, it's better than bringing on a per-hour basis during tax season."
"Definitely, now is the time to look," he said. "We have clients who call in the middle of June. They want to hire in a slower time so they will be ready. If they wait longer, the quality of the candidate goes down, as well as the quantity to choose from. By the time you get to mid-January, if you're looking to hire for tax season, the good ones and the great ones have already been hired."
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