With year-end 2014 fast approaching, certain strategies to reduce 2014 tax liability still remain viable. Some of these are new, having been generated by developments in the law only over the past year; others are the result of transitional rules. Still others can be categorized as "traditional" year-end tax techniques.
In October's column, we explored the year-end techniques principally generated by the Affordable Care Act. This month, we look at other areas that can be equally productive.
Sudden spikes in income, either in 2014 or anticipated in 2015, should be "evened out" if possible. The goal here is to keep the amount of marginal income taxed evenly at the lowest overall rate. For example, the starting points for the 39.6 percent bracket for 2014 and 2015 for married filing jointly are $457,600 for 2014 and $464,850 for 2015. If joint filers project having $400,000 taxable income in 2014 and $650,000 in 2015, they might try to accelerate $64,850 of income from 2015 into 2014 so that amount of accelerated income would be taxed at 35 percent, rather than 39.6 percent.
- Managing AGI. In addition to the application of those income thresholds to the NII tax and Additional Medicare Tax discussed in our previous column ($250,000/$125,000/$200,000, for joint filers, married filing separately and all others, respectively), individuals should also be aware of a number of other thresholds that can trigger higher tax either directly or through the loss of certain tax benefits. Avoiding or lowering exposure to these thresholds, in 2014 or 2015, should be considered in many year-end plans. The thresholds include:
- Pease limitation. The "Pease" limitation on itemized deductions for higher income taxpayers operates under "applicable threshold" levels for 2014 of $305,050 for married couples and surviving spouses; $279,650 for heads of households; $254,200 for unmarried taxpayers; and $152,525 for married taxpayers filing separately. For 2015, the dollar amounts will be $309,900, $284,050, $258,250 and $154,950, respectively.
- Personal Exemption Phaseout. The threshold AGI amounts for the PEP mirror those of the Pease limitation. The total amount of exemptions that may be claimed by a taxpayer is reduced by 2 percent for each $2,500, or portion thereof (2 percent for each $1,250 for married couples filing separately) by which the taxpayer's AGI exceeds the applicable threshold level.
- Other AGI-based thresholds. Also to be considered in efforts either to implement strategies to lower AGI or increase certain deductions are the 10 percent AGI floor on medical expense deductions (7.5 percent for those 65 or older), 10 percent AGI casualty loss floor, and 2 percent AGI floor for miscellaneous itemized deductions, as well as various AGI phaseout ranges for deductible IRA contributions.
- The exemption amounts for the Alternative Minimum Tax. For 2014, the exemption amounts are $52,800 for single individuals and heads of household and $80,800 for married couples filing a joint return and surviving spouses. For 2015, they will be $53,600 and $83,400, respectively.
- myRAs. The Treasury has developed a new retirement account, named myRA, that will be structured as a Roth IRA available to any individual who has an annual income of less than $129,000, or to couples with income of less than $191,000. Account holders can build savings for up to 30 years or until their myRA reaches $15,000, whichever comes first. After that, myRA balances will transfer to private-sector Roth IRAs. The Treasury is expected to unveil implementation of this new retirement savings arrangement before the end of 2014. However, they will be offered through employers that elect to participate and, therefore, likely will not be in full swing until well into 2015.
Final regs (T.D. 9636) for treating costs related to tangible property (the so-called "repair regulations") are generally effective on a mandatory basis for tax years beginning on or after Jan. 1, 2014. Business can also choose to apply the final regulations retroactively to a tax year beginning in 2012 or 2013 instead of the proposed rules (and usually realize a more favorable result).
Taxpayers must follow the final regs to determine whether they can deduct costs as repairs and maintenance under Sec. 162 or must capitalize the costs and depreciate or amortize them over a period of years under Sec. 263. Related MACRS regs deal with general asset accounts, item and multiple asset accounts, and dispositions of MACRS property.
The final regulations offer several more favorable options than the predecessor proposed regulations, some of which require year-end action. The final regulations provide an expanded de minimis safe harbor; they also increase the threshold for materials and supplies over and above that provided under the earlier proposed regulations. Additionally, a new safe harbor allows taxpayers with $10 million or less in annual gross receipts to deduct a limited amount of improvement expenditures on qualifying buildings.
Materials and supplies. The per-item threshold for deducting materials and supplies is $200 (up from $100 as proposed). The property must have a useful life of 12 months or less. Taxpayers can elect to include standby emergency spare parts in the definition of materials and supplies that are deducted when acquired. A rotable or temporary spare part must be deducted in the year of disposition unless the taxpayer elects to capitalize and depreciate it when acquired.
A material or supply is ordinarily deducted in the year used or consumed, but "incidental" materials and supplies can be deducted in the year of purchase. An item is generally considered incidental if no record is kept of its consumption and no inventories are taken.
De minimis safe harbor. For acquisitions of tangible property, a de minimis safe harbor allows taxpayers to deduct certain items: items that cost $5,000 or less (per item or invoice) and that are deductible in accordance with the company's applicable financial statement (AFS) - (the de minimis limit is $500 per item or invoice for companies without an AFS). The election applies to all amounts a taxpayer pays for eligible equipment during the year. Under an anti-abuse rule, a taxpayer cannot avoid the $5,000 (or $500) limit by breaking an item into "components" whose individual cost is below the applicable threshold.
The de minimis safe harbor election is made by including a statement with the taxpayer's return for the year elected. However, if an AFS is involved, taxpayers must have a written policy in place at the beginning of the year that specifies a dollar amount for following book treatment. For taxpayers with no AFS, a written policy is still recommended as the best evidence that accounting policies exist. Calendar-year taxpayers, therefore, in any case should have a policy in place by year-end 2104 to qualify for 2015. The de minimis safe harbor is an annual election and not an accounting method, so it can be made and changed every year.
Routine maintenance. There is also a safe harbor for deducting routine maintenance costs. This includes the inspection, cleaning and testing of the unit of property (the item), and replacing damaged and worn parts with comparable parts. This safe harbor applies to buildings as well as to personal property. For buildings, taxpayers can deduct repairs if performed more than once over a 10-year period (taxpayers had requested a longer period). For other property, taxpayers can deduct repairs performed more than once over the property's class life.
Other significant new IRS regulations released in 2014 have also revised the landscape for year-end consideration. These include:
- S corp shareholder loans. An individual shareholder can deduct the losses to the extent the shareholder has basis in the S corporation. Final regulations (T.D. 9682) clarify when an S corp shareholder can increase basis because of the S corp's indebtedness to the shareholder. The regulations provide two different standards: for a shareholder loan to the S corp, the debt must be bona fide; and for a guarantee of S corporation debt, an actual outlay by the shareholder must take place.
- Money market fund wash sales. Proposed reliance regulations (NPRM REG-107012-14) now provide for a simplified method of accounting for gains and losses on shares of certain money market funds. Generally, shareholders may measure net gain or net loss without transaction-by-transaction calculations, simplifying tax compliance for shareholders. As a result, shareholders can determine their net gain or loss in fine-tuning year-end sales using information that the funds routinely provide to them for non-tax purposes.
- Mixed straddles. The IRS found that taxpayers were using the rules on identified mixed straddles to accelerate losses on positions that could not be disposed of or marked to market. 2014 regulations (T.D. 9678) on IMS's now prevent taxpayers from recognizing gains and losses on a mixed straddle until the straddle is disposed of. Gain or loss is marked but recognition will be frozen until the position is disposed of.
- Code Sec. 83 SRFs. The IRS issued final regulations (T.D. 9659) to clarify the meaning of a substantial risk of forfeiture (SRF) under Code Sec. 83. Generally, the taxation of the property is deferred if it is subject to an SRF. The final regulations clarify, among other points, that whether a condition related to the purpose of the transfer is an SRF depends upon the likelihood that the forfeiture event will occur and the likelihood that the forfeiture will be enforced; and that a transfer restriction, such as certain restrictions in the Securities and Exchange Act of 1934, is not an SRF unless specifically described in the code and regulations.
- Partnership terminations. Final regs (T.D. 9681) now deny accelerated deductions for unamortized start-up expenditures and organizational expenses to partnerships undergoing a technical termination. Acceleration is not deemed appropriate unless the business ceases or the partnership liquidates.
There are many variables that go into year-end tax planning. Smoothing income between tax years, managing adjusted gross income to qualify for a greater number of tax benefits, and reviewing recent developments to identify new opportunities, pitfalls or restrictions are all considerations that are worth a second look for many clients before 2014 draws to a close.
George G. Jones, JD, LL.M, is managing editor, and Mark A. Luscombe, JD, LL.M, CPA, is principal analyst, at Wolters Kluwer, CCH Tax and Accounting.
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