This guide is generally oriented towards the time-honored approach of deferring income and accelerating deductions to minimize 2015 taxes. For individuals, deferring income also may help minimize or avoid AGI-based phaseouts of various tax breaks.
Year-end tax planning for 2015 must take account of the many important “temporary” tax provisions that have expired and may not be retroactively reinstated and extended before year-end (if they are extended at all). They include: the election to claim sales and use taxes as an itemized deduction instead of state income taxes; charitable distributions from IRAs for those age 70-1/2 and older; bonus first-year depreciation deductions for qualifying new purchases; and generous expensing limits under Code Sec. 179.
Effective year-end tax planning also must take into account each taxpayer’s particular situation and planning goals, with the aim of minimizing taxes. For example, higher income individuals must consider the effect of the 39.6% top tax bracket, the 20% tax rate on long-term capital gains and qualified dividends for taxpayers taxed at a rate of 39.6% on ordinary income, the phaseout of itemized deductions and personal exemptions when income is over specified thresholds, and the 3.8% surtax (Medicare contribution tax) on net investment income for taxpayers whose income exceeds specified thresholds (which are lower than the thresholds at which the phase-out of itemized deductions and personal exemptions begins,).
Concerns for High Earning Individuals
Higher-income earners have unique concerns to address when mapping out year-end plans. They must be wary of the 3.8% surtax on certain unearned income and the additional 0.9% Medicare (hospital insurance or HI) tax. The latter tax applies to individuals for whom the sum of their wages received with respect to employment and their self-employment income is in excess of $200,000 ($250,000 for married couples filing jointly and $125,000 for married couples filing separately).
The surtax is 3.8% of the lesser of: (1) net investment income (NII) or (2) the excess of modified adjusted gross income (MAGI) over an unindexed threshold amount ($250,000 for joint filers or surviving spouses, $125,000 for a married individual filing a separate return and $200,000 in any other case). As year-end nears, a taxpayer’s approach to minimizing or eliminating the 3.8% surtax will depend on his estimated MAGI and NII for the year. Some taxpayers should consider ways to minimize (e.g., through deferral) additional NII for the balance of the year, others should try to see if they can reduce MAGI other than net investment income and other individuals will need to consider ways to minimize both NII and other types of MAGI.
The additional Medicare tax may require year-end actions. Employers must withhold the additional Medicare tax from wages in excess of $200,000 regardless of filing status or other income. Self-employed persons must take it into account in figuring estimated tax. There could be situations where an employee may need to have more withheld toward year-end to cover the tax.
While many taxpayers will come out ahead by following the traditional approach (deferring income and accelerating deductions), others, including those with special circumstances, should consider accelerating income and deferring deductions. Most traditional techniques for deferring income and accelerating expenses can be reversed to achieve the opposite effect. For instance, a cash method professional who wants to accelerate income can do so by speeding up his business’s billing and collection process instead of deferring income by slowing that process down. Or, a cash-method taxpayer who sells property in 2015 on the installment basis and realizes a large long-term capital gain can accelerate income by electing out of the installment method.
Inflation adjustments to rate brackets, exemption amounts, etc.
For both 2015 and 2016, some individuals will benefit from inflation adjustments in the thresholds for applying the income tax rates, higher standard deduction amounts, and higher personal exemption amounts.
Long-term capital gains are taxed at a rate of (a) 20% if they would be taxed at a rate of 39.6% if they were treated as ordinary income, (b) 15% if they would be taxed at above 15% but below 39.6% if they were treated as ordinary income, and (c) 0% if they would be taxed at a rate of 10% or 15% if they were treated as ordinary income. And, the 3.8% surtax on net investment income may apply.
Low-taxed dividend income
Qualified dividend income is taxed at the same favorable tax rates that apply to long-term capital gains. Converting investment income taxable at regular rates into qualified dividend income can achieve tax savings and result in higher after-tax income. However, the 3.8% surtax on net investment income may apply.
Traditional IRA and Roth IRA year-end moves
One can convert traditional IRAs to Roth IRAs. And, one can then recharacterize such a conversion and can even, possibly, reconvert the recharacterized transaction.
Unless Congress changes the rules, for qualified property placed in service in tax years beginning in 2015, the maximum amount that may be expensed under the Code Sec. 179 dollar limitation is $25,000, and the beginning-of-phaseout amount is $200,000 (Code Sec. 179(b)) . In earlier years, the dollar limit was $500,000 and the beginning-of-phaseout amount was $2 million. However, despite what Congress does (or doesn’t do) to adjust the Code Sec. 179 limits for 2015, some businesses may be able to buy much-needed machinery and equipment at year-end and currently deduct the cost under a “de minimis” safe harbor election in the capitalization regs.
First-year depreciation deduction
Unless Congress extends Code Sec. 168(k), property bought and placed in service in 2015 (other than certain specialized property) no longer qualifies for the 50% bonus first-year depreciation deduction. However, because of the half-year convention that generally applies in the computation of cost recovery deductions for property (other than real property) first placed in service during the current tax year, year-end purchases of depreciable property can achieve tax savings even if bonus depreciation is not extended. Under the half-year convention, a business asset placed in service at any time during the tax year-even in the final days-is generally treated as having been placed in service in the middle of that year.
Deduction for qualified production activities income
Taxpayers can claim a deduction, subject to limits, for 9% of the lesser of (1) the taxpayer’s “qualified production activities income” for the tax year (i.e., net income from U.S. manufacturing, production or extraction activities, U.S. film production, U.S. construction activities, and U.S. engineering and architectural services), or (2) the taxpayer’s taxable income for that tax year (before taking this deduction into account). This deduction generally has the effect of a reduction in the taxpayer’s marginal rate and, thus, should be taken into account when making decisions regarding income shifting strategies.
Changes in individual’s tax status may call for acceleration of income
Changes in an individual’s tax status, due, say, to divorce, marriage, or loss of head of household status, must be considered.
Alternative minimum tax (AMT)
Watch out for the AMT, which applies to both individuals and many corporations. A decision to accelerate an expense or to defer an item of income to reduce taxable income for regular tax purposes may not save taxes if the taxpayer is subject to the AMT.
Time value of money
Any decision to save taxes by accelerating income must take into account the fact that this means paying taxes early and losing the use of money that could have been otherwise invested.
Rules for estimated taxes can be affected when taxable income is shifted from one tax year to another.
Obstacles to deferring taxable income
The Code contains a number of rules that hinder the shifting of income and expenses. These include the passive activity loss rules, requirements that certain taxpayers use the accrual method, and limitations on the deduction of investment interest.
The timing of charitable contributions can have an important impact on year-end tax planning. Note that in earlier years (but not 2015, unless Congress extends this tax break), individual taxpayers who are at least 70-1/2 years old could contribute to charities directly from their IRAs without having the amount of their contribution included in their gross income. By making this move, some taxpayers reduced their tax liability even more than they would have if they had received the distribution from their IRA and then contributed the amount distributed to charity. Some taxpayers, who would take advantage of this tax break for this year, if it were extended, should consider deferring until the end of the year their required minimum distributions (RMDs) for 2015.
Net operating losses and debt cancellation income
A business with a loss this year may be able to use that loss to generate cash in the form of a quick net operating loss carryback refund. This type of refund may be of particular value to a financially troubled business that needs a fast cash transfusion to keep going. Also, a debtor who anticipates having the debt cancelled or debt reduced should consider steps to defer the resulting taxable income until 2016.
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