Year-End Tax Planning Strategies for Individuals and Businesses

Tax Planning is critical at the end of the year. Here are some ideas to contemplate, along with the tried and true year-end tax savings techniques.

Individual Tax Strategies:

1) Game – The Standard Deduction

If your total itemized deductions are usually close to the standard deduction amount, consider the strategy of bunching together expenditures for itemized deduction items every other year, itemizing those years to deduct more than the standard deduction figure. Then, claim the standard deduction in intervening years. Over time, this can save hundreds or even thousands in taxes by increasing your accumulative write-off. That’s because you’ll bag higher itemized deductions in alternating years and relatively generous standard deductions in the other years. So regardless of what happens with tax rates, you’ll come out ahead.

See the following deduction amounts for 2013 and the estimated amounts for 2014:

            Filing Status                            2013                            2014

            Single                                     $6,100                         $6,200

            Married Joint Filer                  $12,200                       $12,400

            Head of Household                $8,950                         $9,100

2) Prepaid Deductible Expenditures if You Itemize

If you itemize your deductions, it makes sense to accelerate some deductible expenditures into this year to produce higher 2013 write-offs if you expect to be in the same or lower tax bracket next year.

See the table at the end of this article for the estimated 2014 Federal Income Tax Brackets.

·         Perhaps the easiest deductible expense to prepay is included in the house payment due on January 1. Accelerating that payment into this year will give you 13 months’ worth of deductible interest in 2013. You can use the same prepayment drill with a vacation home. However, if you prepay this year, you’ll have to continue the policy for next year and beyond. Otherwise, you’ll only have 11 months of interest in the first year you stop.

·         Next up on the prepayment menu are state and local and property taxes that are due early next year. Prepaying those bills before the end of the year can decrease your 2013 federal income tax bill, because your itemize deductions total will be that much higher.

·         Consider prepaying expenses that are subject to deduction limits based on your AGI. The two prime candidates are medical expenses and miscellaneous itemized deductions. For 2013, medical costs are deductible only to the extent they exceed 10% of AGI for most people. However, if you or your spouse will be age 65 or older as of year end, the deduction threshold is more manageable at 7.5% of AGI. Miscellaneous deductions – for investment expenses, job hunting expenses, fees for tax preparation and advice, and unreimbursed employee business expenses – count only to the extent they exceed 2% of AGI. If you can bunch these kinds of expenditures into a single calendar year, you’ll have a fighting chance of clearing the 2% of AGI hurdle and get some tax savings.

Warning: Prepayment can be a bad idea if you hold the alternative minimum tax (AMT) for this year. That’s because write-offs for state and local income and property taxes are completely disallowed under the AMT rules and so are miscellaneous itemized deductions. Therefore, prepaying these expenses may do little or no tax saving good for AMT victims. Your tax advisor can tell you if you are in AMT mode.

3) Deduct Sales Taxes on Major Year-End Purchases if Itemizing

If you live in a state with a low or no personal income taxes, consider the option of deducting state and local general sales taxes instead of deducting state and local income taxes on your 2013 return. Most people who choose a sales tax option will have to use IRS-provided tables to calculate their allowable sales tax deduction.

 

However, if you hoarded receipts from your 2013 purchases, you can add up the actual sales tax amounts and deduct the total if that gives you a better answer. Even if you are forced to use the IRS table, you can still deduct actual sales tax from major 2013 purchases such as vehicles and boats on top of the predetermined amount from the table. So buying a car or a boat between now and the end of the year could give you bigger sales tax deduction and cut this year’s federal income tax bill.

Warning: The sales tax write-off only helps if you itemize. And if you are hit with AMT, you will lose some or all the tax-saving benefit.

4) Prepaid College Tuition Bills

If your 2013 AIG allows you to qualify for the American Opportunity College Credit (maximum $2,500) or the Lifetime Learning Higher Education Credit (maximum $2,000), consider prepaying college tuition bills that are not due until early 2014 if it would result in a bigger credit on this year’s Form 1040. Specifically, you can claim a 2013 credit based on prepaying tuition for academic periods that begin in January through March of next year.

·      The American Opportunity Credit is phased out (reduced or completely eliminated) if your modified adjusted gross income (MAGI) is too high. The phase-out range for unmarried individuals is between an MAGI of $80,000-$90,000. The range for married joint filers is between an MAGI of $160,000-$180,000. MAGI means “regular” AGI, from the last line on page 1 of your Form 1040, increased by certain tax-exempt income from outside the U.S., which you probably don’t have.

·      Like the American Opportunity Credit, the Lifetime Learning Credit is also phased out if your MAGI is too high. However, the Lifetime Learning Credit phase-out ranges are much lower, which means they are much more likely to affect you. The 2013 phase-out range for unmarried individuals is between an MAGI of $53,000-$63,000. The 2013 range for married joint filers is between an MAGI of $107,000-$120,000.

·      If your MAGI is too high to be eligible for the Lifetime Learning Credit, you might still qualify to deduct up to $2,000 or $4,000 of college tuition costs. If so, consider prepaying tuition bills that are not due until early 2014 if that would result in a bigger deduction on this year’s Form 1040. As with the credits, your 2013 deduction can be based on prepaying tuition for academic periods that begin in the first three months of 2014.

5) Consider Deferring Income

It may also pay to defer some taxable income from this year into next year if you expect to be in the same or lower tax bracket in 2014 (see the table at the end of this article for the 2014 brackets).

For example, if you are in business for yourself and a cash method taxpayer, you could postpone taxable income by waiting until late in the year to send out some client invoices, that way, you won’t receive payment for them until early 2014. You can also defer taxable income by accelerating some deductible business expenditures into this year. Both moves will postpone taxable income from this year until next year. Deferring income can also be helpful if you are affected by unfavorable phase-out rules that reduce or eliminate various tax breaks (the child tax credit, the higher education tax credits, and so on). By deferring income every other year, you may be able to take more advantage of these brackets breaks every other year.

6) Sell Loser Stocks Held in Taxable Accounts

Selling losing investments held in taxable brokerage firm accounts can lower your 2013 tax bill because you can deduct the resulting capital losses against capital gains from earlier in the year. If your losses exceed your gains you will have net capital loss.

You can deduct up to $3,000 of net capital loss (or $1,500 if you are married and file separately) against ordinary income from salary, self-employment activities, alimony, interest or whatever. Any excess net capital loss is carried forward to future years and puts you in a position for tax savings in 2014 and beyond.

7) Set Up Loved Ones to Pay 0% on Investment Income

For 2013, the federal income tax on long-term capital gains and qualified dividends is still 0% for gains and dividends that fall within the 10% or 15% tax rate bracket. While your tax bracket may be too high to take advantage of the 0% rate, you probably have loved ones who are in the bottom two brackets. Consider giving these individuals appreciated stock or mutual fund shares. They can sell the shares and pay no tax on the resulting long-term gains. Remember, their gains will be long-term as long as your ownership period plus the gift recipient ownership period equals at least a year and a day.

Giving away a dividend-paying stock is another great tax idea. As long as the dividends fall within the gift recipient’s 10% or 15% rate bracket, they will qualify for the 0% federal income tax rate. However, be aware that if you give away assets worth more than $14,000 during 2013 to an individual gift recipient, it will reduce your $5.25 million unified federal gift and estate tax exemption. However, you and your spouse can together gift away up to $28,000 without reducing your respective exemptions.

Warning: If your gift recipient is under 24 years of age, the Kiddy Tax rules could potentially cause some of his or her capital gains to be taxed at the parent’s higher rate. That would defeat the purpose. Contact your tax advisor if you have questions about Kiddie Tax.

8) Convert a Traditional IRA to a Roth IRA

The best scenario for this strategy is when you expect to be in the same or higher tax bracket during retirement. There is a current tax cost for converting, because a Roth conversion is treated as a taxable liquidation of your traditional IRA followed by a non-deductible contribution to the new Roth IRA account. After the conversion, all the income and gains that accumulate in the Roth account and all the withdrawals will be free from federal income tax – assuming they are qualified withdrawals. In general, qualified withdrawals are those taken after:

·      You have had at least one Roth account open for more than 5 years; and

·      You have reached age 59½

With qualified withdrawals, you avoid having to pay higher tax rates that may apply during your retirement years. While the current tax hit from a Roth conversion is unwelcome, it could be an acceptable price to pay for future tax savings. If the Roth conversion sounds appealing, contact your tax advisor for a full analysis of all relevant variables.

9) Give to Charity

If you have charitable inclinations here are three suggestions:

·         Donate appreciated stock to charity

·         Sell loser investments and donate cash

·         Make charitable donations out of your IRA

Donate appreciated stock to a charity – If you have appreciated stock or mutual fund shares (currently worth more than you paid) that you’ve owned for more than a year, consider donating them to an IRS-approved charity. You can generally claim an itemized charitable deduction for the full market value at the time of the donation and avoid any capital gains tax hit.

Sell loser investments and donate cash – On the other hand, don’t donate loser stocks. Sell them and book the resulting capital loss, and give away the cash sales proceeds. That way you can generally write off the full amount of the cash donation while keeping your cash saving capital loss for yourself.

Warning: You must itemize deductions to gain any cash saving benefit from charitable donations, except for donations out of an IRA as explained immediately below.

Make charitable donations out of your IRA – For 2013, you can make up to $100,000 in cash donations to IRS-approved charities directly out of your IRA – if you will be age 70½ or older by the end of the year. Such direct-from-IRA donations are called “qualified charitable distributions,” or QCDs. Donations made in this fashion don’t directly affect your tax bill, because QCDs are tax-free and no deductions are allowed for them. However, QCDs count as withdrawals for purposes of meeting the required minimum distribution (RMD) rules that apply to traditional IRAs; therefore, taxes can be avoided by arranging for tax-free QCDs in place of taxable RMDs. If your spouse owns one or more IRAs and is over age 70½, he or she is entitled to separate $100,000 QCD privilege for 2013. 

TAX RATES FOR 2014:

 

Rate

Single

Married Joint

Head of Household

10%

$0 to $9,075

$0 to $18,150

$0 to $12,950

15%

$9,076 to $36,900

$18,151 to $73,800

$12,951 to $49,400

25%

$36,901 to $89,350

$73,801 to $148,850

$49,401 to $127,550

28%

$89,351 to $186,350

$148,851 to $226,850

$127,551 to $206,600

33%

$186,351 to $405,100

$226,851 to $405,100

$206,601 to $405,100

35%

$405,101 to 406,750

$405,101 to 457,600

$405,101 to $432,200

39.60%

$406,751+

$457,601+

$432,201+

 

BUSINESS TAX STRATEGIES:

1) Buy a Heavy SUV/Pickup Truck/Van

While buying a big SUV, Pickup or Van for your business may not be seen as politically correct because of the gas the vehicles use, the fact is they are useful if you need to haul people, equipment and materials around. They also have major tax advantages.

·         Thanks to the section 179 deduction privilege, you can immediately write off up to $25,000 of the cost of a new or used heavy SUV that is placed in service by the end of your business tax year beginning in 2013 and used over 50% for business.

·         For a heavy long bed pickup (one with cargo area of at least 6 feet interior length), the $25,000 section 179 deduction limit does not apply. Instead, the “regular” section 179 deduction limit up to $500,000 applies, as explained later in this article. The same is true for a heavy van that has no seating behind the driver’s seat and no body section protruding more than 30 inches ahead of the leading edge of the windshield. Thanks to 50% first year bonus depreciation privilege (more on that later), you can write off half of the business-used portion of the cost of the new (not used) “heavy” SUV, pickup or van that is placed in service by December 31, 2013, and used more than 50% for business.

·         After taking advantage of the preceding two breaks, you can follow the “regular” depreciation rules to deduct whatever is left of the business portion of the vehicle’s cost over six years, starting with 2013.

Should You Wait Until Next Year?

Some of the first-year depreciation breaks mentioned in this article might be eliminated or cut back next year.

·         The 50% first-year bonus depreciation break is scheduled to expire on December 31, 2013.

·         The $500,000 section 179 deduction is scheduled to drop back to only $25,000 in 2014.

·         The $250,000 section 179 depreciation deductions for real estate are scheduled to vanish for tax years beginning in year 2014.

Congress might extend these breaks, but it makes sense to take advantage of them for 2013 when you know for sure they are available. Next year you can add more assets and take advantage of whatever breaks are available then.

2) Take Advantage of $500,000 Section 179 Deduction for New or Used Assets

For years beginning in 2013, the maximum section 179 deduction for eligible new or used assets other than heavy SUVs is a much larger $500,000. For instance, the larger $500,000 limit applies to section 179 deductions for things like new or used machinery and office furniture, computer equipment and purchased software. As explained earlier, up to $500,000 section 179 deduction privileges is also available for new and used heavy long bed pickups and new and used heavy vans.

Warning: Watch out if your business is expected to have a tax loss for the year (or close) before considering a section 179 deduction. The reason: you cannot claim a section 179 write-off that would create or increase an overall business tax loss. Contact your tax advisor if you think this might be an issue for your operation.

3) Benefit from Bonus Depreciation for Other New Assets

Your business can claim 50% first-year bonus depreciation for qualifying new equipment and software that is placed in service by December 31, 2013. Used assets do not qualify. For example, this tax break is available for new computer systems, purchased software, machine and office furniture..

There is no business taxable income limitation on bonus depreciation deductions. That means 50% bonus depreciation deductions can be used to create or increase in net operating loss (NOL) for your business’ 2013 tax period. You can then carry back the NOL to 2012 and/or 2011 and then collect a refund on some or all taxes paid in one or both of those years. Contact your tax advisor for details on the interaction between asset additions and NOL.

Deadline – The December 31 placed in service deadline for assets eligible for 50% first year bonus depreciation applies whether your business tax year is based on a calendar year or not. So time is growing short if you want to take advantage.

4) Take Advantage of $250,000 Section 179 Deduction for Real Estate Improvements

Real property improvements have traditionally been ineligible for section 179 deductions. However, there is a big exception for qualified real property improvements at your business places in service in a tax year that begins 2013 – you can claim a first-year section 179 deduction up to $250,000. This temporary break applies to:

·         Interiors of leased nonresidential buildings

·         Restaurant buildings

·         Interiors of retail buildings

The $250,000 section 179 allowance for real estate is part of the overall $500,000 allowance and it will not be available for tax years beginning after 2013 unless Congress extends it.

Warning: Once again, watch out if your business is already expected to have a tax loss for the year (or close) before considering any section 179 deductions. You cannot claim a section 179 deduction that would create or increase an overall business tax loss. Also, claiming section 179 deductions for real property can trigger high-tax ordinary income gains when the property is sold. Contact your tax advisor for details.

5) Juggle Income and Deductible Expenditures If They Go on Your Personal Return

If you run your operation as a Sole Proprietorship, S Corporation, LLC or Partnership, your share of the net income generated by the business will be reported on your Form 1040 and taxed at your personal rates. In 2014, individual federal income tax rate brackets will be about the same as this year’s (with modest bumps for inflation), so they will remain relatively taxpayer-friendly.

 

Therefore, the traditional strategy of deferring income into the next year while accelerating deductible expenditures into this year makes sense if you expect to be in the same or lower tax bracket next year. In that case, deferring income and accelerating deductions will, at a minimum, postpone part of your tax bill from 2013 until 2014. On the other hand, if your business is healthy, and you expect to be in a significantly higher tax bracket in 2014 (say 35% vs. 28%), take the opposite approach. Accelerate income into this year and postpone deductible expenditures until 2014. That way, more income will be taxed at this year’s lower rate than next year’s higher rate.

C Corporation: If you run your business as a regular C Corporation, the 2014 corporate tax rates are scheduled to be the same as always.

So if you expect your corporation to pay the same or lower rate in 2014, postpone income into next year while accelerating deductible expenditures into this year.

If you expect the opposite, try to accelerate income into this year while postponing deductible expenditures until next year.

How to do it: Most small businesses use cash method accounting for tax purposes. If your business is eligible, cash method accounting gives you flexibility to manage your 2013/2014 taxable income to minimize taxes over the two-year period. Here are some specific moves if you expect business income to be taxed at the same or lower rate next year:

·         Before year end, charge reoccurring expenses that you would otherwise pay next year on credit cards. You can claim the 2013 deductions even though the credit card bill won’t be paid until next year. However, this favorable treatment doesn’t apply to store revolving charge accounts. For example, you can’t deduct business expenses charged to your Sears account until you actually pay the bill.

·         Pay expenses with checks and mail them a few days before year end. You can deduct these expenses in the year you mailed the checks even though they won’t be cashed or deposited until early next year. For big-ticket expenses, send checks via registered or certified mail. That way you can prove they were mailed this year.

·         Prepay some expenses for next year. This is allowed as long as the economic benefit from prepaying does not extend beyond the earlier of 12 months after the first date in which your business realizes the benefit, or the end of the tax year following the year in which the payment is made. For example, if you claim a 2013 deduction for prepaying the first three months of next year’s office rent, or the premium for the property insurance for the first half of next year.

·         On the income side, put off sending some invoices so you don’t get paid until early next year. The general rule for cash basis tax method is that you report income in the year you receive the cash or checks in hand through the mail. Of course you should never put off sending invoices if it raises the risk of not collecting the money.

When Should You Take the Opposite Approach?

If you expect to pay a significantly higher tax rate on next year’s business income, try to do the opposite of these moves to raise this year’s taxable income and lower next year’s.

Goal for Net Operating Loss

With the exception of section 179 depreciation deduction, the business tax breaks and strategies discussed here can be used to create or increase 2013 net operating loss (NOL) if your business’ expenses exceed income. You can then choose 2013 NOL back for up to two years in order to recover taxes paid in those earlier years. Or you can choose to carry the NOL forward for up to 20 years if you think your business tax rates will go up.

6) Take Advantage of S Corp Built-In Gains Tax Exemptions

Do you operate a corporation that converted from a C to S status a few years ago? You probably know that a corporate level built-in gains tax (the Big Tax) may apply when certain S Corporation assets (including receivables and inventories) are turned in to cash or sold within the recognition period. Recognition period is normally the 10-year period that began on the date when the C to S conversion occurred. However, for gains recognized in the tax years beginning 2013, there is an exemption from the “Big” tax. It implies that the fifth year of your corporation’s recognition period went by before the start of the tax year beginning 2013. If your S Corporation is eligible, consider making some asset sales that trigger built-in gains this year (when the big tax exemption is available) instead of selling in future years (when the big tax might bite).

Contact your tax advisor if you have questions about any of the tax planning strategies described above.

With the above referenced strategies in mind, you may be able to make some tax saving moves by December 31 to potentially lower you as an individual or your business’ 2013 tax bill. It is important that you consult with your tax advisor for more information about your situation.

Happy New Year!