As the end of the year approaches, it is a good time to think of planning moves that will help lower your tax bill for this year and possibly the next. Factors that compound the challenge include turbulence in the stock market, overall economic uncertainty, and Congress's failure to act on a number of important tax breaks that expired at the end of 2014. Some of these tax breaks ultimately may be retroactively reinstated and extended, as they were last year, but Congress may not decide the fate of these tax breaks until the very end of 2015 (or later). These breaks include, for individuals: the option to deduct state and local sales and use taxes instead of state and local income taxes; the above-the-line-deduction for qualified higher education expenses; tax-free IRA distributions for charitable purposes by those age 70-1/2 or older; and the exclusion for up-to-$2 million of mortgage debt forgiveness on a principal residence. For businesses, tax breaks that expired at the end of last year and may be retroactively reinstated and extended include: 50% bonus first-year depreciation for most new machinery, equipment and software; the $500,000 annual expensing limitation; the research tax credit; and the 15-year write-off for qualified leasehold improvements, qualified restaurant buildings and improvements, and qualified retail improvements.
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 an unindexed threshold amount ($250,000 for joint filers, $125,000 for married couples filing separately, and $200,000 in any other case).
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 NII, and other individuals will need to consider ways to minimize both NII and other types of MAGI.
The 0.9% additional Medicare tax also 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 the end of the year to cover the tax. For example, if an individual earns $200,000 from one employer during the first half of the year and a like amount from another employer during the balance of the year, he would owe the additional Medicare tax, but there would be no withholding by either employer for the additional Medicare tax since wages from each employer don't exceed $200,000. Also, in determining whether they may need to make adjustments to avoid a penalty for underpayment of estimated tax, individuals also should be mindful that the additional Medicare tax may be overwithheld. This could occur, for example, where only one of two married spouses works and reaches the threshold for the employer to withhold, but the couple's combined income won't be high enough to actually cause the tax to be owed.
We have compiled a checklist of additional actions based on current tax rules that may help you save tax dollars if you act before year-end. Not all actions will apply in your particular situation, but you (or a family member) will likely benefit from many of them. We can narrow down the specific actions that you can take once we meet with you to tailor a particular plan. In the meantime, please review the following list and contact us at your earliest convenience so that we can advise you on which tax-saving moves to make.
Topics of Special Interest
Healthcare The Affordable Care Act (ACA) is the largest single change to the tax code in 20 years. The act, will affect most, if not all, tax returns, even if it is only checking a box on the tax return. ACA is too complicated to cover in detail in a letter. Presented below are just a few health care related items that may affect your future tax situation:
- Health Insurance Penalty - All Americans are now mandated to have health insurance, or pay a tax penalty. In 2014 this penalty is the greater of 1% of household income or $95 per person. 2015 will see a significant increase in this penalty to 2% of total household income or $325 per person. Because the penalty increases annually, acquiring health insurance sooner than later, will help to reduce or avoid the penalty going forward. Certain individuals are exempt from the penalty.
- Premium tax credit - There is controversy regarding ACA's premium tax credits, meant to help individuals afford the now mandated health care coverage. Per statute language, the credit is available for taxpayers who buy insurance on a marketplace "established by the state". IRS regulations expand the credit to taxpayers purchasing insurance in the federal marketplace. The IRS regulations have been challenged to different results. In 2015 the Supreme Court will resolve the conflict, which may result in more changes in this complicated area. In the meantime the premium tax credit remains available to individuals who purchase coverage through either the federally-run or state-run marketplace.
- Flexible Spending Accounts (FSAs) - FSAs allow the use of pre-tax dollars to pay health care costs. FSA's, once use-it-or-lose-it plans, now allow you to roll over $500 to the following plan year. Note that a new change will make you ineligible to participate in a Health Savings Account (HSA) in 2015 when carrying over $500 from a 2014 FSA.
Retirement related changes
- IRA rollover rule - Beginning in 2015, only one rollover from one IRA to another (or the same) IRA in any 12-month period is allowed regardless of the number of IRA accounts owned. The limit will apply by aggregating all of an individual's IRAs, including SEP and SIMPLE IRAs as well as traditional and Roth IRAs, basically treating all as one IRA for limit purposes. Trustee-to-Trustee transfers between IRAs and rollovers from traditional to Roth IRAs are not limited.
- myRA account - New type of retirement account called myRA. myRA is a Roth account so contributions can be withdrawn tax-free at any time and earnings distributed without penalty once the owner is 59.5 and the account is held at least 5 years. There are no fees associated with the account and the account is guaranteed by the government to never lose value. Deposits must be made via payroll deduction. Accounts can be opened for as little as $25 with direct deposits of $5 or more per pay day. The accounts are portable. Taxpayers with annual income of less than $129,000 ($191,000 for couples) may open an account.
Annual Adjustments and Other Tax Provisions
- Tax Bracket - Income tax rates for ordinary income remain at 10%, 15%, 25%, 28%, 33%, 35% and max out at 39.6%. The top rate for qualified dividends and long-term capital gains remains at 15% for all taxpayers except for the high income taxpayers. The same taxable income thresholds are used to apply a capital gains rate of 20%.
- Qualified Dividends and Capital gains rates - Tax rates on capital gains and qualified dividends remain at 0%, 15%, and 20%. When combined with the net investment income tax of 3.8%, the total top capital gains rate could be as high as 23.8%.
- Alternative minimum tax - The 2015 AMT exemption amounts are $83,400 (MFJ/QW); $53,600 (Single/HOH); $41,700 (MFS). Legislation also continues to allow capital gains to be taxed using the lower capital gains rates for AMT. AMT tax rates remain at 26% and 28%.
- Itemized deductions/personal exemption phase-outs - The 2015 AGI threshold at which itemized deductions may become limited is $309,900 ($258,250 for single filers, $284,050 for head of household filers, and $154,950 for married individuals filing separately). Certain medical expenses, investment interest, casualty, theft, and gambling losses are exempt from the itemized deduction phase-out. Personal exemptions are fully phased out when AGI exceeds $432,400 ($380,750 for single filers, $406,550 for heads of households, and $216,200 for married filing separately).
- IRA Contributions - For the third year in a row, contribution limits for IRA's remains at $5,500 for 2015. Similarly the additional "catch-up" contribution for employees 50 and over is unchanged at $1,000. Income limitations and participation in a qualified retirement plan will affect the deductibility of any contribution.
- Roth Contributions - As with the traditional IRA, Roth contributions remain unchanged at $5,500 (or $6,500 for the 50 and older group). Modified adjusted gross income determines who can contribute and how much can be contributed to a Roth. For 2015 the phase-out limits begin at $183,000 ($118,000 single and head of household filers, $10,000 married filing separate filers).
- Employer-sponsored Retirement Plan Contributions - Salary reduction contribution limitations to IRC 401(k) type plans increase to $18,000 in 2015. Employers may allow those age 50 or over to contribute an additional $6,000 in 2015. The salary deferral limitation for SIMPLE plan participants increases to $12,500 for 2015. SIMPLE plan catch-up contributions for participants age 50 and over also increase to $3,000 in 2015.
- Health Savings Accounts - Health Savings Accounts are a pre-tax savings tool, which enable individuals with high deductible health insurance to make pre-tax contributions to cover health care costs. For 2015, individuals may contribute up to $3,350 for self-only coverage and $6,650 for family coverage. The additional tax on distributions from an HSA or an Archer MSA that are not used for qualified medical expenses remains at 20%.
- Education related provisions - The American Opportunity credit for college expenses was extended through December 31, 2017. This credit replaced the prior Hope Credit and expanded the qualifying expenses to include textbooks, increased the credit to four years instead of two, expanded the phase-out range and allows for a refundable credit.
- Standard mileage rates – The 2015 optional mileage allowance for owned or leased autos has increased to 57.5 cents per business mile (2014 was 56 cents). The 2015 rate for medical miles is 23 cents per mile, down from the 2014 rate of 23.5 cents.
Expired Tax Provisions
- Absent any legislative action, the following items expired on December 31, 2014. While past action may not always predict the future, many of these have been extended retroactively so one should take a wait and see approach.
- Bonus depreciation and Section 179 - Bonus depreciation, with limited exceptions, expired in 2014 and the Section 179 expensing limits have dropped back to the $25,000 maximum and $200,000 investment limit. As a comparison the 2014 maximum expense was $500,000 with an investment limit of $2,000,000.
- State and local sales tax deduction - The itemized deduction for state and local sales taxes
- Above the line Educator expenses and Tuition and Fees Deduction - The above-the-line deduction for higher education expenses (tuition and fees deduction).
- Nonbusiness Energy Property Credit - The nonrefundable personal credit of up to $500 for qualified nonbusiness energy property.
- Mortgage insurance deduction - The itemized deduction for the cost of mortgage insurance paid in connection with the purchase of a qualified residence (more commonly referred to as PMI).
- Mortgage Debt Forgiveness - Debts which are forgiven on a mortgage secured by qualified principal residence may no longer be excluded from gross income.
- Effective tax planning requires a year-round effort each year, especially as your overall financial position changes. If you wish to discuss the provisions affecting you as well as the available tax strategies that would be appropriate to minimize your tax liability and maximize your tax savings, please give us a call at 440-442-7501 to set up an appointment.