Year- End Tax Plans

Washington, Oct. 24, 2014

Dear Client:
  Time to start making your year-end tax plans, even though this year’s tax rules aren’t finalized yet. As usual, tax writers are waiting until the last minute to revive a series of tax breaks that lapsed after 2013. These include the deduction for state sales taxes in lieu of income taxes and direct transfers from IRAs to charity of up to $100,000 for folks age 70½ and up. Despite lawmakers’ delay in reinstating the provisions, we think you can bank on them for 2014 and 2015. 

  The key to end-of-year tax planning is simple: You have to think about both 2014 and 2015 as you weigh your options. You want to cut your tax bill over both years, not just one. Most filers will save by accelerating write-offs into 2014 and deferring income to 2015, since tax rates aren’t changing. If you’ll be in a higher bracket next year, consider doing the opposite…accelerating income and delaying your deductions. State and local income taxes are one of the easiest write-offs to manipulate. Mailing your Jan. 2015 estimate in late Dec. lets you claim the deduction this year. Donations. You can accelerate contributions planned for 2015 into 2014, but you must charge them or mail the checks by Dec. 31 to ensure a 2014 write-off. Try to make your donations with appreciated stock that you’ve owned for over a year. This way, you deduct the full value and never pay capital gains tax on the appreciation. Medicals. If you’ve topped the 7.5%-of-AGI threshold (10% for filers under 65) or are close to it, think about getting and paying for elective procedures this year. Interest. If you make the Jan. 2015 mortgage payment on your residence before the end of this year, you can deduct the interest portion in 2014. However, unless you do the same thing in 2015, you’ll deduct only 11 months of interest then.

  Some filers can hop in and out of the standard deduction from year to year. If your itemizations just top the standard deduction amount, try shifting some to 2014 and take the standard deduction in 2015. If you don’t have enough this year to itemize, delay some and itemize in 2015. This year’s standard deduction for couples is $12,400, plus $1,200 more for those 65 and older. Singles get $6,200…$7,750 if 65 and over. Household heads get $9,100 plus $1,550 if they are 65. Next year’s base amounts will rise by $200 for joint filers, $150 for heads of household and $100 for singles.

  The alternative minimum tax can throw a monkey wrench into your plans. Paying your Jan. 2015 state tax estimate in 2014 won’t work. And interest on home equity loans is not deductible for the AMT unless you use the proceeds to buy, build or renovate your main home. If you exercise an incentive stock option in 2014, the discount you get is hit by the tax unless you sell the shares by Dec. 31. And you won’t benefit from a 2014 payment of a real estate tax bill due in early 2015. Taking certain types of deductions makes you more likely to owe the AMT. Many write-offs must be added back when you calculate AMT liability: Sales taxes, state income taxes, property taxes, some medicals and most miscellaneous write-offs. And large gains can trigger the tax if they cost you some of your AMT exemption. 

HEALTH CARE:  More on the hardship exemption from health reform’s individual mandate: Folks must nail down this exemption before filing. In our Oct. 10 Tax Letter, we noted that people without health insurance will owe a tax when they file for 2014 unless they have an exemption. Those seeking one of the 14 hardship exemptions must get an OK from the exchange before they can claim a waiver on their returns. The approval process will take a minimum of two weeks, according to the government. Individuals must submit a multiple-page application plus required documentation. If the exchange OKs the relief, the applicant will receive a certificate number that he or she will then enter on Form 8965 to substantiate the claimed exemption. Waiting too long to apply will likely delay your refund, especially if the feds end up being swamped by procrastinators who are unfamiliar with the exemption rules. Note that hardship exemptions won’t necessarily be granted for the full year. They’re usually given for the months of the hardship plus one month before and after.

BENEFIT PLANS:  Many key dollar limits on retirement plans will be a bit higher next year: The maximum 401(k) contribution is rising to $18,000, an increase of $500 over this year. Individuals born earlier than 1966 can put in as much as $24,000. The contribution limits apply to 403(b) and 457 plans as well. The ceiling on SIMPLEs will increase to $12,500…$15,500 for individuals who are age 50 or older in 2015. Retirement plan contributions can be based on up to $265,000 of salary. The payin limitation for defined contribution plans increases to $53,000. Anyone making over $120,000 is highly paid for plan discrimination testing. The income ceilings on Roth IRA payins are going up. Contributions phase out at AGIs of $183,000 to $193,000 for couples and $116,000 to $131,000 for singles. Deduction phaseouts for regular IRAs will start at higher levels, ranging from $98,000 of AGI to $118,000 for couples and from $61,000 to $71,000 for singles. If only one spouse is covered by a plan, the phaseout zone for deducting a contribution for the uncovered spouse begins at $183,000 of AGI and finishes at $193,000. The IRA and Roth payin caps remain at $5,500…$6,500 for those 50 and up. U.S. citizens with Canadian retirement plans get a break from IRS. They’ll automatically qualify for deferral of U.S. tax on the income earned on their Canadian retirement accounts, provided they file U.S. income tax returns and report plan distributions in income. IRS is eliminating the rule requiring owners of registered retirement savings plans and registered retirement income funds to file Form 8891 to elect deferral and annually disclose payins, payouts and earnings. The relief doesn’t apply to those who have been reporting the undistributed earnings in taxable income on their 1040s each year. Rev. Proc. 2014-55 has all the details. But they’ll now have to report the value of the plans on IRS Form 8938 if the total value of all foreign financial assets exceeds the threshold for filing the form. The PBGC will start eyeing pension plans that cash out current retirees. Firms are offering lump sum buyouts to participants with deferred vested benefits or are transferring the obligations to an insurance company via an annuity contract to reduce the plans’ potential hit to their bottom lines. However, these measures also lower the premiums owed to the PBGC, which already is in financial difficulty. So the agency says it now wants notice of these de-risking moves, starting in 2015. Can plan sponsors rely on a procedural loophole to escape fiduciary liability? The Supreme Court will decide. Employees sued a 401(k) plan’s fiduciaries for not offering them the lowest-fee versions of investment choices. The lower court ruled for the participants, but only for funds that were first offered less than six years before the employees filed suit. Their claims for the other funds were time-barred. The high court will address whether the six-year rule lets plan sponsors off the hook.

FARM TAXES:  A big win for inactive farmers who are in the Conservation Reserve Program. CRP payments aren’t subject to self-employment tax, an appeals court says in the case of a taxpayer who leased a portion of his land acreage to others to farm and enrolled the other tracts in the CRP. The payments are exempt from SECA tax because they are akin to rental income from real estate (Morehouse, 8th Cir.). For now, the ruling benefits inactive farmers living in just seven states: Ark., Iowa, Minn., Mo., Neb., N.D. and S.D. Those who paid self-employment tax on CRP payments should file refund claims for all open tax years, citing this decision. The result is different for active farmers. In 2000, another appeals court ruled that CRP payments they receive from the government are subject to SECA tax. In 2006, IRS proposed expanding that decision to inactive farmers but never did so. Congress later exempted CRP payments to retired and disabled farmers from SECA tax, but left open the question about whether inactive farmers owed self-employment tax.

BUSINESS TAXES:  Profits of personal service corporations are taxed at a flat 35% rate. This rule applies if at least 95% of a firm’s activities involve services in the fields of law, health, engineering, architecture, consulting, performing arts or actuarial science, and over 95% of the company’s stock is owned by employees performing the services. Adding a subsidiary into the mix lets a personal service firm avoid this rule and use the normal graduated corporate rate schedule, the Tax Court says. In this case, a consulting firm had a subsidiary that operated a ranch at a loss that came close to offsetting the consulting profits. IRS said the consulting profits should be taxed at 35%. The Court ruled that because the companies filed a consolidated tax return and less than 95% of the total activities were consulting-related, the affiliated group wasn’t a personal service corporation (Applied Research Associates, 143 TC No. 17). Thus, the group’s small net profit was taxed at the graduated corporate tax rates. A moving firm can’t accrue a write-off for damage claims paid after year-end, the Service privately says. Even though customer claims for damaged or lost goods happen on a recurring basis, as many who have hired a moving company can attest, they aren’t the type of liability that’s deductible before the claims are actually paid. 

DONATIONS:  Doing a good deed won’t guarantee a tax deduction, the Tax Court decides. After their son died, a couple used the life insurance proceeds they received to fund a nonexempt irrevocable trust to give scholarships in his honor to needy kids. They took a charitable deduction when the trust paid scholarships to three students. The Court said the payouts weren’t deductible because the trust made the payments and the couple didn’t own the trust for tax purposes (Kalapodis, TC Memo. 2014-205).

WAIVED DEBTS:  Expect guidance from IRS on the tax implications of short sales of homes… selling a property for less than the outstanding mortgage loan balance. Many states, such as Calif., bar lenders from going after borrowers for any shortfall on a short sale when the home’s value is less than the purchase-money mortgage on it. IRS has privately ruled that in this situation, the forgiven debt isn’t treated as income from a waived debt. Instead, it’s included in the amount the selling homeowner realizes for figuring gain or loss on the sale, and if the house is the seller’s primary home, up to $500,000 of the gain can be excluded. Because the issue is so important, the agency is now considering publishing a formal ruling that taxpayers can rely on. A break is on the way for lenders and debtors on debt cancellation income. IRS will soon scrap the requirement that lenders must issue Form 1099-C to debtors when no payments have been received on the debt in the past 36 months. This rule has resulted in many mismatches with taxpayers and wasted the Service’s resources, because the trigger for filing the form isn’t based on the actual discharge of the debt. This will take effect once regulations nixing the 36-month rule are finalized next year.

SOCIAL SECURITY:  The Social Security wage base is going up next year to $118,500, a $1,500 hike over this year’s cap. The tax rate on employers and employees will remain at 6.2%. The employer’s share of Medicare tax will stay at 1.45% of all pay. The employee’s share is 1.45%, but the 0.9% Medicare surtax kicks in for singles with wages exceeding $200,000 and couples earning over $250,000. The surtax doesn’t affect the employer’s share. Self-employeds are also subject to the surtax. Social Security benefits are rising 1.7% in 2015…slightly more than in 2014. The earnings limits are heading up, too. People who turn 66 next year will not lose any benefits if they earn $41,880 or less before they reach that age. Individuals between ages 62 and 66 by the end of 2015 can make up to $15,720 before they’ll lose any benefits. There’s no earnings cap once a beneficiary turns 66. Changing jobs midyear? You may qualify for a Social Security tax credit. If your total compensation from your employers this year is more than the wage base, you can claim a credit on your Form 1040 for the excess Social Security tax withheld. But IRS is doing a poor job of policing this credit, Treasury inspectors say. IRS has procedures to identify discrepancies between the credit claimed on the return and the withheld amounts reported by employers. But the Service says its tight budget and limited resources prevent it from following up on all but the most egregious errors.

MEDICARE:  The basic Medicare Part B premium will stay at $104.90 a month in 2015. It will be the third year in a row that the basic premium hasn’t changed. But upper-income seniors will still have to pay higher Part B and D premiums if their modified adjusted gross incomes for 2013 exceeded $170,000 for couples or $85,000 for single people. Modified AGI is AGI plus any tax-exempt interest, EE bond interest that’s used for education, and excluded foreign-earned income. The Part B surcharge for higher-incomers won’t change, but the Part D add-on will increase slightly. The total surcharges can be as high as $301.60 a month.

TAX DEBTS:  Death is one way to beat a federal tax lien, as this case demonstrates. An individual co-owned a house with another person as joint tenants with a right of survivorship. He owed back taxes to IRS, which put a lien on his interest in the house. He died without paying his tax debt, and IRS sought to enforce its lien. But a district court ruled that after his death, the lien ceased to attach to the property because he no longer had an interest in it (NPA Assoc. v. Est. of Cunning, D.C., V.I.).

ENFORCEMENT:  IRS isn’t effectively monitoring sales of foreign-owned U.S. real estate, Treasury inspectors say. Buyers often must withhold 10% of the sales price when a foreigner sells an interest in U.S. real estate. Congress ordered the withholding to ensure that foreigners pay capital gains tax on the sales. To boost compliance, inspectors want IRS to revise Form 1099-S…the form for reporting sales proceeds… to show buyer information and to identify whether the seller is a foreigner. And it must step up its efforts in collecting taxes from folks residing abroad. Treasury inspectors report several weaknesses in IRS’s international collection efforts. Among them: Insufficient training on cross-border collection. Logistical challenges when contacting taxpayers by phone because of time zone and language differences. And working too many unproductive cases, as evidenced by the fact that over one-third of the inventory has been closed as uncollectible. The agency vows to do a better job.
Yours very truly,
Oct. 24, 2014 THE KIPLINGER WASHINGTON EDITORS

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