Tax Statistics: Where the money comes from

April 13, 2015 — Sam H. Fawaz

As the tax filing deadline approaches, Money Magazine has offered some interesting statistics on our annual ritual. In the early months, the IRS says that roughly 83% of all returns have resulted in refunds, with an average refund of $2,893 per return. In all, roughly eight out of ten filers qualify for a refund, and this year’s refund is in line with previous year averages.

Meanwhile, the IRS website notes that in the past few years, roughly 47% of Americans were below the threshold where they had to pay income taxes—which is where the famous “47 percenters” phrase came from in the Romney presidential campaign. However virtually all of those Americans paid FICA taxes. In all, 185.5 million income tax returns were filed last year, but only 34,000 estate tax returns and just 335,000 gift tax returns. The government collected $1.64 trillion in individual income taxes, compared with $353 billion in business income taxes. In aggregate, Californians paid the most taxes, at $369 billion, well ahead of Texas ($265 billion) and New York ($251 billion). At the other end of the spectrum, the citizens of Vermont paid $4.3 billion and people and companies living in Wyoming paid $4.9 billion,

Finally, there’s an interesting comparison. The King James Bible totals around 700,000 words, whereas the U.S. Federal Tax Code numbers 3.7 million words.

If you would like to review your current tax situation or discuss any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch.

Sources:

 http://money.cnn.com/2015/03/26/pf/taxes/average-tax-refund-irs/index.html?iid=SF_PF_River

 http://facts.randomhistory.com/tax-facts.html

 http://www.sars.gov.za/AllDocs/Documents/Tax%20Stats/Tax%20Stats%202014/TStats%202014%20Highlights%20WEB.pdf

 http://www.irs.gov/uac/SOI-Tax-Stats-IRS-Data-Book

 TheMoneyGeek thanks guest writer Bob Veres for writing this post.

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Rollover Rules

November 15, 2014 — Sam H. Fawaz

One of the oddest things about tax law is the fact that often the rules and regulations are decided by the many court cases that are brought by taxpayers who didn’t follow the rulebook. This happened once again in a recent tax court case, where the Tax Court decided that people can only do one IRA rollover in any one-year period, no matter how many other IRA accounts they happen to have. Never mind that the decision directly contradicted the IRS’s own guidance in its Publication 590 and a number of private-letter rulings issued by the IRS.

Since the so-called Bobrow decision (which may be appealed), a common way to move money from one IRA account to another now has to be monitored closely. The ruling affects situations where an IRA owner takes a distribution from an IRA and then rolls those same funds over to another IRA within 60 days. So long as the same amount of money is put back into an IRA account within that time period, no taxes have to be paid on the distribution of funds (and no 10% additional penalty, if the IRA owner is under age 59 1/2). But now you WILL have to pay taxes–and the penalty, if applicable–if you try to do this again with the same or other IRAs during the same 365-day period.

Fortunately, this rule doesn’t apply to direct transfers, which is the way most professionals prefer to move money between IRA accounts. A direct transfer is exactly what it sounds like: the trustee of one IRA moves the money directly from that account into the hands of a trustee for another IRA account; that is, the money flows directly from one account to the other without the taxpayer ever touching it or putting it into his or her own checking account. Under current rules, even with the Bobrow decision, these kinds of transfers can be done all day long, all year long.

It has always been good advice to use only direct transfers to move IRA funds from one IRA to another. Now it’s even more so.

Incidentally, this once-per-year IRA rollover rule doesn’t apply to rollovers from an IRA to a Roth IRA (commonly known as a Roth IRA conversion). But most advisors prefer to handle those on a trustee-to-trustee basis anyway, to avoid confusion and potential problems with the 60-day rule. Mistakes on transfers can be costly from a tax standpoint, and the way things stand, they can’t be fixed after the fact–unless you decide to take the case to court and hope to reverse the current rule of law, which is far more costly still.

If you’d like to know more about rollover rules or if you want to discuss other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.

Source:
http://www.investmentnews.com/article/20140413/REG/304139996/irs-only-one-ira-rollover-per-year

Posted in Consumer Alert, Financial Planning, retirement planning, tax planning, Taxes. Tags: , , , , . Leave a Comment »

2014 Year-end Tax Planning Tips

November 9, 2014 — Sam H. Fawaz

Year-end planning will be more challenging than normal this year. Unless Congress acts, a number of popular deductions and credits expired at the end of 2013 and won’t be available for 2014. Deductions not available this year include, for example, the election to deduct state and local sales taxes instead of state and local income taxes, the above-the-line deductions for tuition and educator expenses, generous bonus depreciation and expensing allowances for business property, and qualified charitable distributions that allow taxpayers over age 70½ to make tax-free transfers from their IRAs directly to charities.

Of course, Congress could revive some or all the favorable tax rules that have expired as they have done in the past. However, which actions Congress will take remains to be seen and may well depend on the outcome of the elections.

Before we get to specific suggestions, here are two important considerations to keep in mind.

  1. Remember that effective tax planning requires considering both this year and next year—at least. Without a multi-year outlook, you can’t be sure maneuvers intended to save taxes on your 2014 return won’t backfire and cost additional money in the future.
  2. Be on the alert for the Alternative Minimum Tax (AMT) in all of your planning, because what may be a great move for regular tax purposes may create or increase an AMT problem. There’s a good chance you’ll be hit with AMT if you deduct a significant amount of state and local taxes, claim multiple dependents, exercised incentive stock options, or recognized a large capital gain this year.

Here are a few tax-saving ideas to get you started. As always, you can call on us to help you sort through the options and implement strategies that make sense for you.

Year-end Moves for Your Business

Employ Your Child. If you are self-employed, don’t miss one last opportunity to employ your child before the end of the year. Doing so has tax benefits in that it shifts income (which is not subject to the Kiddie tax) from you to your child, who normally is in a lower tax bracket or may avoid tax entirely due to the standard deduction. There can also be payroll tax savings since wages paid by sole proprietors to their children under age 18 are exempt from social security and unemployment taxes. Employing your children has the added benefit of providing them with earned income, which enables them contribute to an IRA. The compounded growth in an IRA started at a young age can be a significant jump start to the child’s retirement savings.

Remember a couple of things when employing your child. First, the wages paid must be reasonable given the child’s age and work skills. Second, if the child is in college, or is entering soon, having too much earned income can have a detrimental impact on the student’s need-based financial aid eligibility.

Check Your Partnership and S Corporation Stock Basis. If you own an interest in a partnership or S corporation, your ability to deduct any losses it passes through is limited to your basis. Although any unused loss can be carried forward indefinitely, the time value of money diminishes the usefulness of these suspended deductions. Thus, if you expect the partnership or S corporation to generate a loss this year and you lack sufficient basis to claim a full deduction, you may want to make a capital contribution (or in the case of an S corporation, loan it additional funds) before year end.

Avoid the Hobby Loss Rules. A lot of businesses that are just starting out or have hit a bump in the road may wind up showing a loss for the year. The last thing the business owner wants in this situation is for the IRS to come knocking on the door arguing the business’s losses aren’t deductible because the activity is just a hobby for the owner. Surprisingly, the IRS has been fairly successful recently in making this argument when it takes taxpayers to court. Thus, if your business is expecting a loss this year, we should talk before year-end to make sure we do everything possible to maximize the tax benefit of the loss and minimize its economic impact.

Managing Your Adjusted Gross Income (AGI)

Many tax deductions and credits are subject to AGI-based phase-out, which means only taxpayers with AGI below certain levels benefit. [AGI is the amount at the bottom of page 1 of your Form 1040—basically your gross income less certain adjustments (i.e., deductions), but before itemized deductions and the deduction for personal exemptions.] Unfortunately, however, the applicable AGI amounts differ depending on the particular deduction or credit. The following table shows a few of the more common deductions and credits and the applicable AGI phase-out ranges for 2014:

 

Deduction or Credit

 Adjusted Gross Income Phase-out Range
 

Joint Return

 Single/Head of Household (HOH) Married Filing Separate
American Opportunity Tax Credit $160,000–$180,000 $80,000–$90,000 No credit
Child Tax Credit Begins at $110,000 Begins at $75,000 Begins at $55,000
Itemized Deduction and Personal Exemption Reduction Begins at $305,050 Begins at $254,200 Single, $279,650 HOH Begins at $152,525
Lifetime Learning Credit $108,000–$128,000 $54,000–$64,000 No credit
Passive Rental Loss ($25,000) Exception $100,000–$150,000 $100,000–$150,000 No exception unless spouses live apart
Student Loan Interest Deduction $130,000–$160,000 $65,000–$80,000 No deduction

Managing your AGI can also help you avoid (or reduce the impact of) the 3.8% net investment income tax that potentially applies if your AGI exceeds $250,000 for joint returns, $200,000 for unmarried taxpayers.

Managing your AGI can be somewhat difficult, since it is not affected by many deductions you can control, such as deductions for charitable contributions and real estate and state income taxes. However, you can effectively reduce your AGI by increasing “above-the-line” deductions, such as those for IRA or self-employed retirement plan contributions. For sales of property, consider an installment sale that shifts part of the gain to later years when the installment payments are received or use a like-kind exchange that defers the gain until the exchanged property is sold. If you own a cash-basis business, delay billings so payments aren’t received until 2015 or accelerate paying of certain expenses, such as office supplies and repairs and maintenance, to 2014. Of course, before deferring income, you must assess the risk of doing so. If you’re considering a gift to a person in a lower capital gains bracket or charity (see below), giving appreciated securities avoids recognition of the capital gains and thereby lowers AGI.

See also It May Pay to Wait until the End of the Year to Take Your IRA Required Minimum Distributions below for a possible extension of a tax provision that expired in 2013.

Charitable Giving

You might want to consider two charitable giving strategies that can help boost your 2014 charitable contributions deduction. First, donations charged to a credit card are deductible in the year charged, not when payment is made on the card. Thus, charging donations to your credit card before year-end enables you to increase your 2014 charitable donations deduction even if you’re temporarily short on cash. As mentioned above, donating appreciated securities gets you a charitable contribution deduction at fair market value without having to recognize the capital gain income.

Another charitable giving approach you might want to consider is the donor-advised fund. These funds essentially allow you to obtain an immediate tax deduction for setting aside funds that will be used for future charitable donations. With these arrangements, which are available through a number of major mutual fund companies, custodians, universities and community foundations, you contribute money or securities to an account established in your name. You then choose among investment options and, on your own timetable, recommend grants to charities of your choice. The minimum for establishing a donor-advised fund is often $10,000 or more, but these funds can make sense if you want to obtain a tax deduction now but take your time in determining or making payments to the recipient charity or charities. These funds can also be a way to establish a family philanthropic legacy without incurring the administrative costs and headaches of establishing a private foundation.

Year-end Investment Moves

Harvest Capital Losses. There are a number of year-end investment strategies that can help lower your tax bill. Perhaps the simplest is reviewing your securities portfolio for any losers that can be sold before year-end to offset gains you have already recognized this year or to get you to the $3,000 maximum ($1,500 married filing separate) net capital loss that’s deductible each year. Don’t worry if your net loss for the year exceeds $3,000, because the excess carries over indefinitely to future tax years. Be mindful, however, of the wash sale rule when you jettison losers—your loss is deferred if you purchase substantially identical stock or securities within the period beginning 30 days before and ending 30 days after the sale date. However, never let the tax “tail” wag the investment “dog”; the sale must make investment sense first, tax sense second (always keep in mind long term investment objectives over short-term tax objectives).

Consider a Bond Swap. Bond swaps can be an effective means of generating capital losses. With a bond swap, you start with a bond or bond fund that has decreased in value, which might be due to an increase in interest rates or a lowering of the issuer’s creditworthiness. You sell the bond or fund shares and immediately reinvest in a similar (but not substantially identical) bond or bond fund. The end result is that you recognize a taxable loss and still hold a bond or shares in a bond fund that pays you similar or more interest than before.

Secure a Deduction for Nearly Worthless Securities. If you own any securities that are all but worthless with little hope of recovery, you might consider selling them before the end of the year so you can capitalize on the loss this year. You can deduct a loss on worthless securities only if you can prove the investment is completely worthless. Thus, a deduction is not available, as long as you own the security and it has any value at all. Total worthlessness can be very difficult to establish with any certainty. To avoid the issue, it may be easier just to sell the security if it has any marketable value. As long as the sale is not to a family member, this allows you to claim a loss for the difference between your tax basis and the proceeds (subject to the normal rules capital loss and wash sale rules previously discussed).

Consider a Roth IRA Conversion. If your highest tax bracket is lower than normal this year, consider a Roth IRA conversion of some of your traditional IRA funds. You may also have some “room” in your current tax bracket that might be able to absorb a small Roth IRA conversion without pushing you into a higher tax bracket. Roth conversions affect AGI, so it’s best done with professional help to understand all the ramifications of the conversion.

Year-end Moves for Seniors Age 701/2 Plus

Take Your Required Retirement Distributions. The tax laws generally require individuals with retirement accounts to take withdrawals based on the size of their account and their age beginning with the year they reach age 701/2. Failure to take a required withdrawal can result in a penalty of 50% of the amount not withdrawn. If you turned age 701/2 in 2014, you can delay your 2014 required distribution to 2015 if you choose. But, waiting until 2015 will result in two distributions in 2015—the amount required for 2014 plus the amount required for 2015. While deferring income is normally a sound tax strategy, here it results in bunching income into 2015. Thus, think twice before delaying your 2014 distribution to 2015—bunching income into 2015 might throw you into a higher tax bracket or bring you above the modified AGI level that will trigger the 3.8% net investment income tax. However, it could be beneficial to take both distributions in 2015 if you expect to be in a substantially lower bracket in 2015. For example, you may wish to delay the 2014 required distribution until 2015 if you plan to retire late this year or early next year, have significant nonrecurring income this year, or expect a business loss next year.

It May Pay to Wait until the End of the Year to Take Your Required Minimum Distributions. If you plan on making additional charitable contributions this year and you have not yet received your 2014 required distribution from your IRA, you might want to wait until the very end of the year to do both. It is possible that the Congress will bring back the popular Qualified Charitable Distributions (QCDs) that expired at the end of 2013. If so, IRA owners and beneficiaries who have reached age 70½ will be able to make cash donations totaling up to $100,000 to IRS-approved public charities directly out of their IRAs. QCDs are federal-income-tax-free to you and they can qualify as part of your required distribution, but you get no itemized charitable write-off on your Form 1040. That’s okay because the tax-free treatment of QCDs equates to an immediate 100% federal income tax deduction without having to itemize your deductions or worry about restrictions that can reduce or delay itemized charitable write-offs. However, to qualify for this special tax break, the funds must be transferred directly from your IRA to the charity. Once you receive the cash, the distribution is not a QCD and won’t qualify for this tax break.

Ideas for the Office

Maximize Contributions to 401(k) Plans. If you have a 401(k) plan at work, it’s just about time to tell your company how much you want to set aside on a tax-free basis for next year. Contribute as much as you can stand, especially if your employer makes matching contributions. You give up “free money” when you fail to participate to the max for the match.

Take Advantage of Flexible Spending Accounts (FSAs). If your company has a healthcare and/or dependent care FSA, before year-end you must specify how much of your 2015 salary to convert into tax-free contributions to the plan. You can then take tax-free withdrawals next year to reimburse yourself for out-of-pocket medical and dental expenses and qualifying dependent care costs. Watch out, though, FSAs are “use-it-or-lose-it” accounts—you don’t want to set aside more than what you’ll likely have in qualifying expenses for the year.

If you currently have a healthcare FSA, make sure you drain it by incurring eligible expenses before the deadline for this year. Otherwise, you’ll lose the remaining balance. It’s not that hard to drum some things up: new glasses or contacts, dental work you’ve been putting off, or prescriptions that can be filled early.

Adjust Your Federal Income Tax Withholding. If it looks like you are going to owe income taxes for 2014, consider bumping up the federal income taxes withheld from your paychecks now through the end of the year. When you file your return, you will still have to pay any taxes due less the amount paid in. However, as long as your total tax payments (estimated payments plus withholding) equal at least 90% of your 2014 liability or, if smaller, 100% of your 2013 liability (110% if your 2013 adjusted gross income exceeded $150,000; $75,000 for married individuals who filed separate returns), penalties will be minimized, if not eliminated.

Don’t Overlook Estate Planning

For 2014, the unified federal gift and estate tax exemption is a historically generous $5.34 million, and the federal estate tax rate is a historically reasonable 40%. Even if you already have an estate plan, it may need updating to reflect the current estate and gift tax rules. Also, you may need to make some changes for reasons that have nothing to do with taxes.

Conclusion

Through careful planning, it’s possible your 2014 tax liability can still be significantly reduced, but don’t delay. The longer you wait, the less likely it is that you’ll be able to achieve a meaningful reduction. The ideas discussed in this article are a good way to get you started with year-end planning, but they’re no substitute for personalized professional assistance. Please don’t hesitate to call us with questions or for additional strategies on reducing your tax bill. We’d be glad to set up a tax or financial planning meeting by calling (734) 447-5305 or assist you in any other way that we can. You can always visit our web site at http://www.ydfs.com

Posted in estate planning, Financial Planning, Taxes. Tags: , , . 1 Comment »

Expiring Tax Provisions: How You Probably WON’T Be Affected

November 28, 2013 — Sam H. Fawaz

Happy Thanksgiving! I hope that your families and you have an enjoyable holiday and (hopefully) extended weekend.

You may have read that the last day of 2013 is scheduled to be the last day for an estimated 57 different tax deductions–unless the U.S. Congress turns its attention away from the next potential government shutdown and extends some or all of them.  All of these deductions will be available to the 2013 tax return that you file by April 15.  But as it stands now, they won’t be available next year, creating another potential stealth tax increase in 2014.
 
How will this impact you?  Only a few of the 57 are relevant to you at all, unless you qualify for the American Samoa Economic Development Credit, the “special expensing” rules for film and television production, the mine rescue team training credit or special three-year depreciation for your race horses that happen to be two years or younger.
 
You probably do, however, claim deductions for state and local taxes, which expire at the end of the year, and people with kids and/or grandkids in college might miss the above-the-line deduction for tuition and related educational expenses.  Many Americans will be at least slightly affected by the loss of the deduction for mortgage insurance premiums, and some retired Americans over age 70 1/2 will be distressed to learn that they can no longer make tax-free distributions of up to $100,000 from an IRA account to their favorite charity.  School teachers will lose their classroom expense deductions of up to (a whopping) $250 for un-reimbursed expenses.
 
And thousands of homeowners whose homes are listing below what they paid for them should realize that, at the end of December, they will lose a provision that lets them exclude from their taxable income any reduction in their mortgage obligation (through debt modification or a short sale) up to a maximum of $2 million.
 
Other expiring tax breaks that may affect some people reading this:
 
-Enhanced tax breaks for people who donate property (or easements on their property) to the Nature Conservancy or a local land trust.
 
-Tax credits for the purchase of 2- or 3-wheeled electric vehicles and a separate credit of $7,500 for those who buy certain 4-wheeled electric vehicles like the Ford Focus Electric and the Nissan Leaf.
 
-A maximum $500 tax credit for making certain energy-efficiency improvements in your home (like adding insulation), plus other credits for constructing new energy-efficient homes and a credit for energy-efficient appliances.
 
The biggest expiring corporate tax break is the research and development tax credit.  At the end of the year, companies will also lose the additional first-year depreciation for 50% of the basis of qualified property.
 
In the past, Congress has allowed tax provisions to expire and then, retroactively, extended them for another year or two–and many tax observers believe this will almost certainly happen with the state/local tax deduction and corporate R&D tax credits, and quite possibly for the tuition tax credit as well. 

So when you read about the 57 expiring provisions, and you are not in the biodiesel fuel business (four expiring credits) or planning to claim the electricity production credit for building a renewable power plant, or actively mining coal on Indian lands, you shouldn’t get too worried.  Chances are you aren’t going to get hammered on next year’s taxes–and Congress may even get around to extending the provisions that you really care about, at the very last minute of course.

Whether you’re looking for year-end tax planning, financial planning or money management help, please get in touch with us for unbiased, fiduciary advice that always puts your interests first.

I welcome your feedback, questions and comments. Have a great long weekend!

Source: https://www.jct.gov/publications.html?func=startdown&id=4499

 

My thanks to Bob Veres, publisher of Inside Information, for his help with this post

 

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2013 Year-End Tax Planning Tips

November 16, 2013 — Sam H. Fawaz

As we approach year-end, it’s again time to focus on last-minute moves you can make to save taxes—both on your 2013 return and in future years.

For most individuals, the ordinary federal income tax rates for 2013 will be the same as last year: 10%, 15%, 25%, 28%, 33%, and 35%. However, the fiscal cliff legislation, passed early this year, increased the maximum rate for higher-income individuals to 39.6% (up from 35%). This change affects taxpayers with taxable income above $400,000 for singles, $450,000 for married joint-filing couples, and $425,000 for heads of households. In addition, the new 0.9% Medicare tax and 3.8% Net Investment Income Tax (NIIT) potentially kick in when modified adjusted gross income (or earned income in the case of the Medicare tax) goes over $200,000 for unmarried, $250,000 for married joint-filing couples, which can result in a higher-than-advertised federal tax rate for 2013.

Despite these tax increases, the current federal income tax environment remains relatively favorable by historical standards. This article presents several tax-saving ideas to get you started. As always, you can call on us to help you sort through the options and implement strategies that make sense for you.

Ideas for Maximizing Non-business Deductions

One way to reduce your 2013 tax liability is to look for additional deductions. Here’s a list of suggestions to get you started:

Make Charitable Gifts of Appreciated Stock. If you have appreciated stock that you’ve held more than a year and you plan to make significant charitable contributions before year-end, keep your cash and donate the stock (or mutual fund shares) instead. You’ll avoid paying tax on the appreciation, but will still be able to deduct the donated property’s full value. If you want to maintain a position in the donated securities, you can immediately buy back a like number of shares. (This idea works especially well with no load mutual or exchange traded funds because there are no transaction fees involved.)

However, if the stock is now worth less than when you acquired it, sell the stock, take the loss, and then give the cash to the charity. If you give the stock to the charity, your charitable deduction will equal the stock’s current depressed value and no capital loss will be available. Also, if you sell the stock at a loss, you can’t immediately buy it back as this will trigger the wash sale rules. This means your loss won’t be deductible, but instead will be added to the basis in the new shares. You must wait more than 30 days to buy back shares sold at a loss to avoid the wash sale rules.

Don’t Lose a Charitable Deduction for Lack of Paperwork. Charitable contributions are only deductible if you have proper documentation. For cash contributions of less than $250, this means you must have either a bank record that supports the donation (such as a cancelled check or credit card receipt) or a written statement from the charity that meets tax-law requirements. For cash donations of $250 or more, a bank record is not enough. You must obtain, by the time your tax return is filed, a charity-provided statement that shows the amount of the donation and lists any significant goods or services received in return for the donation (other than intangible religious benefits) or specifically states that you received no goods or services from the charity.

Maximize the Benefit of the Standard Deduction. For 2013, the standard deduction is $12,200 for married taxpayers filing joint returns. For single taxpayers, the amount is $6,100. Currently, it looks like these amounts will be about the same for 2014. If your total itemized deductions are normally close to these amounts, you may be able to leverage the benefit of your deductions by bunching deductions in every other year. This allows you to time your itemized deductions so that they are high in one year and low in the next. You claim actual expenses in the year they are bunched and take the standard deduction in the intervening years.

For instance, you might consider moving charitable donations you normally would make in early 2014 to the end of 2013. If you’re temporarily short on cash, charge the contribution to a credit card—it is deductible in the year charged, not when payment is made on the card. You can also accelerate payments of your real estate taxes or state income taxes otherwise due in early 2014. But, watch out for the AMT, as these taxes are not deductible for AMT purposes.

Manage Your Adjusted Gross Income (AGI). Many tax breaks are only available to taxpayers with AGI below certain levels. Some common AGI-based tax breaks include the child tax credit (phase-out begins at $110,000 for married couples and $75,000 for heads-of-households), the $25,000 rental real estate passive loss allowance (phase-out range of $100,000–$150,000 for most taxpayers), and the exclusion of social security benefits ($32,000 threshold for married filers; $25,000 for other filers). In addition, for 2013 taxpayers with AGI over $300,000 for married filers, $250,000 for singles, and $275,000 for heads-of-households begin losing part of their personal exemptions and itemized deductions. Accordingly, strategies that lower your income or increase certain deductions might not only reduce your taxable income, but also help increase some of your other tax deductions and credits.

Making the Most of Year-end Securities Transactions

For most individuals, the 2013 federal tax rates on long-term capital gains from sales of investments held over a year are the same as last year: either 0% or 15%. However, the maximum rate for higher-income individuals is now 20% (up from 15% last year). This change affects taxpayers with taxable income above $400,000 for singles, $450,000 for married joint-filing couples, $425,000 for heads-of-households, and $225,000 for married individuals who file separate returns. Higher-income individuals can also get hit by the new 3.8% NIIT on net investment income, which can result in a maximum 23.8% federal income tax rate on 2013 long-term gains.

As you evaluate investments held in your taxable brokerage firm accounts, consider the tax impact of selling appreciated securities (currently worth more than you paid for them). For most taxpayers, the federal tax rate on long-term capital gains is still much lower than the rate on short-term gains. Therefore, it often makes sense to hold appreciated securities for at least a year and a day before selling to qualify for the lower long-term gain tax rate.

But be smart about this and don’t let the tax “tail” wag the investment “dog”; you don’t want hold the investment long term just to gain tax benefits at the cost of a possible loss of the accumulated gain.

Biting the bullet and selling some loser securities (currently worth less than you paid for them) before year-end can also be a tax-smart idea. The resulting capital losses will offset capital gains from other sales this year, including high-taxed short-term gains from securities owned for one year or less. For 2013, the maximum rate on short-term gains is 39.6%, and the 3.8% NIIT may apply too, which can result in an effective rate of up to 43.4%. However, you don’t need to worry about paying a high rate on short-term gains that can be sheltered with capital losses (you will pay 0% on gains that can be sheltered).

If capital losses for this year exceed capital gains, you will have a net capital loss for 2013. You can use that net capital loss to shelter up to $3,000 of this year’s high-taxed ordinary income ($1,500 if you’re married and file separately). Any excess net capital loss is carried forward to next year.

Selling enough loser securities to create a bigger net capital loss that exceeds what you can use this year might also make sense. You can carry forward the excess capital loss to 2014 and beyond and use it to shelter both short-term gains and long-term gains recognized in those years.

Identify the Securities You Sell. When selling stock or mutual fund shares, the general rule is that the shares you acquired first are the ones you sell first. However, if you choose, you can specifically identify the shares you’re selling when you sell less than your entire holding of a stock or mutual fund. By notifying your broker of the shares you want sold at the time of the sale, your gain or loss from the sale is based on the identified shares. This sales strategy gives you better control over the amount of your gain or loss and whether it’s long-term or short-term.

Secure a Deduction for Nearly Worthless Securities. If you own any securities that are all but worthless with little hope of recovery, you might consider selling them before the end of the year so you can capitalize on the loss this year. You can deduct a loss on worthless securities only if you can prove the investment is completely worthless. Thus, a deduction is not available, as long as you own the security and it has any value at all. Total worthlessness can be very difficult to establish with any certainty. To avoid the issue, it may be easier just to sell the security if it has any marketable value. As long as the sale is not to a family member, this allows you to claim a loss for the difference between your tax basis and the proceeds (subject to the normal rules for capital losses and the wash sale rules restricting the recognition of loss if the security is repurchased within 30 days before or after the sale).

Ideas for Seniors Age 701/2 Plus

Make Charitable Donations from Your IRA. IRA owners and beneficiaries who have reached age 701/2 are permitted to make cash donations totaling up to $100,000 to IRS-approved public charities directly out of their IRAs. These so-called Qualified Charitable Distributions, or QCDs, are federal-income-tax-free to you, but you get no itemized charitable write-off on your Form 1040. That’s okay because the tax-free treatment of QCDs equates to an immediate 100% federal income tax deduction without having to worry about restrictions that can delay itemized charitable write-offs. QCDs have other tax advantages, too. Contact us if you want to hear about them.

Be careful—to qualify for this special tax break, the funds must be transferred directly from your IRA to the charity. Also, this favorable provision will expire at the end of this year unless Congress extends it. So, this could be your last chance.

Take Your Required Retirement Distributions. The tax laws generally require individuals with retirement accounts to take withdrawals based on the size of their account and their age every year after they reach age 701/2. Failure to take a required withdrawal can result in a penalty of 50% of the amount not withdrawn. There’s good news for 2013 though—QCDs discussed above count as payouts for purposes of the required distribution rules. This means, you can donate all or part of your 2013 required distribution amount (up to the $100,000 limit on QCDs) and convert taxable required distributions into tax-free QCDs.

Also, if you turned age 701/2 in 2013, you can delay your 2013 required distribution to 2014, if you choose. However, waiting until 2014 will result in two distributions in 2014—the amount required for 2013 plus the amount required for 2014. While deferring income is normally a sound tax strategy, here it results in bunching income into 2014. Thus, think twice before delaying your 2013 distribution to 2014—bunching income into 2014 might throw you into a higher tax bracket or have a detrimental impact on your other tax deductions in 2014.

Ideas for the Office

Maximize Contributions to 401(k) Plans. If you have a 401(k) plan at work, it’s just about time to tell your company how much you want to set aside on a tax-free basis for next year. Contribute as much as you can stand, especially if your employer makes matching contributions. You give up “free money” when you fail to participate to the max for the match.

Take Advantage of Flexible Spending Accounts (FSAs). If your company has a healthcare and/or dependent care FSA, before year-end you must specify how much of your 2014 salary to convert into tax-free contributions to the plan. You can then take tax-free withdrawals next year to reimburse yourself for out-of-pocket medical and dental expenses and qualifying dependent care costs. Watch out, though, FSAs are “use-it-or-lose-it” accounts—you don’t want to set aside more than what you’ll likely have in qualifying expenses for the year.

Married couples who both have access to FSAs will also need to decide whose FSA to use. If one spouse’s salary is likely to be higher than what’s known as the FICA wage limit (which is $113,700 for this year and will likely be somewhat higher next year) and the other spouse’s will be less, the one with the smaller salary should fund as much of the couple’s FSA needs as possible. The reason is that the 6.2% social security tax levy for 2014 is set to stop at the FICA wage limit (and doesn’t apply at all to money put into an FSA). Thus, for example, if one spouse earns $120,000 and the other $40,000 and they want to collectively set aside $5,000 in their FSAs, they can save $310 (6.2% of $5,000) by having the full amount taken from the lower-paid spouse’s salary versus having 100% taken from the other one’s wages. Of course, either way, the couple will also save approximately $1,400 in income and Medicare taxes because of the FSAs.

If you currently have a healthcare FSA, make sure you drain it by incurring eligible expenses before the deadline for this year. Otherwise, you’ll lose the remaining balance. It’s not that hard to drum some things up: new glasses or contacts, dental work you’ve been putting off, or prescriptions that can be filled early.

Adjust Your Federal Income Tax Withholding. As stated at the beginning of this article, higher-income individuals will likely see their taxes go up this year. This makes it more important than ever to do the calculations to see where you stand before the end of the year. If it looks like you are going to owe income taxes for 2013, consider bumping up the federal income taxes withheld from your paychecks now through the end of the year. When you file your return, you will still have to pay any taxes due less the amount paid in. However, as long as your total tax payments (estimated payments plus withholdings) equal at least 90% of your 2013 liability or, if smaller, 100% of your 2012 liability (110% if your 2012 adjusted gross income exceeded $150,000; $75,000 for married individuals who filed separate returns), penalties will be minimized, if not eliminated.

Watch Out for the Alternative Minimum Tax

Recent legislation slightly reduced the odds that you’ll owe the alternative minimum tax (AMT). Even so, it’s still critical to evaluate all tax planning strategies in light of the AMT rules before actually making any moves. Because the AMT rules are complicated, you may want our assistance.

Don’t Overlook Estate Planning

For 2013, the unified federal gift and estate tax exemption is a historically generous $5.25 million, and the federal estate tax rate is a historically reasonable 40%. Even if you already have an estate plan, it may need updating to reflect the current estate and gift tax rules. Also, you may need to make some changes for reasons that have nothing to do with taxes.

Ideas for Your Business

Take Advantage of Tax Breaks for Purchasing Equipment, Software, and Certain Real Property. If you have plans to buy a business computer, office furniture, equipment, vehicle, or other tangible business property or to make certain improvements to real property, you might consider doing so before year-end to capitalize on the following generous, but temporary tax breaks:

  • Bigger Section 179 Deduction. Your business may be able to take advantage of the temporarily increased Section 179 deduction. Under the Section 179 deduction privilege, an eligible business can often claim first-year depreciation write-offs for the entire cost of new and used equipment and software additions. (However, limits apply to the amount that can be deducted for most vehicles.) For tax years beginning in 2013, the maximum Section 179 deduction is $500,000. For tax years beginning in 2014, however, the maximum deduction is scheduled to drop to $25,000.
  • Section 179 Deduction for Real Estate. Real property costs are generally ineligible for the Section 179 deduction privilege. However, an exception applies to tax years beginning in 2013. Under the exception, your business can immediately deduct up to $250,000 of qualified costs for restaurant buildings and improvements to interiors of retail and leased nonresidential buildings. The $250,000 Section 179 allowance for these real estate expenditures is part of the overall $500,000 allowance. This temporary real estate break will not be available for tax years beginning after 2013 unless Congress extends it.

Note: Watch out if your business is already expected to have a tax loss for the year (or be close) before considering any Section 179 deduction, as you cannot claim a Section 179 write-off that would create or increase an overall business tax loss. Please contact us if you think this might be an issue for your operation.

  • 50% First-year Bonus Depreciation. Above and beyond the bumped-up Section 179 deduction, your business can also claim first-year bonus depreciation equal to 50% of the cost of most new (not used) equipment and software placed in service by December 31 of this year. For a new passenger auto or light truck that’s used for business and is subject to the luxury auto depreciation limitations, the 50% bonus depreciation break increases the maximum first-year depreciation deduction by $8,000 for vehicles placed in service this year. The 50% bonus depreciation break will expire at year-end unless Congress extends it.

Note: First-year bonus depreciation deductions can create or increase a Net Operating Loss (NOL) for your business’s 2013 tax year. You can then carry back a 2013 NOL to 2011 and 2012 and collect a refund of taxes paid in those years. Please contact us for details on the interaction between asset additions and NOLs.

Evaluate Inventory for Damaged or Obsolete Items. Inventory is normally valued for tax purposes at cost or the lower of cost or market value. Regardless of which of these methods is used, the end-of-the-year inventory should be reviewed to detect obsolete or damaged items. The carrying cost of any such items may be written down to their probable selling price (net of selling expenses). [This rule does not apply to businesses that use the Last in, First out (LIFO) method because LIFO does not distinguish between goods that have been written down and those that have not].

To claim a deduction for a write-down of obsolete inventory, you are not required to scrap the item. However, in a period ending not later than 30 days after the inventory date, the item must be actually offered for sale at the price to which the inventory is reduced.

Employ Your Child. If you are self-employed, don’t miss one last opportunity to employ your child before the end of the year. Doing so has tax benefits in that it shifts income (which is not subject to the Kiddie tax) from you to your child, who normally is in a lower tax bracket or may avoid tax entirely due to the standard deduction. There can also be payroll tax savings since wages paid by sole proprietors to their children age 17 and younger are exempt from both social security and unemployment taxes. Employing your children has the added benefit of providing them with earned income, which enables them to contribute to an IRA. Children with IRAs, particularly Roth IRAs, have a great start on retirement savings since the compounded growth of the funds can be significant.

Remember a couple of things when employing your child. First, the wages paid must be reasonable given the child’s age and work skills. Second, if the child is in college, or is entering soon, having too much earned income can have a detrimental impact on the student’s need-based financial aid eligibility.

Conclusion

Through careful planning, it’s possible your 2013 tax liability can still be significantly reduced, but don’t delay. The longer you wait, the less likely it is that you’ll be able to achieve a meaningful reduction. The ideas discussed in this article are a good way to get you started with year-end planning, but they’re no substitute for personalized professional assistance. Please don’t hesitate to contact us with questions or for additional strategies on reducing your tax bill. We’d be glad to set up a planning meeting or assist you in any other way that we can. You can find us at http://ydfs.com

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