NEW YORK (MainStreet) — It’s that time of year again. Time to talk about year-end tax planning – and what you can do during the last two months of the year to make sure that you will pay the absolute least possible amount of federal and state income tax for 2014.
- There are no year-end tax planning strategies that apply to all taxpayers in all cases. Year-end transactions must be based on the specific facts and circumstances of your individual situation.
- Your first criteria for evaluating any proposed financial transaction should always be economic. Tax considerations should come second.
- Consider the state and local tax consequences of potential year-end transactions. And be aware of how transactions will affect your exposure to the Alternative Minimum Tax (AMT). While a year-end strategy may reduce your “regular” federal income tax for 2014, it may end up costing you additional state income taxes or make you fall victim to AMT.
- And perhaps most important, do not take any action on year-end strategies without first discussing them with your tax professional.
THE TRADITIONAL ROUTE
Traditional year-end planning calls for postponing the receipt of taxable income until 2015 and accelerating allowable deductions to be claimed in 2014. This strategy will generally apply if you expect to be in the same tax bracket for both 2014 and 2015, or if you expect to be in a lower bracket in 2015.
If you anticipate a substantial jump in income in 2015, which will push you into a higher bracket, you should do the opposite and accelerate the receipt of taxable income this year and postpone deductible expenses until next year. Income will be taxed at a lower rate in 2014, and deductions claimed in 2015 will provide a greater tax savings.
If you are unsure what your 2015 income will look like follow the traditional advice and “when in doubt, defer.” Postpone income and accelerate expenses.
An employee cannot do much, if anything, to postpone income to 2015. If you have a choice when to receive a year-end bonus choose 2015. Self-employed individuals can put off sending out invoices until late December or January.
Be advised that cash-based businesses must report income in the year actually received, whether or not deposited into your bank account. You cannot push taxable income into 2015 by simply holding on to cash and checks received in-hand in the last weeks of December and waiting until January to make a deposit.
THE TIMING OF DEDUCTIONS
It does not pay to itemize on Schedule A unless your total deductions exceed the Standard Deduction that applies to your filing status, plus any additions for age or blindness.
Make charitable contributions scheduled for early 2015 in 2014, and make your January mortgage payment in December. If you are making quarterly state estimated tax payments make the fourth payment, due January 15, 2015, in December.
But if your projected return indicates you don’t have anywhere near enough deductions to receive a tax benefit from itemizing, postpone making any deductible payments until 2015. Making these payments in 2014 will not produce any tax savings, but it is possible that by deferring them until next year you may be able to itemize in 2015.
Whether a deduction is allowed in 2014 or 2015 depends not on the date written on the check but on the check's “date of delivery. Put payments in the mail on December 24th and not December 31st. Checks dated as late as December 31 that are hand delivered to payees before the ball drops at One Times Square and the New Year is rung in will be deductible in 2014.
If you do not have the cash available to pay for deductible items that you have scheduled as part of your 2014 year-end tax plan you can use a credit card. Allowable expenses charged to a “bank” credit card (Visa, MasterCard, Discover, American Express, Diners Club) are deductible in the year charged, and not in the year that you actually pay for the charge. This is not true for “store” credit cards like those issued by Sears or JCPenney.
MEDICAL AND MISCELLANEOUS DEDUCTIONS
The timing of deductions is especially important when it comes to medical expenses and miscellaneous job-related and investment expenses.
You are allowed to deduct medical expenses only if the total exceeds 10% of your Adjusted Gross Income (AGI) - 7.5% for taxpayers age 65 and older. If you anticipate an AGI of $70,000, you must exclude the first $7,000 of medical expenses. If your medical expenses to date are close to or more than $7,000, and you will be able to itemize, pay any outstanding medical bills and schedule, and pay for, check-ups, doctor visits and needed dental work in November and December. If your medical payments to date are substantially less than $7,000, put off paying any more medical bills until 2014.
When adding up medical expenses be sure to include travel to and from doctors, dentists, clinics, hospitals, therapy, etc. at 23.5 cents per mile and related parking and tolls.
Most miscellaneous deductions, such as job-related, investment and tax preparation expenses, are only deductible to the extent the total exceeds 2% of AGI. If your anticipated AGI is $70,000 the first $1,400 of these miscellaneous expenses are not deductible. This 2% exclusion does not apply to gambling losses. If you itemize qualifying losses are deductible in full regardless of your income.
As with medical costs, time the payment for these items to maximize your tax savings.
CAPITAL GAINS AND LOSSES
When preparing your projected return you should review the performance of your investment portfolio for the year. Add up all of your realized gains and losses from actual sales for the first ten months of the year, with separate net totals for short-term (held one year or less) and long-term (held more than one year) activity. Gains and losses from the sale of inherited property are considered long-term, as are any “capital gain distributions” from mutual funds.
Do a similar calculation for any unrealized “paper” gains and losses on the investments you still hold.
Short-term losses are first used to offset short-term gains before being used to offset long-term gains, and long-term losses are used to offset long-term gains before they are used to offset short-term gains.
You may want to sell something before the end of the year at a loss to wipe out year-to-date gains, or at a profit to offset year-to-date losses in excess of the $3,000 maximum you are allowed to claim as a current deduction.
Long-term capital gains, and qualified dividends, are taxed separately on the federal return, both under “regular” tax and the AMT, as follows –
- 0% if you are within the 10% and 15% brackets
- 15% if you are within the 25%, 28%, 33%, and 35% brackets
- 20% if you are within the 39.6% bracket
If you will fall within the 10% or 15% brackets you may want to generate additional long-term capital gains to take full advantage of the 0% federal rate. These gains will, however, be taxed on your state return.
When coming up with your year-end plan, remember that while excess capital losses can be carried forward to future years on the federal return, this may not be true on your state return. For example, losses in excess of gains are lost forever on the state 1040.
And be aware of the wash sale rule. You cannot claim a current loss for the sale of an investment if you purchase the same, or a “substantially identical,” investment within 30 days before or after the date of the sale.
This does not apply if the sale results in a profit. If you need a gain to offset excess losses, or to take advantage of the 0% rate, you can sell an investment that has increased in value, claim the capital gain, and buy back the exact same investment the next day.
--Written by Robert D. Flach for MainStreet