Overview

As you get set to welcome 2015, now is the time to take steps toward managing your tax liability for 2014. Although you will not file your 2014 tax returns until 2015, many tax planning strategies need to be acted on prior to December 31, 2014. This article suggests federal tax planning strategies to consider as you are preparing your 2014 return. However, being that every taxpayer’s situation is unique, we recommend that you consult a qualified tax advisor before implementing any of the strategies discussed in this article.

Uncertainty Surrounding Extenders

Even with the 2014 elections in the rearview mirror, there has been no movement on the tax breaks that lapsed as of December 31, 2013 (the “Extenders”), including deduction for state and local sales taxes; above-the-line (i.e., not contingent on a taxpayer’s opting to itemize) deduction for certain expenses incurred by teachers; above-the-line deduction for qualified tuition and related expenses; deduction for mortgage insurance premiums; exclusion of discharge of principal residence indebtedness from gross income; qualifying tax-free transfers directly from IRAs to charities for individuals age 70½ and up; increased cap on charitable deductions for certain conservation easements; $500 credit for energy-efficient home improvements; and temporary 100% tax exemption for gain on certain qualified small business stock. There could still be movement on the Extenders between the date of this article and the end of the year, so please check with your advisor to see how you might be affected.

Tax Brackets, Deductions, and Personal Exemptions

For the 2014 tax brackets, standard deductions, and personal exemption, please refer to the following table and numbers. Note that the top tax bracket remains at 39.6%, having last increased from 35% with the American Tax Relief Act of 2012. Being in the top tax bracket can have additional unfavorable consequences. The long-term capital gains (LTCG) tax on the highest income tax bracket increased from 15% to 20% in 2013, and remains at that level for 2014 returns. This increased 20% rate applies to any LTCG in excess of the threshold for the highest tax bracket. For example, if you are a single taxpayer and you have $400,000 of taxable income and an additional $50,000 in LTCG, then $6,750 of the LTCG would be taxed at 15% and the remaining $43,250 of the LTCG would be taxed at 20% (because the latter constitutes the portion of total income that exceeds the threshold for the highest tax bracket). You should consider whether it is prudent for you to employ some of the strategies below to remain out of this top tax bracket.

2014 Tax Brackets

2014 Standard Deductions

2014 Personal Exemption

The personal exemption amount in 2014 is $3,950. However, the personal exemption is phased out starting with adjusted gross income of $254,200 for individuals and $305,050 for married couples filing jointly. The personal exemptions phase out completely at $376,700 for individual taxpayers and $427,550 for married couples filing jointly.

2014 Gift Tax Exclusion

The annual exclusion for gift tax purposes is $14,000 for 2014. Therefore, an individual can transfer up to $14,000 without having to pay the gift tax. However, making a gift will not affect your federal income tax unless you are making a charitable contribution (see below for deductions of charitable contributions).

At the end of October, the Internal Revenue Service (IRS) announced the annual inflation adjustments for several tax provisions, notably the tax brackets, standard deductions, and personal exemption. The table and numbers below should be referenced when you prepare your 2015 tax returns in 2016. For your 2014 tax returns, please refer to the table and numbers above.

2015 Tax Brackets

2015 Standard Deductions

2015 Personal Exemption

The personal exemption amount in 2015 is $4,000. However, the personal exemption is phased out starting with adjusted gross income of $258,250 for individuals and $309,900 for married couples filing jointly. The personal exemptions phase out completely at $380,750 for individual taxpayers and $432,400 for married couples filing jointly.

2015 Gift Tax Exclusion

The annual exclusion for gift tax purposes remains at $14,000 for 2015.

Additional Taxes to Be Aware of

Aside from an increased top tax bracket of 39.6%, the American Tax Relief Act of 2012 brought other tax increases that are especially relevant to higher-income individuals. The Medicare surtax and the Net Investment Income Tax (NIIT) are now in their second tax season. Both of these taxes are in addition to the statutory tax rates discussed above and should be taken into account when determining estimated tax for 2014.

Medicare Surtax

The Medicare surtax is an additional 0.9% Medicare tax on wages and self-employment income. The surtax applies only to income in excess of certain thresholds. For 2014, the Medicare surtax applies to single tax filers with income above $200,000, married couples with combined income above $250,000, and those who are married but filing separately with income above $125,000. For example, if you are a single taxpayer and you have a salary of $300,000, you will pay Medicare tax at a rate of 1.45% on $200,000 of your salary, but 2.35% on the $100,000 above the threshold.

Net Investment Income Tax

The Net Investment Income Tax applies to taxpayers to the extent that their net investment income and their modified adjusted gross income, exceeds the following thresholds: $200,000 for single tax filers, $250,000 for married couples, and $125,000 for those who are married but filing separately. The 3.8% tax is applied to the lesser of the taxpayer’s net investment income or the taxpayer’s modified adjusted gross income above those thresholds. Investment income includes the following types of income: interest; dividends; capital gains; rental and royalty income; non-qualified annuities; income from businesses involved in trading of financial instruments or commodities; and income from businesses that are considered passive activities. If you think you will be subject to the Net Investment Income Tax, you might wish to consider tax planning strategies such as deferring income to 2015 or increasing your above-the-line deductions (both discussed below).

Penalties to Be Aware of

One key benefit of assessing your tax liability now is that it can help you ensure that you do not pay any unnecessary penalties. Under the Affordable Care Act, individuals are required to have health insurance. If you do not have health insurance, you could face a penalty of $95 or 1% of gross income, whichever is greater.

In addition to checking your health insurance, you should check to see if you will be subject to an estimated tax underpayment penalty. If you have substantial income in addition to your salary, you might find that the amount of tax withheld from your salary is not enough to cover your required estimated tax payments. Under-withholding can be the result of miscalculation or unawareness of certain tax liabilities, such as unexpected exposure to the Net Investment Income Tax. Increasing your withholding now can help you avoid an estimated tax underpayment penalty.

Strategies to Manage Deductions

Above-the-Line Deductions

Every taxpayer should review their expenses for the year to make sure that they are fully utilizing the deductions available to them. Above-the-line deductions are especially favorable because they not only reduce your taxable income, they may eliminate or mitigate the impact of the phase-out of itemized deductions, and they may bring you below the threshold of the Net Investment Income Tax or reduce your liability thereunder. Above-the-line deductions include deductions for:IRA or Health Savings Account contributions; health insurance premiums for self-employed individuals; qualified student loan interest; qualified moving expenses; alimony; and business expenses for a self-employed individual. Maximizing your IRA contributions is often the easiest way to take advantage of above-the-line deductions. In 2014, the maximum contribution for 401(k) plans is $17,500 for individuals under age 50 and $23,000 for individuals aged 50 and over.

Itemized Deductions

If you have numerous itemized (below-the-line) deductions, it might make sense for you to forgo the standard deduction (see standard deductions for 2014 above). Itemized deductions include deductions for charitable contributions; state and local income taxes; property taxes; medical expenses; unreimbursed employee travel expenses; home mortgage interest; and gambling losses (to the extent of gambling income). Generally, the easiest deductions to shift from 2015 to 2014 are charitable contributions, state and local taxes, and your January 2015 home mortgage interest payment.

Charitable contributions in particular provide additional tax savings opportunities. If you have appreciated stock (held for more than 1 year), consider contributing the stock instead of cash. Your contribution will be equal to the value of the stock, and you will avoid the capital gains tax and possibly the 3.8% Net Investment Income Tax you would have incurred had you sold the assets. On the other hand, if you are considering contributing an investment asset that has declined in value, it would be prudent for you to sell the asset first and then contribute the cash. This way, you will get a charitable deduction and a capital loss. However, keep in mind that the tax laws do limit the deductions of charitable contributions based on the donor’s income, the type of contribution made, and the type of organization to which the contribution is made.

It is important to note that certain itemized deductions start to phase out if your income exceeds certain thresholds ($254,200 for individuals and $305,050 for married couples filing jointly). In addition, if you are subject to the Alternative Minimum Tax (AMT), you will not be able to fully utilize all of the itemized deductions.

Strategies to Postpone Taxable Income

Deferring some of your taxable income from 2014 to a later year might be advisable, especially if doing so would cause you to fall into a lower tax bracket. If you are just above the threshold of the highest tax bracket, you might find this option especially attractive because you can avoid the higher rate of 20% on LTCG. Deferring taxable income would also be beneficial if doing so would cause you to fall below the threshold of the Net Investment Income Tax or reduce your liability thereunder.

There are various tax planning strategies that you can implement to defer income past 2014. If you are selling an asset, you could do so with the installment method and thereby spread your gain over several years. If you are a salaried employee and your company is flexible in the timing of bonuses, it might make sense for you to delay your bonus into 2015. Your ability to do this will depend on whether it is standard practice for your company to do so and whether it is willing to defer its deduction for payment of your bonus to 2015. On the other hand, if you are self-employed or a partner, you might want to consider delaying some of your billing until early in 2015. Doing so will defer a portion of your taxable income.

However, you should note that income deferral does not always align with business goals, which means that the appropriateness of such a strategy depends on your circumstances and financial objectives. In considering these strategies, you should be cognizant of your projected income for 2015. Deferring income into 2015 would not be wise if you expect your 2015 marginal tax rate to be higher than your 2014 marginal tax rate.

Strategies to Manage Investment Income

How you structure and manage your investment portfolio can have significant tax implications. Your portfolio may still hold opportunities for you to reduce your 2014 tax liability.

Take Advantage of the 0% Tax Rate on Capital Gains

Review your income for the year to see if you may have income low enough to take advantage of the 0% rate. This is especially true if you are in-between jobs, retired, or suffered business losses during the year. If you do fall under the threshold, you should review your portfolio to see if any gains can be realized without any tax impact.

Timing Your Capital Gains and Losses

If you have large capital gains in 2014 and you have unrealized losses in your investment portfolio, you might want to consider selling some of those assets now and using the losses to offset gains. If you do not plan on having any capital gains in the coming years, this could severely constrain the application of capital losses to those years, because capital losses in excess of capital gains may be used to offset only up to $3,000 of ordinary income each year.

On the other hand, if you have carried forward significant capital losses into 2014 from previous years, consider selling appreciated property that will produce capital gains. Recognizing those gains will allow you to absorb some of the losses that you have carried forward. This strategy merits extra consideration if you think that the property has reached its peak value.

Shift Investments to Avoid the NIIT

If you think you will have a significant tax liability under the Net Investment Income Tax, you might want to consider shifting some of your investments to alternative vehicles. Interest income from municipal bonds and distributions from retirement accounts such as IRAs and 401(k)s are exempt from the 3.8% Net Investment Income Tax. Municipal bonds can provide an additional benefit to you, in that the interest income will be exempt from federal taxes.

Conclusion

As the calendar year comes to a close, there may be tax saving opportunities available to you with the proper planning. Keep in mind that this article addresses only federal tax provisions and federal tax planning strategies. There may be additional state tax planning opportunities available to you. Any strategy needs to be tailored to your circumstances and financial objectives, and we do not recommend implementing any of these strategies without first consulting a qualified tax advisor.

If you have any questions about this article or would like additional information, please contact a Hinckley Allen Tax professional