2014 Tax Planning Guide for Individuals
Apply traditional techniques
One year ago, prospects for comprehensive tax reform were looking up in Congress. Two senior lawmakers, Sen. Max Baucus, D-Montana, and Rep. Dave Camp, R-Mich., had worked together to develop a tax reform package. In early 2014, Camp introduced a sweeping tax reform bill, the Tax Reform Act of 2014. If it had passed, Camp’s bill would have turned traditional year-end planning upside down. However, momentum for tax reform quickly faded. Baucus retired from Congress to become U.S. ambassador to China. Camp also announced his plans to retire after 2014. Several proposals in Camp’s bill have moved separately in the House, but not yet in the Senate, and any action on the overall bill is extremely unlikely before year-end.
What does this mean for tax planning? It means that the current Tax Code, with all its complexities, will be around for 2015 and likely for 2016. The current individual income tax rate structure (10, 15, 25, 28, 33, 35, and 39.6 percent) will be in place for 2015. The same is true for the current tax treatment of capital gains and dividends. The limitation on itemized deductions and the personal exemption phaseout are also expected to remain unchanged for 2015. The alternative minimum tax (AMT) is “patched,” thanks to the American Taxpayer Relief Act of 2012 (ATRA), providing enhanced exemption amounts and allowing the use of nonrefundable personal credits against regular tax and AMT liability. All these developments provide some certainty in tax planning for year-end 2014.
Individuals should take a look at traditional year-end tax planning techniques. One traditional technique is, if possible, to spread the recognition of income between 2014 and 2015. This may come into play for individuals who are able to postpone year-end bonuses, maximize deductible retirement contributions, and delay year-end billings. Individuals may want to consider the prepayment of real estate taxes or mortgage interest. Timing the recognition of capital gains and losses at year-end may help to minimize an individual’s net capital gains tax and maximize deductible capital losses. Life changes can also impact traditional year-end tax planning. Individuals who married or divorced, changed jobs, retired, or experienced other life events in 2014 need to review how these events may have revised their tax planning. A change in employment, for example, may bring about severance pay, sign-on bonuses, stock options, moving expenses, and COBRA health benefits, which all must be taken into account in year-end tax planning.
Retirement savings strategies also fall within traditional year-end planning techniques. Individuals also can contribute up to $5,000 to an IRA or Roth IRA for 2014. If they qualify, individuals can make additional so-called “catch-up contributions” up to $5,500. This treatment is targeted to individuals age 50 and older. Keep in mind that individuals have until April 15, 2015, to make an IRA contribution for 2014. Code Sec. 401(k) plans and similar arrangements, including new myRA accounts, should be explored to determine their maximum benefit.
Gift-making in general should be part of a year-end review. Individuals can make tax-free gifts of $14,000 per recipient (unlimited in number) for 2014. Married couples may combine their gift-tax exclusion amounts and make tax-free gifts per recipient of up to $28,000 for 2014. There is an important and often over-looked provision affecting gifts. An individual can make unlimited tax-free gifts used for qualified tuition or medical expenses of another person. The qualified tuition or medical expenses must be paid directly to a medical or educational institution.
Planning for net investment income tax
For some individuals, the new net investment income tax has become part of their year-end tax planning. The Affordable Care Act created the net investment income tax to help fund health care reform. There are three categories of net investment income: • Category 1: gross income from interest, dividends, annuities, royalties and rents, if the income is not derived in a trade or business; • Category 2: income from a “trade or business” that is a passive activity, as determined under Code Sec. 469, or is from a business as a financial trader; and • Category 3: net gains from the sale of property, unless the property is held in a nonpassive trade or business.
Under Code Sec. 469, individuals may group multiple activities into a single activity. Generally, an individual must meet the material participation standard of Code Sec. 469 for each activity. Grouping into a single activity can make it easier for a taxpayer to meet the standard by combining the taxpayer’s hours and participation. By grouping activities, a taxpayer may be able to avoid having income treated as net investment income.
The Affordable Care Act envisioned that the net investment income tax would impact higher income taxpayers. The Affordable Care Act set certain income thresholds for triggering the net investment income tax: $200,000 for single taxpayers; $250,000 for married couples filing a joint return; and $125,000 for married couples filing separately.
New considerations from Affordable Care Act
As of January 1, 2014, the Affordable Care Act requires all individuals to carry health insurance or make a shared responsibility payment, unless exempt. For many, employer-provided health insurance will satisfy the individual mandate. Others will satisfy the individual mandate if they are covered by Medicare or Medicaid. Individuals who are not exempt will need to make a shared responsibility payment when they file their 2014 returns in 2015. Generally, the shared responsibility payment amount is either a percentage of the individual’s income or a flat dollar amount, whichever is greater. The amount owed is 1/12th of the annual payment for each month that a person or the person’s dependents are not covered and are not exempt. For 2014, the payment amount is the greater of:
- 1 percent of the person’s household income that is above the tax return threshold for their filing status; or
- A flat dollar amount, which is $95 per adult and $47.50 per child, limited to a maximum of $285.
The individual shared responsibility payment is capped at the cost of the national average premium for the bronze level health plan available through the Marketplace in 2014.
The lack of health insurance does not automatically mean an individual must make a shared responsibility payment. The types of exemptions are broad. For example, an individual may have no affordable coverage options because the minimum amount he or she must pay for the annual premiums is more than eight percent of household income. An individual also may have a hardship that prevents him or her from obtaining coverage. Some seven million individuals have obtained health insurance through the Affordable Care Act Marketplace. Many qualified for a special tax break to help offset the cost of coverage (the Code Sec. 36B credit) and many took advance payments of the credit. In these cases, individuals must reconcile the amount paid in advance with the amount of the actual credit computed when they file their tax returns. Life changes in 2014 may impact the final credit amount.
ESTATE AND GIFT TAXES
After a number of years during which significant uncertainty existed over the federal estate and gift tax system, ATRA finally provided a permanent structure under which planning can now take place. ATRA permanently provides for a maximum federal unified estate and gift tax rate of 40 percent with an inflation-adjusted $5 million exclusion for gifts made and estates of decedents dying after December 31, 2012.. ATRA also preserved the annual gift tax exclusion. This exclusion allows taxpayers to give up to an inflation-adjusted $14,000 to any individual, gift tax free and without counting the amount of the gift toward the lifetime $5 million exclusion, adjusted for inflation.
LIFE CYCLE CHANGES IMPORTANT TO YEAR-END STRATEGIES
In addition to changes in the tax law, year-end tax strategies should also consider personal circumstances that changed during 2014. These “life cycle” changes include:
- Change in filing status: marriage, divorce, death or head of household changes
- Birth of a child
- Child no longer young enough for child credit
- Child who has outgrown the “kiddie” tax
- Casualty losses
- Changes in medical expenses
- Moving/relocation
- College and other tuition expenses
- Employment changes
- Retirement
- Personal bankruptcy
- Large inheritance
- Business successes or failures
TRADITIONAL YEAR-END STRATEGIES
Year-end 2014 presents unique challenges. At the same time, traditional year-end planning techniques nevertheless remain important both to maximize benefits in connection with what’s new and to do so within the usual ebb and flow of the taxpayer’s personal economy. The following traditional income and deduction acceleration techniques and their reciprocal deferral strategies should be considered:
Income Deferral/Acceleration:
- Enter into/Sell installment contracts
- Defer/Receive bonuses before January
- Hold/Sell appreciated assets
- Accelerate income to use available carryforward losses
- Hold/Redeem U.S. Savings Bonds
- Accumulate/Declare special dividend
- Postpone/Complete Roth conversions
- Delay/Accelerate debt forgiveness income
- Minimize/Maximize retirement distributions
- Delay/Accelerate billable services
- Structure/Avoid mandatory like-kind exchange treatment
Deductions and Credits Acceleration/Deferral
- Bunch itemized deductions into 2014 and take standard deduction in 2015/reverse steps
- Pay bills in 2014/postpone payments until 2015
- Pay last state estimated tax installment in 2014/delay payment until 2015
- Accelerate economic performance/postpone performance
- Watch AGI limitations on deductions/credits
- Watch net investment interest restrictions
- Match passive activity income and losses