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Tax Newsletter
November, 2014

Another year end is fast approaching, so it it’s a good time to review your financial picture. Our year-end newsletter reviews various concepts and rules with regard to managing your portfolio and the potential tax ramifications, as well as other year-end opportunities. By taking steps before 2014 draws to a close, taxpayers may be able to reduce the size of their tax bill for the year.

There remains uncertainty surrounding the fate of numerous tax provisions that expired in 2013 as there continues to be talk of extending provisions such as—

  • Tax-free distributions (up to $100,000) from IRAs to charities
  • The State and local sales tax deduction
  • Credit for residential energy property
  • Alternative motor vehicle credit for qualified fuel cell motor vehicles

The prospect of extension of expired provisions, with retroactive implementation, can make planning extremely difficult. This puts a premium on maintaining flexibility in planning, while making it a challenge to keep all options open.

One thing is certain—tax rates are higher today than in the most recent past. With a top federal rate of 39.6%, a Net Investment Income tax (NII) of 3.8%, an additional Medicare tax of .9% for high wage earners, the federal rates can reach 44.3%. Add in the top California tax rate of 13.3%, and the combined federal and California tax exceeds 57% at the top brackets. Therefore, it is more important than ever to consider strategies that result in immediate tax savings. Strategies for reducing income tax may involve timing of income and deduction items, deferral of income through retirement plans, and shifting liabilities through charitable contributions or non-charitable gifts.

Income tax planning

Taxpayers should consider both 2014 and 2015 in their planning, particularly if income in one year is anticipated to be significantly higher than the other. Against a backdrop of shifting economics and the net investment income tax, taxpayers should consider traditional year-end tax strategies:

  • Shifting income by deferring income and accelerating deductions
  • Maximizing retirement plan contributions
  • Making charitable gifts
  • Harvesting capital losses; possibly accelerating capital gains

Since the tax increases apply when Adjusted Gross Income or taxable income exceeds specified thresholds, planning should be directed towards reducing/deferring income or increasing/deferring deductions to fall below the threshold amounts, where possible.

  • The 3.8% tax on net investment income applies when modified adjusted gross income exceeds $200,000 for single filers and $250,000 for married couples filing jointly
  • The .9% additional Medicare tax applies when wages and self-employment income exceed $200,000 for single filers and $250,000 for married couples filing jointly

It is possible that many mutual funds may make year-end distributions resulting in sizable capital gains to shareholders who will have to pay income taxes on the distributions.

Strategies for reducing Net Investment Income and/or Adjusted Gross Income could include:

  • Sell loss securities to offset capital gains you have already realized
  • Donate appreciated securities instead of cash to escape capital gains while receiving a charitable deduction
  • Consider a Charitable Remainder Trust (CRT) to spread out the income/gains on appreciated property over the payout term of the CRT, thus spreading out the associated income taxes
  • Defer gains by spreading them out with an installment sale and/or participating in a Section 1031 Like Kind Exchange
  • Invest in tax exempt investments
  • Invest in life insurance products and/or tax deferred annuity products
  • Maximize net investment interest deductions

Retirement plans

Maximizing contributions to a retirement plan can reduce current year taxable income. Funding the retirement plan contribution of a child or spouse may allow for additional income deferrals. Current year plan contribution limits are:

IRA $5,500 under 50; $6,500 over 50
401(k), 403(b) $17,500 and up to $23,000 for those over 50

A planning strategy that expired at the end of 2013 but may possibly be extended prior to 2014 is the contribution made directly to charity from an IRA. Although the payment does not give rise to a charitable contribution deduction, the withdrawal from the IRA escapes taxation.

Charitable contributions

As mentioned above, gifts of appreciated stock provide an opportunity to benefit charity and avoid tax liability that might otherwise be incurred. An individual could sell appreciated stock, pay the tax, and contribute the net proceeds to charity. Alternatively, that individual could contribute the appreciated stock to the charity and claim a charitable contribution deduction based on the fair market value of the stock. Because the charity is not subject to income tax, it can sell the stock without incurring tax liability.

A charitable remainder trust is one vehicle for retaining some income from trust assets while also receiving a charitable deduction upon creation of the trust. In the current low-interest rate environment, one might consider a Charitable Lead Annuity Trust (CLAT) as a vehicle to achieve both charitable and estate planning objectives. Under the terms of a CLAT, annuity payments are made to charity for the term of the trust. At the end of the CLAT’s term, the remaining assets are distributed to one or more non-charitable beneficiaries. While the gift of the remainder interest constitutes a gift, the value of the gift using IRS-prescribed interest rates may be lower than the amount actually transferred to the beneficiaries at the end of the term if the trust outperforms the prescribed rate. The October 2014 IRS rate is 2.2%.

A contribution to donor advised funds or creation of a private foundation are additional planning tools that may help reduce income taxes while helping you achieve your charitable goals. These may be particularly effective when you wish to make a large charitable contribution in the current year but are uncertain of the ultimate recipient of your charitable gift.

Shifting assets through non-charitable gifts

The American Taxpayer Relief Act of 2012 provided a permanent structure under which estate tax planning can now take place, including $5 million exclusion for non-charitable gifts made and estates of decedents dying after December 2012. The inflated-adjusted exclusion available for calendar year 2014 is $5,340,000. Thus an individual can make lifetime gifts or a transfer of assets at death up to this exclusion amount before gift or estate tax liability results.

Each taxpayer can give an inflation-adjusted annual exclusion gift of $14,000 to as many individuals as they wish without incurring any gift tax or reducing any of their lifetime exclusion amount. Tuition payments made directly to a school and medical service payments made directly to the provider are not counted as part of the $14K annual exclusion.

Section 529 plans are vehicles for investing funds to pay for future educational expenses. Funds grow tax-free and can be distributed tax-free as long as the funds are used for qualified educational expenses. Gifts to a child or grandchild’s section 529 plan is a means of transferring assets that will grow in a tax-free environment to offset future educational costs.

Gifts of appreciated property to children may be one approach to shifting the tax on gains to children in lower tax brackets. However, this strategy will not be effective when the “kiddie tax” causes income to be taxed at parents’ rates.

Planning for Businesses

  • The IRS has expanded the de minimis safe harbor that allows taxpayers to deduct an unlimited amount of improvement expenditures on qualifying buildings. The safe harbor applies to items of tangible property that cost $5K or less, and are deductible.
  • The Section 179 annual dollar limitation for the calendar year 2014 is $25,000, therefore, if total purchases in 2014 exceed $25K, certain assets will be expensed and others depreciated , using the election for the assets with the longest depreciation periods;
  • Bonus depreciation is no longer available, it expired as of December 31, 2013;
  • Research credit expired as of December 31, 2013;
  • California has started phasing in Net Operating Loss Carryback provisions for businesses and individuals. Taxpayers will be allowed a 2 year carryback as follows: 50% of the NOL generated in 2013, 75% of the NOL generated in 2014 and 100% of the NOL generated in 2015 and beyond;
  • Businesses subject to the mandatory electronic funds transfer (EFT) requirement in California can use credit card payments to meet this EFT requirement.

Affordable Care Act. Starting in 2014, the new national health insurance rules provides that individuals must carry health insurance or otherwise pay a monthly penalty (shared responsibility payment) unless exempt. For any month in 2014, taxpayers who fail to have the minimum essential coverage are subject to the “shared responsibility payment”.

In general the penalty is either a percentage of your income or a flat dollar amount, whichever is greater. You will owe 1/12th of the annual payment for each month you do not have coverage and are not exempt. The annual payment amount for 2014 is the greater of:

  • 1% of the yearly household income over the filing threshold; or
  • Flat dollar amount, which is $95 per adult and $47.50 per child, limited to a maximum of $285.

The maximum penalty assessed will be the national average yearly premium for a bronze level health plan.

Household income – generally is the sum of your adjusted gross income (AGI);
Filing threshold for families is estimated to be $20,000;
The IRS has published that the annual cost of a bronze level plan for a family would be between $12,000 and $12,500.

No penalty will be imposed on individuals without coverage for fewer than 90 days (with only one period of 90 days allowed in a year).

Note: The penalties are scheduled to increase in later years. In 2015 the penalty is scheduled to be the greater of 2% of income or $325 per person, and in 2016 and later the penalty is scheduled to be the greater of $2.5% of income or $695 per person.

Running the numbers. We recommend running tax projections for 2014 and future years before implementing year-end tax strategies. Please let us know if you would like our assistance in preparing a projection. For taxpayers making estimated tax payments, such estimates may have to be increased to adjust to potentially higher tax rates on 2014 income.


The information contained in this newsletter is general in nature and does not constitute tax advice or opinion. Applicability to specific situations should be determined through consultation with your tax advisor.

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