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                                                                                                                                                                                                                         November-­‐December  2014      Dear  H&M  Clients  and  Friends:  

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   and   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  multiyear  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  

 

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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  

 

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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.  

 

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.  

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,   as   well   as   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   ($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.  

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).  

 

 

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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  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   withholdings)   equal   at   least   90%   of   your   2014  liability   or,   if   smaller,   100%   of   your   2013   liability   (110%   if   your   2013   adjusted   gross   income   exceeded  

 

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$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  letter  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  planning  meeting  or  assist  you  in  any  other  way  that  we  can.  

 Sincerely,  

                                                                                                                                                                                                                                                 Certified  Public  Accountants