Despite what Democratic Senator Ron Wyden of Oregon calls “a rotting economic carcass that’s infected with chronic diseases like loopholes and inefficiencies,” federal tax reform is unlikely to occur until after the U.S. presidential election in 2016. Deadlock between the political parties is likely to continue, especially in light of Republicans gaining control of both houses of government during the November 2014 elections.
However, despite the inaction of Congress, the fact remains that more than 50 tax breaks expired at the end of 2013 – and many Americans are unaware of the changes, even though their tax bill may incur a significant increase. If you are among those earners who may be affected, it is important to recognize these changes and to take action before the end of the year to keep more of your gross earnings.
Tax Law Changes That May Affect You in 2015
High-earning taxpayers will be liable for higher taxes due to laws passed in 2013 that include the following:
- New top tax bracket of 39.6% for incomes greater than $400,000 for individuals and $450,000 for joint filers
- Medicare surtax charge of 0.9% for individuals who earn more than $200,000, or $250,000 for joint filers
- Net Investment Income Tax of 3.8% on the lesser of your net investment income or the excess of your modified adjusted gross income (MAGI) over $200,000 for individuals, or $250,000 filing jointly
- Limitations on itemized deductions and personal exemptions for those with incomes of $254,200 or more ($305,050 for joint filers)
Additional changes that may increase your taxes include the following:
- Higher Threshold for Unreimbursed Medical Expenses. For taxpayers under age 65, the threshold for deducting unreimbursed medical expenses has risen from 7.5% to 10% of adjusted gross income (AGI).
- Loss of Charitable IRA Rollovers for Older Taxpayers. The provision that allowed taxpayers 70 1/2 years of age and older to donate up to $100,000 to a charity without recognizing the distribution as income has expired.
- Loss of Sales Tax Deduction. Residents of states that do not have income taxes, such as Florida and Texas, can no longer deduct state sales tax from their gross income.
- Loss of Private Mortgage Insurance (PMI) Premium Deduction. Homeowners who have less than 20% equity in their homes typically have PMI, whose premiums were deductible in 2012 and 2013. While the premiums are no longer deductible, interest on the mortgage continues to be.
- Affordable Care Act Penalty. If you do not have health insurance or meet certain provisions, you must pay either 1% of your taxable income or $95 per adult and $47.50 per child, with a maximum of $325 per family, whichever is greater.
- Loss of Teacher Expenses Deduction. Teachers who pay for classroom supplies and other unreimbursed expenses are no longer allowed to deduct up to $250 from their income.
- Loss of Qualified Tuition and Fees Deduction. The opportunity to deduct up to $4,000 of qualified tuition and fees for the taxpayer, the taxpayer’s spouse, or dependent has expired.
- Expiration of Certain Green Tax Credits. Credits for buying electric vehicles or making energy-efficient improvements to your principal residence are no longer available.
- Expiration of Section 179 Expense Deduction for Small Business Owners. The ability to deduct up to $500,000 for the purchase of qualified equipment in the year purchased, instead of depreciating the cost over time, has been cut to $25,000.
Fortunately, there are some slightly higher limits through inflation adjustments that can benefit certain taxpayers:
- Personal and dependent exemptions rise to $3,950 in 2014, up from $3,900 in 2013.
- In 2014, the standard deduction rises to $12,400 for married taxpayers filing jointly, $9,100 for heads of households, and $6,200 for those filing separately. This compares to $12,200 for married persons filing jointly, $8,950 for heads of households, and $6,100 for singles and those filing separately in 2013.
- Annual deduction for health savings accounts increases to $6,500 ($6,450 in 2013) for families and $3,300 ($3,250 in 2013) for individuals.
In addition, self-employed taxpayers remain eligible for the simplified home office deduction passed in 2013.
Year-End Tax Strategies
The classic tax strategy has always been to defer income into the future and accelerate deductions into the present tax period. This strategy is particularly beneficial in 2014, as the likelihood of tax increases (for all but the highest earners) in the following several years appears to be low.
Useful Methods to Defer Income to a Later Calendar Year
1. Postpone Bonus or Commission Income
If you delay any portion of your salary, a bonus, or a commission, thereby transferring the tax liability to a later calendar period, avoid “constructive receipt” of the payment – the IRS generally accepts the cash accounting method that recognizes income when it is physically received, unless a taxpayer is using accrual accounting (recording payments when earned) or is in constructive receipt of the payment. Constructive receipt means that your employer or other payor cannot credit the payment to your account in the current year, set the payment aside in a segregated account for your benefit, or otherwise let you control its disbursement. As a consequence, the bonus or commission cannot be deducted from your employer’s account and tax filing until it is actually paid to you.
2. Delay Year-End Billings
If you are self-employed, postpone your December billings until January of next year. This tactic moves collections to the following tax year, reducing your current tax year revenues by an equivalent amount. Be sure you file taxes under the cash accounting method (when income is physically received), rather than the accrual method (when you earn it).
3. Delay Retirement Distributions
Wait until after January 1st to take money from your retirement plans. The exception to this advice would be taking distributions that are treated as a return of principal, such as some withdrawals from a Roth IRA, or taking required minimum distributions (RMDs) from a traditional IRA.
Useful Methods to Cut Taxable Income in the Present Year
4. Make Maximum Contributions to Tax-Deferred Retirement Plans
Contributions reduce taxable income. The limit on 401k contributions is $17,500 for those under 50 and $23,000 for those 50 and older for tax year 2014. These contributions must be made by year-end to be deductible. However, April 15th is the last date for deductible IRA contributions (up to $5,500 if you are under age 50 and $6,500 if older for tax year 2014). If you or your spouse contributes to an employer retirement plan and your modified adjusted gross income exceeds $60,000, the amount of your deductible contribution may be limited or excluded.
5. Consider Taking Short-Term Investment Losses Before the End of the Year
While tax savings should never be a reason to sell any investment, losses can be used to offset capital gains and up to $3,000 of ordinary income. Just be sure to avoid the “wash sale” provisions of the IRS tax code for those securities you want to own long-term. Since these provisions can be complex, consult the IRS or your tax professional for guidelines.
6. Pay the Following Year’s Property Taxes in the Current Calendar Year
Property taxes are deductible in the year they are paid if you are using the cash method of accounting.
7. Prepay Mortgage Payments for the Early Months of the Coming Year
If your mortgage payment is due on the first of the month, make January’s payment by December 31st to claim the interest portion of that payment for the present tax year. If you wait until January 1st, you won’t be able to claim the interest portion until next tax year.
8. Pay Other Tax-Deductible Expenses in the Present Year
This is particularly true if you have a home-based business and are able to deduct a proportional share of utilities. You may also consider purchasing supplies this year that you’re certain to use next year so they’re deductible in the current tax year.
9. Donate Appreciated Stock to Charities, Rather Than Cash
This enables you to capture the deduction for charitable giving without having to recognize and pay taxes on the appreciation of a stock. There is one requirement to get the full value of the stock in a deduction: You need to be sure the asset has been held for more than a year. If it hasn’t, your deduction is limited to the stock cost.
10. Make Expected Charitable Donations for the Following Year Now
Such deductions can include cash or property, and may require special documentation and records. Be aware of the various limits on donations based upon your income or the type of gift donated.
In the coming years, even with the possibility of tax reform, the federal debt and deteriorating financial condition of state and local governments is likely to result in increased and novel ways to separate you from your hard-earned dollars by way of higher taxes. As a consequence, tax planning should be a year-round effort to maximize your share of the income you earn, rather than a last-minute rush every December.
Do you expect to pay more or less taxes than in previous years?