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2014 Year-End Tax Planning Basics

When it comes to year-end tax planning, you need to have a good understanding of both your own financial situation and the tax rules that apply.

For some, that's going to be a little challenging this year because a host of popular tax provisions, commonly referred to as "tax extenders," expired at the end of 2013. And while it remains possible that Congress could retroactively extend some or all of the expired provisions, you can't count on it. Despite this uncertainty, the window of opportunity for many tax-saving moves closes on December 31, so it's important to evaluate your tax situation now, while there's still time to affect your bottom line for the 2014 tax year.

Timing is everything

Consider any opportunities you have to defer income to 2015. For example, you may be able to defer a year-end bonus, or delay the collection of business debts, rents, and payments for services. Doing so may allow you to postpone paying tax on the income until next year. If there's a chance that you'll be in a lower income tax bracket next year, deferring income could mean paying less tax on the income as well.

Similarly, consider ways to accelerate deductions into 2014. If you itemize deductions, you might accelerate some deductible expenses like medical expenses, qualifying interest, or state and local taxes by making payments before year-end. Or, you might consider making next year's charitable contribution this year instead.

Sometimes, however, it may make sense to take the opposite approach--accelerating income into 2014, and postponing deductible expenses to 2015. That might be the case, for example, if you can project that you'll be in a higher tax bracket in 2015; paying taxes this year instead of next might be outweighed by the fact that the income would be taxed at a higher rate next year.

Factor in the AMT

Make sure that you factor in the alternative minimum tax (AMT). If you're subject to the AMT, traditional year-end maneuvers, like deferring income and accelerating deductions, can have a negative effect. That's because the AMT--essentially a separate, parallel, income tax with its own rates and rules--effectively disallows a number of itemized deductions. For example, if you're subject to the AMT in 2014, prepaying 2015 state and local taxes won't help your 2014 tax situation, but could hurt your 2015 bottom line.

Additional considerations for higher-income individuals

Changes that first took effect in 2013 complicate planning opportunities for higher-income individuals. First, a higher 39.6% marginal tax rate applies if your taxable income exceeds $406,750 in 2014 ($457,600 if married filing jointly, $228,800 if married filing separately, $432,200 if head of household); prior to 2013, the highest marginal tax rate was 35%. If your taxable income places you in the top 39.6% tax bracket, a maximum 20% tax rate on long-term capital gains and qualifying dividends also generally applies (prior to 2013, the top rate that generally applied was 15%).

Second, if your adjusted gross income (AGI) is more than $254,200 ($305,050 if married filing jointly, $152,525 if married filing separately, $279,650 if head of household), your personal and dependency exemptions may be phased out for 2014, and your itemized deductions may be limited. If your AGI is above this threshold, be sure you understand the impact before accelerating or deferring deductible expenses.

Additionally, a 3.8% net investment income tax (unearned income Medicare contribution tax) may apply to some or all of your net investment income if your modified AGI exceeds $200,000 ($250,000 if married filing jointly, $125,000 if married filing separately, $200,000 if head of household).

Note: Individuals with wages that exceed $200,000 ($250,000 if married filing jointly or $125,000 if married filing separately) are also subject to an additional 0.9% Medicare (hospital insurance) payroll tax.

IRAs and retirement plans

Make sure that you're taking full advantage of tax-advantaged retirement savings vehicles. Traditional IRAs and employer-sponsored retirement plans such as 401(k) plans allow you to contribute funds on a deductible (if you qualify) or pretax basis, reducing your 2014 taxable income. Contributions to a Roth IRA (assuming you meet the income requirements) or a Roth 401(k) aren't deductible or pretax, so there's no tax benefit for 2014, but qualified Roth distributions are completely free from federal income tax, which makes these retirement savings vehicles appealing.

For 2014, you can contribute up to $17,500 to a 401(k) plan ($23,000 if you're age 50 or older), and up to $5,500 to a traditional IRA or Roth IRA ($6,500 if you're age 50 or older). The window to make 2014 contributions to an employer plan typically closes at the end of the year, while you generally have until the April 15, 2015, tax filing deadline to make 2014 IRA contributions.

Roth conversions

Year-end is a good time to evaluate whether it makes sense to convert a tax-deferred savings vehicle like a traditional IRA or a 401(k) account to a Roth account. When you convert a traditional IRA to a Roth IRA, or a traditional 401(k) account to a Roth 401(k) account, the converted funds are generally subject to federal income tax in the year that you make the conversion (except to the extent that the funds represent nondeductible after-tax contributions). If a Roth conversion does make sense (whether a Roth conversion is right for you depends on many factors, including your current and projected future income tax rates), you'll want to give some thought about the timing of the conversion. For example, if you believe that you'll be in a better tax situation this year than next (e.g., you would pay tax on the converted funds at a lower rate this year), you might want to think about acting now rather than waiting.

If you convert a traditional IRA to a Roth IRA and it turns out to be the wrong decision (things don't go the way you planned and you realize that you would have been better off waiting to convert), you can recharacterize (i.e., "undo") the conversion. You'll generally have until October 15, 2015, to recharacterize a 2014 Roth IRA conversion--effectively treating the conversion as if it never happened for federal income tax purposes. You can't undo an in-plan Roth 401(k) conversion, however.

"Tax extenders"

A number of popular tax breaks expired at the end of 2013. It's possible that some or all of these provisions will be retroactively extended, but there's no guarantee. You'll want to consider carefully the potential effect of these provisions on your 2014 tax situation and stay alert for any late-breaking changes. Tax-extender provisions include:

  • The ability to make qualified charitable contributions (QCDs) of up to $100,000 from an IRA directly to a qualified charity if you were 701⁄2 or older. Such distributions were excluded from income but counted toward satisfying any RMDs you would otherwise have to receive from your IRA.
  • Increased Internal Revenue Code (IRC) Section 179 expense limits and "bonus" depreciation provisions.
  • The above-the-line deduction for qualified higher-education expenses.
  • The above-the-line deduction for up to $250 of out-of-pocket classroom expenses paid by education professionals.
  • For those who itemize deductions, the ability to deduct state and local sales taxes in lieu of state and local income taxes.
  • The ability to deduct premiums paid for qualified mortgage insurance as deductible interest on IRS Form 1040, Schedule A.

Talk to a professional

When it comes to year-end tax planning, there's always a lot to think about. A tax professional can help you evaluate your situation, keep you apprised of any legislative changes, and determine whether any year-end moves make sense for you.

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Kenneth S. Rakes has 25 years of experience in public accounting and is a graduate of John Carroll University. Ken provides tax planning and preparation services for individuals, partnerships, corporations, estates, and trusts. Ken is a Personal Financial Specialist (PFS) providing retirement, estate, investment, insurance, and education planning for individual clients with an emphasis on the tax implications of planning decisions. Ken's other areas of expertise include: Manufacturing, Wholesale, Retail and Service Industries, Non-Profit Organizations and Sub-Chapter "S" Corporations.