“Our Constitution  is in Actual Operation;  Everything appears to Promise That It Will Last; But in This World Nothing is Certain But Death And Taxes”

                                                                                                                                                                                                                 Letter To M. Leroy – 1789                               

At this time last year, there was talk in Washington about comprehensive tax reform in 2014.  Not surprisingly, no such reform was passed.  However, lawmakers again are waiting until the last minute to revive a series of tax breaks that expired after 2013.  Two of the more popular of these tax breaks include the deduction for state sales taxes in lieu of income taxes and direct transfers from IRAs to charity of up to $100,000 for individuals 70 1/2 and up.  Despite delays in implementing these tax breaks, some basic tax planning ideas remain the same.  We expect income tax rates to remain the same next year.  This makes tax planning easier – it doesn’t mean planning should be ignored – it just makes it easier to do.  As always, to be successful with your planning, you want to be able to cut your tax bill over both 2014 and 2015, not just one of those years.  Many, but not all, of you will benefit by accelerating your deductions from 2015 into 2014.  If, however, you expect to be in a higher income tax bracket in 2015, consider accelerating income into 2014 and delaying deductions until 2015.

Capital Gains.  For those individuals who find themselves in the 25% to 35% marginal income tax bracket, the capital gains tax rate is 15%. For those individuals whose marginal income tax bracket is between 0% and 15%, the capital gains tax rate is zero.  For those individuals who fall into the 39.6% marginal income tax bracket, the capital gains tax rate is 20%.  To the extent you are in a position to control the timing of your income or the timing of when you pay deductible expenses, it makes sense to manipulate these items between years to your advantage.  For instance, you should consider whether you will be in different tax brackets in one year and not the next, whether you are subject to the AMT in one year and not the next, whether you are subject to the surtax on net investment income – discussed below – in one year and not the next.  We are expecting some large capital gain distributions from a number of our mutual funds in 2014, so if you have capital loss carry forwards, you can use those losses to offset realized capital gains in your portfolio.  If your capital loss carry forwards exceed your realized capital gains for the year, you can still use $3,000 of those loss carry forwards to offset earned income.  If you need assistance with capital gain planning, please contact us.

Surtax on Net Investment Income.    In 2013, a new 3.8% surtax on net investment income became effective.  Net investment income includes, among other things, dividends, rents, interest, capital gains and income from nonqualified annuities.  It does not include income from qualified retirement plans and IRAs.    This tax applies to married filers with modified adjusted gross incomes in excess of $250,000 and to single filers with modified adjusted gross incomes in excess of $200,000.  So, if you are in a position to control the timing of your income, it may make sense to do so to avoid this surtax. 

Itemized Deductions.  The phase-out of certain itemized deductions for higher-income taxpayer’s remains in effect for 2014. For single filers, the threshold amount is $254,200 and for married filers the threshold amount is $305,050.  Deductions for medical expenses, investment interest, casualty and theft losses, and gambling losses are not subject to the limitation.  As to medical expenses, you can deduct medical expenses only if the total of your medical expenses exceeds 10% of your adjusted gross income unless you are 65 or older, in which case the threshold amount is 7.5%.  Despite these limitations, paying your January 2015 estimated state or local tax payment, your real estate tax payment, or your mortgage payment in December may allow you to claim those deductions in 2014 rather than 2015.  You can also accelerate charitable contribution deductions into 2014 by making the contributions in December.  Consider making the contribution using appreciated securities as this allows you to deduct the fair market value of the securities on the date of the contribution and avoids you having to pay capital gain tax on the sale of the security.  If you have exceeded the 10% or 7.5% adjusted gross income threshold for medical deductions, consider having elective procedures done before year-end.  If you owe alternative minimum tax, some of these strategies may not work.

Fund Company Retirement Plans and Iras.  Regardless of income tax rates, it is always a good idea to fund your company retirement plan or IRA to get the benefit of tax-deferred growth.  Make sure you are contributing as much as your budget allows.

Give Shares To Your Children.  If you want to help your adult children, give them shares of stocks or mutual funds instead of cash if they are in a lower income tax bracket than you.  If the child earns less than $36,900, his or her long-term capital gain tax rate is 0%.  So, instead of selling shares to give cash to your children, give them the shares and let them sell them.  This only works with children who are old enough to be exempt from the “kiddie tax” which means they must be 19 or older and out of school, or 24 or older if they are still in school.

Roth Ira Conversions.  Anyone can convert a traditional IRA to a Roth IRA.  So if you are in a lower income tax bracket now compared to the tax bracket you anticipate being in once you  begin taking distributions from your traditional IRA, or if you like the idea of using the Roth IRA as an estate planning vehicle by passing assets on to your heirs income tax free, you may want to consider making a Roth conversion in 2014.  We can help you with this analysis.

IRA Distributions to Charity.  As mentioned earlier, one of the most popular tax breaks that has not been renewed is the ability of individuals age 70 1/2 and older to make tax-free distributions of up to $100,000 from their IRAs directly to their charity of choice.  We hope that this tax break and others are ultimately extended and of course will be watching it closely.

IRA and Retirement Plans

• Taxpayers can make IRA contributions for 2014 up to April 15, 2015.  Contribution limits are 100% of compensation up to $5,500.  Catch-up contributions for those individuals age 50 and older are $1,000, bringing the total contribution limit for the 50 and older crowd to $6,500.
• Taxpayers who did not participate in a company sponsored retirement plan in 2014 can fully deduct their IRA contribution, regardless of the level of their income.  However, taxpayers who were “active participants” in a company sponsored retirement plan can be phased out of a deductible IRA contribution, depending on the amount of their adjusted gross income.  Those limits are $70,000 for single taxpayers and $116,000 for married taxpayers who file jointly.  For married couples filing jointly, where one spouse is an active participant and one spouse is not, the deduction for the spouse who is not an active participant is phased out if the couples’ joint income exceeds $191,000. If you do exceed the aforementioned income limits, you can still make a non-deductible IRA contribution which will grow on a tax-deferred basis.  You are required to keep track of your non-deductible IRA contributions on your Federal income tax return.
• 2014 contributions to a Roth IRA are phased out for single taxpayers at an AGI of $129,000 and $191,000 for married taxpayers filing jointly.  Roth IRA contributions are not      deductible but grow tax-deferred, distributions are withdrawn tax-free and mandatory distributions are not required at age 70 ½.
• Contribution limits for employees who participate in 401(k), 403(b) and 457 plans are as follows:

Contributions     2014 = $17,500    2015 =  $18,000

Catch-up contributions    2014 =  $5,500     2015 = $6,000

Payroll Tax

The Social Security wage base will increase in 2015 to $118,500, a $1,500 increase over 2014’s figure.  In 2015, the Social Security tax rate paid by employers and employees stays at 6.2%, while the Medicare portion for both stays at 1.45%.  A .9% Medicare payroll tax applies to single filers with modified adjusted gross income in excess of $200,000 and for couples with modified adjusted gross income in excess of $250,000.  This tax does not affect employers.

Estate and Gift Tax

The Federal estate tax exemption amount is currently $5,340,000 and the Federal estate tax rate is 40%.  This exemption amount will increase by $90,000 in 2015 to $5,430,000.    This allows a married couple to pass $10,860,000 of assets Federal estate tax-free to their beneficiaries.  The estate tax rate will remain the same.  For gift tax purposes, the annual gift tax exclusion amount for 2014 is $14,000 per donee and will remain the same in 2015.

Year-end Gifting and Retirement Account Contributions

Please keep in mind that if you plan on making gifts to your favorite charity, to a family member or make a contribution to a qualified retirement plan before the end of the year, Schwab needs time to process those requests to make sure they occur in calendar year 2014.  In order to meet Schwab’s deadlines, we generally need to be provided with any gift or contribution requests by the end of the day on December 12, 2014.  Thanks for your understanding with this issue.