Holbrook & Manter, CPAs is pleased to present the second in our three part series of tax planning strategies for 2013-2014 tax planning. This post highlights additional potential tax-saving opportunities for you to consider.
Deferring Income to 2014
If you expect your AGI to be higher in 2013 than in 2014, or if you anticipate being in the same or a higher tax bracket in 2013, you may benefit by deferring income into 2014. Deferring income will be advantageous so long as the deferral does not bump your income to the next bracket. Deferring income could be disadvantageous, however, if your deferred income is subject to §409A, thus making the income includible in gross income and subject to additional tax. Some ways to defer income include:
Delay Billing: If you are self-employed and on the cash-basis, delay year-end billing to clients so that payments will not be received until 2014.
Interest and Dividends: Interest income earned on Treasury securities and bank certificates of deposit with maturities of one year or less is not includible in income until received. To defer interest income, consider buying short-term bonds or certificates that will not mature until next year. If you have control as to when dividends are paid, arrange to have them paid to you after the end of the year.
Accelerating Income into 2013
In limited circumstances, you may benefit by accelerating income into 2013. For example, you may anticipate being in a higher tax bracket in 2014, or perhaps you will need additional income in order to take advantage of an offsetting deduction or credit that will not be available to you in future tax years. Note, however, that accelerating income into 2013 will be disadvantageous if you expect to be in the same or lower tax bracket for 2014. In any event, before you decide to implement this strategy, we should “crunch the numbers.”
If accelerating income will be beneficial, here are some ways to accomplish this:
Accelerate Collection of Accounts Receivable: If you are self-employed and report income and expenses on a cash basis, issue bills and attempt collection before the end of 2013. Also see if some of your clients or customers might be willing to pay for January 2014 goods or services in advance. Any income received using these steps will shift income from 2014 to 2013.
Year-End Bonuses: If your employer generally pays year-end bonuses after the end of the current year, ask to have your bonus paid to you before the beginning of 2014.
Retirement Plan Distributions: If you are over age 59 ½ and you participate in an employer retirement plan or have an IRA, consider making any taxable withdrawals before 2014.
You may also want to consider making a Roth IRA rollover distribution, as discussed above.
Deduction timing is also an important element of year-end tax planning. Deduction planning is complex, however, due to factors such as AGI levels, AMT, and filing status. If you are a cash-method taxpayer, remember to keep the following in mind:
Deduction in Year Paid: An expense is only deductible in the year in which it is actually paid. Under this rule, if your tax rate is going to increase in 2014, it is a smart strategy to postpone deductions until 2014.
Payment by Check: Date checks before the end of the year and mail them before January 1, 2014.
Promise to Pay: A promise to pay or providing a note does not permit you to deduct the expense. But you can take a deduction if you pay with money borrowed from a third party. Hence, if you pay by credit card in 2013, you can take the deduction even though you won’t pay your credit card bill until 2014.
AGI Limits: For 2013, the overall limitation on itemized deductions (“Pease” limitation) applies for taxpayers whose AGI exceeds an “applicable amount.” For 2013, the applicable amount is $300,000 for a married couple filing a joint return or a surviving spouse, $275,000 for a head of household, $250,000 for an unmarried individual, and $150,000 for a married individual filing a separate return. In addition, certain deductions may be claimed only if they exceed a percentage of AGI: 10% for medical expenses (7.5% for certain older taxpayers), 2% for miscellaneous itemized deductions, and 10% for casualty losses.
Standard Deduction Planning: Deduction planning is also affected by the standard deduction. For 2013 returns, the standard deduction is $12,200 for married taxpayers filing jointly, $6,100 for single taxpayers, $8,950 for heads of households, and $6,100 for married taxpayers filing separately. As you can see from the numbers, for 2013, the standard deduction for married taxpayers is twice the amount as that for single taxpayers. If your itemized deductions are relatively constant and are close to the standard deduction amount, you will obtain little or no benefit from itemizing your deductions each year. But simply taking the standard deduction each year means you lose the benefit of your itemized deductions. To maximize the benefits of both the standard deduction and itemized deductions, consider adjusting the timing of your deductible expenses so that they are higher in one year and lower in the following year. You can do this by paying in 2013 deductible expenses, such as mortgage interest due in January 2014.
Medical Expenses: For 2013, medical expenses, including amounts paid as health insurance premiums, are deductible only to the extent that they exceed 10% of AGI (7.5% for taxpayers age 65 or older). This is an increase from 2012 when it was 7.5% for all taxpayers.
State Taxes: If you anticipate a state income tax liability for 2013 and plan to make an estimated payment most likely due in January, consider making the payment before the end of 2013. However, too high a payment could lead towards being subject to the AMT. Note that the election to deduct as an itemized deduction state and local sales taxes instead of state and local income taxes is scheduled to expire at the end of 2013.
Charitable Contributions: Consider making your charitable contributions at the end of the year. This will give you use of the money during the year and simultaneously permit you to claim a deduction for that year. You can use a credit card to charge donations in 2013 even though you will not pay the bill until 2014. A mere pledge to make a donation is not deductible, however, unless it is paid by the end of the year. Note, however, for claimed donations of cars, boats and airplanes of more than $500, the amount available as a deduction will significantly depend on what the charity does with the donated property, not just the fair market value of the donated property. If the organization sells the property without any significant intervening use or material improvement to the property, the amount of the charitable contribution deduction cannot exceed the gross proceeds received from the sale.
To avoid capital gains, you may want to consider giving appreciated property to charity.
Regarding charitable contributions please remember the following rules: (1) no deduction is allowed for charitable contributions of clothing and household items if such items are not in good used condition or better; (2) the IRS may deny a deduction for any item with minimal monetary value; and (3) the restrictions in (1) and (2) do not apply to the contribution of any single clothing or household item for which a deduction of $500 or more is claimed if the taxpayer includes a qualified appraisal with his or her return. Charitable contributions of money, regardless of the amount, will be denied a deduction, unless the donor maintains a cancelled check, bank record, or receipt from the donee organization showing the name of the donee organization, and the date and amount of the contribution.
A special provision gives taxpayers the ability to distribute tax-free to charity up to $100,000 from a traditional or Roth IRA maintained for an individual whose has reached age 701/2. Note that this provision is scheduled to expire at the end of 2013.
Equipment Purchases: If you are in business and purchase equipment, you may make a “Section 179 Election,” which allows you to expense (i.e., currently deduct) otherwise depreciable business property. For 2013, you may elect to expense up to $500,000 of equipment costs (with a phase-out for purchases in excess of $2,000,000) if the asset was placed in service during 2013. Note that for assets placed in service in 2013 (2015 for certain longer-lived and transportation property), taxpayers can expense 50% of their business equipment purchases under §168(k), a provision giving taxpayers bonus depreciation, mitigating the need for the §179 election. It is important to note that new and used equipment qualifies for Section 179; however, only new equipment qualifies for bonus depreciation.
In 2014, the dollar amounts for §179 expensing are scheduled to be $25,000, with a phase-out amount of $200,000. Although there is a chance the 2014 figures will go up if Congress acts, it would be wise to place more assets in service in 2013 if you have yet to hit the $500,000 figure.
In addition, careful timing of equipment purchases can result in favorable depreciation deductions in 2013. In general, under the “half-year convention,” you may deduct six months worth of depreciation for equipment that is placed in service on or before the last day of the tax year. (If more than 40% of the cost of all personal property placed in service occurs during the last quarter of the year, however, a “mid-quarter convention” applies, which lowers your depreciation deduction.) A popular strategy in recent years is to purchase a vehicle for business purposes that exceeds the depreciation limits set by statute (i.e., a vehicle rated over 6,000 pounds). Doing so would not subject the purchase to the statutory dollar limit, $11,160 for 2013 (due to bonus depreciation rules); $11,360 in the case of vans and trucks (due to bonus depreciation rules). Therefore, the vehicle would qualify for the full equipment expensing dollar amount. However, for SUVs (rated between 6,000 and 14,000 pounds gross vehicle weight) the expensing amount is limited to $25,000.
NOL Carryback Period: If your business suffers net operating losses for 2013, you generally apply those losses against taxable income going back two tax years. Thus, for example, the loss could be used to reduce taxable income—and thus generate tax refunds—for tax years as far back as 2011. Certain “eligible losses” can be carried back three years; farming losses can be carried back five years.
Bonus Depreciation: Taxpayers can claim 50% bonus depreciation for assets placed in service in 2013. Bonus depreciation is also allowed for machinery and equipment used exclusively to collect, distribute, or recycle qualified reuse and recyclable materials and qualified disaster assistance property. In 2014, with limited exceptions, bonus depreciation does not apply.
Capitalization v. Expensing for Materials and Supplies and Repairs: Effective for taxable years beginning on or after January 1, 2014, the IRS finalized regulations that determine when taxpayers should capitalize or deduct as a current expense repairs on tangible property, plus the deductibility of materials and supplies. A deduction for materials and supplies is allowed under a de minimis rule that includes property that has an acquisition or production cost of $200 or less. Also, another de minimis safe harbor states that for repairs to be deductible, among other requirements, the unit of property must cost less than $5,000 per invoice or item substantiated by the invoice for taxpayers with applicable financial statements and $500 per invoice for taxpayers without applicable financial statements.
Education and Child Tax Benefits
Child Tax Credit: A tax credit of $1,000 per qualifying child under the age of 17 is available on this year’s return. In order to qualify for 2013, the taxpayer must be allowed a dependency deduction for the qualifying child. Another qualifying determination is that the qualifying child must be younger than you. The credit is phased out at a rate of $50 for each $1,000 (or fraction of $1,000) of modified AGI exceeding the following amounts: $110,000 for married filing jointly; $55,000 for married filing separately; and $75,000 for all other taxpayers. A portion of the credit may be refundable. For 2013, the threshold earned income level to determine refundability is set by statute at $3,000. Legislation in early 2013 made the per child credit amount of $1,000 permanent.
Credit for Adoption Expenses: For 2013, the adoption credit limitation is $12,970 of aggregate expenditures for each child, except that the credit for an adoption of a child with special needs is deemed to be $12,970 regardless of the amount of expenses. The credit ratably phases out for taxpayers whose income is between $194,580 and $234,580. Legislation in early 2013 made the adoption credit permanent for all types of adoptions.
Education Credits: Back in 2009, significant changes were put in place for the Hope credit, including a name change to the American Opportunity Tax Credit. Due to legislation in early 2013, these changes continue through 2017. The maximum credit for 2013 is $2,500 (100% on the first $2,000, plus 25% of the next $2,000) for qualified tuition and fees paid on behalf of a student (i.e., the taxpayer, the taxpayer’s spouse, or a dependent) who is enrolled on at least a half-time basis. The credit is available for the first four years of the student’s post-secondary education. For 2013, the credit is phased out at modified AGI levels between $160,000 and $180,000 for joint filers, and between $80,000 and $90,000 for other taxpayers. Forty percent of the credit is refundable, which means that you can receive up to $1,000 even if you owe no taxes. The term “qualified tuition and related expenses” includes expenditures for “course materials” (books, supplies, and equipment needed for a course of study whether or not the materials are purchased from the educational institution as a condition of enrollment or attendance). One way to take advantage of the credit for 2012 is to prepay the spring 2013’s tuition. In addition, if your child’s books for the spring semester are known, those can be bought and the costs qualify for the credit.
The Lifetime Learning credit maximum in 2013 is $2,000 (20% of qualified tuition and fees up to $10,000). A student need not be enrolled on at least a half-time basis so long as he or she is taking post-secondary classes to acquire or improve job skills. As with the Hope (American Opportunity Tax Credit in 2013) credit, eligible students include the taxpayer, the taxpayer’s spouse, or a dependent. For 2013, the Lifetime Learning credit are phased out at modified AGI levels between $107,000 and $127,000 for joint filers, and between $53,000 and $63,000 for single taxpayers.
Coverdell Education Savings Account: For 2013, the aggregate annual contribution limit to a Coverdell education savings account is $2,000 per designated beneficiary of the account. The limit is phased out for individual contributors with modified AGI between $95,000 and $110,000 and joint filers with modified AGI between $190,000 and $220,000. The contributions to the account are nondeductible but the earnings grow tax-free. Legislation in early 2013 made the contribution amount and AGI phase-out amounts permanent.
Student Loan Interest: You may be eligible for an above-the-line deduction for student loan interest paid on any “qualified education loan.” The maximum deduction is $2,500. The deduction for 2013 is phased out at a modified AGI level between $125,000 and $155,000 for joint filers, and between $60,000 and $75,000 for individual taxpayers. Legislation in early 2013 made certain rules permanent the keep the student loan interest deduction at its current levels. Generally, you can claim the deduction if your filing status is any filing status except married filing separately, no else is claiming an exemption for you on his or her tax return, you are legally obligated to pay the interest on a qualified student loan, and you paid interest on a qualified student loan.
Kiddie Tax: For 2013, the kiddie tax applies to: (1) children under 18; (2) 18-year old children who have unearned income in excess of the threshold amount, do not file a joint return and who have earned income, if any, that does not exceed one-half of the amount of the child’s support; and (3) children between the ages of 19 and 23 and if, in addition to the above rules, they are full-time students. For 2013, the kiddie tax threshold amount is $2,000.
Have questions about any of the above strategies? Please contact us. We can help you create a plan that will meet your financial goals and maximize your tax savings.