Close of 2014 tax planning presents challenges to individuals, businesses: Part 2

In part 1 of this column I discussed tax breaks for individuals and businesses that may be extended or reinstated retroactively by Congress, as well as what those who earn higher incomes should address in their year-end tax planning. This part of the column lists some moves individuals can make right now that have potential tax-savings benefits.

These additional actions based on current tax laws mentioned here are beyond those discussed in Part 1 and may help save tax dollars if they are acted on before year-end. Although not all actions will apply in your particular situation, you or a family member could likely benefit from some of them.

Some potential tax-saving moves applicable to individuals that can be done now are as follows:

- Realize losses on stock while substantially preserving your investment position. There are several ways this can be done. For example, you can sell the original holding and then buy back the same securities at least 31 days later. It may be advisable to meet with a financial advisor to meet to discuss any year-end trades you are considering making;

- Postpone income until 2015 and accelerate deductions into 2014 to lower your 2014 tax bill. This strategy may enable you to claim larger deductions, credits, and other tax breaks for 2014 that are phased out over varying levels of adjusted gross income. These include child tax credits, higher education tax credits, and deductions for student loan interest. Postponing income also is desirable for those taxpayers who anticipate being in a lower tax bracket next year due to changed financial circumstances. Note, however, that in some cases, it may pay to actually accelerate income into 2014. For example, this may be the case where a person's marginal tax rate is much lower this year than it will be next year or where lower income in 2015 will result in a higher tax credit for an individual who plans to purchase health insurance on a health exchange and is eligible for a premium assistance credit;

- If you believe a Roth IRA is better than a traditional IRA, and want to remain in the market for the long term, consider converting traditional-IRA money invested in beaten-down stocks (or mutual funds) into a Roth IRA if eligible to do so. Keep in mind, however, that such a conversion will increase your adjusted gross income for 2014. Taxes for a Roth IRA conversion must be paid from non IRA funds for a Roth conversion to be beneficial; and

- If you converted assets in a traditional IRA to a Roth IRA earlier in the year, the assets in the Roth IRA account may have declined in value, and if you leave things as is, you will wind up paying a higher tax than is necessary. You can back out of the transaction by recharacterizing the conversion, that is, by transferring the converted amount (plus earnings, or minus losses) from the Roth IRA back to a traditional IRA via a trustee-to-trustee transfer. You can later reconvert to a Roth IRA.

- It may be advantageous to try to arrange with your employer to defer until 2015 a bonus may be coming to you this year;

- Consider using a credit card to pay deductible expenses before the end of the year. Doing so will increase your 2014 deductions even if you do not pay your credit card bill until after the end of the year;

- If you expect to owe state and local income taxes when you file your return next year, consider asking your employer to increase withholding of state and local taxes (or pay estimated tax payments of state and local taxes) before year-end to pull the deduction of those taxes into 2014 if doing so will not create an alternative minimum tax (AMT) problem;

- Take an eligible rollover distribution from a qualified retirement plan before the end of 2014 if you are facing a penalty for underpayment of estimated tax and the option of having your employer increase your withholding is either unavailable or will not sufficiently address the problem. Income tax will be withheld from the distribution and will be applied toward the taxes owed for 2014. You can then do a timely rollover the gross amount of the distribution (i.e., the net amount you received plus the amount of withheld tax) to a traditional IRA. No part of the distribution will be able to be included in income for 2014, but the withheld tax will be applied pro rata over the full 2014 tax year to reduce previous underpayments of estimated tax. If you do not recomplete the rollover within a 60-day period from the rollover distribution, the amount will be treated as ordinary income;

- Estimate the effect of any year-end planning moves on the AMT for 2014. Keep in mind that many tax breaks allowed for purposes of calculating regular taxes are disallowed for AMT purposes. These include the deduction for state property taxes on your residence, state income taxes, miscellaneous itemized deductions and personal exemption deductions. Other deductions, such as for medical expenses, are calculated in a more restrictive way for AMT purposes than for regular tax purposes in the case of a taxpayer who is over age 65 or whose spouse is over age 65 as of the close of the tax year. As a result, in some cases, deductions should not be accelerated;

- You may be able to save taxes this year and next year by applying a bunching strategy to “miscellaneous” itemized deductions, medical expenses and other itemized deductions;

- You may want to pay contested taxes to be able to deduct them this year while continuing to contest them next year;

- You may want to settle an insurance or damage claim in order to maximize your casualty loss deduction this year;

- Take the required minimum distribution (RMD) from your IRA or 401(k) plan (or other employer-sponsored retired plan) if you have reached age 70½. Failure to take a required withdrawal can result in a penalty of 50% of the amount of the RMD not withdrawn. If you turned age 70½ in 2014, you can delay the first required distribution to 2015 (i.e., prior to April 1, 2015), but if you do, you will have to take a double distribution in 2015 —the amount required for 2014 plus the amount required for 2015. Think twice before delaying 2014 distributions to 2015 as bunching income into 2015 might push you into a higher tax bracket or have a detrimental impact on various income tax deductions that are reduced at higher income levels. However, it could be beneficial to take both distributions in 2015 if you will be in a substantially lower bracket that year;

- Increase the amount you set aside for next year in your employer’s health flexible spending account if you set aside too little for this year;

- If you are eligible to make health savings account (HSA) contributions in December of this year, you can make a full year’s worth of deductible HSA contributions for 2014. This is so even if you first became eligible on December 1, 2014; and

- Make gifts sheltered by the annual gift tax exclusion before the end of the year and thereby save gift and estate taxes. You can give $14,000 in 2014 to each of an unlimited number of individuals, but you cannot carry over unused exclusions from one year to the next. The transfers also may save family income taxes where income-earning property is given to family members in lower income tax brackets who are not subject to the kiddie tax.

This article appears in multiple parts because of the many important tax considerations this year. The next and final part of the article includes a checklist of actions that may help save tax dollars for business owners if acted on before year-end.

For more information:

Kenneth W. Rudzinski, CFP, CLU, ChFC, CRPC, CASL, CAP, a partner in the financial planning firm Heritage Financial Consultants, is a registered representative and investment advisor representative with Lincoln Financial Advisors Corp., a broker/dealer (member SIPC) and registered investment advisor. Rudzinski offers insurance through Lincoln affiliates and other companies. This information should not be construed as legal or tax advice. You may want to consult a legal or tax advisor regarding this material as it relates to your personal circumstances. CRN-942477-060914. Questions can be emailed to Kenneth.Rudzinski@LFG.com. He can be reached at Heritage Financial Consultants LLC, 2036 Foulk Rd., Suite 104, Wilmington, DE 19810; 302-529-1264.