Year End Tax Planning is Crucial for Savings

The Early Bird Catches the Fewest Number of Penalties and Surcharges

As 2014 winds to a close, are you dreading the coming tax season? After the champagne is poured on New Year’s Eve, many folks return to their daily grind, shuffling to gather their documents and make their way to their accountant’s office for another grueling tax preparation meeting. Unfortunately, they will find that the post-New Year’s meeting is in vain if they are trying to save on their taxes. Due to the phasing in and phasing out of many tax laws, surcharges and new penalties from to the Affordable Care Act, and changes in capital gains and loss statutes, it is in the best interests of individuals and families in higher tax brackets to review and take action on their taxes prior to the year’s end. Running 2014 tax numbers before the end of the year can also pay off for those who have experienced a major life event-such as a birth, death, marriage, divorce, sale of a home, or a job change.

Here are the key areas that need to be reviewed in order to avoid excess tax penalty:

Adjusted Gross Income (AGI) and Capital Gains and Losses

There are some tricky things in our tax code that can significantly affect those in higher income brackets. For those who earn over $250,000 as married couples or $200,000 as single individuals, there will be a 3.8% surtax on investment income and a 0.9% Medicare surtax. Both of these new penalties are part of the Affordable Care Act and are new in the tax code this year. For those whose AGI is $305,050 (married) and $254,200 (single) they will see a phase out of the $3950 personal exemption as well as a Pease Limit[i] on itemized deductions. The most efficient and effective manner of avoiding these types of penalties and phase outs is to keep your Adjusted Gross Income as low as possible.

1. Spread income over multiple years, offset capital gains with capital losses and using up to $3000 of capital losses against ordinary income each year
2. Drive down AGI by making pretax contribution to 401(k), IRA or other retirement plan, contributing to a HSA, FSA or Dependent Care Account and other deductions such as moving expenses.
3. By scrutinizing your holdings in taxable accounts you may identify what capital gains and losses you will be taking this year and you can make the choice to offset gains with losses from the current year or prior years. This tactic will serve to reduce your AGI
4. Spreading gains over more than one year in order to avoid triggering the 3.8% surtax on net investment income is also a valuable manner to avoid new penalties.
5. Trying to offset AGI by taking mortgage interest deductions will not help as those are calculated on schedule A after AGI is determined.

Charitable giving

If you are not sure where your AGI is going to end up prior to the end of the year but you are concerned that you may hit the aforementioned penalty thresholds, you may want to consider making some end of the year donations. A traditional cash donation to charity is a sound manner of offsetting your AGI as well as a nice gesture; however there may be more cost effective and beneficial ways to help that donation work for you in the short and long term.

Donate Appreciated Assets:  If an individual wanted to avoid paying capital gains on an asset as well as make a charitable gift, he or she could donate appreciated assets to an organization which could be realized by the organization for the full market value of the asset and would result in avoiding the capital gains tax on the asset’s growth. For example, if a person had bought stock in Company A for $1,000 in 2000 and now that stock was worth $5,000 he or she could donate the asset to a chosen charitable organization which would receive the gift at full market value of the stock. They would not have to pay capital gains tax on the growth of the asset and neither would you but, you can still get the charitable gift deduction for the total amount of $5,000.

Donor Advised Funds: Another alternative to traditional cash giving is the use of a Donor Advised Fund. Donor Advised Funds allow taxpayers to take a full deduction for a large gift in the year it is made and then decide later how to disburse the funds. Meanwhile the money can be invested and grow tax-free.[ii] It is important to remember that all charitable contributions must be made by the end of the year in order to qualify and what is great about the Donor Advised Fund is that the decision about how the funds will be used does not have to be made in a rush simply because it is the end of the year.

Medical Costs and Health Insurance

Medical costs were once a fairly easy deduction to make; however in recent years they are not as simple or beneficial as they were in the past. In order to make itemized deductions of medical expenses, they need to exceed 10% of AGI or 7.5% of AGI for individuals over the age of 65. There are still some expenses that are deductible outside of typical medical expenses and some of them are widely unknown. Acupuncture and contact lens cleaner are just a few that come to mind. Assisted living facilities and skilled nursing homes are counted as deductions as are special needs schools for students who need additional care. It is important to note that unused medical deductions cannot be carried over to another year so understanding the code in IRS publication 502 is paramount to getting the deductions one deserves.

The Affordable Care Act will levy a tax on those who were uninsured even for a portion of 2014. There will be a penalty to those who were not covered by an approved policy for at least nine months of 2014. This penalty will amount to a flat fee of $95 for adults and half of that for their children or 1% of income, whichever is greater. For those who saw no benefit in abiding by the new regulation because they wanted to keep their less traditional plan, or because they are part of the group known as the “invicibles”, (30 something men and women who are convinced that the costs outweigh the benefits when it comes to owning health insurance) these penalties could amount to quite a bit depending on their income. By 2016 this penalty will more than double and the flat fee will more than triple. Knowing whether or not you will owe a sizable amount in penalties from not abiding the ACA prior to the end of the year could help you make an educated decision for 2015. If the penalty is greater than the costs of buying a qualified, insurance policy then you may opt to enroll for 2015. The open enrollment period closes on December 31 though, so when it comes to making a decision, knowledge and timing is paramount.

Tax Preparation Costs

Investments in alternative assets (hedge funds, equity funds, etc) can be costly when it comes to tax preparation. Advisors and their clients should work with their accountants to ensure that the benefits outweigh the costs. The tax prep on a $20,000 investment in a hedge fund can be up to $500 which is 2.5% of the amount invested. If the advisor is taking 1% on top of that, then the rate of return is likely not worth the costs of the investment. To protect yourself, ensure that you have an open dialogue with your advisor about an investment’s accounting costs prior to buying in.

Clearly, it is in the interest of more affluent individuals and families to take advantage of getting an early start on tax season. Reviewing your portfolio, charitable donations and insurance with your financial advisor is something you will want to schedule right away if you haven’t already. Once you have done so, make a plan to meet with your accountant before the end of the year. Otherwise you may get stuck holding the bag when it comes to paying more than your share in taxes.

For more information contact Ferguson Financial Inc. today at (952) 406-8316 or info@fergusonfinancialinc.com.