Be proactive in planning to reduce your 2014 income tax liability with these suggestions.
By Kathy Laursen
Buying equipment before year-end to take advantage of accelerated tax depreciation deductions has been a normal move for business owners in recent years. Unless late legislation enhances this option, the Section 179 equipment expensing limit for 2014 is $25,000, and no bonus depreciation is available. However, it is possible to take advantage of the de minimis safe-harbor election under recently issued IRS repair regulations to expense the costs of inexpensive assets, including materials and supplies. To currently deduct otherwise capital expenditures under this de minimis safe harbor, a taxpayer must complete both of the following requirements:
Have an accounting policy in place as of the beginning of the applicable tax year, requiring expensing of items costing no more than a specified dollar amount for book purposes.
Apply that policy for book financial-reporting purposes.
If such requirements are satisfied, the otherwise capital-acquisition cost of tangible property subject to the policy can be expensed for tax purposes. For taxpayers with applicable financial statements—audited financial statements and certain financial statements required to be provided to a state or federal government agency other than the IRS—the policy can be as high as $5,000 per invoice or item and must be in writing as of the beginning of the tax year. For all other taxpayers, the amount is $500 or less per invoice or item; the policy is not required to be in writing, though a written policy is recommended for documentation purposes.
The repair regulations contain other provisions beside the safe-harbor rule and are effective for tax years beginning on or after January 1, 2014. The regulations require most business taxpayers to file accounting method changes with the IRS for capitalizing and expensing repair, maintenance and supplies expenditures. These rules could affect year-end planning; knowing how these rules can impact taxable income before year-end is advisable. The rules are too complex and lengthy for this article, so review these issues with your tax professional.
Stay on top of accounting to project income or loss before year-end. Knowing where you are prior to year-end can help avoid nasty surprises on tax day. Deferring or accelerating income or deductions can smooth the ups and downs between years that put you in higher and lower tax brackets.
If you have a loss from a partnership or S-corporation, consider whether you have enough at-risk basis in the entity to deduct the loss.
If you do not have enough basis in the entity, you might consider increasing your basis by making a capital contribution or, in the case of a partnership, guaranteeing or increasing a guarantee of the partnership’s debt. To take advantage of an increase in basis, action must be taken prior to year-end to deduct the loss.
Qualified retirement plans are a great way to potentially reduce taxes while saving money for retirement. The qualified plan should be set up prior to year-end; contributions can be currently deducted, and taxpayers have until the due date of the tax return, including extensions, to fund the contribution amount.
Individual taxpayers (excluding nonresident aliens) are subject to an additional 3.8 percent net investment income tax (NIIT) on the lesser of net investment income or the excess of modified adjusted gross income less the applicable threshold. The applicable threshold is $250,000 for married taxpayers filing jointly and surviving spouses, $125,000 for married taxpayers filing separately and $200,000 for all other taxpayers. Although this tax generally does not apply to active business income, related passive businesses may be subject to the 3.8 percent tax. You may want to consider making a grouping election to treat the activities as active and potentially avoid the 3.8 percent tax. The passive activity and grouping election rules are complex, so consult with your tax advisor to determine if you can make an election.
In addition, you may want to revisit converting an active trade or business to an S-corp as a long-term planning solution. S-corp owner earnings in excess of amounts paid out as reasonable compensation will not be subject to the 3.8 percent Medicare surtax, the 0.9 percent Medicare tax on high-income earners or self-employment tax. Further, trusts are subject to the 3.8 percent tax when undistributed income exceeds $12,150 during 2014. Consider distributing trust income to beneficiaries who are in lower tax brackets and not subject to the NIIT.
A health savings account (HSA) may be an option to set aside funds for current and future medical expenses and, potentially, for retirement. HSAs operate like IRAs: The contributions are deductible when made, earnings from the account are tax-free and distributions paid out for qualified medical expenses are not taxed. Contribution limits for 2014 are $3,300 for self-only coverage and $6,550 for family coverage. Those over age 55 can increase the contribution by $1,000. The account can be set up at any point during the year and funded for the entire year.
Consider paying state income tax liability in December to receive a deduction for 2014 if you are not subject to the alternative minimum income tax rules.
It is important to implement these strategies before year-end to take advantage of the benefits in 2014; taxpayers also should consider the impact of any potential legislation passed by Congress before year-end. Consult with your tax adviser before implementing any of these strategies.
Kathy Laursen is a tax partner in the Kansas City office of BKD.