Year-end tax planning is especially challenging this year because Congress has yet to act on a host of tax breaks that expired at the end of 2013.
Some of these tax breaks may be retroactively reinstated and extended, but Congress likely will not decide the fate of these tax breaks until the very end of this year (and, possibly, not until next year).
This no doubt will delay the start of the tax filing season, perhaps even significantly, so plan accordingly, especially if you are someone who expects to receive a nice refund and have already made early plans about what you intend to do with it!
The expired breaks include, for individuals: the option to deduct state and local sales and use taxes instead of state and local income taxes; the above-the-line-deduction for qualified higher education expenses; tax-free IRA distributions for charitable purposes by those age 70-1/2 or older; and the exclusion for up-to-$2 million of mortgage debt forgiveness on a principal residence.
For businesses, tax breaks that expired at the end of last year and may be retroactively reinstated and extended include: 50% bonus first year depreciation for most new machinery, equipment and software; the $500,000 annual expensing limitation; the research tax credit; and the 15-year write-off for qualified leasehold improvements, qualified restaurant buildings and improvements and qualified retail improvements.
Higher-income-earners have unique concerns to address when mapping out year-end plans.
They must be wary of the 3.8% surtax on certain unearned income and the additional 0.9% Medicare (hospital insurance, or HI) tax that applies to individuals receiving wages with respect to employment in excess of $200,000 ($250,000 for married couples filing jointly and $125,000 for married couples filing separately).
The surtax is 3.8% of the lesser of: (1) net investment income (NII), or (2) the excess of modified adjusted gross income (MAGI) over an un-indexed threshold amount ($250,000 for joint filers or surviving spouses, $125,000 for a married individual filing a separate return, and $200,000 in any other case).
As year-end nears, a taxpayer's approach to minimizing or eliminating the 3.8% surtax will depend on his estimated MAGI and net investment income (NII) for the year.
Some taxpayers should consider ways to minimize (such as through deferral) additional NII for the balance of the year, while others should try to see if they can reduce MAGI other than net investment income. Still other individuals will need to consider ways to minimize both NII and other types of MAGI.
The additional Medicare tax could also require year-end actions.
Employers must withhold the additional Medicare tax from wages in excess of $200,000 regardless of filing status or other income. Self-employed persons must take it into account in figuring estimated tax.
There could be situations where an employee needs to have more withheld toward year end to cover the tax. For example, an individual earns $200,000 from one employer during the first half of the year and a like amount from another employer during the balance of the year. He would owe the additional Medicare tax, but there would be no withholding by either employer for the additional Medicare tax since wages from each employer don't exceed $200,000.
Also, in determining whether they may need to make adjustments to avoid a penalty for underpayment of estimated tax, individuals also should be mindful that the additional Medicare tax may be over-withheld. This could occur, for example, where only one of two married spouses works and reaches the threshold for the employer to withhold, but the couple's income won't be high enough to actually cause the tax to be owed.