Close of 2014 tax planning presents challenges to individuals, businesses

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 may not decide the fate of these breaks until the very end of this year and, possibly, not until next year.

For individuals, these breaks include the following:

-      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 70½ or older; and

-      The exclusion for up-to-$2 million of mortgage debt forgiveness on a principal residence.

For businesses, the tax breaks that expired at the end of 2013 and may be retroactively reinstated and extended include the following:

-      A 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 their year-end plans. They must be wary of the 3.8% surtax on certain unearned income and the additional 0.9% Medicare (hospital insurance, known as HI) tax that applies to individuals who receive 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 unindexed 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 their estimated MAGI and net investment income (NII) for the year. Some taxpayers should consider ways to minimize additional NII for the balance of the year (e.g., through deferral). Others should try to see if they can reduce MAGI other than net investment income and other individuals will need to consider ways to minimize both NII and other types of MAGI.

The additional Medicare tax may 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 this into account when figuring their estimated tax. There could be situations where an employee may need to have more withheld toward year end to cover the tax. An example of where this may be the case is an individual who 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. The taxpayer 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 do not exceed $200,000. Also, to determine whether they may need to make adjustments to avoid a penalty for underpayment of estimated tax, individuals 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 will not be high enough to actually cause the tax to be owed.