We start this year’s tax guide with some good news: You may have a smaller federal tax bill in 2015.
The Internal Revenue Service (IRS) adjusted several line items to account for inflation. This indexing increases the dollar amounts defining each tax bracket and the dollar amounts for various exemptions and deductions. The net result is that less of your income may be taxed. Plus, if you are just above the breakpoint for a tax bracket this year, the adjustments could potentially put you into a lower tax bracket in 2015.
The amount of any federal tax savings will vary by taxpayer. Some of you may actually pay more, particularly if your income is higher in 2015 or if there are certain exemptions or deductions that you no longer qualify for. A new penalty for not having health insurance is now in effect as well. Still, many taxpayers will get a savings next year. Wolters Kluwer, CCH estimates that a married couple with total taxable income of $100,000 will pay $125.50 less in income taxes in 2015 than they will on the same income in 2014, assuming they file a joint return. An unmarried person with income of $50,000 will pay $62.50 less in 2015 than he or she will in 2014. Keep in mind that these are just estimates. The numbers also exclude the impact of state and local taxes.
Most of the inflation adjustments for 2015 are included in this guide. In a welcome change, the Internal Revenue Service published much of the index adjustments before we went to press. This has recently not been the case because of the fiscal cliff situation in 2012 and the government shutdown in 2013. There were a few line items yet to be adjusted for 2015, such as the mileage deductions, and we’ll update them on AAII.com after the information becomes available.
We’re also waiting to hear about the final fate of tax extenders. More than 50 tax breaks for individuals and businesses expired at the end of 2013 and were never renewed. They include the deduction for state and local sales taxes, tax-free distributions from an individual retirement account to a charity, the mortgage insurance deduction, and parity for employer-provided mass transit and parking benefits. There is scuttlebutt about a compromise being reached to renew at least some of these breaks during the lame duck session of Congress. If the extenders actually are renewed, and it’s not certain that they will be, we’ll post an update on AAII.com.
Some of the changes in the tax code occurred outside of the legislative branch. The IRS published new rules regarding the disbursement of pretax and aftertax contributions to defined-contribution retirement plans (e.g., 401(k) plans). A tax court ruling led to a new rule limiting IRS rollovers to one per year. The implementation of floating net asset values for money market funds prompted a proposed rule change sparing individuals from incurring the wash-sale rule. We’ll cover all of these changes in this guide.
This year, we’ve also added a new section discussing the tax impact of investing for and in retirement (here). This section is intended to add some clarity to the rules. It also lists milestone birthdays to be aware of both before and during retirement.
There is some speculation that progress could be made on comprehensive tax reform in 2015. It’s a difficult task complicated by politics, ideological differences and special interest influences. Regardless of what does or does not happen on the legislative front, one thing will be constant: You will still have to pay taxes. Furthermore, even a simplified tax code is still likely to be too complex; hence the need for tax guides. As has been the case in years past, our tax guide provides an overview of the tax rates and deductions likely to impact the majority of AAII members. Since there are many details, loopholes and pitfalls within the tax code, it is impossible for this guide to provide enough details to cover specific tax situations. If you have questions, consult a tax professional. It is your tax return, and the IRS will hold you responsible for any errors made on it.
We are continuing to give you the ability to estimate your 2014 and 2015 tax liabilities on AAII.com. Our Tax Forecasting Worksheet allows you to enter your data on our website. The fillable PDF document will calculate the results.
Once you are finished, you can print a copy for your records. (Be sure to print the document if you want to preserve your work, since the document cannot be saved to AAII.com.)
Most individuals will continue to fall into the long-standing tax brackets of 10%, 15%, 25%, 28%, 33% and 35%. High-income earners will pay a 39.6% marginal tax rate on income. The dollar amounts defining each brackets have been revised upward to account for inflation.
Social Security is taxed at 6.2% for employees and 12.4% for those working in self-employed positions on the first $117,000 of wages. In 2015, this limit will rise to $118,500.
The alternative minimum tax (AMT) exemption is $82,100 for married couples filing jointly and $52,800 for single filers in 2014. In 2015, the exemption will rise to $83,400 and $53,600, respectively. The exemptions are indexed to the rate of inflation and will continue be raised accordingly in the future barring any new legislation. This automatic increase is important because previously the AMT exemption was not indexed to inflation. New legislation had to be passed to prevent the AMT from ensnaring an ever-larger number of taxpayers.
The personal exemption phases out at income levels of $305,050 for married couples filing jointly and $254,200 for single filers for 2014. The phase-outs will increase to $309,900 and $258,250, respectively, in 2015. The total amount of exemptions that can be claimed by a taxpayer is reduced by 2% for each $2,500 or portion thereof by which adjusted gross income exceeds the threshold level. Married couples filing separate returns will see their exemptions reduced by 2% for each $1,250 of adjusted gross income.
| 2014 | 2015 | 2016 | |
| Long-Term Capital Gains Rate | |||
| Tax Bracket Equals 39.6%* | 20% | 20% | 20% |
| Tax Brackets 25%–35%* | 15% | 15% | 15% |
| Tax Bracket 15% or Below | 0% | 0% | 0% |
| Qualified Dividends Rate | |||
| Tax Bracket Equals 39.6%* | 20% | 20% | 20% |
| Tax Brackets 25%–35%* | 15% | 15% | 15% |
| Tax Bracket 15% or Below | 0% | 0% | 0% |
| Marginal Income Tax Rates | |||
| Top Bracket | 39.6% | 39.6% | 39.6% |
| Sixth Bracket | 35% | 35% | 35% |
| Fifth Bracket | 33% | 33% | 33% |
| Fourth Bracket | 28% | 28% | 28% |
| Third Bracket | 25% | 25% | 25% |
| Second Bracket | 15% | 15% | 15% |
| First Bracket | 10% | 10% | 10% |
| Child Tax Credit | $1,000 | $1,000 | $1,000 |
| Marriage Penalty Relief | |||
| Standard Deduction (% of S.D. for singles) | 200% | 200% | 200% |
| 15% Tax Bracket (% of bracket for singles) | 200% | 200% | 200% |
| Personal Exemption Phase-outs | $305,050 | $309,900 | $309,900** |
| Limitation on Itemized Deductions | $305,050 | $309,900 | $309,900** |
| AMT Exemption | |||
| Single | $52,800 | $53,600 | $53,600** |
| Married Filing Joint | $82,100 | $83,400 | $83,400** |
| Head of Household | $52,800 | $53,600 | $53,600** |
| Estate Tax | |||
| Exemption | $5.34 million | $5.43 million | $5.43 million** |
| Maximum Rate | 40% | 40% | 40% |
|
*3.8% net investment income tax (NII) surtax applies when AGI is above $250,000/$200,000. **Subject to change based on inflation. |
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An adjustment for the so-called “marriage penalty” puts the standard deduction for married couples filing jointly at double the standard deduction for those filing single. Married couples filing jointly can claim a standard deduction of $12,400 and single filers can claim a standard deduction of $6,200 on their 2014 tax returns. In 2015, those amounts are projected to increase to $12,600 and $6,300, respectively.
The phase-out for the $1,000 maximum child tax credit is not indexed to inflation. This means the $1,000 credit is phased out for married couples filing jointly with modified adjusted gross income (MAGI) above $110,000 in 2014 and will remain at this level without legislative action. If the child tax credit exceeds the tax liability, the difference will be paid to the taxpayer, subject to certain requirements. See IRS Publication 972 for more information.
Most taxpayers will not see a change in long-term capital gains and dividend tax rates, barring a drop into the lowest marginal tax bracket or a rise into the top marginal tax bracket. Long-term capital gains and qualified dividends are taxed at 15% if incurred for securities held within a taxable account. (There is no capital gains tax or dividend taxes for securities held within a retirement account, such as an IRA. See Robert Carlson’s article, “Do’s and Don’ts of IRA Investing,” in the March 2010 AAII Journal for investments that can cause an unexpected tax problem) Collectibles, which include gold coins and bars, are taxed at a maximum 28% rate. Short-term capital gains are taxed as ordinary income. If you are in the 10% or 15% tax bracket, long-term capital gains and qualified dividends are not taxed.
A 20% tax applies to long-term capital gains and dividends realized in taxable accounts by married couples filing jointly with incomes above $457,600 and single filers with incomes above $406,750 in 2014. The same higher tax rate will apply to married couples filing jointly with incomes above $464,850 and single filers with incomes above $413,200 in 2015. Married couples filing joint returns with net investment income or modified adjusted gross incomes above $250,000 and single filers with net investment income or modified adjusted gross incomes above $200,000 also must pay the additional 3.8% net investment income (NII) surtax on capital gains and dividends. Collectibles, which include gold coins and bars, are taxed at a 28% rate, but are eligible for the 3.8% surcharge as well. The $250,000/$200,000 thresholds are not indexed to inflation and will remain the same in 2015.
The individual shared responsibility provision of the Affordable Care Act went into effect on January 1, 2014. It requires adults and children to have minimum essential health coverage. Both Medicare Part A and Medicare Part C (Medicare Advantage) qualify as minimum essential health coverage. Taxpayers who did not have qualifying coverage and did not qualify for an exemption in 2014 will be assessed a penalty of either the greater of 1% of household income above the gross income threshold for filing a tax return or $95 per adult ($47.50 per child) limited to a family maximum of $285. In 2015, the penalty will rise to 2% of household income above the gross income threshold for filing a tax return or $325 per adult ($162.50 per child) limited to a family maximum of $975. The penalty will rise to 2.5% of income or $695 per person in 2016 and will be indexed to inflation afterward. Visit www.irs.gov/aca for more information.
The mandate is on top of the additional Medicare tax and the NII tax. The 0.9% additional Medicare tax applies to wages, compensation and self-employment income above $250,000 for married persons filing jointly and $200,000 for single persons. The previously mentioned surtax on net investment income applies to married couples filing jointly and single filers with net investment income or modified adjusted gross income exceeding $250,000 and $200,000, respectively.
More information about these taxes can be found in the box here.
The tax impact of the Affordable Care Act includes surcharges, higher limits on medical expense deductions, changes to flexible savings account contributions and carryovers, and a penalty for not complying with the medical insurance mandate.
A 0.9% additional Medicare tax applies to wages, compensation and self-employment income above $250,000 for married persons filing jointly and qualifying widows(ers), $200,000 for single persons and head of households and $125,000 for those who are married but filing separately. The tax applies to wages that are subject to the Medicare tax and does not depend on adjusted gross income. Should the additional tax not be withheld from wages (a situation that could occur for dual-income couples or individuals working more than one job), the tax could be subject to a penalty if not paid with estimated taxes or through additional withholdings (you can request that your employer increase the income tax withholding on your W-4). More information about the additional Medicare tax can be found on the IRS website at www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Questions-and-Answers-for-the-Additional-Medicare-Tax.
A 3.8% surtax on net investment income (NII) applies to the lesser of net investment income or modified adjusted gross income exceeding $250,000 for married persons filing jointly and qualifying widows(ers), $200,000 for single persons and head of households and $125,000 for those who are married but filing separately. (These thresholds are not indexed for inflation.) Investment income subject to the tax includes, but is not limited to, taxable interest, dividends, non-qualified annuities, rents and royalties, capital gains and passive income from partnerships. Capital gains from the sale of one’s primary residence are subject to the tax to the extent the income exceeds the applicable home sale exclusion ($500,000 for joint filers and $250,000 for single filers). Excluded are tax-exempt interest (e.g., municipal bond interest payments), distributions from individual retirement accounts (IRAs) and distributions from qualified retirement plans (e.g., 401(k) plans). The IRS has answers to common NII surtax questions at www.irs.gov/uac/Newsroom/Net-Investment-Income-Tax-FAQs.
Uninsured medical expenses must exceed 10% of adjusted gross income before they can be claimed as a deduction. Individuals age 65 and older qualify for the lower 7.5% floor through 2016.
Flexible savings arrangement contributions for 2014 are limited to $2,500 annually. This limit is indexed to inflation and will rise to $2,550 in 2015. At the election of their plan sponsors, employees can either carry over unused balances of $500 into the next plan year or take a grace period of up to two-and-half months.
As of January 1, 2014, failure to maintain minimum essential health coverage will result in a penalty. The penalty is the greater of 1% of household income above the gross income threshold for filing a tax return or $95 per adult ($47.50 per child) limited to a family maximum of $285. In 2015, the penalty will rise to 2% of household income above the gross income threshold for filing a tax return or $325 per adult ($162.50 per child) limited to family maximum of $975. The penalty will rise to 2.5% of income or $695 per person in 2016 and will be indexed to inflation afterward.
Though several deductions, exemptions and limits were either kept unchanged or were only increased by a modest amount because of the low levels of inflation in 2014, many of them will be increased in 2015.
For example, the maximum contribution a worker can make to a 401(k) plan was held steady at $17,500 in 2014, but will increase to $18,000 in 2015. There are some exceptions, however, such as the deductible IRA contribution. This will stay unchanged at $5,500 ($6,500 for those ages 50 or older) in 2015.
Many, but not all, 2015 figures had been announced by press time; we have noted in the tables the numbers that have not yet been updated by the IRS.
The estate tax rate will remain at 40% in 2014 and 2015. The estate tax exemption is indexed to inflation, which means a large dollar amount of a person’s estate can be shielded from the tax rate. The exemption is $5.34 million in 2014 and will be increased to $5.43 million in 2015. This is a per-spouse exclusion and it is portable, meaning if one spouse passes away, the surviving spouse can claim the exclusion, resulting in a total effective exclusion of $10.68 million in 2014 and $10.86 million in 2015. The large figures will prevent most families from having to pay estate taxes.
The step-up basis rule is a permanent part of tax code, barring any change made by future legislation. Under the step-up basis rules, if an inherited asset is sold, the capital gain resulting from the sale is calculated as the difference between the proceeds at the time of the sale transaction and the value of the assets at the time of inheritance.
Brokers are now required to report the cost basis for options and bonds bought and sold by their clients on or after January 1, 2014. Pay attention to the date; if you bought an option or a bond in 2013 or in a previous year, your broker is not required to report the cost basis. Certain debt instruments, particularly those that are more complex than traditional bonds, will not be covered by the cost basis reporting rule until January 1, 2016. As we noted in last year’s guide, the rule covering bonds and options was originally intended to go in effect on January 1, 2013.
The cost basis reporting requirement is a change from previous years, when brokers only reported the proceeds from a sale. This is the third part of a rule that started going into effect in 2011. Brokers and mutual fund companies must report the cost basis for stocks purchased after January 1, 2011, and mutual fund, exchange-traded fund (ETF) and dividend reinvestment program (DRP) shares purchased after January 1, 2012.
If you sold a capital asset in 2014, you will need to fill out Form 8949. See the special write-up in the “Cost Basis” box here for details on the rules.
The cost basis and the proceeds from options and bonds purchased after January 1, 2014, will be reported by your broker. This date reflects a one-year postponement from the previous implementation date of January 1, 2013. The cost basis for complex debt instruments, including inflation-indexed debt instruments, convertible bonds and stripped bonds, is not required to be reported by brokers until January 1, 2016. The delay reflects requests by brokers for more time to implement the systems needed for handling the complexities of these types of securities.
Investors have the option of notifying their broker as to how market discounts or interest is treated. Brokers will follow a default method of amortizing bond premiums if not otherwise notified. The rules are complex and we suggest speaking with your brokerage firm about the application of the rules, as well as a tax professional about the best tax treatment to use.
The type of option owned alters how cost basis is reported. Index options may be subject to different cost basis reporting rules. Again, we suggest speaking with your broker if you have questions about how the cost basis is reported.
Brokers have previously been required to report cost basis for stocks purchased after January 1, 2011, and for mutual fund, exchange-traded fund (ETF) and dividend reinvestment plan (DRP) shares purchased after January 1, 2012. Brokers are also required to state whether any gain or loss on a sale is short term or long term. The rules do not apply to securities and funds purchased before the aforementioned dates.
A default accounting methodology known as first-in, first-out (FIFO) is used when the purchase of securities (other than a mutual fund or DRP shares) involves more than one transaction. The FIFO method treats the first shares purchased (“first in”) as also being the first shares sold (“first out”). Depending on how the stock has performed, this treatment can result in a larger tax bill (the shares appreciated in value) or a bigger capital loss (the shares fell in value).
For mutual funds and DRP stocks, the adjusted basis must be reported in accordance with the broker’s default method—average cost basis—unless you specify otherwise. As the name implies, the average purchase price for your shares, regardless of when they are acquired, is used to determine the cost basis. You can specify FIFO instead of average cost basis. Another option is specific identification. The specific identification method allows you to choose the specific shares that are sold. This treatment can also result in a larger or a smaller tax bill, depending on how the fund has performed relative to the purchase price of the selected shares. You may be able to use other methods such as highest-in, first-out (HIFO) or last-in, first-out (LIFO). Contact your broker, fund family or DRP program to determine what their default methodology is and what choices you have for selecting methodologies.
If you want your broker or fund family to use a specific methodology other than their default methodology (e.g., FIFO for stocks or average cost for mutual funds), you must notify them. In order to do this, you must provide written instructions to your broker or fund administrator detailing your intentions before the order is executed, not afterward.
Dustin Stamper at Grant Thorton’s National Tax Office emphasized the importance of providing these instructions in writing. If you give your broker or fund family specific instructions and they report a different methodology to the IRS, the only way you can dispute what is on Form 1099-B is to provide a dated copy of your instructions. Stamper said that investors will not be able to retroactively determine which shares were sold; they must provide written instructions at or before the time the shares are sold.
The higher threshold for deducting medical expenses remains in effect. Those under the age of 65 at the end of 2014 can only deduct medical expenses exceeding 10% of adjusted gross income (AGI). Those age 65 or older at the end of 2014 will continue to be able to use the lower 7.5% floor for deducting medical expenses through 2016.
Medical insurance premiums for the self-employed are deductible and can be used to reduce adjusted gross income on Form 1040.
Workers participating in flexible savings accounts (FSA) can carry over up to $500 of unused amounts into the next plan year if their plan sponsor allows them to. Plan sponsors have the choice of either offering employees the ability to carry over up to $500 or allowing employees a grace period of up to two-and-half months.
A new rule from the Securities and Exchange Commission (SEC) requires some money market funds, particularly institutional prime money market funds and tax-free institutional money market funds, to use floating net asset values (NAVs). This means their NAVs are not pegged to $1 per share, but rather can move above or below that benchmark.
The IRS responded to the SEC’s ruling by saying “No gain or loss is determined for any particular redemption of a taxpayer’s shares in a floating-NAV money market fund. Without a determination of loss, a particular redemption does not implicate the wash-sale rules.” The wash-sale rules disallow a loss being claimed for tax purposes when an investment is sold and a substantially identical investment is purchased within 30 days of the sale.
The IRS made two changes to the rules regarding IRA rollovers. The first limits aggregate IRA rollovers to one per person per year. The old rule, which remains in effect until December 31, 2014, allows one rollover per account per year. The new rule does not apply to trustee-to-trustee transfers, meaning you can move the actual account from broker to broker as many times as you would like. The key is that you do not move funds from one IRA to another. The new rule goes into effect on January 1, 2015, and applies to rollovers made on or after this date. Rollovers made in 2014 are disregarded as long as the 2015 distribution is from a different IRA that neither made nor received the 2014 distribution.
Rollovers to or from a qualified plan (e.g., a 401(k) plan) are excluded from the new rule. Trustee-to-trustee transfers are also excluded. This means you can move your entire IRA account directly from one broker to another without triggering the one-year waiting period as long as the assets are directly transferred to the new broker and not to you first. Roth IRA conversions are not subject to the one-year limitation and the IRS will disregard them in terms of applying the one-rollover-per-year limitation to other rollovers. A rollover between Roth IRAs would, however, trigger the one-year waiting period for both Roth IRAs and traditional IRAs.
The second rule change governs distributions composed of both pretax and aftertax contributions from defined-contribution plans, such as 401(k), 403(b) or 457(b) plans. As long as directions are given to the plan administrator in advance of the distribution, the pretax and aftertax contributions can be assigned to different accounts. Previously, the pretax and aftertax distributions were not allowed to be assigned to separate accounts. This rule can be used as guidance for distributions taken on or after September 18, 2014. See IRS Notice 2014-54 for more information and examples of various scenarios.
For a complete tax guide to the buying and selling of your personal investments, go to our Personal Investments 2014 Tax Guide.
The legalization of same-sex marriage in a larger number of states has tax implications. Same-sex marriages receive treatment similar to common-law marriages under the tax code if the couple was married in a jurisdiction where such marriages are legally recognized.
Last year, in United States v. Windsor, the U.S. Supreme Court struck down Section 3 of the Defense of Marriage Act, which defined marriage as a union between one man and one woman. In response, the IRS clarified and amplified the revenue ruling that determined the tax status of couples living in a common-law marriage situation for federal income tax purposes. In doing so, the IRS said that for over 50 years, it has recognized marriages based on the laws of the states they were entered into.
The last sentence is important. If a couple enters into a same-sex marriage in a state where it is legal to do so, the couple is considered married for federal tax purposes, regardless of where they currently reside. Common-law marriages are recognized if the two people entered into a common-law marriage in a state where the common law is recognized.
Couples in domestic partnerships, civil unions, or other similar formal relationships recognized but not denominated as marriage under state law are not considered to be married for federal tax purposes. The IRS says this applies to both opposite-sex and same-sex relationships.
Several tax breaks for individuals expired at the end of 2013. These tax breaks are no longer in existence and cannot be claimed on 2014 or 2015 taxes. They include, but are not limited to: the deduction of the state and local sales taxes, IRA distributions to charity and transit benefits. It is possible that legislation renewing these tax breaks could be passed after we send this guide to the printer.
Although the tax rates, deductions and exemptions for 2014 were covered in the January 2013 tax legislation and many of the 2015 numbers were updated by the IRS recently, if you use a software program (e.g., TurboTax), a book (e.g., “J.K. Lasser’s Your Income Tax 2015”) or a related aid, check for updates before filing. Doing so will help to ensure that you are using the most up-to-date forms and information.
Here is a list of the tax rates, deductions, exemptions, credits and other related items that may apply to your 2014 and 2015 taxes. These numbers reflect the changes made by the American Taxpayer Relief Act of 2012 (ATRA) and 2015 inflation adjustments announced by the IRS.
If you are expecting a refund on your 2014 income tax, you can check on its status if it has been at least four weeks since the date you filed your return by mail, or 24 hours if you filed electronically. You will need to supply the following information: your Social Security number or IRS Individual Taxpayer Identification number, your filing status and the exact whole-dollar refund amount as it is shown on your return.
You can check the status of your refund in two ways:
If you are unable to get information on your refund through either of these two automated services, you can call the IRS for assistance at 800-829-1040.
The IRS website also allows you to start a trace for lost or missing refund checks, or to notify the IRS of an address change when refund checks go undelivered. Taxpayers can avoid undelivered refund checks by having refunds deposited directly into a personal checking or savings account. This option is available for both paper and electronically filed returns.
For 2014, the standard deduction is $12,400 for married couples filing a joint return, $6,200 for those who are single or married filing separate returns and $9,100 for heads of household.
For 2015, the standard deduction will be $12,600 for married couples filing a joint return, $6,300 for those who are single or those who are married filing separate returns and $9,250 for heads of household.
The 2014 personal exemption is $3,950. The exemption can be claimed for yourself, your spouse (if filing a joint return) and any qualifying dependents. The exemption will start to phase out at $305,050 for married couples filing jointly and $254,200 for single filers.
The personal exemption will rise to $4,000 in 2015. The phase-out levels will be raised to $309,900 for married couples filing jointly and $258,250 for single filers.
The maximum allowed IRA contribution for 2014 is $5,500 ($6,500 for any individual who is age 50 or older). The contribution limits were unchanged in 2014 and will remain unchanged in 2015. The additional catch-up contribution limit of $1,000 is not indexed to inflation and will also be unchanged next year. The contributions can be fully deducted for modified adjusted gross incomes (modified AGIs) below $96,000 and $60,000 for married filing joint and single returns, respectively. In 2015, the phase-outs for deducting IRA contributions will rise to $98,000 and $61,000, respectively.
| Combined Income* | Percent of SS Benefits Taxed |
| Below $25,000 Single & Head of Household | 0% |
| Below $32,000 Married Filing Jointly | |
| $25,000 to $34,000 Single & Head of Household | up to 50% |
| $32,000 to $44,000 Married Filing Jointly | |
| Above $34,000 Single & Head of Household | up to 85% of benefits + other income |
| Above $44,000 Married Filing Jointly | |
| *The Social Security Administration defines combined income as: Your adjusted gross income + nontaxable interest + ½ of your Social Security benefits. | |
In 2014, the maximum annual contribution limit to a 401(k) plan or similar type of defined-contribution plan is $17,500 ($23,000 if you are age 50 or over), unchanged from 2013. The maximum contribution will increase in 2015 to $18,000 ($24,000 if you are age 50 or over).
In 2014, the maximum annual contribution for SIMPLE plans is $12,000 (those age 50 or over can make a maximum catch-up contribution of $2,500); in 2015, the maximum contribution will increase to $12,500.
In 2014, the maximum annual contribution for qualified plans, including SEP and Keogh plans, is $52,000 or 25% of your compensation, whichever is less; in 2015, the maximum contribution will be $53,000 or 25% of your compensation, whichever is less.
Tax laws passed in 2010 and 2013 made the estate tax exemption both portable and indexed to inflation. The exemption is $5.34 million in 2014. In 2015, the exemption will rise to $5.43 million. See the previous section about the estate tax for information on calculating taxable gains from the sale of the inherited assets.
The annual gift tax exclusion is $14,000 in 2014 and $28,000 for consenting couples. (You will need to file Form 709.) The exclusions will stay unchanged in 2015.
Individuals age 70½ and older are required to take a distribution from their retirement accounts by December 31, 2014. These accounts include 401(k) plans, 403(b) plans, 457(b) plans, traditional IRAs, SEP IRAs, SARSEP IRAs, SIMPLE IRAs and Roth 401(k) plans. RMDs from defined-contribution plans, such as 401(k) plans, can be postponed beyond age 70½ if you are still working, contributing to a defined-contribution plan and own less than 5% of the company. Roth IRA plans are exempt while the owner is alive.
If you turned 70½ in 2014, you have until April 1, 2015, to take your first RMD. You will need to take a second RMD during 2015 to satisfy that year’s distribution requirement.
According to the IRS, “Generally, an RMD is calculated for each account by dividing the prior December 31st balance of that IRA or retirement plan account by a life expectancy factor that IRS publishes in tables in Publication 590, Individual Retirement Arrangements (IRAs).”
In 2014 and 2015, the maximum child tax credit for dependent children younger than 17 is $1,000. The credit was made permanent by the ATRA.
In 2014, the “kiddie tax” applied to children up to age 18 and could apply to children up to age 23—depending on how much earned income they have and whether or not they are full-time students.
Under the kiddie tax rules, children with investment income above a certain amount may have part or all of their investment income taxed at their parents’ income tax rate.
The kiddie tax applies in both 2014 and 2015 if the child is age 17 or younger by the end of the year. In 2014, the kiddie tax will apply if the child’s total investment income exceeds $2,000. It will increase to $2,100 in 2015.
In addition, the kiddie tax can apply to older children, depending on how much earned income they have and whether or not they are full-time students.
Donations of clothing and other personal items must be in “good condition” or better in order to be deducted. Form 8283 must be filled out if your total deduction for all noncash contributions exceeds $500.
In addition, charitable contributions of cash (regardless of the amount) to any qualified charity must be supported by a dated bank record (such as a cancelled check) or a dated receipt from the charity that must include the name of the charity and the date and amount of the contribution.
The provision that allowed those age 70½ or older to distribute up to $100,000 from their traditional individual retirement account (IRA) tax-free to qualified charities expired in 2013. The provision was NOT renewed for 2014 or beyond as of press time. New legislation is required for this provision to be reinstated.
Taxpayers who itemize deductions can deduct (as a medical expense) the premiums they pay for Medicare Part B supplemental insurance and Medicare Part D prescription drug insurance. Premiums for voluntary coverage under Medicare Part A are only deductible by those over the age of 65 and not covered by Social Security.
Medical expenses must exceed 10% of adjusted gross income to qualify for deductions for those under the age of 65 in tax years 2014 and beyond. The lower 7.5% floor will remain in effect for those age 65 or older through the year 2016.
The phase-out of itemized deductions (the “Pease” limitation) for taxpayers with adjusted gross income above a certain amount was reinstated by the ATRA. It applies to married filing jointly and single taxpayers with incomes of $305,050 and $254,200, respectively, or higher in 2014. For 2015, the phase-out levels will rise to $309,900 and $258,250, respectively.
Planning Considerations:
Married taxpayers filing jointly will need to calculate whether taking the increased standard deduction or itemizing deductions will generate the most tax savings overall. When doing so, make sure to consider whether state law restricts the ability to itemize to only those who itemize for federal purposes. The higher deductions may also require more couples to pay alternative minimum tax (AMT).
The provision allowing taxpayers who itemize deductions the option of choosing between a deduction of sales taxes or income taxes when claiming a state and local tax deduction was NOT extended into 2014 as of press time. New legislation is required to reinstate it.
State and local governments are required to report interest paid on tax-exempt state and local bonds on Form 1099-INT, Interest Income. This amount must be shown on your tax return and is for information only.
You may be able to take a deduction if you contributed to a Health Savings Account (HSA). To qualify, you must be covered by a “high-deductible health plan.”
More information on this can be found here.
You may be able to deduct contributions to a Health Savings Account (HSA). These tax-free savings accounts were established under the Medicare Act of 2003, and can be used to pay for medical expenses incurred by you, your spouse or your dependents. They are used in conjunction with high-deductible health plans, where your basic health insurance does not cover first-dollar medical expenses.
HSAs may be established by anyone who is covered by an HSA-qualified “high-deductible health plan,” is not covered by any other health insurance and is not enrolled in Medicare. Qualified high-deductible health plans must have an annual deductible of at least $1,250 for self-coverage and $2,500 for family coverage in 2014; these minimums will increase to $1,300 and $2,600 respectively in 2015.
Tax-deductible contributions can be made to the health savings account up to a maximum of $3,300 for self-coverage and $6,550 for families in 2014. In 2015, these amounts will increase to $3,350 and $6,650, respectively. If you are over age 55, you can also make a “catch-up” contribution to your account of up to $1,000 and still enjoy the same tax advantages.
Individuals can also make a one-time transfer from their IRA to an HSA, subject to the contribution limits applicable for the year of the transfer.
Contributions to HSAs can be made by you, your employer or both. You can fully deduct your own contributions to an HSA, even if you do not itemize, and contributions made by your employer are not included in your taxable income. The interest and investment earnings generated by the account are also not taxable while in the HSA.
Amounts distributed from the HSA are not taxable as long as they are used to pay for qualified medical expenses. They can be used to:
Amounts distributed that are not used to pay for qualified medical expenses will be taxable, plus a 20% penalty will be applied.
HSAs are similar to IRAs in that they are owned by individuals—you are not dependent on a particular employer to enjoy the advantages of an HSA. And if you change jobs, the HSA goes with you.
What if you already have an existing medical savings account (MSA)? In that case, you can either retain it or roll the amount over into a new HSA.
For more information on HSAs, read IRS Publication 969, available at www.irs.gov.
The maximum Hope Scholarship Credit (the American Opportunity education credit) of $2,500 per year for the first four years of post-secondary education for tuition and related expenses (including books) was extended through 2017 by the ATRA. This credit can be claimed in both 2014 and 2015.
The Lifetime Learning credit can be claimed for education expenses beyond the fourth year of post-secondary education and for non-degree courses intended to improve job skills. The maximum credit is $2,000 annually and is subject to income phase-outs.
You can make non-deductible contributions to qualified tuition plans, also known as section 529 plans. (However, the contributions may be deductible from your state income tax, depending on where you live.) These accounts, offered by states or their designees, are maintained solely for the qualified higher education expenses of a beneficiary. Distributions are tax-free, provided that the distributions are used to pay qualified expenses.
The ATRA made the $2,000 per beneficiary contribution limit to a Coverdell Education Savings Account permanent. The contributions are not deductible, but they grow tax-free in the IRA. Coverdell accounts may be used to fund qualified elementary, secondary and higher education expenses. However, the amount that can be contributed is limited for higher-income taxpayers.
The inability of members of Congress to find much common ground on fiscal issues leaves the future of the tax code in doubt. Though the ATRA provided clarity in terms of current legislation, any long-term agreement on the federal budget and debt reduction could include changes to the tax code.
Though we cannot predict what the politicians in Washington will do, or when they will do it, there are strategies that make sense regardless of the legislative environment. Listed below are traditional tax planning strategies that can help keep your tax bill down. It is important, however, to keep in mind that your goals and risk tolerance, not just the income tax impact of an investment, should drive your investment decisions.
You have the option of converting all or part of your traditional IRA into a Roth IRA, regardless of your adjusted gross income. Roth IRAs can provide certain advantages: The converted assets can be withdrawn tax-free at any time, future earnings are also tax-free (with some limitations) and Roth IRA owners are not required to take any minimum distributions in retirement. The downside, however, is that the conversion amount is taxable in the year it occurs.
While the benefits of a Roth IRA conversion could be considerable, taxpayers must carefully weigh the upfront tax costs against the long-term tax advantages. For more on this, see “Retirement Plans: Evaluating the New Roth IRA Conversion Opportunity” by Christine Fahlund in the November 2009 AAII Journal and “New Rules for Converting to a Roth IRA” by William Reichenstein, Alicia Waltenberger and Douglas Rothermich in the January 2010 AAII Journal. Though the articles discuss the one-time 2010 option for delaying the taxes from the conversion, their suggestions regarding whether to convert or not continue to be applicable. You may also want to consult a tax adviser.
You cannot convert required minimum distributions (RMDs) from your traditional IRA for a particular year (including the calendar year in which you reach age 70½) to a Roth IRA. IRS publication 590 explains the rules for RMDs and Roth IRA conversions.
Deferring income that is taxed at higher ordinary tax rates makes sense. Most taxpayers will pay long-term capital gain tax rates of 0% or 15%. For married couples filing jointly with income above $457,600 and single filers with income above $406,750 in 2014, the long-term capital gains rate is 20%. In 2015, the 20% long-term capital tax rate will apply to married couples filing jointly and single filers with incomes above $464,850 and $413,200, respectively. Short-term capital gains, in contrast, are taxed at ordinary income tax rates and run as high as 39.6%. The 3.8% net investment income (NII) surtax, which went into effect on January 1, 2013, applies to taxpayers with income above the $250,000/$200,000 thresholds. This tax applies to both short- and long-term capital gains, as well as taxable interest, dividends, non-qualified annuities, rents and royalties, and passive income from partnerships. The NII surtax is not indexed to inflation, and the $250,000/$200,000 thresholds are effective for both 2014 and 2015.
Similar rules apply to qualified dividends. For married couples filing jointly with income above $457,600 and single filers with income above $406,750 in 2014, dividends are taxed at 20%. In 2015, the 20% qualified dividend tax rate will apply to married couples filing jointly and single filers with incomes above $464,850 and $413,200, respectively.
Though tax considerations should never be the primary reason for selling a security, if you have large positions in either gifted or inherited stocks, or stocks received from a sale of a business, you should consider whether it makes sense to sell shares over a period of time to take advantage of the long-term capital gains rates and use the proceeds from selling the stock to diversify your portfolio. This is particularly the case if a large portion of your wealth is concentrated in just a few securities.
While tax considerations should not drive your investment decision, you can take advantage of losses in holdings that you would prefer to either sell or reduce from an investment standpoint.
Capital losses first reduce capital gains: long-term losses reduce long-term gains first, and short-term losses reduce short-term gains first. Any long-term losses left over reduce short-term gains, and vice versa. If you still have losses remaining after offsetting capital gains, you can reduce your “ordinary” income by up to $3,000. Losses not used this year can be carried forward to future years until they are used up. For more information, see “Capital Pains: Rules for Capital Losses” by Julian Block in the September 2010 AAII Journal.
When planning, make sure you don’t run afoul of the wash-sale rules. If you sell an investment at a loss and then acquire a substantially identical security during the 30-day period before or 30-day period after the sale, the loss will be disallowed. If your loss is disallowed by the wash-sale rule, you can increase the cost basis of the new position of the substantially identical security by the amount of the disallowed loss. The holding period for the new position is also adjusted to include the holding period of the position sold at the disallowed loss. You cannot adjust the cost basis or holding period if you acquire the investment in an IRA or Roth IRA, however. For information, see “Keeping Transactions Clean From the Wash-Sale Rules” in this issue.
Selecting tax-aware managers of mutual funds may be important to maximizing your aftertax rate of return in your taxable investment portfolio.
You may choose when to sell specific shares of the fund and may, therefore, create long-term versus short-term capital gains, as long as you notify the fund family or your broker in writing with specific instructions. But you don’t control the investments within the fund. Should an equity manager fail to extend the holding period on a stock, it could cost you as much as 19.6% of your gain (39.6% ordinary rate for short-term capital gains versus the 20% long-term capital gains rate).
Some mutual fund dividends can be treated as qualified dividends and eligible for the reduced tax rate, while others will not qualify. Dividends paid by stocks held by the fund and passed through to the shareholder are eligible for the qualified dividend tax treatment. However, capital distributions and bond interest are not. These payments are reported on Form 1099, which specifies the type of distribution.
Read more on mutual fund distributions here.
Investment returns generated by a mutual fund or an exchange-traded fund (ETF) can take the form of dividends, interest or capital gains and losses. Funds are required to distribute dividends, interest and net realized gains to you each year. (However, both mutual fund and ETF managers can use strategies to limit distributions and offset realized capital gains; therefore, it is possible for a fund not to distribute a realized gain for a given year.)
Distributions are taxable whether you take them in cash or reinvest them in fund shares, unless they are income dividends from tax-exempt municipal bond funds, or if they are within a tax-sheltered account such as an IRA. (Capital gain, dividend and ordinary income taxes are generally not triggered for funds held in an IRA; rather, withdrawals from a traditional IRA, or similar type of account, are taxed.)
The status of any capital gain or dividend distributed to you by a fund depends on how long the fund owned the securities that produced the gain or dividend—not on how long you owned shares in the fund. The information you will need to determine how your distributions are taxed will be on your fund’s Form 1099.
What about losses?
A fund’s capital losses are never distributed to shareholders, but are used to offset capital gains realized by the fund during the year. Any additional losses are carried forward by the fund to apply against gains realized in the future. The only losses you can claim are those you may have incurred when you redeemed your own shares of a fund.
Because fund distributions are taxed even if they are reinvested, it is important to remember that you should add reinvested income, dividends and capital gains (from both taxable and tax-free funds) to your original cost basis when it comes time to figure gains or losses on any fund shares that are sold. If you do not, you will, in effect, be paying taxes twice on those distributions. (As of January 1, 2012, mutual funds and brokers were required to report the cost basis for mutual fund shares and ETFs bought and sold after that date.)
In addition, consider delaying an investment in a fund if you are investing close to the fund’s ex-dividend date. When a distribution is made, it is subject to tax, even if you reinvest it back into the same fund. (The reinvested amount increases your tax basis in the fund, however).
Most funds commonly make distributions toward the end of the year. Investors must be wary of the distribution date. Generally, you should not invest in a fund shortly before its distribution date, because a portion of your investment will be immediately returned to you with an accompanying tax liability. Most mutal fund and ETF providers should be able to give you a good idea of when their year-en distributions will take place, so calling the fund company prior to investing can be a wise move.
AAII's "Individual Investor's Guide to the Top Mutual Funds" and Individual Investor's Guide to the Top Exchange-Traded Funds" list tax-cost ratios for all covered funds. The February 2015 AAII Journal will include the latest mutual fund guide; the ETF guide was published in the August 2014 AAII Journal.
Interest from tax-free municipal bonds is generally exempt from federal income taxes, unlike the interest from taxable bonds, which is taxed as income. Like any bond, credit quality matters, as you want to ensure that the issuer will not default. Changing yields can also alter the aftertax yield advantage, making municipal bonds more or less attractive to taxable bonds.
Additionally, private-activity bonds (a type of tax-free bond) could increase your exposure to the alternative minimum tax since their interest income is taxable for purposes of the alternative minimum tax. There are exceptions, including qualified 501(c)(3) bonds, New York Liberty bonds and Gulf Opportunity Zone bonds. Furthermore, the interest on qualified bonds issued in 2009 and 2010 is not subject to the alternative minimum tax. Check with the bond issuer to find out the bond’s tax status.
You should review your bond and money market accounts to make sure that you are earning the highest aftertax return. But don’t forget to consider the state tax implications of switching from tax-free to taxable bonds before making any final portfolio decisions.
Increasing retirement savings makes sense from a financial planning standpoint and, depending on your adjusted income, may reduce your tax bill. You have until April 15, 2015, to make an IRA contribution for the 2014 tax year. See the box above for yearly contribution limits to various types of retirement plans.
The spread between capital gains and ordinary income rates has important implications with respect to your asset allocation between taxable and taxdeferred (retirement) accounts.
For example, from a tax perspective, holding individual stocks in tax-deferred accounts and bonds in taxable accounts could be expensive because the longterm gains resulting from stocks held in tax-deferred plans such as IRAs or 401(k) plans will be taxed at ordinary rates when taken as a distribution. By reversing that structure, taxable bonds and other tax-inefficient assets will be shielded from taxation in the deferred accounts, while equities will enjoy the reduced rates for capital gains in personal accounts.
Tax-free municipal bonds should, of course, remain outside of retirement accounts. Individuals should also consider the cost of commissions and taxes, current cash flow needs, and the 0.9% additional Medicare tax and 3.8% NII surtax before making any investment moves between taxable and tax-deferred accounts.
If you are receiving Social Security benefits, you may have to pay taxes on them if your combined income (primarily your adjusted gross income plus any tax-exempt interest income plus half of your Social Security benefits) exceeds certain levels.
To protect your benefits, watch the amount of interest you receive from municipal bonds, since this amount is included in your modified adjusted gross income when determining the Social Security benefit taxability. In addition, you may want to delay taxable distributions from a retirement plan or IRA.
It is important to remember that taxes are not the key to investment planning. However, one thing is certain: There will be more tax changes coming, and everyone should consider how the changes directly affect their overall tax and investment strategies.
At the end of each year, you should take the time to assess your tax situation. Doing so will give you the opportunity to shift certain items around, should that be beneficial in terms of your tax liability. Taking a few initial steps now and using year-end planning strategies can result in significant tax savings.
How can you effectively plan?
Here are the basic steps you should take to help start your personal tax planning:
To minimize your taxes, consider both short-term and long-term tax planning issues and strategies. Starting early will give you extra time to obtain additional information about items that concern you and to investigate additional ideas for tax savings or deferral. The Tax Forecasting Worksheet (fillable PDF) will provide a starting point for evaluating the tax effects of various strategies.
Make sure you determine your 2015 tax liability as early as possible, as well as the due dates for paying those taxes (including the self-employment tax and the alternative minimum tax), so that you avoid underpayment penalties.
Federal tax law requires the payment of income taxes throughout the year as you earn your income. This obligation may be met through withholding, quarterly estimated tax payments or both. If you do not meet this obligation, you may be assessed an underpayment penalty.
If your total tax due minus the amount you had withheld is less than 10% of your total tax due, you will not be assessed an underpayment penalty. The disadvantage of overpaying throughout the year, though, is that you are in effect making an interest-free loan to the government. However, the underpayment penalty can be high, and it is calculated as interest on the underpaid balance until it is paid, or until the regular filing date for the final tax return, whichever is earlier.
You can avoid underpayment tax penalties by adopting one of the safe harbor rules. The basic rule is to pay the required amount by the end of the year through withholding and quarterly estimated payments. The required amount will be one of the following, depending on your individual situation:
Penalties are based on any underpayment, which is the difference between the lowest amount required to be paid by each quarterly payment date and the amount actually paid by that date. The annual required amount, based on either of the first two alternatives, is paid in equal installments. In the case of the third method, which is based on annualized income, the amount due each quarter is based on actual income received for each installment period. The third method is typically more beneficial if you do not earn income evenly throughout the year (e.g., you operate a seasonal business) or had an unexpected increase in income because it allows for lower required payments in the early quarters.
Income tax payments made through withholding from your paycheck (or from your pension or other payments) are given special treatment. The IRS treats income tax that is withheld as having been paid equally throughout the year (unless you prefer to use actual payment dates). This lets you make up for underpaid amounts retroactively because amounts withheld late in the year may be used to increase the amounts paid in earlier quarters.
State and Local Rules:
Be aware that many states have underpayment rules that vary from the federal requirements.
You have opportunities to reduce your taxes if you can control the timing of either your income or expenses. However, it is important to make sure you understand whether you may be subject to the alternative minimum tax (AMT) before adopting these strategies. (See the box here for more information.)
Are you subject to the alternative minimum tax? This tax comes as a surprise to many taxpayers. You may be subject to this tax, especially if any of the following criteria apply to your situation:
The alternative minimum tax is calculated by first determining the tentative minimum tax. The 2014 minimum tax for married couples filing joint returns and singles is 26% of the first $182,500 of alternative minimum taxable income in excess of the exemption amount, plus 28% of any additional alternative minimum taxable income. A 26%/28% threshold of $91,250 exists for married filing separately. However, for alternative minimum tax purposes, dividends and capital gains will be taxed under the same rules as those used for regular tax calculations. The alternative minimum tax is the excess of the tentative minimum tax above the regular tax calculated.
Alternative minimum taxable income adds back certain preference items to regular taxable income—including state income taxes, real estate taxes and miscellaneous itemized deductions—and can cause the alternative minimum tax to be larger than the regular tax.
In addition, although the tax rate on capital gains and dividend income is the same for both the regular tax and the alternative minimum tax, the disparity in rates between the alternative minimum tax and the regular tax may result in a higher effective rate on all income, including capital gains and dividends.
The IRS offers the AMT Assistant, an electronic version of the AMT Worksheet in the 1040 Instructions. By filling in answers to a few simple questions, you can determine whether or not you owe the alternative minimum tax.
Income
Your income is generally taxed in the year of receipt, so having the ability to control when you receive it affords a strategic tax planning opportunity. Deferring income until a later year will, in most cases, delay the payment of tax. You cannot defer taxation by merely delaying receipt of the income if the funds are available to you and the time of payment is subject to your unrestricted discretion. Any decision to defer income must be weighed with the lost time value of the money and other risks that could alter or forfeit your right to the income.
The timing of bonuses, recognition of capital gains from the sale of stocks, and the exercise of non-qualified stock options are all events that can easily be delayed into a subsequent year. Consider the deferral of compensation through the use of various retirement plans and deferred-compensation arrangements. If you operate a business or collect rental income and report that income on the cash receipts and disbursements method, you have an opportunity to delay or accelerate the billing to your customers or tenants and determine the timing of the related income.
Deductions
You can reduce taxes by controlling the payment of deductible expenses. If paid by December 31, you may deduct certain expenses that are due the following year on your current year tax return. This strategy helps when you have a higher tax liability in the current year than you expect to have in the coming year. Again, you must balance this decision with the time value of money and other inherent risks.
For example, if you pay a deductible expense in December 2014 instead of April 2015, you reduce your 2014 tax instead of your 2015 tax, but you also lose the use of your money for three-and-one-half months. Generally, this will be to your advantage, unless you have an alternative use for the funds that will produce a very high return in that three-and-one-half-month period. You must decide whether the cash used to pay the expense early should be used for something more urgent or more valuable than the accelerated tax benefit.
For those who will pay 2015 estimated taxes based on their 2014 tax liability, reducing your 2014 taxes has another advantage: Your 2015 estimated tax payments may be smaller.
State Taxes
If accelerating deductions makes sense for you and you choose to claim a deduction on your state and local income taxes, you may want to prepay the balance on your estimated state tax liability in December 2014, rather than waiting until 2015. This secures that deduction on your 2014 tax return, even though the payment might not be required by the state until January 15, 2015, or April 15, 2015.
Charitable Contributions
If you are planning on making a gift to a charity in 2015, consider making the gift in 2014 to accelerate the tax benefit of the contribution. However, it is important to note that certain limitations exist with respect to deductions for charitable contributions.
You should also consider the benefits of gifting appreciated stock to a charity. If you donate long-term appreciated stock directly to the charity, you get a deduction for the full fair market value of the stock; whereas if you sell the stock first and donate cash, you only get a deduction for the aftertax cash donated. (If you have an unrealized loss in the stock, however, it might be more beneficial from a tax standpoint to sell the stock and then donate the cash proceeds. Doing so would give you deductions for both the capital loss and the charitable donation.)
When making a gift to charity, you must have an appropriate record of the gift in order to properly support the deduction. In addition, cash contributions of any amount must be supported by a written record, either in the form of a bank record (for example, a cancelled check) or a written receipt from the charity. The record must include the name of the charity, the date and the amount of the contribution.
Prepaid Interest
A cash basis taxpayer may not deduct prepaid interest before the tax year to which the interest relates. However, there is some flexibility to prepay year-end interest that is due early in the following year. For example, if a mortgage payment is due on January 10, a taxpayer can accelerate the deduction of the portion of the interest relating to the period up to January 1 by mailing the check in December.
The most significant interest deductions currently available are for home mortgage interest and for investment interest expense to the extent of current-year investment income. Interest paid in relation to investments that earn a tax-free return is not deductible.
You may be able to exclude up to $250,000 of gain ($500,000 for married taxpayers filing jointly) when you sell your main home. The exclusion is allowed each time you sell your main home, but no more than once every two years. To exclude the gain, you must have owned the home and used it as your principal residence for at least two out of the five years before its sale. Periods of use include short absences (such as summer vacations), but not longer breaks (such as one-year sabbaticals). You also must not have excluded the gain on another home sale during the two years before the current sale.
Married taxpayers filing a joint return can exclude gains if either qualifies for the year of the sale, but both spouses must meet the use test to claim the $500,000 maximum exclusion.
If you do not meet the ownership and use tests, you may be allowed to exclude a reduced amount if the sale was due to health, a change in employment or certain unforeseen circumstances.
A widow or widower can take up to two years after the death of a spouse to sell a home and claim the $500,000 exclusion, as long as the survivor has not remarried and the sale would otherwise meet the requirements.
Be aware that under a change in tax laws that took effect in 2009, if you convert a second home into your main home, you may not be able to exclude all of your gain on the subsequent sale of that home even if you meet the ownership and use requirements. The portion of the gain that is no longer excludable is based on the ratio of the time after 2008 that it was a second home relative to the total time you owned it.
Excluded gains are not reported on your federal tax report; unexcluded gains are reported on Schedule D, Capital Gains or Losses.
For a complete description of the rules, see IRS Publication 523, Selling Your Home, available at www.irs.gov.
Medical Expenses
If the timing of certain medical and dental expenditures is flexible and your overall medical expenses are high in the current year, you may want to accelerate the timing of these expenses. Because unreimbursed medical expenses are only deductible to the extent that they exceed 10% of adjusted gross income (7.5% for those age 65 and older through 2016), it is best from a tax standpoint to incur expenses—such as replacement eyeglasses or contact lenses, elective surgery, dental work and routine physical examinations—in a year in which you have already gone over (or the added expenses would take you over) the 10% threshold.
Miscellaneous Itemized Deductions
Miscellaneous itemized deductions are only deductible to the extent that they exceed 2% of adjusted gross income. This category is large but includes:
Accelerating miscellaneous itemized deductions only benefits taxpayers who accumulate expenses sufficient enough to exceed the 2% threshold. If possible, it may be advantageous to pay these types of expenses in one year if, because of the 2% floor, you would not receive a benefit of the deduction in each of the two consecutive years.
The alternative minimum tax (AMT) was originally designed to ensure that everyone would pay his or her fair share of income taxes. In 1987, only 140,000 taxpayers were subject to the AMT. Since then, however, it has evolved into a separate tax regime that required a permanent fix in the ATRA to prevent from it ensnaring millions of Americans.
The wisdom of conventional tax planning advice to defer income and accelerate certain types of deductions may not hold true if an individual expects to be subject to the AMT. Accordingly, during the tax planning process, it is critical that you determine whether you are subject to the AMT in both the current year and the following year.
If you are continuously subject to the AMT, avoid investing in private-activity (municipal) bonds. Income from these bonds is taxable for AMT purposes. (There are exceptions, including qualified 501(c)(3) bonds, New York Liberty bonds and Gulf Opportunity Zone bonds. Also, the interest on qualified bonds issued in 2009 and 2010 is not subject to the alternative minimum tax. Check with the bond issuer for the bond’s tax status.) Furthermore, you should be aware that unusual combinations of income and deductions might require AMT planning that runs contrary to conventional tax-planning advice.
Although the exercise of an incentive stock option (ISO) does not give rise to regular taxable income for the employee, the difference between the exercise price and the market price of a stock must be recognized for AMT purposes for the year in which the option is exercised. Accordingly, the exercise of incentive stock options with a large bargain element often causes a tax liability under the alternative minimum tax regime.
The AMT arena is extremely complex, so generalizations are difficult to make. If you think you may be subject to the alternative minimum tax, you should consult with a tax professional to determine how best to minimize your exposure to it.
Year-end planning from an estate planning perspective typically involves ensuring that “annual exclusion” gifts are completed by the end of a calendar year.
Under the federal gift tax system, each donor is permitted to make non-taxable gifts of a certain amount each year to any donee. These gifts are called “annual exclusion” gifts and do not count against the donor’s lifetime gifts exemption. The annual gift tax exclusion level is $14,000 for 2014 and will stay at this level in 2015. To the extent that it is not used, the annual exclusion evaporates at the end of each calendar year.
Annual transfers that take advantage of this exclusion can both diminish the donor’s estate tax liability and improve the lives of the recipients. These gifts can take many forms (cash, stocks, real estate, partnership interests) and can be given outright through Uniform Transfers to Minors accounts, and even through a trust—provided it contains special provisions designed to allow the gift to qualify for the annual exclusion.
A special note of thanks goes out to Mark Luscombe, a principal federal tax analyst for tax content and software provider Wolters Kluwer, CCH (CCHGroup.com) and John Hewitt, the founder and CEO of tax preparation provider Liberty Tax Service (libertytax.com), for answering detailed questions about the current and prospective rules. Sources of information used for this year’s guide include CCH, “J.K. Lasser’s Your Income Tax 2015” (John Wiley & Sons, 2014), the Internal Revenue Service and the Social Security Administration.