Yearend Tax Planning Strategies

Post on: 6 Апрель, 2015 No Comment

Yearend Tax Planning Strategies

By Kenneth H. Bridges, CPA, PFS

Late November through year end is the time for year-end tax planning.  While every client’s situation is unique, here are some of the more common strategies we employ.

Harvesting of capital losses – Capital losses can, for the most part, only be deducted against capital gains.  And while capital losses can be carried forward, for individuals they cannot be carried back to previous years.  Accordingly, it is generally a good strategy to go ahead and recognize any potential capital losses you have, at least up to the amount of your capital gains for the year.  If you have a significant capital gain from earlier in the year (e.g. from the sale of a business), it is important to realize these losses for tax purposes before year end in order to be able to deduct them against the capital gain.  You should be aware that under the “wash sale rules” if you buy the same stock within 30 days before or after you sell the stock at a loss, then your tax loss is disallowed. To the extent that you are concerned that the market may bounce back within the 30 day period and you do not want to risk missing out on the recovery, you can generally buy a similar stock (or similar mutual fund) without violating the wash sale rules.

Timing of payment of state income taxes There seems to be a commonly-held belief that you should always accelerate the payment of your state income taxes into December in order to get the tax deduction in the current year.  While that is sometimes a good strategy, such is not always the case.  Individuals in the alternative minimum tax (AMT) posture receive no Federal tax benefit from their payment of state income tax. By running tax projections for the current and upcoming year, you can determine the optimal timing for payment of state income tax, sometimes resulting in a substantial permanent tax savings. This is especially true with respect to a year in which you have a substantial gain, such as from the sale of your business.

Use of tax credits to minimize state income tax – There are various tax credits which can be utilized to minimize or avoid state income tax. Some (e.g. the Georgia jobs credit, research credit and retraining credit) must be generated by a business entity, some can essentially be purchased (e.g. the Georgia low-income housing credit and the film credit), and others are based on taking some sort of action which the government is encouraging (e.g. the Georgia credit for donations to Student Scholarship Organizations).  Some of these credits (e.g. the Georgia low-income housing credit) are generally priced in such a way that they really only make sense for individuals if they are in the alternative minimum tax posture.

Timing of charitable donations – It is generally advantageous to time significant charitable donations to coincide with a year in which you have significant income and are in a higher rate bracket. Because of the percentage of income limitations on charitable donation deductions (e.g. 50% of income for cash donations and 30% of income for donations of appreciated property) and the inability to carry the deduction back to earlier years, making a substantial donation in the year after a big gain can potentially result in the permanent loss of a tax benefit versus having made the donation in the same year as the substantial gain.  On the other hand, if you have charitable carryforwards that are in danger of expiring, deferring additional donations to the next tax year may be prudent.  Likewise, if your charitable deduction would be substantially limited by the percentage of income limitation on itemized deductions in a year of high income or if your income is already offset by other deductions and exemptions in a year of low income, then deferring your deduction may be advantageous.

Estimated tax payments – In order to avoid a penalty, you are generally required to pay in through withholding or quarterly estimated tax payments the lesser of 90% of your current year tax liability or 110% of your prior year tax liability.  With respect to estimated tax payments, you get credit the day you actually make the payment. Withholding, however, is generally deemed to have occurred ratably throughout the year, regardless of when actually withheld.  Accordingly, if you realize late in the year that you have a shortfall for earlier quarters, you can sometimes avoid the penalty by increasing your withholding late in the year; e.g. having all of a year-end bonus withheld for taxes.

Acceleration or deferral of income and deductions – Businesses which use the cash basis of accounting for income tax purposes often have a great deal of control over the timing of income and deductions. Shifting income from a high-rate bracket year to a low-rate bracket year can obviously result in a permanent tax savings.  And even where your rate bracket will be the same from year to year, deferring income to the next year can result in a time-value-of-money savings.

S-corp and LLC basis and at-risk limitations – In general, you can deduct your share of losses from S-corps, LLCs and partnerships, and distributions from such entities are generally tax-free.  However, the ability to deduct losses or receive tax-free distributions is limited by the “basis” and “at-risk” rules.  Basically, the amount of loss you can deduct or distributions you can receive tax free is limited to your unreturned investment in the entity (including past undistributed profits and, in the case of partnerships and LLCs, your share of the entity’s liabilities which are either bank debt on a real estate project or debts for which you are personally liable). With respect to flow-through entities in which you own a stake, you should review your basis and at-risk amounts prior to year end to determine whether any tax advantage can be gained by increasing such amounts and whether such is prudent from an economic standpoint.

Exercise of ISOs in year not in AMT – “Incentive stock options” (ISOs) hold out the promise of being able to potentially convert what would otherwise be ordinary income (taxed at the highest rates) into long-term capital gain (taxed at more favorable rates). However, because the bargain element is an “alternative minimum tax” (AMT) adjustment on the date of exercise, the AMT often eliminates much of the hoped for benefit. A tax year in which you will not be in the AMT represents an opportunity to exercise some ISOs at no tax cost, meaning a potential permanent tax savings if you hold the stock for the requisite period of at least one year from date of exercise and two years from date of grant.

Sale of ISO shares that have fallen in value - If you exercise ISOs and sell in the same tax year, then the AMT issue goes away.  Accordingly, we typically advise our clients who want to exercise and hold ISOs to do so early in the year, giving us almost a full year to watch the stock price and to sell the stock before year end if necessary in order to cure the AMT problem.  If you exercised ISOs earlier this year, you still hold the shares, and the value of the shares has fallen dramatically, then now may be the time to sell.

Bonus first-year depreciation – For most new depreciable assets (other than buildings) placed in service during 2011, 100% of the cost can be expensed immediately, with the balance recovered under the regular depreciation rules.  This special first-year deduction applies both for regular tax and alternative minimum tax.  For autos and light trucks, for which first-year depreciation would otherwise be limited under the so-called “luxury automobile rules”, bonus depreciation of $8,000 may be taken (bringing the total deduction to approximately $11,000).

Section 179 expense – Small companies (which for these purposes means those which have purchased less than $2,000,000 in furniture and equipment) can elect to immediately expense up to $500,000 of the cost of furniture and equipment against otherwise taxable profit.  Because of the 100% bonus depreciation rules which apply for 2011 (see paragraph above), the section 179 provision (with its limitations) is not as important as usual for 2011.  However, while only “new” assets are eligible for bonus depreciation, “used” assets can qualify for section 179 expensing.

Yearend Tax Planning Strategies

Selection of accounting methods – New businesses can, within certain limitations, select the tax accounting methods (e.g. cash or accrual) which are most beneficial for them.  And existing businesses have some latitude to later change their accounting methods.  Your situation should be reviewed each year in order to determine which accounting methods are most advantageous for you.

Net operating loss carryback claims – Tax operating losses can generally be carried back to recover tax paid in previous years.  Accordingly, if you will have a tax loss for the current year and paid tax at a high rate in previous years, then maximizing your current year tax loss may be advantageous.

Conversion of IRA to Roth status With a traditional deductible IRA, you get a tax deduction on the front end when you make the contribution, but then are subject to ordinary income tax rates on any withdrawals (with an additional 10% penalty generally applying if you make withdrawals before age 59 ½).  With a nondeductible traditional IRA, you get no tax deduction on the front end and then are subject to ordinary income tax rates on a portion of your withdrawals (the portion representing the income earned by the IRA account).  The Taxpayer Relief Act of 1997 introduced a third type of IRA, called the “Roth IRA”, with which you get no front-end tax deduction but the appreciation in value permanently escapes tax.  Traditional IRAs can be converted to Roth IRAs. The conversion is a taxable event, so careful planning is necessary to determine if a conversion makes sense for you.

Utilization of annual gifting exclusion – With respect to the estate and gift tax, there is an annual exclusion which permits you to give up to $13,000 per year per donee, without incurring any gift tax or eating into your lifetime exemption against such. For married couples electing gift-splitting, this amount is effectively doubled to $26,000 per year per donee.  For those with a significant number of potential heirs, this represents an opportunity to remove a significant amount of value from their taxable estate, especially where gifting assets that may be subject to discounted valuation (e.g. an interest in a family partnership).  The annual exclusion is on a use-it-or-lose-it basis with no carryover, so if you haven’t maximized your annual exclusion gifts yet for 2011, consider doing so before year end.

Setting expectations and avoiding surprises – One of the key advantages to engaging in year-end planning is that it enables you to appropriately plan your required cash outlay for taxes and avoid any unpleasant surprises at April 15 or any regrets as to actions that could have been taken by year-end but weren’t.

Kenneth H. Bridges, CPA, PFS is a partner with Bridges & Dunn-Rankin, LLP an Atlanta-based CPA firm.

This article is presented for educational and informational purposes only, and is not intended to constitute legal, tax or accounting advice.  The article provides only a very general summary of complex rules.  For advice on how these rules may apply to your specific situation, contact a professional tax advisor.


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