David & Johnson, Ltd. is a Lake Tahoe-based accounting firm. We serve clients in the Lake Tahoe Basin, as well as clients located throughout the States of Nevada and California, and several neighboring States.
David and Johnson, Ltd. is made up of CPA's, professionals, and support staff whose primary objective is to provide a quality and progressive range of accounting, taxation and business advisory services for private companies, family-owned businesses, not-for-profit organizations, individuals, and estates.
Our team approach provides for the development of professionals who can work across functions and industries to maximize every opportunity for our clients. The benefit for our employees is a changing and challenging work environment where retention rates exceed the national average. The end result for our clients is a dedicated workforce with diverse and exceptional skills. We take great pride in providing outstanding service to meet the needs of our many clients.
Just as the daylight hours are getting shorter, so is the time for fine tuning any last-minute strategies to lower your 2015 tax bill. While year-end legislation extending certain expired tax benefits may still come to pass and be of benefit to you, there are other options we should explore for potentially lowering your taxes. Often, the correct steps to take will depend on whether you see your income going up or down next year.
For 2015, the top tax rate of 39.6% will apply to incomes over $413,201 (single), $464,851 (married filing jointly and surviving spouse), $232,426 (married filing separately), and $439,000 (heads of households). However, high-income taxpayers are also subject to the 3.8 percent net investment income tax and/or the .9 percent Medicare surtax. If you are subject to one or both of these additional taxes, there are certain actions we should discuss that can mitigate the damage of these additional taxes.
Finally, there is the alternative minimum tax which can creep up on taxpayers with a multitude of deductions; but there are also strategies available to deal with this if they make sense in the context of your situation.
Thus, it's important that we meet before the end of the year to nail down any actions that may be appropriate with respect to your 2015 tax return. The following are some ideas that you may want to consider before our meeting.
Retirement Plans Considerations
Fully funding your company 401(k) with pre-tax dollars will reduce current year taxes, as well as increase your retirement nest egg. For 2015, the maximum 401(k) contribution you can make with pre-tax earnings is $18,000. For taxpayers 50 or older, that amount increases to $24,000.
If you have a SIMPLE 401(k), the maximum pre-tax contribution for 2015 is $12,500. That amount increases to $15,500 for taxpayers age 50 or older.
If certain requirements are met, contributions to an individual retirement account (IRA) may be deductible. For taxpayers under 50, the maximum contribution amount for 2015 is $5,500. For taxpayers 50 or older but less than age 70 1/2, the maximum contribution amount is $6,500. Contributions exceeding the maximum amount are subject to a 6 percent excise tax. Even if you are not eligible to deduct contributions, contributing after-tax money to an IRA may be advantageous because it will allow you to later convert that traditional IRA to a Roth IRA. Qualified withdrawals from a Roth IRA, including earnings, are free of tax, while earnings on a traditional IRA are taxable when withdrawn.
If you already have a traditional IRA, we should evaluate whether it is appropriate to convert it to a Roth IRA this year. You'll have to pay tax on the amount converted as ordinary income, but subsequent earnings will be free of tax. And if you have a traditional 401(k), 403(b), or 457 plan that includes after-tax contributions, a new rule allows you to generally rollover these after-tax amounts to a Roth IRA with no tax consequences. A rollover of a SIMPLE 401(k) into a Roth IRA may also be available. As with all tax rules, there are qualifications that apply to these rollovers that we should discuss before you take any actions.
Finally, self-directed IRAs allow an IRA owner to have more control over the type of investments that will be held in the IRA. However, the large amount of money held in self-directed IRAs makes them attractive targets for fraud promoters. Thus, self-directed IRA can be costly if not properly managed. In addition, because of the types of investments taxpayers with self-directed IRAs are able to make, taxpayers have a greater risk of running afoul of the prohibited transaction rules. The prohibited transaction rules impose an excise tax on certain transactions - such as sales of property, the lending of money or extension of credit, or the furnishing of goods, services, or facilities - between an IRA and a disqualified person. If you have a self-directed IRA, we need to review the specifics of your arrangement.
Net Investment Income Tax Considerations
A 3.8 percent tax applies to certain net investment income of individuals with income above a threshold amount. The threshold amounts are $250,000 (married filing jointly and qualifying widow(er) with dependent child), $200,000 (single and head of household), and $125,000 (married filing separately). In general, investment income includes, but is not limited to: interest, dividends, capital gains, rental and royalty income, non-qualified annuities, and income from businesses involved in trading of financial instruments or commodities. Thus, while the top tax rate for qualified dividend income is generally 20%, the top rate on such income increases to 23.8% for a taxpayer subject to the net investment income tax.
One way around the increased tax rate on dividend income is to invest instead in tax-exempt state and municipal bonds. The bonds generate tax-exempt income which isn't subject to the net investment income tax and is not included in determining if you meet the threshold amount for being subject to the net investment income tax. Note, however, that such income may be subject to state taxes and the alternative minimum tax. Additionally, if you are selling an appreciated asset and the gain on the sale will throw you over the threshold amount for being subject to the net investment income tax, you might consider selling the asset on an installment basis.
The net investment income tax also applies to income from trades or businesses that are passive activities. An activity is not generally considered passive if the taxpayer materially participates in the activity. If you are engaged in an activity which may be considered passive and thus has the potential to trigger the net investment income tax, we should evaluate the factors for determining material participation to see if they can help you escape this tax.
Finally, since net capital losses can be used against capital gains, you may want to consider getting rid of some of your losing stocks.
Additional Medicare Taxes
An additional Medicare tax of 0.9 percent is imposed on wages and self-employment income in excess of a threshold amount. The threshold amount is $250,000 in the case of a joint return or surviving spouse, $125,000 in the case of a married individual filing a separate return, and $200,000 in any other case. Employers are required to withhold the extra .9 percent once an individual's wages pass $200,000. No deduction is allowed for the additional tax. However, you may be due a credit if, for example, your status is married filing jointly, one of you had wages over $200,000, but joint wages are less than $250,000. On the flip side, you may owe the additional .9 percent if you and your spouse file jointly and each made under $200,000 of wages but together made over $250,000 in wages.
Because many deductions taken for regular tax purposes are not allowed for alternative minimum tax (AMT) purposes, you may be subject to the AMT if you have excessive deductions. Deductions which typically throw taxpayers into an AMT situation include high state and local taxes, interest on home equity loans, a high number of dependent deductions, and a large amount of miscellaneous itemized deductions. For 2015, the AMT rate is 26% on alternative minimum taxable income (AMTI) up to $185,400 ($92,700 for married filing separately) and 28% on AMTI over that amount. However, you are allowed an AMT exemption depending on your filing status; but the exemption is phased out for taxpayer's above a certain income level.
If it looks like you may be subject to the AMT this year, we should discuss what actions can be taken to reduce your exposure. Since the calculation of the AMT begins with adjusted gross income, lowering your adjusted gross income by maximizing contributions to a tax-deferred retirement plan (e.g., 401(k)) or tax-deferred health savings account may be appropriate. Additionally, if you use your home for business, related expenses (e.g., a portion of your property taxes, mortgage interest, etc.) allocable to Schedule C will also reduce your adjusted gross income.
American Opportunity Credit
If you, your spouse, or a dependent incurred qualified education expenses to attend an accredited postsecondary institution (e.g., a college or university), you may be eligible for the American Opportunity Credit. The maximum annual credit is $2,500 per eligible student. Expenses which qualify for the credit include tuition and fees required for the enrollment or attendance at an eligible educational institution. For taxpayers with modified adjusted gross income in excess of $80,000 ($160,000 for joint filers), the amount of the credit is phased out. The credit is not available for married taxpayers filing separately.
Under Obamacare, there is a penalty, known as the "shared responsibility payment," for not having health insurance coverage. You may be liable for this penalty if you didn't have health insurance for two or more months in 2015. However, depending on your income, you may be eligible for an exemption from the penalty. The penalty is 2 percent of your 2015 income or $325 per adult, whichever is higher, and $162.50 per uninsured dependent under 18, up to $975 total per family.
Extension of the Health Coverage Tax Credit
Taxpayers who receive benefits under certain trade adjustment assistance (TAA) programs or benefits from the Pension Benefit Guaranty Corporation (PBGC) generally are allowed a credit for a percent of amounts paid for qualified health insurance coverage. This Health Coverage Tax Credit (HCTC) was set to expire at the end of 2013 but was extended and modified by the Trade Preferences Extension Act of 2015. The HCTC can now be claimed for coverage through 2019.
If you received the type of benefits mentioned in either 2014 or 2015 (or both), we should determine if you were eligible for the credit and make sure that you receive the tax benefit.
Tax Extenders Legislation
Additional tax benefits may be available if Congress passes Tax Extender legislation introduced in the Senate in August. That legislation would retroactively extend many tax breaks that expired in 2014. If it passes, the bill will extend the following tax breaks through 2016:
- the deduction by elementary and secondary school teachers of up to $250 of qualified expenses they paid during the year $500 on a joint return if both spouses were eligible educators) and expand the deduction to include expenses in connection with the professional development activities of an educator;
- the exclusion from income of imputed income from the discharge of acquisition indebtedness for a principal residence;
- the equalization of the tax exclusion for employer-paid mass transit and parking benefits and expands such exclusion to include bike sharing programs;
- the tax deduction for mortgage insurance premiums;
- the tax deduction for state and local general sales taxes in lieu of state and local income taxes;
- the tax deduction for contributions of property made for conservation purposes;
- the deduction from gross income for qualified tuition and related expenses; and the tax-free distributions from IRAs for charitable purposes.
Other Steps to Consider Before the End of the Year
The following are some of the additional actions we should review before year end to see if they make sense in your situation. The focus should not be entirely on tax savings. These strategies should be adopted only if they make sense in the context of your total financial picture.
Accelerating Income into 2015
Depending on your projected income for 2016, it may make sense to accelerate income into 2015 if you expect 2016 income to be significantly higher. Options for accelerating income include:
- harvesting gains from your investment portfolio, but keeping in mind the 3.8 investment income tax;
- as previously mentioned, converting a retirement account into a Roth IRA and recognizing the conversion income this year;
- taking IRA distributions this year rather than next year;
- if you are self-employed with receivables on hand, trying to get clients or customers to pay before year end; and
- settling lawsuits or insurance claims that will generate income this year.
Deferring Income into 2016
There are also scenarios (for example, if you think that your income will decrease substantially next year) in which it might make sense to defer income into 2016 or later years. Some options for deferring income include:
- if you are due a year-end bonus, asking your employer to pay the bonus in January 2016;
- if you are considering selling assets that will generate a gain, postponing the sale until 2016;
- delaying the exercise of any stock options you may have;
- if you are selling property, considering an installment sale; and
- parking investments in deferred annuities.
Deferring Deductions into 2016
If you anticipate a substantial increase in taxable income, we may want to explore pushing deductions into 2016 by looking at the following:
- postponing year-end charitable contributions, property tax payments, and medical and dental expense payments, to the extent you might get a deduction for such payments, until next year; and
- postponing the sale of any loss-generating property.
Accelerating Deductions into 2015
If you expect your income to decrease next year, accelerating deductions into the current year can offset the higher income this year. Some options include:
- prepaying your property taxes in December;
- making your January mortgage payment in December;
- if you owe state income taxes, making up any shortfall in December rather than waiting until your return is due;
- since medical expenses are deductible only to the extent they exceed 10 percent (7.5 percent if you or your spouse are 65 before the end of the year) of your adjusted gross income (AGI), bunching large medical bills not covered by insurance into one year to help overcome this threshold;
- making any large charitable contributions in 2015, rather than 2016;
- selling some or all of your loss stocks; and
- if you qualify for a health savings account, consider setting one up and making the maximum contribution allowable.
Certain life events can also affect your tax situation. If you've gotten married or divorced, had a birth or death in the family, lost or changed jobs, retired during the year, we need to discuss the tax implications of these events.
Finally, these are some additional miscellaneous items to consider:
- If you have a health flexible spending account with a balance, remember to spend it before year end (unless your employer allows you to go until March 15, 2016, in which case you'll have until then). You may want to check with your employer to see if they give the optional grace period to March 15.
- If you own a vacation home that you rented out, we need to look at the number of days it was used for business versus pleasure to see if there is anything we can do to maximize tax savings with respect to that property. For example, if you spent less than 14 days at the home, it may make sense to spend a few more days and have the house qualify as a second residence, with the interest being deductible. For a rental home, rental expenses, including interest, are limited to rental income.
- We should also consider if there is any income that can be shifted to a child so that the income is paid at the child's rate.
- If you have any foreign assets, there are reporting and filing requirements with respect to those assets. Noncompliance carries stiff penalties.
Once again we find ourselves nearing the end of the year and wondering what Congress will do as far as extending important tax breaks for businesses. Extender legislation aside, there have been some tax developments this year of which you should be aware. It would be helpful for us to meet before the end of the year, not only to review projections of your business's net income for 2015 and ensure that estimated tax payments are in line with those projections, but also to nail down any end-of-the-year actions that may be appropriate to reduce your 2015 tax liability. At the same time, we can discuss next year's income projections and plan the quarterly estimated tax payments for 2016. The following are some items you may want to consider with respect to your 2015 business tax return.
Code Sec. 179 Expensing
One of the biggest tax benefits to a business is the Section 179 deduction, which allows taxpayers to write off property purchases that would otherwise be capitalized and depreciated. At the end of 2014, last-minute legislation extended the generous deduction of prior years to property purchased in 2014. As a result, a business was eligible to expense up to $500,000 of qualified property placed into service in 2014 (i.e., the Section 179 deduction). Currently, for property placed in service in 2015, the Section 179 expense deduction is capped at $25,000. It's still worthwhile to evaluate whether it's appropriate in your situation to increase capital improvement purchases to take advantage of this deduction.
Note that there is currently a bill before the Senate (S. 1946, The Tax Relief Extension Act of 2015) which, if passed by Congress and signed into law, will extend to 2015 and 2016 the same $500,000 Section 179 deduction allowed to businesses in 2014.
Retroactive 2014 Bonus Depreciation
The IRS has recently issued guidance on how fiscal year taxpayers can retroactively elect to take the 50-percent bonus depreciation deduction for qualified property placed in service during the 2014 portion of fiscal years beginning in 2013. The guidance, which additionally addresses carrying over disallowed Code Sec. 179 deductions for qualified real property, applies to taxpayers who filed their 2013 returns (or 2014 short year returns) before enactment of last year's tax extenders bill on December 19, 2014. If you are eligible, we should meet to discuss the possibility of electing the retroactive bonus depreciation.
Vehicle Deductions and Substantiation
Expenses relating to vehicles used in a business can add up to major deductions. The deductible vehicle expenses of a business are generally calculated using one of two methods: the standard mileage rate method or the actual expense method. If the standard mileage rate is used, parking fees and tolls incurred for business purposes can be added to the total amount calculated.
Since the IRS tends to focus on vehicle expenses in an audit and disallow them if they are not property substantiated, you should ensure that the following are part of your tax records with respect to each vehicle used in your business: (1) the amount of each separate expense with respect to the vehicle (e.g., the cost of purchase or lease, the cost of repairs and maintenance); (2) the amount of mileage for each business or investment use and the total miles for the tax period; (3) the date of the expenditure; and (4) the business purpose for the expenditure. The following are considered adequate for substantiating such expenses: (1) records such as an account book, diary, log, statement of expense, or trip sheets; and (2) documentary evidence such as receipts, canceled checks, bills, or similar evidence.
Records such as an account book, diary, log, statement of expense, or trip sheet are considered adequate to substantiate the element of an expense only if the records are prepared or maintained in such a manner that each recording of an element of the expense is made at or near the time the expense is incurred.
S Shareholder Salaries
The IRS is scrutinizing the salaries, or lack thereof, paid to S shareholder-employees. Some S shareholders prefer to take money out of an S corporation as a distribution rather than a salary on which employment taxes must be paid.
The IRS has been going after such shareholders. Thus, if you are actively involved in an S corporation, you must be paid a "reasonable compensation" for your services. The key to establishing reasonable compensation is determining what type of work you did for the S corporation as an employee-shareholder. If you are in this situation, we need to document the factors that support the salary you are being paid.
While your business is not required to have a retirement plan, you may want to consider adding one. By starting a retirement savings plan, you not only help your employees save for the future but also attract and retain qualified employees. Such plans offer tax savings to your business because employer contributions are deductible from the business's income. Additionally, a tax credit is available to small employers for the costs of starting a retirement plan. Please let me know if this is an option you would like to discuss further.
Changes Made to Tax Return Due Dates
A new law changed the due date for partnership and C corporation tax returns. It also extended the automatic extension for corporate income tax returns from three to six months. The changes generally apply to tax years beginning after 2015.
The due date for partnership returns has been moved up to coincide with the due date of S corporation returns. Thus, partnership returns are now due by the 15th day of the third month after the close of the partnership tax year. The change is meant to help individual partner's avoid having to file an extension because partnership K-1s don't generally arrive until after the April 15 due date for individual tax returns.
The due date for filing a C corporation return has been changed from the 15th day of the third month (i.e., March 15 for a calendar year corporation) to the 15th day of the fourth month (i.e., April 15 for a calendar year corporation). However, there is an exception for C corporations with a June 30 fiscal year. The due date for filing a June 30 C corporation return remains the 15th day of the third month following the end of the year (i.e., September 15) for the next 10 years. All other changes are effective for tax years beginning after 2015.
Overstating Basis of Property Sold Can Extend Statute of Limitations
The same new law overrides a Supreme Court decision that was favorable to taxpayers. The new law extends the statute of limitations from three years to six years in cases where a taxpayer overstates the basis in property sold and thus understates the gain on the sale. The change applies to (1) returns filed after July 31, 2015, and (2) returns filed on or before July 31 if the statute of limitations (determined without regard to the change) for assessment of the taxes with respect to which such return relates has not expired as of such date.
Tax Extender Legislation
As previously mentioned, tax extender legislation is before the Senate and, if signed into law, will extend the increased Code Sec. 179 deduction limitations to 2015 and 2016. Another large tax break included in the legislation is bonus depreciation. Bonus depreciation allows a 50-percent additional first year depreciation deduction for qualified property acquired by a taxpayer after 2007 and placed in service by the taxpayer before 2014. This benefit was extended at the last minute in 2014 to businesses who placed property in service before January 1, 2015 (before January 1, 2016, for certain longer-lived and transportation assets) and also allowed a business to elect to accelerate some AMT credits in lieu of taking the bonus depreciation.
Currently, there is no provision for taking bonus depreciation for assets placed in service in 2015. However, under S. 1946, the bonus depreciation deduction would be extended to property placed in service in 2015 and 2016. Other items in the legislation that, if passed and signed into law, will be extended through 2015 and 2016 include the following:
- the classification, for depreciation purposes, of certain race horses as three-year property;
- accelerated depreciation of qualified leasehold improvements, qualified restaurant buildings and improvements, and qualified retail improvements;
- the classification, for depreciation purposes, of motorsports entertainment complexes as seven-year property;
- accelerated depreciation of business property on Indian reservations;
- the deduction for charitable deductions of food inventory by taxpayers other than C corporations;
- the election to expense mine safety equipment;
- the expensing allowance for certain film and television productions and the cost of live theatrical productions;
- the deduction for income attributable to domestic production activities in Puerto Rico;
- tax rules relating to payments between controlled foreign corporations and dividends of regulated investment companies;
- the subpart F income exemption for income derived in the active conduct of a banking, finance, or insurance business;
- the tax rule exempting dividends, interest, rents, and royalties received or accrued from certain controlled foreign corporations by a related entity from treatment as foreign holding company income;
- the 100 percent exclusion from gross income of gain from the sale of small business stock;
- the basis adjustment rule for stock of an S corporation making charitable contributions of property;
- the reduction to five years of the recognition period for the built-in gains of S corporations; and
- tax incentives for investment in empowerment zones.