With the higher tax rates passed by Congress for 2013, it’s likely that many top earners will owe a lot more in taxes. Pre-year-end tax projections are a must if you want to minimize the impact of these major changes – and time is running out. Here are some of our favorite last minute tips to help clients realize significant savings:
One way to defer your income is to make deductible contributions to a retirement plan. While the plan must be set up before the end of the year, you have until the extended due date of the tax return to make your contributions (Sept 15 for businesses and Oct 15 for individuals).
If you invest in an oil and/or gas drilling partnership, you should be able to deduct 80-95% of your investment. For example, if you invest $100,000 before the end of the year you could be able to deduct up to $95,000 from your 2013 income.
The expectation is that in subsequent years there will be an income stream from oil (or gas) production that is partially sheltered by “statutory percentage depletion” (15% of gross revenue). It is a way to shift taxable income into future years. The after tax ROR will depend on the price of oil and the level and life of production from the reserves. The higher the marginal tax rate the better the after tax ROR.
Another good way to lower your taxable income is by making a charitable contribution of cash or property before year end. A cash contribution should be paid by check or credit card – and make sure you get the appropriate receipts!
You can also make charitable contributions in the form of property. Now is the time to go through your storage unit, garage, house, office, etc. to see if there are any items you want to give away to charity. You can deduct the fair market value of “similar” items up to $5,000 in value without requiring an appraisal. For example, you could give away $3,000 of clothing, $2,000 of skiing equipment, and $4,000 of office furniture without needing to have the items appraised.
If you are giving away a lot of high value items, you should be able to substantiate your claim – make a list of what you’re giving away, take photos, and have a receipt from the charity you’re contributing to. Many people limit their deductions to $500 because a separate form (IRS 8283) is required for any donation of a larger amount. However, this form can be easily filed by a tax professional.
Finally, consider a donation of long-term appreciated securities. If you hold stocks, bonds, or mutual funds that have increased in value, and that were purchased over a year ago, you can donate them to charity without paying taxes on the gain. This is more effective than selling the securities and then donating cash because you would have to pay taxes on the sale prior to making your charitable contribution.
If you want to make a charitable contribution now, receive an immediate deduction, and then parcel out the gifts over time, you should consider utilizing a donor-advised fund (DAF). For example, using a DAF you could donate $100,000 today, receive a $100,000 deduction for the current year, and then instruct the fund to give $20,000 to one organization next March, $30,000 to another in July, and $50,000 to a third in October.
If you’re facing a potential estate tax liability, don’t forget the annual $14,000 Estate and Gift Tax exclusion. The $14,000 is per donor and per recipient. For example, a married couple with two children could make a non-taxable, non-reportable gift of $28,000 to each child, for a total of $56,000.
If you need to lower your taxable income this year, consider selling substantially depreciated assets. For example, let’s say you invested $100,000 in a Blockbuster video franchise in 2010 and your investment is now only worth $5,000. If you sell your investment to an unrelated party for $5,000, you could use the $95,000 loss to shelter other capital gains.
Alternatively, if you know you will be in a higher tax bracket next year, you may want to sell appreciated assets now to avoid paying higher taxes next year.
If you purchase a depreciable business asset, you can obtain either an expense or bonus depreciation deduction. However, it is important to note that you must also place the asset in service before the end of the year. For example, if you’re buying a piece of manufacturing equipment, it would need to be in the factory, installed, and ready to produce widgets before January 1st.
For businesses, tax breaks that are available through the end of this year but won’t be around next year unless Congress acts include: 50% bonus first-year depreciation for most new machinery, equipment and software; an extraordinarily high $500,000 expensing limitation; the research tax credit; and the 15-year write off for qualified leasehold improvements, qualified restaurant buildings and improvements and qualified retail improvements.
If you are expecting a loss or know you’ll be in a lower tax bracket this year, consider converting money in a tax-deferred retirement plan to a tax-free retirement plan. For example, let’ say you started a business this year and have a significant deductible loss. Currently, you have $100,000 in a Traditional IRA, which will be worth $500,000 by the time you retire. When you retire, you’ll be required to pay taxes on the full $500,000 when you withdraw the funds. By converting your Traditional IRA to a Roth IRA this year, you would only have to pay taxes on the current $100,000, leaving you $500,000 of tax-free income when you retire.
Because California state income taxes are so high, many California residents are subject to the Alternative Minimum Tax. While state income taxes and property taxes are normally deductible for regular federal income tax purposes, they are are not deductible for alternative minimum (AMT). purposes.
For example, suppose you have a gain of $10 million for 2013, leaving you $1 million with a California balance due on January 15th, 2014. After doing some tax planning, you determine your income for 2014 will only be $500,000. If you were to pay the taxes in January 2014, you would have a regular federal taxable income of -$500,000 ($500,000 income minus the $1 million deduction) and at income of $500,000 for AMT purposes. Thus, you would have to pay taxes on $500,000 for 2014 (the higher of your regular federal taxable income or AMT). The deduction would do you no good.
However, if you were to pay the 2013 state taxes before December 31st, you would likely be able to deduct the amount from your 2013 income of $10 million, allowing you avoid paying taxes on$1 million worth of income.
If you’re thinking about starting a new legal entity for tax or business purposes, such as a corporation or LLC, it’s often wise to have it set up effective as of the beginning of the year. If you were to wait until March of next year, for example, you could be missing out on on two months of tax benefit.
While these tactics can be extremely helpful, it is important to note that only a small percentage of tax planning can be done at the last minute. The best tax planning is done well in advance so you can make the right moves throughout the year – which means now is the time to start your 2014 tax planning. For a confidential, complimentary review of your tax situation please contact us today.