Dear Clients, Colleagues and Friends:
The 2013 tax year will be rough for many folks. After 11 years of the “Bush tax cuts”, higher income taxpayers will again be subject to Clinton-era tax rates. To make matters worse, 2013 also brings a new Medicare tax and related Net Investment Income Tax (NIIT). The maximum federal income tax rate increased from 35% in 2012 to 39.6% in 2013 (43.4% on net investment income). Additionally, all employees and self-employed individuals whose wages and self-employment earnings exceed $200,000 ($250,000 married filing joint) will be subject to a 0.9% Medicare surcharge.
The only slight consolation is that there is now more certainty to tax planning. The 2012 tax act made its tax changes permanent and indexed many provisions for inflation. These changes mean that Congress will not be scrambling at year-end to extend provisions. However, certainty in planning should not be confused with simplicity in planning. The new law provides a dizzying assortment of brackets, thresholds and phase-outs which will bring a new level of complexity to tax planning.
The new higher income tax rates will impact taxpayers making more than $450,000 ($400,000 for singles). The new 3.8% Net Investment Income Tax will apply to those making more than $250,000 ($200,000 for singles). Also back in 2013 are the “Pease and PEP rules” which reduce itemized deductions and personal exemptions for those making more than $300,000 ($250,000 for singles). The tables below describe these changes.
Before getting to the planning strategies, we wanted to remind you that we have moved our offices and are now at 303 W Madison, Suite 950, Chicago, IL 60606. We look forward to meeting in our new space this upcoming season.
Individual Income Tax
Defer Income and Accelerate Deductions
Defer income tax to a later year by deferring income and accelerating deductions. Where possible, you should defer income recognition to 2014 on items such as bonuses, IRA distributions and non-qualified stock option exercises. Similarly, you should accelerate deductions into 2013 on items such as retirement, charitable and HSA contributions.
Income and deduction timing can be especially important (and tricky) when attempting to navigate the new tax rate brackets. For example, this strategy can be especially effective if it can reduce income below the $450,000 income threshold or below the $250,000 NIIT threshold. Similarly, extra care must be used if it would push you above those thresholds in 2014.
Planning for Increased Capital Gains Rates
Individuals with taxable income over $450,000 ($400,000 for singles) will now face a 23.8% tax rate (20% + 3.8%) on long-term capital gains and qualified dividends. These taxpayers will also pay 43.4% tax (39.6% + 3.8%) on short-term capital gains. Taxpayers with income under $450,000 but over $250,000 ($200,000 single) are subject to the 3.8% NIIT, but still qualify for the 15% long-term capital gains and qualified dividends rate (total of 18.8%). Investors in the 10% and 15% tax brackets will continue to qualify for the 0% long-term capital gains and qualified dividend rate.
Taxpayers not consistently above the $450,000 threshold may further benefit by deferring capital gains (or accelerating gains into a low income year) to stay below the $450,000 gains rate threshold or $250,000 NIIT threshold. This may be done by timing the sale of securities into two tax years or, for non-public security sales, with an installment sale.
Taxpayers who happen to have a very low income year (i.e.: are in the 10% or 15% bracket) should attempt to recognize enough capital gains to utilize the 0% gains bracket.
Harvest Portfolio Losses
For many investors, tax loss harvesting is the single most important tool for tax reduction. Recognizing portfolio losses by year-end can be especially beneficial for taxpayers with income above the $250,000 NIIT threshold and/or the $450,000 high bracket threshold as such losses can shelter income from the 3.8% NIIT and the high bracket rates (20%/39.6%).
However, the strategy can become complicated for taxpayers below these income thresholds if they expect to be above the income thresholds in the future. In such cases it may actually make sense to defer tax losses or even time gains in low income years when not subject to the NIIT or high rate brackets.
Small Business Stock Gain Exclusion
“Qualified Small Business Stock” acquired after September 27, 2010 and before January 1, 2014 qualifies for a 100% gain exclusion if the stock is held for more than 5 years. Acquisitions on or after January 1, 2014 will qualify for the regular 60% gain exclusion. Angel investors and entrepreneurs organizing as a C-corporation should fund such corporations prior to year-end in order to lock in qualification for the higher gain exclusion. The aggregate exclusion per corporation is not to exceed the greater of $10 million or 10 times the aggregate adjusted basis of qualified small business stock issued by such corporation and disposed of by the taxpayer during the taxable year.
Practice Tax-Efficient Investing
Taxes have a major impact on investment returns and not all investment income is taxed alike. Although your financial objectives should drive your investment decisions, keep in mind the following tax basics of investing:
- New in 2013, taxpayers with income above certain levels, $200,000 single and $250,000 married, will be subject to an additional 3.8% NIIT on net investment income.
- Consider investing in U.S. government or state municipal bonds. Interest on U.S. government bonds are subject to federal tax but state tax exempt; conversely municipal interest is federal tax exempt and subject to state tax; (in-state bond may be exempt from state tax too).
- Invest in tax-deferred accounts such as a 401(k) or IRA; investment earnings will compound tax deferred until withdrawal, typically in retirement.
- Avoid excessive portfolio turnover in your brokerage and/or mutual fund accounts. Capital appreciation is taxed every time a security is sold.
- Avoid purchasing a mutual fund at year-end before its distribution date; otherwise you may be purchasing an unexpected tax obligation.
- Favor investments generating qualified dividends and long-term capital gains, which will be taxed at a favorable rate versus interest income taxed at the maximum ordinary rate.
- Beware of tax-exempt private activity bonds – interest is taxable for AMT purposes.
Net Investment Income Tax (NIIT) Planning
Beginning in 2013 a new 3.8% Net Investment Income Tax (NIIT) applies to net investment income for married couples making over $250,000 ($200,000 for Singles).
The Net Investment Income Tax applies to Investment Income which includes taxable interest, dividends, rents, royalties, annuities, and passive income from a trade or business. However, in determining the $250,000 (or $200,000) threshold, income from all sources is considered. For example, IRA and pension income would not be subject to the NIIT but would be included in computing whether you meet the income threshold. Therefore, planning for the NIIT involves two objectives: 1) structuring to get total income below the $250,000 (or $200,000) income threshold and 2) structuring to minimize the income classified as Investment Income.
Consider the following strategies to mitigate the Net Investment Income Tax:
- Structure investment portfolios to tilt toward growth assets and municipal bonds and away from dividend-paying stocks and taxable bonds.
- Manage other ordinary income to stay below the income thresholds, such as maximizing retirement contributions.
- Divert some investment income to family members not subject to the NIIT via gifts or a family limited partnership.
- Defer investment interest expense to a more advantageous year if possible.
- Recognize capital gains in years with substantial expenses or a year known to be below the threshold.
- Recognize capital gains over multiple years using installment sales or timing sales over multiple years.
- Attempt to make business income non-passive by participating in the business or grouping the business with a non-passive activity under the passive activity rules.
NIIT Planning for Trusts and Estates
Taxable Trusts are also subject to the NIIT and are subject at a particularly low income threshold ($11,950). This is also the income threshold at which the high-brackets kick in, i.e.: 20% on long term capital gains and 39.6% on ordinary income. Trust income that is distributed to a beneficiary is not subject to tax at the trust level but to the recipient beneficiary. Therefore, trusts have particular incentive to distribute income to beneficiaries who are not subject to the NIIT and/or the high-income income tax brackets.
While it may be possible to reduce income tax and NIIT by distributing trust income to a beneficiary, this strategy will not normally work with respect to capital gains. Capital gains are generally taxed to the trust and most likely subject to the higher 20% Long Term Capital Gains rate and the 3.8% NIIT. Therefore, trustees may consider strategies to permit capital gains to pass to a beneficiary. These strategies are by no means simple, nor are they possible in many situations. Some possibilities include: a) reforming the trust to make it a grantor trust to a beneficiary, b) reforming the trust’s income definition to include capital gains, c) terminating small trusts altogether, and d) distributing appreciated property rather than cash.
A final major issue for trusts is the treatment of business income. Business income earned by the trust is subject to NIIT if the income is passive but not subject to the NIIT if the income is non-passive. The “passive versus non-passive” determination is normally made by looking to the activities of the trustee. Therefore, trustees should consider ways to make business income non-passive, usually by providing services to the business or grouping the business activity with other non-passive activities.
Efficiently Utilize Debt
When debt is appropriately utilized as part of a personal or business investment strategy, significant post-tax benefits can be achieved. Businesses may consider utilizing debt to make year-end asset acquisitions. With still historically low borrowing costs and taxpayer-friendly depreciation rules, financing an asset acquisition can create substantial economic benefits. Investors on the other hand may consider debt as an alternative to selling assets or as a mechanism to shelter investment income.
Taxpayers should review their debt positions annually to ensure they are paying the lowest after-tax rate. Note that not all interest expense is deductible. Interest on home acquisition indebtedness up to $1M is deductible, as is interest of up to $100,000 of home equity indebtedness. Investment interest expense is deductible to the extent of investment income. Interest on borrowing used in a trade or business is generally deductible in full.
Accelerate Your Charitable Donations
Make donations by year-end for a 2013 deduction. Donations charged to your credit card prior to year-end are deductible in 2013 even if paid in 2014. As always with donations, the tax benefit is greatest when donating appreciated securities.
A written acknowledgement from the charitable organization for all donations exceeding $250 is required. You must retain written support for all cash contributions regardless of amount.
Establish a Donor-Advised Fund
Donor-advised funds are a popular way to make deferred charitable gifts. Donors receive a current year charitable deduction for contributions made to the fund and can later direct distributions to charities of their choice. Donor advised funds are low cost and administratively easy, but they do require a couple weeks to set-up. Before making a large donation it may be worthwhile to run a tax model to make sure full benefit is received.
Increase Withholding to Eliminate Estimated Tax Penalties
If you face estimated tax penalties and have failed to make sufficient estimated tax payments this year, consider increasing your withholding in the final 2013 pay periods. Income tax withholding is deemed paid evenly throughout the year and can help eliminate penalties when a year-end estimated tax payment may not.
The rules for avoiding estimated tax penalties are clear. Pay in ratably through withholding or estimated tax payments 110% of last year’s tax liability or 90% of this year’s liability.
The Illinois estimated tax penalties are severe but a taxpayer-friendly rule exists that can help you mitigate your liability. Illinois residents with K-1 income can defer estimated tax payments related to K-1 income until the fourth quarter. The rule provides that income earned through a K-1 is deemed received on the last day of the entity’s tax year for estimated tax purposes.
Alternative Minimum Tax (“AMT”) should impact fewer taxpayers starting in 2013 because Congress permanently indexed the AMT exemption for inflation and because higher tax rates will pull more high income taxpayers out of AMT. AMT has the effect of disallowing certain deductions and credits, but it actually works by creating an alternate parallel tax regime. Many folks find themselves perpetually in AMT without any realistic ability to avoid the AMT. Unfortunately, this is not likely to change for Taxpayers near or below the $450,000 high-bracket income threshold.
AMT planning usually requires a detailed tax projection, and even with a projection there are limited options for planning around the AMT. AMT planning should be considered by those with or expecting a unique tax event in the current or future year such as a stock option exercise or unique income event. AMT planning involves timing income events and expense payments, such as state taxes and investment expenses, into years where they will provide the most efficient result.
Fund Retirement Plans
You can save for retirement while deferring tax on current earnings by maximizing contributions to your employer-sponsored retirement plan. The 2013 and 2014 limits for employee contributions to a 401(k) plan are $17,500 ($23,000 if 50 or older). If your employer makes matching contributions, be sure to minimally contribute enough to receive the full match.
If your employer doesn’t offer a retirement plan or you are a lower income taxpayer, you can contribute up to $5,500 to a deductible IRA ($6,500 if 50 or older) in each of 2013 and 2014. If you don’t qualify for a deductible contribution, you can still make a non-deductible contribution. Non-deductible IRA contributions can make a lot of sense to the extent you can convert those contributions into a Roth IRA.
Elective deferrals to a SIMPLE IRA in 2013 and 2014 are limited to $12,000. Participants age 50 and older can make an additional $2,500 “catch-up” contribution each year. SEP-IRA limitations for 2013 are the lesser of $51,000 or 25% of compensation (or 20% of self-employed earnings). The limitation increases to $52,000 in 2014.
Roth IRA and Roth Conversion
Married taxpayers with adjusted gross income under $188,000 ($127,000 for Singles) should consider making a Roth IRA contribution. Even though a Roth contribution is not tax deductible, it is a very powerful tax planning vehicle because its qualifying distributions are never subject to income tax.
Higher income taxpayers can take advantage of the Roth strategy by making Roth contributions to a company 401(k) (if offered) or by converting a Traditional IRA to a Roth. Converting a traditional IRA to a Roth IRA will trigger current income tax, but can generate significant long term tax benefits under certain circumstances. If you have already made a Roth conversion, don’t forget to make the 2013 non-deductible IRA contribution and conversion.
Children under age 19 (24 if a full-time student) pay tax at parents’ tax rates on investment income exceeding $2,000 in 2013 (same limit for 2014). Parents should look for opportunities to direct investment income to their children up to these limits to utilize the child’s lower tax brackets. This is commonly accomplished by gifting assets that generate investment income through an UTMA account or trust. Parents also save by avoiding the NIIT on these gifted assets.
Dependent Care Credit and Flexible Spending Account
The dependent care credit is up to $600 for one qualifying dependent with a $3,000 expense limit. If you have two or more qualifying dependents, the credit is up to $1,200 with a $6,000 expense limit. Note for married taxpayers, both spouses must have earned income to be eligible for the credit.
Another option to consider is a dependent care flexible spending account. If offered by your employer, dependent care FSAs allow spouses to exclude up to a total of $5,000 of otherwise taxable wages. Contributions to a dependent care FSA reduce the dependent care costs eligible for the dependent care credit, meaning you can only take the credit or exclude income through FSA. Though the credit is generally more beneficial, an FSA may provide a larger tax benefit to those in higher tax brackets.
Illinois Credit for K-12 Education Expenses
Illinois taxpayers with children enrolled in kindergarten through 12th grade may qualify for an Illinois tax credit up to $500. The tax credit is 25% of qualified education expenses in excess of $250 for any number of qualifying students. Qualifying students must be an Illinois resident under 21 at the end of the school year and attending a public or private school in Illinois.
Education Tax Provisions
The American Opportunity Tax Credit provides a $2,500 credit per eligible student for qualified educational expenses including tuition, fees and course materials. The credit is available for the first four years of post-secondary education and is partially refundable. Phase-outs begin in 2013 for single taxpayers with modified AGI of $90,000 and $180,000 for married taxpayers. The 2013 Lifetime Learning Credit remains at $2,000 and begins to phase out at $62,000 and $124,000 for single and married taxpayers, respectively.
Though set to expire at year-end, the Tuition and Fees Deduction provides an alternative to the education credits and may generate greater tax benefits. Run your return multiple ways to determine which option is best.
Note the above credits and deduction cannot be claimed on qualifying expenses paid through 529 plans.
Education Tax Credits Planning
If your child is in college and you are not eligible to claim one of the education credits due to income limitations, consider having your dependent child claim them on his/her return. Your child may be eligible for one of the credits and does not need to pay the expenses directly. You lose your ability to claim a dependency exemption for your child, but the net benefit to the family may be worth it. Run the numbers to determine the best outcome.
Deduct the Cost of Your MBA
Part-time MBA candidates may obtain larger tax benefits by deducting their education costs as employee business expenses versus taking the Lifetime learning Credit or the Tuition and Fees Deduction. Qualifying part-time MBA candidates can deduct their education costs if the classes maintain or improve skills used in their current job. The deduction is a 2% miscellaneous itemized deduction and provides no benefit for taxpayers in AMT. Note that the IRS heavily scrutinizes this deduction, so be sure you qualify.
529 Education Plan
A 529 Plan is an educational savings vehicle that helps families save for future college costs. The donor’s investments grow tax-free and qualifying distributions are non-taxable, even for out-of-state institutions. Although contributions provide no federal benefit, many states offer deductions or credits. Illinois allows a deduction up to $20,000 for married taxpayers ($10,000 single) for contributions to qualified Illinois plans. Even if you have a child attending college now, consider contributing to a 529 plan today for a state tax deduction; you can distribute funds for tuition shortly afterward. You can also name yourself as the beneficiary, so consider setting up a plan for your own education costs. Note nonqualified distributions are subject to tax and penalty. You can always change the beneficiary on the account, however, eliminating the risk of having a balance post-graduation or a child who does not attend a qualified institution.
Prepay State and Local Taxes
If you itemize deductions, consider paying your fourth-quarter state tax estimate or projected 2013 state tax liability by December 31st; the deduction can be claimed in the year paid. Use caution in pre-paying state taxes if you may be in a higher tax bracket next year. It is best to defer the payment if you’re in AMT because state income and real estate taxes are AMT preferences
Health Savings Account
Consider establishing a Health Savings Account (“HSA”) to pay for qualified medical expenses with pre-tax dollars. An HSA is a tax-favored savings account which is paired with a high-deductible health insurance plan. For 2013, the maximum HSA contribution for an individual is $3,250 and $6,450 for a family. Individuals age 55 and older may make a “catch-up” contribution of $1,000. Funds not used in your HSA account will roll forward and earn interest tax-free. Contributions for 2013 can be made until April 15, 2014. Note that when you become eligible for Medicare you can no longer contribute to your HSA, but you can continue to use your HSA funds tax-free for qualified medical expenses.
Plug-In Electric Drive Vehicle Credit
Qualifying plug-in electric vehicles purchased after December 31, 2009 are eligible for a tax credit of $2,500 to $7,500, depending on the vehicle’s battery capacity. The credit offsets both regular tax and AMT, but begins to phase out after the manufacturer sells 200,000 models. The list of qualifying vehicles is extensive, but includes the Tesla Model S, Honda Accord Plug-In Hybrid and BMW i3. Though not eligible to offset AMT, the cost to install a refueling station at your home is also eligible for a credit.
Credit for Residential Energy Efficient Property
The cost of acquiring and installing certain residential energy efficient property prior to 2017 is eligible for a tax credit of 30%. Qualifying property includes solar hot water heaters, solar electric equipment and wind turbines. There is no limit on the amount of credit available for most property and any unused portion is carried forward to future years. Not all energy-efficient improvements qualify, so be sure you have the manufacturer’s tax credit certification statement.
Same Sex Marriage
Following the U.S. Supreme Court decision on the Defense of Marriage Act, the IRS ruled that they will now recognize all legal same-sex marriages nationwide. Note that marriage for this purpose does not include domestic partnerships, civil unions or similar relationships. Tax returns filed after September 2013 by same sex spouses now must be filed as married filing jointly or married filing separately (previously as two single returns). In the case of dual income households, this will likely result in a significantly higher combined tax liability.
Taxpayers who filed as single taxpayers in prior years, but could have benefited from filing joint, can claim refunds for any open tax year by filing an amended return. There is no obligation to amend prior returns should it not be beneficial under your circumstances.
Employee benefits for same-sex spouses is also an area of potential refund. The IRS has provided special procedures for employers to correct 2013 employment tax forms for the law changes.
Business Income Tax
Accelerate Fixed Asset Additions
The 2013 tax year is the final year for especially favorable depreciation rules. Businesses should consider accelerating planned asset acquisitions into 2013 to take advantage of the favorable Bonus Depreciation rules and higher Sec. 179 expensing election.
For 2013 a business can deduct 50% of the cost of new equipment immediately, without regard to any limitations. This so-called bonus depreciation will expire January 1, 2014. There is a small window of opportunity as qualifying equipment must be purchased and placed into service before the end of the year. Note that Code Sec. 179 depreciation should be used before bonus depreciation as bonus requires an Illinois modification. Also, consider electing out of bonus for passive real estate investments to avoid an Illinois income pick-up without a corresponding federal deduction.
Code Sec. 179
In 2013 businesses can deduct up to $500,000 of qualifying asset acquisitions. The deduction begins to phase out after purchases exceed $2,000,000. Note that businesses must have taxable income to qualify for the current year deduction. In 2014 the amount that can be expensed will decrease significantly to $25,000 and will begin to phase out after purchases exceed $200,000.
In 2013 the Treasury finalized “repair” regulations to make significant taxpayer-friendly changes to temporary regulations issued in 2011. Larger taxpayers should pay particular attention to the new regulations and integrate the changes into their 2014 accounting policies.
R & D Credit
Though it has bipartisan support and a high probability of being extended, the R&D credit is scheduled to expire at the end of 2013. If extended, the R&D credit would continue to benefit several companies, from large manufacturing firms to smaller software and services companies. The credit is up to 20% of qualifying R&D expenditures, depending on the taxpayer’s elected method. Eligible costs include improvements to existing processes, testing for new or improved products and certain software development. Though no longer offsetting AMT, unused credits can be carried back one year or forward 20 years. Talk with your advisor if you haven’t previously qualified as new computational methods may be available.
U.S. manufacturers can deduct up to 9% of Qualified Production Activity Income (net income from U.S. manufacturing activities, natural resource production, film production, construction, engineering and architecture). For S corporations and partnerships, the benefit is determined at the shareholder or partner level, so both passive and non-passive investors can qualify.
Write-off Bad Debts
Many accrual basis taxpayers are carrying accounts receivable that are entirely or partially worthless. Depending on the situation, there may be an opportunity to take these bad debts as ordinary tax deductions. To take advantage, the account, or part of the account, must be written off by year end. Note that it is not enough to simply provide a reserve; you must identify specific receivables which have become worthless during the year.
Holiday Pay and Bonuses
Accrual businesses can currently deduct 2013 year-end bonuses paid in 2014 as long as: 1) the employee is not a related party to the corporation, 2) the bonus is accrued on the company’s books before year-end and 3) the company pays the bonus within two and half months after year-end. Accrual taxpayers can also generally deduct January 1, 2014 holiday pay in 2013 if they accrue the liability in 2013 and it is supported by the company’s holiday pay policy.
Employ Your Minor Children
Business owners with minor children should consider paying them compensation. The business will receive a deduction and the children will pay little or no tax. Furthermore, the child’s earnings could be invested in a Roth IRA for even more tax efficiency.
FICA Limitations and Medicare Tax
FICA tax is paid on earnings up to $113,700 in 2013 and $117,000 in 2014. Employment income is subject to a 1.45% Medicare tax to both employees and employers. The 0.9% Additional Medicare Tax is assessed only to employees with taxable income of $200,000 ($250,000 married filing joint). Self-employed individuals will pay both the employee and employer share. It is possible for self-employed and small businesses to minimize their employment taxes via appropriate structuring.
Standard Business Mileage Rate
The standard business mileage rate increased to 56.5 cents/mile for all of 2013. For charitable mileage, the rate is unchanged at 14 cents/mile and for medical or moving purposes, the rate has increased to 24 cents/mile.
Small Employer Pension Plan Startup Cost Credit
A small employer pension plan startup cost credit is allowed for small businesses that did not have a pension plan during the previous three years. Eligible expenses include those to start and administer a new employee retirement plan and retirement-related education of employees. For an eligible small employer, the credit is 50% of the qualified startup costs paid or incurred during the tax year. The credit is limited to $500 per year for the first credit year and each of the following two tax years. No credit is allowed for any other tax year. The credit is part of the general business credit, which can be carried back or forward to other tax years if it cannot be used in the current year.
Section 132 Qualified Transportation Expenses
Code Section 132 allows employees to pay for specific qualified transportation costs with pre-tax dollars under an employer plan. The maximum monthly limits for commuter transit costs are $245 in 2013 and $130 in 2014. The maximum monthly parking benefit is $250.
Illinois Pass-Through Entity Withholding Requirements for Non-Resident Owners
Illinois-resident Partnerships, S corporations and trusts are required to remit tax on behalf of their non-resident owners to ensure compliance with Illinois tax laws. Partnerships, S corporations and trusts have two options to satisfy this requirement: composite filings or non-resident withholding. Composite filings remove individual filing requirements for non-resident owners, but non-resident withholding does not. Note, however, that for tax years ending on or after December 31, 2014, Illinois will no longer permit composite filings. This will require that all entities remit withholding tax on non-resident owners and those owners will be required to file an Illinois individual return.
Medicare Surcharge – Employer Impact
Employers must withhold the additional 0.9% Medicare surcharge on wages paid to an employee in excess of $200,000. This is only a withholding obligation as there is no “employer share” of the 0.9% Medicare surcharge on employment income.
Affordable Care Act Basic Summary
Beginning in 2014, non-exempt individuals must carry insurance or be penalized. Individuals who do not have plans offered to them from employers may enroll through insurance exchanges. Starting in 2015, large employers, defined as those with 50 or more full-time equivalent employees, may be subject to penalties if they do not offer adequate and affordable insurance for their full-time employees. If you are an employer, and have fewer than 50 full-time equivalent employees, you would not be required to offer your full-time employees coverage, nor would you be subject to a penalty. However, if you do provide coverage, you may be eligible for a credit. See section titled Small Business Health Care Tax Credit.
Small Business Health Care Tax Credit
Small businesses with fewer than 25 employees and average wages less than $50,000 which provide health insurance may qualify for a valuable tax credit. The credit is up to 50% of employer health care premium costs (35% for nonprofit employers). A qualifying employer must cover at least 50% of the cost of health care coverage for its employees. The credit phases out gradually for firms with the equivalent of 10 – 25 employees and with average annual wages between $25,000 – $50,000. Taxpayers looking to claim this credit should be aware that this credit is subject to sequestration, which means that refund payments processed on or after October 1, 2013 and on or before September 30, 2014 may be reduced.
Utilize Stock Options to Compensate Employees
As businesses seek effective ways to encourage employees and to align compensation with company performance, they are increasingly turning to stock options. Employees often don’t understand their rights and defer critical decisions for fear of making a mistake. With careful planning, however, employees can maximize post-exercise value, minimize tax exposure and effectively manage cash flow. Given that these property rights represent such a large source of wealth for many employees, it’s critical that they fully understand their choices. Employees should do the following: 1) run a cash flow analysis under multiple exercise scenarios to mitigate tax surprises; 2) understand the AMT implications of exercising Incentive Stock Options; 3) prepare multi-year tax projections to understand long-term tax and cash implications; 4) educate themselves on the various legal rights and obligations built into their grant agreement; 5) examine their market risk tolerance related to exercising and holding company stock to lock in long-term capital gains rates; and 6) analyze how future company performance impacts employee value.
Gift and Estate Tax
The 2013 tax year provided stability and relief for high-wealth families. Though the estate tax rate increased to 40%, the $5m estate tax exemption was made permanent and indexed for inflation. Estate tax portability was also made permanent, furthering the benefit for married couples.
Utilize your $5.25m Estate/Gift Exemption
The 2013 estate exemption is now $5.25m ($5.34m in 2014). While the permanently higher estate exemptions will remove the pressure for many moderately wealthy families to make planning gifts, high-wealth families should still consider gifting strategies to leverage this exemption.
Annual Exclusion Gifts
The annual gift exclusion is $14,000 in 2013 and 2014. This is the amount that each person can give to any other person without tax. Annual exclusions are a use-it-or-lose-it proposition, so those facing a taxable estate should not let them go to waste without good reason. Those apprehensive about gifting outright but wanting to take advantage of exclusions should consider a Crummey trust.
Utilize Low Interest Rates
Intra-family loans must bear a minimum interest rate or interest will be imputed for income and gift tax purposes. Interest rates have been rising but are still relatively low (i.e.: a nine year loan made in December 2013 can carry a 1.65% interest rate). Low interest loans to family members can be an effective part of an estate and gift planning strategy.
Irrevocable Life Insurance Trust
Purchase life insurance via an irrevocable life insurance trust. If appropriately structured, ILITs will keep the insurance proceeds out of your estate.
Consider Asset Protection
Wealthy individuals should consider from time-to-time whether their asset holdings could be structured to more efficiently protect them from creditor claims. Trusts, entities, insurance and retirement plans can all play a role in protecting assets from legal claims.