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 2015 on items such as bonuses, IRA distributions, and non-qualified stock option exercises. Similarly, you should accelerate deductions into 2014 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 $457,600 high bracket threshold or below the $250,000 NIIT threshold. Similarly, extra care must be use if it would push you above those thresholds in 2015.
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 $457,600 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, especially for taxpayers that pay a 0% capital gains rate. 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 between September 27, 2010 and December 31, 2014 and held for 5 years qualifies for a 100% gain exclusion on up to $10M of realized gain (or 10x adjusted basis if larger). Acquisitions on or after January 1, 2015 qualify for a more limited 50% gain exclusion with the other 50% taxable at a 28% rate combined with a 7% AMT preference. Entrepreneurs should consider these benefits as they consider their optimal entity selection; partnerships and S corporations do not qualify. Investors may favor corporations over traditional flow through investments until this provision expires.
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:
- Consider investing in state municipal or U.S. government bonds. Municipal bond interest is federally tax exempt but subject to state tax (in-state bond income may be exempt from state tax too). Conversely, interest on U.S. government bonds is subject to federal tax but not state tax.
- Invest in tax-deferred accounts such as a 401(k) or an 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 or 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 normal ordinary rates.
- Beware of tax-exempt private activity bonds as interest is taxable for AMT purposes.
Planning for Capital Gains Rates
The 2013 changes to the capital gains tax rates make it difficult for the average investor to estimate their capital gains exposure. Individuals with taxable income over $457,600 ($406,750 for singles) are subject to a 20% tax rate on long-term capital gains and qualified dividends plus a 3.8% NIIT. These same taxpayers pay a combined 43.4% tax (39.6% + 3.8%) on net short-term capital gains. Taxpayers with income under $457,600 ($406,750) but over $250,000 ($200,000 single) are subject to the 3.8% NIIT, but qualify for the 15% long-term capital gains and qualified dividends rate (for a total of 18.8%). Investors in the 10% and 15% tax brackets qualify for the 0% long-term capital gains and qualified dividend rate.For taxpayers with income fluctuating year-to-year, structuring your income to stay below the applicable 20% long-term rate threshold or 3.8% NIIT threshold may prove beneficial. Further, 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.
Net Investment Income Tax (NIIT) Planning
The Net Investment Income Tax (NIIT) imposes a 3.8% surtax on certain unearned 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, “trader” income, 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 $250,000 (or $200,000), 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 by maximizing retirement contributions.
- Divert some investment income producing assets 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.
- Harvest capital losses in years with other considerable capital gains.
- Recognize capital gains over multiple years using installment sales or defer indefinitely through a like-kind exchange.
- Attempt to control participation levels of certain business activities to dictate non-passive versus passive status or consider grouping businesses under the passive activity rules for non-passive treatment.
- Control retirement distributions to keep income below applicable thresholds.
- Donate appreciated securities directly to charitable organizations.
NIIT Planning for Trusts and Estates
Taxable Trusts are also subject to the NIIT and at a particularly low income threshold ($12,150). 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. That said, trust income that is distributed to a beneficiary is not subject to tax at the trust level: the tax liability is passed on to the recipient beneficiary. Trusts therefore 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 (1) reforming the trust to make it a grantor trust to a beneficiary, (2) reforming the trust’s income definition to include capital gains, (4) terminating small trusts altogether, and (4) 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 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 2014 deduction. Donations charged to your credit card prior to year-end are deductible in 2014 even if paid in 2015. 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 2014 pay periods. Unlike estimated tax payments, 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 (100% for taxpayers with AGIs less than $150K) or 90% of this year’s liability.
The Illinois estimated tax penalties are severe, but a taxpayer-friendly rule exists that can help 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 again in 2014. The AMT exemption will generally protect taxpayers with incomes under $250,000 while the new, higher marginal income tax rates will pull high income earners out of AMT. AMT has the effect of disallowing certain deductions and credits, but it actually works by creating an alternate tax regime. Many taxpayers find themselves perpetually in AMT without any realistic ability to avoid it. Unfortunately, this is not likely to change for taxpayers with incomes between $250,000 and $500,000.
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 expecting a unique tax event in a current or future year such as a stock option exercise or business transaction. AMT planning involves timing income events and expenses, 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 2014 and 2015 limits for employee contributions to a 401(k) plan are $17,500 ($23,000 if 50 or older) and $18,000 ($24,000 if 50 or older), respectively. 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 2014 and 2015. 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 2014 and 2015 are limited to $12,000 and $12,500, respectively. Participants age 50 and older can make an additional $2,500 “catch-up” contribution each year. SEP-IRA limitations for 2014 are the lesser of $52,000 or 25% of compensation (or 20% of self-employed earnings). The limitation increases to $53,000 in 2015.
Roth IRA and Roth Conversion
Married taxpayers with adjusted gross income under $191,000 ($129,000 for Singles) in 2014 and $193,000 ($131,000) in 2015 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 and minimum distributions are not required as with a traditional IRA.
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. If you have already made a Roth conversion, don’t forget to make the 2014 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 2014 ($2,100 in 2015). 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
If you paid someone to care for your child, spouse or dependent, you may be able to claim the dependent care credit. Taxpayers with one qualifying dependent are eligible for a credit of up to $600 with a $3,000 expense limit. For those with two or more qualifying dependents, the credit is up to $1,200 with a $6,000 expense limit. Note for married taxpayers that both spouses must have earned income to be eligible for the credit.Another option to consider is a dependent care flexible spending account (FSA). 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 2014 for single taxpayers with modified AGI of $80,000 and $160,000 for married taxpayers. The 2014 Lifetime Learning Credit remains at $2,000 and begins to phase out at $64,000 and $128,000 for single and married taxpayers, respectively.
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. With the return of the Personal Exemption Phase-out (PEP), many high earners won’t receive a dependency exemption anyway. Run the numbers to determine the best outcome.
Deduct the Cost of Your MBA
Part-time MBA candidates may obtain 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 or other “qualified higher education expenses” shortly afterward. You can also name yourself as the beneficiary, so consider setting up a plan for your own education costs. Note nonqualified distributions of the plan’s investment gain 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 2014 state tax liability by December 31st. The deduction can be claimed in the year paid. Use caution in pre-paying state taxes if you expect to be in a higher tax bracket next year. It is also 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 use pre-tax dollars to pay for qualified medical expenses. An HSA is a tax-favored savings account which is paired with a high-deductible health insurance plan. For 2014, the maximum HSA contribution for an individual is $3,300 and $6,550 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 generate tax-free investment returns. Contributions for 2014 can be made until April 15, 2015. Note that when you become eligible for Medicare or leave your job, you can no longer contribute to your HSA, but you can continue to use your HSA funds tax-free for qualified medical expenses. The list of qualified medical expenses is extensive, so confirm whether your medical expense is covered prior to paying funds out-of-pocket.
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 vehicles in the U.S. The list of qualifying vehicles is extensive but includes the Tesla Model S, Toyota Prius, BMW i3 and i8, and Chevy Volt. Though not eligible to offset AMT, the cost to install a refueling station at your home is also eligible for a credit. Note Illinois also offers a nontaxable rebate of up to $4,000 for the purchase of a new alternate fuel vehicle.
Credit for Residential Energy Efficient Property
The cost of acquiring and installing certain residential energy efficient property prior to 2017 is eligible for a 30% tax credit. 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.
Illinois Tax Credit for Angel Investors
Investments into Illinois-based innovative technology companies that have registered with the state as Qualified New Business Ventures may qualify for an Illinois tax credit equal to 25% of the investment (up to $2M). Illinois will allocate $10M of credits to qualified investors annually on a first come, first serve basis through 2016. Investors receive tax credits in the year they make an investment and must remain in the qualified business for at least 3 years. To qualify, the investor must directly or indirectly own less than 51% ownership in the qualified business. Lastly, the tax credit offsets an investor’s Illinois income tax liability while unused credits are carried forward for up to 5 years.
Note that the current statues do not address the qualifying date of convertible notes and as such, you may wish to confirm with the State on their administration’s stance prior to making your investment. NDH is in close contact with the program administrators and aims to keep current on this situation.
New Rules for Same-Gender Couples
Following the U.S. Supreme Court decision on the Defense of Marriage Act, the IRS ruled that they will now recognize all legal same-gender marriages nationwide. Note that marriage for this purpose does not include domestic partnerships, civil unions, or other similar relationships. Tax returns filed after September 2013 by same-gender 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 jointly, 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. Other tax benefits come through a variety of estate planning techniques, such as the marital deduction and portability. Last, same-gender spouses now have the opportunity to get tax-free employer health insurance coverage for the employee’s spouse.
Pitfalls of Spending Bitcoins
Taxpayers using virtual currencies such as Bitcoin to purchase goods or services should be aware that each transaction triggers a taxable event. For example, purchasing a $2 cup of coffee with bitcoins bought for $1 would trigger $1 in capital gain for the coffee drinker and $2 of gross income for the coffee shop. As a result, determining the net capital gain or loss at the end of the year can be challenging as each taxpayer will need to have record of each purchase and subsequent use.
Business Income Tax
Code Section 179
In 2014, businesses can deduct up to $500,000 of qualifying asset acquisitions. The deduction begins to phase out after purchases exceed $2M. Note that businesses must have taxable income to qualify for the current year deduction. Businesses should consider accelerating planned asset acquisitions into 2014 to take advantage of the favorable Bonus Depreciation rules and higher Section 179 expensing election.
Congress has extended bonus depreciation into 2014. A business can deduct 50% of the cost of new, qualifying personal property purchased in 2014, without regard to income limitations. Certain leasehold improvements also qualify for this business-friendly provision. Note that taxpayers generally should elect to apply the Section 179 rules prior to bonus depreciation as Illinois does not recognize this federal benefit and requires an unfavorable Illinois modification. Also consider electing out of bonus depreciation for rental real estate activities generating suspended losses to avoid an Illinois modification without a corresponding federal deduction.
The new repair regulations, finalized in 2013, require businesses to examine their capitalization policies, file for accounting method changes, and reexamine their prior cost segregation efforts. While these regulations are complex and will likely increase administrative costs, they also present opportunity. Business that do not obtain a financial statement audit can elect to expense up to $500 of otherwise capitalizable costs. Businesses with an audit may elect to deduct up to $5,000 of costs so long as the expense policy mirrors the company’s policy for financial reporting purposes. To make these elections, businesses must draft an expense policy statement as of the beginning of the year.
R & D Credit
The R&D credit provides benefit to businesses in a variety of industries including manufacturing, software development and sales, technology, and professional services. Qualifying expenses include salaries, contractor costs, and supplies connected to research that is technological and incurred to improve existing processes, test for new or improved products, and to develop software. While the credit does not offset AMT, it can be carried back one year or forward 20 years to offset regular tax liability. Also, be aware that new computational methods are available for businesses that previously failed to qualify for this credit.
The domestic production deduction provides an extra benefit to U.S. manufacturers and producers. They can deduct up to 9% of net income from U.S. manufacturing activities, natural resource production, film production, construction, and engineering and architecture services. The rules are complex, but analysis is warranted since many business activities qualify under the statutes’ broad definitions of production activities.
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.
Obsolete or Damaged Inventory
Businesses should review their inventory prior to year-end to accelerate a tax benefit for obsolete or damaged inventory. Taxpayers can write down their carrying cost to probable selling price if the inventory is offered for sale at the reduced price within 30 days of year-end. Note that this accelerated deduction is not available to taxpayers using the Last-in, First out (LIFO) valuation method. Additionally, if no market exists for the inventory item, taxpayers may write off 100% of the cost in the current period. Taxpayers should be careful when reviewing inventory, since damaged or obsolete inventory does not include slow moving inventory. Note that it is not enough to simply provide a reserve; you must identify specific inventory which will be reduced.
Holiday Pay and Bonuses
Accrual businesses can currently deduct 2014 year-end bonuses paid in 2015 as long as the employee is not a related party to the corporation, the bonus is accrued on the company’s books before year-end, and the company pays the bonus within two and half months after year-end. Accrual taxpayers can also generally deduct January 1, 2015 holiday pay in 2014 if they accrue the liability in 2014 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 $117,000 in 2014 and $118,500 in 2015. Employment income is subject to a 1.45% Medicare tax to both employees and employers. Self-employed individuals will pay both the employee and employer share. The 0.9% Additional Medicare surcharge is assessed only to employees with taxable income of $200,000 ($250,000 married filing joint). 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 decreased to 56 cents/mile for all of 2014. For charitable mileage, the rate is unchanged at 14 cents/mile, and for medical or moving purposes the rate has decreased to 23.5 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 three years of the plan.
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 $130 in 2014, and will remain unchanged in 2015. The maximum monthly parking benefit also remains at $250 in 2014.
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’ share of Illinois-sourced income to ensure compliance with Illinois tax laws. Businesses 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.
Affordable Care Act Basic Summary
Individuals who do not have insurance plans offered to them from employers may enroll in plans through the Health Insurance Marketplace, and non-exempt individuals who do not have insurance will be subject to a penalty. In 2015, large employers, typically those with 50 or more full-time equivalent employees (FTE), must offer adequate and affordable insurance for their full-time employees or pay a per-month “Employer Shared Responsibility Payment” on their federal tax return. Employers with 100+ FTE must provide insurance to at least 70% of their FTE by 2015 and 95% by 2016, while employers with 50-99 FTE must start insuring employees by 2016. The maximum fee for not offering coverage is $2,000 per employee (with the first 30 FTE exempt) and is not tax deductible.
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 Business topic Small Business Health Care Tax Credit, below).
The Affordable Care Act may be in flux as the Republican-dominated House recently sued President Obama over the administration’s implementation of the Act.
Small Business Health Care Tax Credit
Small businesses with fewer than 25 employees and average wages less than $50,000 may qualify for a valuable tax credit if they provide health insurance to their employees. 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 enrolled in a qualified plan offered through a Small Business Health Options Program (SHOP) Marketplace. The credit phases out gradually for firms with the equivalent of 10–25 employees and with average annual wages between $25,000 and $50,000.
Illinois Small Business Job Creation Tax Credit
Illinois employers should act quickly to take advantage of the extended $2,500 tax credit for creating new jobs. Eligible jobs must be full-time positions newly created between July 1, 2012 and July 30, 2016. The position itself must be sustained for at least one year and must pay no less than $10.00 per hour or the equivalent salary, for a minimum of $18,200 annualized. Note that the credit may also be claimed for an hourly employee working an average of at least 35 hours per week.
Illinois has also expanded the guidelines for employer eligibility. Eligible employers are those who employ 50 or fewer full-time employees (at all locations) and now includes not-for-profit organizations, Professional Employer Organizations, and any sized business that hires a 2010 “Put Illinois to Work Program” worker-trainee.
The tax credit is $2,500 per job and must be applied against an employer’s Illinois withholding tax on Form IL-941. One year after filing the new position, the employer must provide supporting data as requested to be issued a tax credit certificate. The credit must be claimed in the reporting period in which it is received and can be carried forward for up to five years. Register online now at JobsTaxCredit.illinois.gov; the program is first-come, first-serve and is capped at $50M in credits.
Illinois Angel Investment Program for Innovative Businesses
Innovative businesses looking to raise capital this year should be aware of the Illinois Angel Investment Program. Since the program’s existence, NDH has successfully registered over 15% of all Illinois innovative businesses currently registered under the Illinois Angel Investment Credit Program. Under the program, qualified investors receive a tax credit equal to 25% of their investment (up to $2M) in a Qualified New Business Venture (see Individual topic Illinois Tax Credit for Angel Investors, above). To qualify as a New Business Venture, businesses must have the following characteristics:
- Principally engaged in innovation
- Fewer than 100 employees
- Operating lifespan of less than 10 years
- Illinois headquarters
- At least 51% of employees located in Illinois
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 is 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 2012 legislation brought new clarity to estate tax planning by permanently extending several favorable provisions involving higher estate exemptions, inflation indexing and portability. Thanks to these provisions, there are no material changes in 2014.
Utilize your $5.34m Estate/Gift Exemption
The 2014 estate exemption is now $5.34M ($5.43M in 2015). While the permanently higher estate exemptions will remove the pressure for many moderately wealthy families when planning gifts, high-wealth families should still consider gifting strategies to leverage this exemption for greater estate tax savings.
Annual Exclusion Gifts
The annual gift exclusion is $14,000 in 2014 and 2015. This is the amount that each person can give to any other person without a taxable gift (i.e. $28,000 if you are married and your spouse joins in the gift). 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 are still relatively low (i.e. a nine-year loan made in December 2014 can carry a 1.72% 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 (ILIT). 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.
Plan for Illinois Estate Tax
Under current law the Illinois estate tax threshold is $4M, and amounts in excess of the threshold carry high marginal tax rates. Individuals with estates exceeding $4M should consider planning for the Illinois estate tax. A gifting program may be effective in reducing or eliminating Illinois estate tax as Illinois does not have a separate gift tax. Illinois residents with connections to another non-taxable state may consider establishing domicile in that other state.
A family limited partnership (FLP) or family limited liability company (FLLC) can serve as a valuable component of asset protection and estate tax planning. Shares in a family partnership can be transferred at favorable valuation discounts and can utilize gift tax exemptions while minimizing estate taxes.
Miscellaneous Itemized Deduction (2%) Bundled Fees
The Treasury Department finalized regulations requiring trust taxpayers to subject a percentage of “bundled fees” to the 2%-of-AGI limitation, reducing the tax benefit of these payments. Bundled fees are amounts typically paid to financial institutions for a combination of services including investment advisory, accounting, tax, and trust administration. Historically, trusts would deduct these fees without limitation; the new rules require trusts to segregate the fees allocable to the 2%-of-AGI bucket and to subject them to the limitations. Costs incurred by a trust that would otherwise not be incurred by another taxpayer continue to qualify for deduction without limitation. Investment advisory fees included in a bundled fee should be segregated. To minimize tax inefficiency, we recommend documenting your allocation and consistently adhering to it.