Individuals & Self-Employed
Plain vanilla year-end tax planning strategies suggest that all taxpayers should generally defer income and accelerate expenses to reduce current-year taxable income and tax liabilities. But the AMT (Alternative Minimum Tax) is becoming an increasingly big problem, turning most tax planning logic upside down.
Alternative Minimum Tax
AMT is catching more and more individuals. Those who happen to have significant deductions – those living in a state with a relatively high personal income tax rate and high real estate taxes – are vulnerable. The AMT makes year-end planning difficult and potentially dangerous if done in a vacuum.
Reducing regular tax liability through deductions, deferral, and overall rate reductions has increased the AMT liability exposure. All planning must consider multiple years to be truly effective. While credit for prior-year AMT may be available against regular income tax in a subsequent year, there is no guarantee that the AMT will ever be recovered.
Individual Income Tax Considerations
• Bonuses and Salaries – If your employer will defer the payment into January next year, bonus and salary amounts will not be taxed on your return until next year.
• Stock and Bond Sales – You may want to consider not selling stock with a gain until January to defer recognition. Likewise, sell those stocks with losses before the end of the year to reduce any other gains you may have, including capital gain dividends. However, only $3,000 of net losses from security transactions can be deducted currently.
• Deductible Expenses – Charge deductible expenditures on credit cards to get a current deduction even if payment of the charge will not be made until next year.
• Charitable Donations – Make charitable donations with appreciated stock owned for more than one year. The fair market value is used to measure the donation, and there is no tax on the difference between your cost and the fair market value. (If the fair market value is less than your cost, consider selling the item to recognize the loss and contribute the cash proceeds.) Remember that charitable contributions must be substantiated with bank records or receipts – the “miscellaneous” cash contribution is no longer allowed without a receipt.
• Retirement Contributions – Make the maximum contribution to retirement arrangements whether employer-sponsored or an IRA.
• Passive Activity – Dispose of a passive activity with suspended losses. When a passive activity has suspended losses, those losses become deductible in the year the activity is sold.
• Installment Sales – Consider an installment sale of property rather than collecting all proceeds this year. You can defer part of the gain on the sale until you collect the cash.
Tax Considerations for the Self-employed
• For cash-basis method businesses, send out invoices late in December so that collections will not be made until January.
• Establish a retirement plan before year-end. The deduction is allowed on the current-year return even if funded just before you file the return next year. While many plans can be funded next year for a deduction, only a SEP plan can be established next year. Other plans need to be established this year.
• Employ your minor children to perform administrative tasks and avoid Social Security taxes on wages – this shifts income to a lower bracket. (The children may establish Roth IRAs to gain future benefits.)
In addition, it’s very difficult to generalize about year-end tax planning because ideas that help one taxpayer could backfire on other taxpayers. What is useful depends on the specifics of each family, the source and type of income, etc.
Finally, please keep in mind that I do not subscribe to spending money just to save on taxes. Tax planning should always have a valid business purpose and should be analyzed critically to ensure that both the business and tax side of the business are taken into account.
TOP TEN YEAR END TAX PLANNING CHECKLIST
1. If you own a business, do you have an EIN, an operating agreement, and a separate bank account?
2. Have you recorded all the income and expenses related to the business on the business bank account? This is a huge audit item.
3. If you own an investment property that was foreclosed or sold as a short sale, have you considered the impact of the cancellation of debt income on your income taxes? Have you calculated the loss of sale of investment property?
4. If you generated any kind of active real estate income, have you considered restructuring your business to minimize the impact of self-employment taxes?
5. If you have significant real estate education expenses, have you registered a business in order to minimize your audit exposure by deducting these expenses?
6. If you have significant business expenses and already have a registered business, have you considered converting to a partnership to avoid an audit flag?
7. For homes that have been repossessed, do you know the rules on recourse vs. non-recourse debt?
8. Do you understand what your tax filing requirements are for the states where your business is registered such as annual filing, personal property tax returns, etc.?
9. If you own an investment property, have you considered doing a cost-segregation study in order to increase your depreciation expense?
10. If you bought or sold property this year, have you considered the impact of capital gains, adding rehab expenses to the basis of the property, and whether the holding costs (mortgage interest, taxes, and insurance) are deductible next year?
WHAT WBCPA WILL DO FOR YOU AS PART OF A YEAR-END TAX PLANNING SERVICE…
• For business owners, check that you have an EIN, an operating agreement, and a separate bank account. Record all the income and expenses related to the business in the business bank account. This is a huge audit item.
• For investment property that was foreclosed or sold as a short sale, we will consider the impact of the cancellation of debt income on your income taxes and calculate the loss of sale of investment property.
• For active real estate income, we will restructure your business to minimize the impact of self-employment taxes, and for significant real estate education expenses, we will register a business to minimize your audit exposure by deducting these expenses.
• If you have significant business expenses and already have a registered business, we will look at converting to a partnership to avoid an audit flag
• We will examine your tax filing requirements for the states where your business is registered such as annual filing, personal property tax returns, etc. and if you own an investment property, we will do a cost-segregation study in order to increase your depreciation expense.
• If you bought or sold property this year, we will examine the impact of capital gains, adding rehab expenses to the basis of the property, and whether the holding costs (mortgage interest, taxes, and insurance) are deductible.
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