Year-End Tax Planning Moves for Individuals

Tax Services – We have compiled a checklist of additional actions based on current tax rules that may help you save tax dollars if you act before year -end . Not all actions will apply in your particular situation, but you (or a family member) will likely benefit from many of them. We can narrow down the specific actions that you can take once we meet with you to tailor a particular plan. In the meantime, please review the following list and contact us at your earliest convenience so that we can advise you on which tax-saving moves to make:
Realize losses on stock while substantially preserving your investment position. There are several ways this can be done. For example, you can sell the original holding, then buy back the same securities at least 31 days later. It may be advisable for us to meet to discuss year-end trades you should consider making.
Postpone income until 2015 and accelerate deductions into 2014 to lower your 2014 tax bill. This strategy may enable you to claim larger deductions, credits, and other tax breaks for 2014 that are phased out over varying levels of adjusted gross income (AGI). These include child tax credits, higher education tax credits, and deductions for student loan interest. Postponing income also is desirable for those taxpayers who anticipate being in a lower tax bracket next year due to changed financial circumstances. Note, however, that in some cases, it may pay to actually accelerate income into 2014. For example, this may be the case where a person’s marginal tax rate is much lower this year than it will be next year or where lower income in 2015 will result in a higher tax credit for an individual who plans to purchase health insurance on a health exchange and is eligible for a premium assistance credit.
If you believe a Roth IRA is better than a traditional IRA, and want to remain in the market for the long term, consider converting traditional-IRA money invested in beaten-down stocks (or mutual funds) into a Roth IRA if eligible to do so. Keep in mind, however, that such a conversion will increase your adjusted gross income for 2014.
If you converted assets in a traditional IRA to a Roth IRA earlier in the year, the assets in the Roth IRA account may have declined in value, and if you leave things as is, you will wind up paying a higher tax than is necessary. You can back out of the transaction by recharacterizing the conversion, that is, by transferring the converted amount (plus earnings, or minus losses) from the Roth IRA back to a traditional IRA via a trustee-to-trustee transfer. You can later reconvert to a Roth IRA, if doing so proves advantageous.
It may be advantageous to try to arrange with your employer to defer a bonus that may be coming your way until 2015.
Consider using a credit card to pay deductible expenses before the end of the year . Doing so will increase your 2014 deductions even if you don’t pay your credit card bill until after the end of the year .
If you expect to owe state and local income taxes when you file your return next year, consider asking your employer to increase withholding of state and local taxes (or pay estimated tax payments of state and local taxes) before year -end to pull the deduction of those taxes into 2014 if doing so won’t create an alternative minimum tax (AMT) problem.
Take an eligible rollover distribution from a qualified retirement plan before the end of 2014 if you are facing a penalty for underpayment of estimated tax and having your employer increase your withholding isn’t viable or won’t sufficiently address the problem. Income tax will be withheld from the distribution and will be applied toward the taxes owed for 2014. You can then timely roll over the gross amount of the distribution, i.e., the net amount you received plus the amount of withheld tax, to a traditional IRA. No part of the distribution will be includible in income for 2014, but the withheld tax will be applied pro rata over the full 2014 tax year to reduce previous underpayments of estimated tax .
Estimate the effect of any year-end planning moves on the alternative minimum tax (AMT) for 2014, keeping in mind that many tax breaks allowed for purposes of calculating regular taxes are disallowed for AMT purposes. These include the deduction for state property taxes on your residence, state income taxes, miscellaneous itemized deductions, and personal exemption deductions. Other deductions, such as for medical expenses, are calculated in a more restrictive way for AMT purposes than for regular tax purposes in the case of a taxpayer who is over age 65 or whose spouse is over age 65 as of the close of the tax year. As a result, in some cases, deductions should not be accelerated.
You may be able to save taxes this year and next by applying a bunching strategy to “miscellaneous” itemized deductions (i.e., certain deductions that are allowed only to the extent they exceed 2% of adjusted gross income), medical expenses and other itemized deductions.
You may want to pay contested taxes to be able to deduct them this year while continuing to contest them next year.
You may want to settle an insurance or damage claim in order to maximize your casualty loss deduction this year.
Take required minimum distributions (RMDs) from your IRA or 401(k) plan (or other employer-sponsored retired plan) if you have reached age 70-1/2 . Failure to take a required withdrawal can result in a penalty of 50% of the amount of the RMD not withdrawn. If you turned age 70-1/2 in 2014, you can delay the first required distribution to 2015, but if you do, you will have to take a double distribution in 2015—the amount required for 2014 plus the amount required for 2015. Think twice before delaying 2014 distributions to 2015—bunching income into 2015 might push you into a higher tax bracket or have a detrimental impact on various income tax deductions that are reduced at higher income levels. However, it could be beneficial to take both distributions in 2015 if you will be in a substantially lower bracket that year.
Increase the amount you set aside for next year in your employer’s health flexible spending account (FSA) if you set aside too little for this year.
If you are eligible to make health savings account (HSA) contributions in December of this year, you can make a full year’s worth of deductible HSA contributions for 2014. This is so even if you first became eligible on Dec. 1, 2014.
Make gifts sheltered by the annual gift tax exclusion before the end of the year and thereby save gift and estate taxes. You can give $14,000 in 2014 to each of an unlimited number of individuals but you can’t carry over unused exclusions from one year to the next. The transfers also may save family income taxes where income-earning property is given to family members in lower income tax brackets who are not subject to the kiddie tax .

Also, as always, we’re ready to assist you with other tax and business matters.
AB Tax Accounting
(651) 621-5777, (952) 583-9108, (612) 224-2476, (763) 269-5396

Corporation Was Not Entitled To Deduct Amount of Shareholder’s Bonus Check

The Tax Court in Vanney Associates Inc., TC Memo 2014-184, held that the corporation could not deduct its sole shareholder/CEO’s yearend bonus as officer compensation because the corporation did not have the funds to cover the check he received. Therefore, the check could not have been paid.

The corporation is a personal service architectural C corporation that uses the cash method of accounting. The corporation’s sole shareholder, an experienced, licensed architect, is also the corporation’s CEO, CFO, vice president of marketing, vice president of operations, and director of human resources. Although the corporation has other employees, the shareholder is primarily responsible for marketing, bringing in new business, and signing construction documents.

The shareholder’s wife is responsible for the corporation’s books and records. She is a CPA with an inactive license, and is also employed as vice president of finance for an unrelated company. She prepares the payroll checks and the shareholder signs and distributes them.

At the end of each tax year, the shareholder and his wife determine the corporation’s remaining profits after paying outstanding bills and employee bonuses. The shareholder’s wife then prepares a check on behalf of the corporation and pays the remaining profit to the shareholder as his yearend bonus. The shareholder and his wife both testified that they did this only to pay out the remaining profit, and they did not intend to zero out the corporation’s tax liability, even if that was the result.

In 2008, the corporation paid the shareholder a yearend bonus of $815,000. After making appropriate withholdings, the shareholder received a check for approximately $464,000. He signed the check on behalf of the corporation, and then endorsed it in his own name and made it payable to the corporation. He never attempted to cash the check, his wife recorded the payment on the books as a loan from the shareholder to the corporation, and the corporation repaid the shareholder in March 2009.

The total balance of the corporation’s bank accounts on 12/31/08 was approximately $389,000. After adjusting for outstanding deposits and checks, the balance was approximately $283,000. The shareholder testified that he believed the corporation did not have the funds to honor the check. However, he claimed the corporation could have received a loan to cover it. His wife testified that the corporation was strong and had considerable receivables. Further, she testified that although they considered taking out a loan for the corporation, they decided not to because they personally did not need the money and wanted to avoid the expenses of taking out a loan.

The corporation timely filed its income tax return for 2008, reporting no taxable income and claiming a deduction for officer compensation. The IRS disallowed the $815,000 of the deduction that represented the shareholder’s yearend bonus check.

The court noted that payment by check is a conditional payment because it is subject to the condition subsequent that the check be paid on presentation to the drawee. When the condition subsequent is fulfilled, it is generally reasonable to conclude that the payment relates back to the time the check was given. Therefore, the allowance of a deduction is dependent on proper payment of the check. The court has previously disallowed a deduction when a check was not paid due to insufficient funds. Further, it has held that the relation-back doctrine is inapplicable when the payee knows the payor has insufficient funds and so refrains from cashing the check.

Also, transactions between related entities are subject to special scrutiny. The economic reality of a transaction will prevail over its form, and a finding of economic reality depends on whether the transaction would have followed the same form if the parties were unrelated. The court has disallowed deductions when there was no actual economic outlay and the payments were “wholly circular.”

The corporation argued that the bonus check to the shareholder was unconditional and the payment occurred when the shareholder took possession of the check. It relied on O’Connor, TC Memo 1954-90, PH TCM ¶54195, 13 CCH TCM 623 , in which the court held that the essential element was that the control of property distributed by way of a dividend must have passed absolutely and irrevocably. The court in O’Connor also relied on the fact that the payee had unrestricted use of the money and the amount was unqualifiedly his to do with as he wished.

The court pointed out that this was distinguishable from the situation here. The shareholder’s wife knew or should have known that the corporation did not have the funds to cover the bonus check, and the shareholder testified that he had at least some idea of the same. Further, the shareholder had only a restricted use of the check. He could not cash it at the bank, use it to pay a debt, or use it to make a loan to someone other than the corporation. The shareholder’s only option to make use of the money was to lend it back to the corporation because the check could not be honored.

Additionally, the court stated that it had previously held that although a taxpayer maintains possession of a check, the amount of the check may not be treated as a distribution or may not be included in gross income when the account has insufficient funds to honor the check. Therefore, the IRS’s disallowance of the portion of the deduction for officer compensation relating to the shareholder’s bonus check was upheld.

Also, as always, we’re ready to assist you with other tax and business matters.
AB Tax Accounting
(651) 621-5777, (952) 583-9108, (612) 224-2476, (763) 269-5396

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