Sidney Kess ()
On May 20, 2014, I chaired the AICPA (American Institute of CPAs) Conference on Tax Strategies for High Income Individuals in Las Vegas, Nev. A renowned panel of tax experts discussed some of the best tax strategies for this year. Here are some of the best ones from the panel, which was moderated by Julie Welch, partner with Meara Welch Browne, an accounting, auditing and consulting firm in Leawood, Kan.
Health Insurance Issues
In light of the Affordable Care Act (ACA), individuals and businesses need to review their health coverage in order to avoid the applicable penalties for not complying with the rules (Code Sec. 5000A).
For individuals. While the cost of the penalty under ACA is lower than the cost of health coverage, it is still advisable to obtain coverage because of the potential risk of large health care expenses associated with a major illness or accident; these expenses can create financial problems for years to come. Those who cannot afford coverage may qualify for government assistance in the form of Medicaid or eligibility for the premium tax credit (Code Sec. 36B).
Health savings accounts (HSAs) continue to be an attractive health care solution, combining a high-deductible health plan (usually the bronze plan in the system, commonly known as the Marketplace) with a savings account that can be tapped tax-free to pay for qualified medical costs (distributions for nonqualified costs are penalty-free once the person reaches age 65) (Code Sec. 223). Investment returns on contributions are not currently taxed; unused funds continue to grow (an estimated $220,000 is needed for a person’s out-of-pocket health costs, exclusive of long-term care, after retirement). The HSA contribution is tax-deductible, even for those who do not itemize.
For businesses. Many high-income individuals own businesses. Determine whether an employer is subject to the employer mandate (starting in 2015 for employers with 100 or more full-time and/or full-time equivalent employees; 2016 for employers with 50 to 99 such employees) and what solutions will be used. There is an excise tax of $2,000 per full-time employee if minimum essential coverage is not provided. Even if coverage is offered, an excise tax of $3,000 applies if the coverage to an employee is not affordable (it is more than 9.5 percent of an employee’s compensation), the employee seeks coverage from the Marketplace, and qualifies for the premium tax credit (see above).
Small for-profit companies may qualify for the small employer health insurance credit if they pay at least 50 percent of the cost of coverage for workers and their payroll (number of employees; average wages) is within set limits (Code Sec. 45R). The credit in 2014 and 2015 can only be claimed for coverage obtained through the Small Business Health Options Program (SHOP), which is the Marketplace for small companies. Small businesses can enroll at any time (they are not subject to the deadline for individuals). The federal SHOP is not available online as yet; call 800-706-7893 for information.
Anyone who works for a company that offers a designated Roth account option, which is like a Roth IRA tacked onto a 401(k) plan, should consider making contributions to it. Distributions from the designated Roth account are tax-free if certain conditions are met. There is no income limit for contributions to designated Roth accounts as there is for contributions to Roth IRAs. Find more information about designated Roth accounts from the IRS at http://www.irs.gov/Retirement-Plans/Retirement-Plans-FAQs-on-Designated-Roth-Accounts.
If an individual has a low tax year (e.g., there is a net operating loss or other loss of income), consider converting a traditional IRA to a Roth IRA to create future tax-free income. While there is no income limit on being able to make the conversion, a low-tax year is the best time to do it because the income resulting from the conversion is currently taxable (assuming that the traditional IRA was funded entirely with tax-deductible contributions).
Check for eligibility for the retirement savers credit of up to 50 percent of contributions up to $2,000 to IRAs or qualified retirement plans (Code Sec. 25B). While the credit is designed to encourage low- and moderate-income taxpayers to make retirement contributions, recent graduates or those who have been laid off may fall under the income limits to qualify for the credit.
Self-employed individuals with earnings below the compensation limit ($260,000 for 2014) can consider a solo 401(k) to maximize their retirement savings. This allows them to contribute up to $52,000 ($57,500 if age 50 or older by year end); this contribution reflects both an employer and employee contribution even though a self-employed individual is neither an employer nor an employee. The plan can be combined with a designated Roth account to create tax-free retirement income.
Those who engage a nanny, housekeeper, or other household worker in their home should always treat the worker as an employee rather than as an independent contractor. While this means paying the nanny tax (Social Security and Medicare taxes if the worker earns $1,900 or more in 2014, as well as federal and state unemployment insurance), it will help avoid a tax audit as well as potential wage disputes.
If working parents have a child under age 13 who is being cared for by a nanny or housekeeper, the parents can take a dependent care credit (the minimum credit is 20 percent of qualified child care expenses). The credit is based on the wages paid to the caregiver and employment taxes on those wages up to $3,000 for one child, or $6,000 for two or more children (Code Sec. 21). If one of the parent’s employers offers a dependent care assistance plan, generally up to $5,000 of wages can be set aside and excluded from income to pay dependent care expenses.
Despite the phase-out in itemized deductions (Code Sec. 68(b)), which reduces somewhat the tax benefit of making charitable donations, philanthropic-minded individuals can still achieve tax savings. Consider:
• Donor-advised funds. If donors are not certain now which charities they want to give to, they can use donor-advised funds, in which the donor places money for charitable purposes without indicating to which charity it goes while still gaining a current income-tax deduction. They can then suggest (but not demand) which charities will benefit from their donations. Donors do not pay any capital gains on appreciated securities or other properties given to the funds.
• Charitable remainder unitrusts. These are trusts in which the donor retains an income interest (unitrust payments) for life, with the remainder interest passing to charity. The use of such trusts is especially helpful when a person is planning a significant taxable event, such as the sale of a highly appreciated asset. By giving the property to the charity before the event, the person reaps a current tax deduction for the value of the remainder interest while effectively spreading the tax on the gain over his or her life.
• Grantor charitable lead annuity trusts. Here, the charity has the income interest while the remainder reverts to the donor or his or her children. This type of vehicle is best suited for a person who has significant ordinary income (e.g., income from the exercise of nonqualifed stock options or a large compensatory bonus).
• Direct transfers from IRAs for those age 70-½ up to $100,000. This tax break expired at the end of 2013 but is expected to be extended for 2014 or made permanent (both houses of Congress support this measure). While no charitable deduction is allowed, the transfer avoids tax on the distributed IRA funds (including required minimum distributions). Check for congressional action before making any transfer solely for purposes of this tax break.
Note: When giving appreciated realty, closely held stock, or other property (other than publicly traded securities), be sure to obtain a qualified appraisal. Such appraisal is required for non-cash contributions exceeding $5,000. The failure to have the appraisal can result in the loss of the entire contribution or a greatly diminished one if the IRS questions the return (see e.g., Alli, TC Memo 2014-15, where a deduction for a donation of realty was denied for lack of a proper appraisal).
Gifts to family members are not tax-deductible but may be free from gift tax. The annual gift-tax exclusion for 2014 is $14,000 per donee. The demographic group age 45 to 54 has the highest median household income, but may be providing financial support for parent and/or children. Giving appreciated securities in lieu of cash can save the family in taxes if the donee (e.g., an elderly parent) is in the 10 percent or 15 percent tax bracket because the donee pays zero capital gains tax. However, this strategy may not be helpful for children still subject to the so-called kiddie tax (Code Sec. 1(g)).
Owners of profitable real estate investments are potentially subject to the 3.8 percent additional Medicare tax on net investment income (Code Sec. 1411). However, those who qualify as a real estate professional can avoid this tax. Review the taxpayer’s activities, looking for those as a landlord, developer, or other real estate endeavor. For those who cannot qualify as a real estate professional and own multiple properties, explore regrouping options to minimize passive activity income.
Tax-deferral strategies are more valued than ever in light of the additional Medicare tax. Consider installment sales to spread the tax on gains over the years in which payments are received (Code Sec. 453). There are non-tax advantages of installment sales: They facilitate the transaction (a buyer may not be able to finance a lump-sum purchase) and create an income stream for the seller.
Make sure that those with foreign bank accounts valued at any time during the year at $10,000 or more file the annual information return with the U.S. Treasury. FinCEN Form 114 (which replaced Form TD 90-22.1) must be filed electronically by June 30; no filing extension is permissible. Expect the IRS to be on the lookout for taxpayers who fail to file this form because international tax issues are expected to remain the highest enforcement priority for the IRS for the next three to five years.
These are just some tax-saving ideas from the nation’s leading tax experts. As the mid-year approaches, review these and other strategies to achieve optimum tax results for this year.
Sidney Kess, CPA-attorney, is of counsel at Kostelanetz & Fink, consulting editor to CCH, author and lecturer.