We have numerous clients who own businesses as well as many clients who do not. Regardless of whether you own a business or not, conducting year-end tax planning now can pay big dividends for you next year when you file your 2014 income tax returns. For those who own businesses, the rewards can be even greater.
We are approaching the October 15th deadline which means 2013 individual returns (form 1040) that were extended must be filed by then to avoid being subject to late filing penalties that would accrue if you owe tax to the IRS or the state. What that also means is that our year-end tax planning season is about to begin. We typically meet with clients in late October or November to review their year-to-date activity looking for opportunities to pull any strategic triggers before year-end that would reduce or mitigate their 2014 income tax or self-employment tax liability. Most clients who meet with us for the first time in this planning capacity have doubts about the benefits that doing so might bring. With very few exceptions, our clients generally become believers and are quick to schedule the planning session again the next year.
Each case is unique but I will mention here many typical tax planning tools we can use when applicable. One tool is the funding of a qualified retirement plan either before year-end or by the April filing deadline. Contributions to these accounts will reduce your taxable income base which will translate into a lower tax liability for the year. Examples of employer-sponsored qualified retirement plans are 401(k), 403(b) and SIMPLE plans. Other qualified retirement plans include a SEP plan and a traditional individual retirement account (IRA). The deadline to contribute in order to be deductible on your 2014 income tax return depends on the plan chosen.
For our business owner clients, we can discuss the benefit of purchasing needed business equipment or vehicles before year-end in order to deduct all or a large portion of the expense in the current year using the section 179 depreciation deduction rather than to expense off the cost of the item over several years under normal depreciation methods. The annual limit on the section 179 deduction has risen over the years but is currently slated to drop back to $25,000 for 2014 if Congress does not act by year-end to extend the higher deduction threshold. Because it is an election year, we may not know the result on this issue until after the November election.
Another option available to many of our employee (W-2) clients is a flexible spending account. An FSA lets you elect to pay qualified health or dependent care expenses on a pretax basis which reduces your taxable income.
If the taxpayer is of the age to receive social security benefits, we can determine how much of their benefits will be taxable income to them for a given year based on their overall income level. Many clients fail to realize that a large portion of their social security benefits may be taxable if their overall income is over certain limits. The maximum portion of their social security benefits that can be taxable is 85%.
Potential limits on several tax deductions and exemptions are based on your adjusted gross income (AGI). This figure is the bottom line of page one of your form 1040. With proper planning, we can often reduce this figure and, therefore, increase the amount that can be claimed as a deduction or exemption on page two of the return. The adjustments to income allowed near the bottom of page one are more valuable than itemized deductions claimed near the top of page two and that is because they reduce AGI. Adjustments allowed on page one include health savings account (HSA) contributions, moving expenses, the self-employment tax deduction, the self-employed health insurance deduction, alimony payments, IRA contributions, student loan interest payments and college tuition and fees.
With the new net investment income surcharge of 3.8% on investment income that was enacted effective for the 2013 tax year, we can analyze the tax hit this new provision may cause for you and reduce exposure to it, if possible. In addition, many of our clients must consider the additional tax that the alternative minimum tax (AMT) rules may create for them. In a nutshell, there is a basic set of IRS rules to determine tax liability. Then, if your income is over certain levels and you meet other criteria, you may be subject to additional tax on your income as many otherwise deductible items are ignored in the AMT calculation.
Lastly, we try to maximize the federal and state tax credits claimed on our clients’ returns. A credit is much more valuable than a deduction since a credit reduces your tax liability dollar for dollar while a deduction merely reduces your taxable income base before the tax is calculated on that amount. There are many federal tax credits available and, in our state Arizona, there are many opportunities to reduce your tax burden such as the public schools tax credit, the private tuition organization credit and the contributions to qualifying charitable organization credit. A taxpayer can contribute to all three of these and reap the benefits of the credit in each case. In essence with these Arizona credits, you are redirecting your tax liability to the organization of your choice rather than paying the amount you owe to the state general fund.
Our goal in conducting strategic planning is to reduce your income tax and self-employment tax liability as much as possible. Once that is accomplished, the next step is to ensure that you have paid in enough tax for the year to avoid estimated tax and late payment penalties. Employees have federal and state income tax withheld from their wages, but self-employed taxpayers are required to make quarterly estimated tax payments to the IRS and state to satisfy their respective liabilities.
If you would like to explore opportunities to reduce your tax liability, please contact us to schedule an appointment to meet for a tax planning strategy session.