Congress has a record of restoring prized income tax breaks at the last minute. So it seems likely that lawmakers will get off their collective duff and extend many of the 50-plus provisions that expired last year, even though they’d made little progress toward that as of early October.
One in abeyance that’s dear to advisors and their clients allows an individual age 70 and a half or older to exclude from income up to $100,000 of individual retirement account distributions directed to charity.
Business owners, including advisors, would also love to see the renewal of bonus depreciation on new equipment purchased this year. They would also appreciate an increase in the Section 179 election, which lets them immediately write off the cost of assets they buy, rather than spread the cost over time through depreciation. This deduction is limited to $25,000 for 2015—downright puny compared with last year’s $500,000 cap—and begins phasing out once the business has purchased more than $200,000 of eligible assets, whereas it could purchase $2 million worth of equipment in 2014. Boo, hiss.
Whether or not Washington acts, advisors can take steps to help clients lower their 2015 tax bills.
They can start by seeking an update on the client’s marginal tax rate. Maybe 2015 has been a better-than-expected year and the busy client has neglected to tell you.
With the top ordinary bracket now 39.6%, “Clients may be paying over 50 cents on their last dollar earned when you include state income tax and the 3.8% net investment income tax,” observes CPA Tony A. Rose, founding partner of Rose, Snyder & Jacobs LLP, an accounting firm in Encino, Calif. “It calls into question how much risk the client should take to make another taxable dollar.” Tax-free income opportunities may deserve a closer look.
Advisors should also check state tax withholding for married gay clients in states that didn’t recognize same-sex marriage until a ruling by the U.S. Supreme Court in June required them to. These clients entered 2015 expecting to file their state returns as single individuals, as they have in the past. “Married” is now their state filing status after the court’s decision in Obergefell v. Hodges. Make sure these clients’ state tax withholding reflects the change.
Several non-recognition states have said they’ll permit, but not require, married gays to amend recent tax returns to reflect their married filing status. Among the latest are Alabama, Mississippi, Nebraska and North Dakota, according to Wolters Kluwer Tax & Accounting, an information provider in Riverwoods, Ill. (For other timely planning issues for gay clients and prospects, see the sidebar.)
The 2013 advent of the aforementioned 3.8% tax on investment income has made a mark on year-end tax planning. For one thing, it makes tax-loss harvesting more valuable to clients. Capital gains are subject to this surcharge when income tops $250,000 if a couple is filing jointly or $200,000 when the taxpayer is filing as single.
Blake E. Christian, a tax partner at accounting firm HCVT LLP in Park City, Utah, and Long Beach, Calif., says, “Our firm is spending more time with our clients’ investment advisors in building tax-efficient investment portfolios and, during the year-end planning process, attempting to net capital losses against gains to minimize the 3.8% tax.”
The tax can be squirrely. Christian has seen cases where clients have had to pay the 3.8% surcharge on their investment income even when their regular income tax was zero thanks to significant itemized deductions and tax credits.
AMT Meets The 3.8% Tax
This galling little levy can also affect planning for the alternative minimum tax, according to Jerry Yu, an accountant with Moss Adams LLP in Silicon Valley. Usually, clients who are subject to the AMT are advised to make their fourth-quarter state estimated tax payment when it’s due in mid-January, rather than in December. That’s because state income tax is not deductible under alt-min, so there’s no point in prepaying it in the current year.
“But a portion of the state tax payment may be deductible against income subject to the 3.8% tax,” Yu points out. “So we run a calculation to see whether it makes sense for AMT clients to prepay their state tax by December 31 to potentially reduce the 3.8% tax for this year,” he says.
Usually a significant portion of the client’s income must derive from investments in order for prepaying to be beneficial, Yu notes.
The Hidden Costs Of Alts
Keeping taxes in check is good. So is keeping a lid on accounting fees, and year-end planning is an opportunity to explore the tax implications of any alternative investments you’re considering for clients. The alts universe is vast, diverse and full of investments drenched with tax issues that can lead to higher tax-prep costs.
Rose, the Encino CPA, says, “One of my clients put $100,000 into an alt investment that ended up having some reportable items in relatively small dollar amounts. But they had to be reported, and that makes the tax return more complicated and more expensive to produce.”
At Moss Adams, Yu has noticed an uptick in U.S.-based hedge funds investing overseas or in other funds that then invest overseas. This can lead to potential disclosure requirements under tax code rules, including those involving passive foreign investment companies. “PFICs are one of those things that should scare people because of the tax-reporting complexity. They are tricky, and the disclosures can be very costly to the client,” Yu says.
The bottom line is that before piling clients into alts, it might be worth factoring tax accounting costs into the projected return. Rose adds that many alt vehicles are partnerships or limited liability companies, many of which don’t send tax-filing information to their investors until summer. That’s something clients who prefer to get their taxes in early need to consider.
