Americans are living in a multi-dimensional tax world, the way CPA and tax educator Robert Keebler sees it. First, You have the regular rules. Those sneaky phaseouts of itemized deductions and personal exemptions form another dimension, in Keebler’s view. Yet a third consists of what he calls the “super rates” on the highest incomes, 39.6% for ordinary income and 20% for long-term gains and qualified dividends.

Who can deny that the alternative minimum tax is a slice of reality all its own? And don’t overlook the health-care-reform taxes, 0.9% on earned income and 3.8% on net investment income for big earners.

“There are five dimensions to our tax system and whenever a client is considering a transaction, you need to walk around it from each of the five dimensions,” says Keebler, founding principal of Keebler & Associates LLP in Green Bay, Wis. See the “Tax Planning By The Numbers” box for key figures.

Against this polygonal backdrop, year-end tax strategies are now taking shape. Consider how Mike Tedone of Connecticut Wealth Management is helping a client divest a large, low-basis holding. “We’re trying to manage the gains over time by planning around the 3.8% tax and the higher capital gains rate, to not pay those where we can work it,” says Tedone, a CPA/PFS and partner in the Farmington, Conn., financial-planning firm.

You don’t have to be a tax nerd to help clients with year-end planning, although if you aren’t one, encouraging folks to utilize a knowledgeable accountant who’s outfitted with sophisticated, up-to-date tax software is a great idea.

“You can’t ballpark tax estimates anymore. Clients have to sit down with their tax professional and really work through the issues because there can be a lot of savings involved,” says Tedone. Today’s higher tax rates mean planning can save more, while the law’s inscrutable complexity demands a pro’s touch, something you can tell clients who enjoy visiting their CPA’s office as much as their dentist’s.

Has a client ever neglected to tell you something important? Same happens to accountants. That’s another reason to encourage dialogue with the CPA.

Better still, insert yourself into the conversation. Tedone does. This year he’s particularly concerned about the mutual fund distributions his clients will be receiving, given the run-up in the market. “We plan to be very proactive with tax preparers to say, ‘Our mutual client may be having this issue. We’ll let you know as we find out more.’ Advisors who are not tax preparers can do their clients a great service by quarterbacking year-end tax planning,” Tedone says.

Your Projection Is Key
The best year-end planning now takes into account the client’s tax picture over several years, a portrait that is painted from the planner’s forecast of the client’s income. With a realistic earnings projection “you can take a long-term view and focus on bracket management over time,” says Keebler, the Green Bay CPA.

For example, the client may wish to convert a large traditional individual retirement account to a Roth. That would create taxable income—ugh. But a careful projection of the client’s income and tax situation lets you plan to execute, over a period of years, a string of partial Roth conversions, each just the right size to prevent the client’s income from reaching into the next tax bracket.

A good income projection will indicate whether the client is in AMT one year and not the next, or vice versa. “When you have that pattern, there’s a lot of planning you can do,” says CPA Blake Christian, a tax partner at HCVT LLP, in Long Beach, Calif.



The planning opportunities revolve around the significant difference between the top rate under the regular tax system, 39.6%, and the 28% maximum federal AMT rate that applies after the client’s AMT exemption has been fully phased out (i.e., joint filers with AMT income above $484,900, or $328,500 for single individuals).

“With a client who is in AMT this year but will be subject to a higher ordinary rate next year, you generally want to load up on taxable income now and push out most deductions into next year,” Christian says, noting that higher-income clients who retired this year or sold a business or other large asset may fit this profile.

To increase income in an AMT year to take advantage of its comparatively low tax rate, the client might exercise stock options or convert a traditional IRA to a Roth, among other things.

Education is something else advisors can offer. Clients whose itemized deductions are phased out (that is, curtailed) often wonder whether they’ll get any tax break for making charitable gifts. Yes is the answer for the majority, but it depends.

Under what’s called the Pease limitation, a client’s deductions can be phased out in two ways: by having the rare combination of an extraordinarily high income and relatively few deductions, or—as is far more common—by having income above a threshold. In the latter case, additional charitable gifts work out to be fully deductible.

Looking at the calculation at the bottom of the example in “Phaseout Math,” you can see that more income would increase the amount of lost deductions above the $6,000 already phased out. It’s also clear that the amount of charitable contributions has nothing to do with the calculation. So you could tell the hypothetical couple, “If you make more charitable contributions, you are going to get the full tax benefit because your phase-out is based on your income,” Tedone says.

On the subject of charitable gifts, Tedone is telling his clients who are over age 70 and a half to wait to donate until late in the year. He believes Congress could reinstate qualified charitable distributions, a technique allowing older clients to make tax-free distributions from their traditional IRAs to charity. This popular provision expired last year.

 

Saved By AMT
Last year, Christian was working with a client who was in the top ordinary bracket at the time. But he was planning to sell a business in 2014 and Christian’s forecast showed that he’d be in AMT this year.

Accordingly, Christian sought to minimize 2013 taxable income, leaning on such techniques as cost segregation and other liberalized tax depreciation and expensing strategies, even though the accelerated depreciation would be recaptured (included in income) in 2014 upon sale of the business. Why bother pursuing additional deductions that you’ll just have to add back one year later?

“Because in 2013 we took the deductions at 39.6%, but we’ll recapture them this year at 28%,” Christian says. The client will save tens of millions as a result. Christian cautions that advice such as this rests on detailed projections that account for all of the tax code’s moving parts.

Troll For Business Deductions
A shopping spree at the office-equipment store no longer produces major tax savings, you should warn business owners. A mere $25,000 is the largest write-off clients can get for their 2014 equipment buys under the Section 179 expensing election, and the deduction begins to phase out when purchases exceed $200,000. These figures are a fraction of their previous size.

Moreover, bonus depreciation—a handsome deduction for 50% of the cost of new property—ended last year. Of the dozens of expired tax-code provisions Washington could potentially resurrect for 2014, these depreciation goodies may have the best prayer. Nevertheless, Christian has other plans for skinnying-down clients’ business income this year.

A potential deduction for “subnormal” inventory is something he’s already begun discussing with a high-end apparel manufacturer. When styles change, old product can be hard to move. But under Code Section 471, clients can get a deduction for offering to sell inventory below tax cost within 30 days of year’s end, either before or after.

“You can write it down to the price that you offered even if the offer isn’t accepted. For example, if the unit cost on some shirts is $35 and you offer them for $20 to a longtime distributor or retailer, you can generally deduct the $15 difference even if the shirts don’t get sold,” Christian told his client.

Bad debts are also in his sights. “Maybe a customer owes our client $30,000 and it’s 120 days past due. If the client has documented efforts to collect it, looked at the customer’s balance sheet and knows he’s not going to get paid, you can generally write it off on the books and take a deduction in the year you determined it’s uncollectible,” Christian says.

There’s no need to get greedy. The rules for claiming partially worthless bad debts are more liberal than those for writing off an entire debt. “You could just write off $20,000 this year and the balance next year. That’s often easier than arguing with the IRS that none of it would ever be collected. Collectibility should be carefully evaluated near year-end and doubtful collections written off,” Christian says.

Nexus
On the state-tax front, advisors can help by telling business owners they need to let the accountant know when they start doing business in another state. That way the accountant can determine whether nexus has been established—that is, connection to a state that warrants paying business income tax to it and/or collecting sales tax from customers there.

In year-end planning meetings, “we ask clients where they’re doing business and what they’re doing there, such as whether they’re sending people into states to repair equipment that they sold. Those kinds of things trigger nexus, which triggers filing requirements,” says CPA Mike Robbins, tax principal at Rehmann, a financial services, accounting and consulting firm in the Midwest and Florida.

Finally, a note regarding an intriguing case clients might’ve heard about. In Miller v. Commissioner, the U.S. Tax Court allowed a home-office deduction to a Big Apple taxpayer who failed to use the office space exclusively for business as the law requires. Passing through it to access her studio apartment’s sleeping quarters, along with some occasional personal clerical use, was ruled de minimis and insufficient to deny the deduction.

But don’t get too excited. The decision came in a Tax Court summary opinion (2014-74), which other taxpayers may not rely on as precedent.