Many experts seem to think the Great Recession is over, or nearly so. This means

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1 License OBTP#15341 Annual Newsletter, Vol. 5 Many experts seem to think the Great Recession is over, or nearly so. This means income is climbing for many people. Many have seen increases in compensation; others have shared in impressive gains in the Metro area real estate market. Rental rates are also on the rise and the stock markets have had a good year and we seem to be moving into 2015 with the markets on the upswing. It should not surprise anyone that higher income means more taxes, but also more opportunities for rebuilding retirement savings and acquiring investment assets. There are areas where the goal of reducing taxes and building wealth coincide and the first part of our 2014 newsletter focuses on these jewels within the Tax Code. We will also take a look at changes for the 2014 filing season with a focus on our potential reporting nemesis the Affordable Care Act. Tax Advantaged Retirement Savings Strategies Many of our clients have had to forego or reduce their annual savings for retirement due to lower incomes. Hopefully, all of our economic health is rising with the tide as we ease out of the recession years and we should take this opportunity to ramp up our savings. There are many tools within our Tax Code that are designed to create savings incentives. These tools work for modest and low income households as well as those with high incomes. pg. 1

2 If you can participate in an employer sponsored 401K plan this is perhaps the best option of all. Not only do you get to deduct your contribution amount from taxable wages, but there is frequently a match from the employer (read free money!). Your very highest retirement savings priority should be to max out your benefit under these plans. Savings using the basic, traditional IRA works great too and is very easy to do. For 2014 and 2015 contribution amounts are $5,500 for those under age 50 and $6,500 for those above. In order to make an IRA contribution you have to have compensation (typically wages or self employment income). Non working spouses can use a working spouse s income to meet this requirement. For the self employed there is a special form of IRA called a SEP which allows you to deduct up to 25% (about 20% effective rate after some complicated adjustments) of your net business income. For self employed people experiencing a high income year there is an Owner 401K available that has perhaps the highest contributions of all the available options. There is an employee piece that maxes out at $17,500 for 2014 and $18,000 for 2015 (23,000 and $24,000 if you are 50 or older) and then there is an added profit share piece that is up to 25% of net business income. There are deadlines for all these retirement savings tools. The traditional IRA account needs to be established and funded by April 15 with no extensions. The SEP IRA can be established and funded up until the timely filing of a return, including extensions. The owner 401K must be established before the end of the year you want to take the deduction for. The employee portion has to be funded by the 15 th business day in January of the following year and the profit share portion is funded before the return is timely filed including extensions. There are other tax advantaged retirement vehicles available, but these are the tools our clients use the most. Tax Benefits of Owning Investment Real Estate Real estate may be a type of investment you are thinking about or, perhaps, already have. This is not a riskfree area as many, many people learned through a recession that was largely driven by massive real estate losses. There are some tax advantages to owning rental property and, who knows, maybe the tide has turned and real estate is back as a good place to invest. It certainly has been for the last few years within our region. Most clients that have invested in real estate have single or multi family rental properties. Some have commercial property and others are invested through REITS or TICs (tenant in common interests). REITS are more like stock investments and the following benefits really do not apply to them. The rest all have in common the basic notion that they are operated like a business with operating expenses paid and deducted, income received and assets depreciated over time. Of course, it is best to actually show a profit from any business activity including rentals, but there is what can be called a sweet spot with rental properties where they generate positive cash flow but a loss for tax purposes (a paper loss if you will). The sweet spot comes from the use of depreciation and the Tax Code fiction that your building will only last 27.5 years (39 years for commercial property). These are the time periods you must use to depreciate your investment in real property. Now, you may have paid cash for your property or you may have borrowed most of the money to pg. 2

3 make the purchase. Either way, you can deduct the entire amount allocated to buildings and related improvements over these time periods. So, what you have as your rental investment advances through the years is a sizeable deduction that is really not paid for during the year in which you take it. Even with repayments of principal under a loan, you are still taking a larger deduction than you are actually paying out in cash during the early years of your purchase. You can use this deduction to shelter that much rental income from tax or, if you meet the rental loss criteria described below, create a negative income amount that is used to offset other types of income. Using rental losses is a tricky business because of our passive activity loss rules. The IRS has understood for many years that wealthy taxpayers could acquire an interest in a business run and managed by others and harvest losses from it. There are endless ways in which this type of investment can be configured so IRS limits the use of this type of loss for any activity in which you do not materially participate, better known as a passive activity. With two important exceptions, rental property investments are deemed passive activities and their losses can only be used to offset other passive activity income, which, by the way, does not include investment income like interest and dividends. Fortunately, the two exceptions apply to many real estate investors. The first exception is for people that focus most of their earning activity on real estate as a business, either buying and selling it, managing it or just owning it as an investment. The second exception allows individuals with incomes below $100,000 to take a loss of up to $25,000 against other types of income. There is a phase out of the loss amounts you can use for incomes between $100,000 and $150,000. Above $150,000 no losses can be used in the year incurred. But all is not lost if you have income above $150,000. If you cannot use a passive loss in the year it is incurred it is suspended and carried forward until you either have other passive income or you dispose of the asset. If you have a year with substantial income from any source there can be significant benefits to liquidating an asset with accumulated passive losses. Real Estate Gains are Back and Section 1031 is Still Here to Help Before the Great Recession we reported many Section 1031 real estate transactions. After about 2008 this reporting basically disappeared. It seems that people are making money buying and selling real estate again in our region and our expectation is that Section 1031 reporting will pick up again. So what is Section 1031 all about? It is all about deferring tax on gains. To use Section 1031 you need to reinvest the gains from the sale of real property into property that is deemed like kind property. There is not a lot of mystery to this in the real estate realm. Pretty much any type of real property configuration on either side of the sale or purchase will work. There are many technical details to a Section 1031 transaction and there used to be an entire sector of the financial industry that serviced these types of transactions with specialized knowledge. As the amount of real estate gains increases there should be a revival among these professionals. If you think you might want pg. 3

4 to use a Section 1031 exchange to change the location, type or size of your real property investment you should begin the process well in advance of your target sale date and let the professionals you are working with know this is your intention. This will give them time to assemble the resources they will need to insure you meet the Section 1031 requirements. Using Carryover Capital Losses If you have carryover capital losses from a prior year or have unrealized losses you want to harvest in the current year you can use these to offset capital gains dollar for dollar. The normal rule requires you only use up to $3,000 in capital losses to offset any type of income. This is a special rule that applies to reduce capital gains and makes faster use of the losses. However, this is not necessarily the most efficient use of the loss as offsetting ordinary income at its higher tax rate saves more money in the long run. But, if you have an asset with lots of gain and a large loss to work with you can match up the two for a one time, current year tax savings. A word of caution here; capital losses carry forward until used, but do not carry back. One of the biggest tax mistakes you can make is incurring a capital gain one year and a capital loss the next. The better strategy is to reverse that order, incurring the loss first and allowing it to carry forward and offset the gain the next year. These are just a few of the tax strategies available to manage increasing income. There is a great deal of detail involved in understanding how these rules might apply to your particular situation so we encourage you to consult your financial and tax adviser if you have questions about them and the benefit they may provide. Tax Highlights for 2014 and Beyond The Affordable Care Act has created quite a stir among tax professionals this season. This is the first year that we must tackle mandatory insurance reporting and there has been a great deal of uncertainty about how this will be done. IRS has allocated significant resources to manage the reporting on their side and at our seminars this fall and winter we have learned the basics about how this reporting will be done. We do not, however, have all the details. IRS has only issued drafts of the forms needed for this reporting as of this writing and for 2014 employers and insurance companies are not required to issue the information forms taxpayers are supposed to receive to complete their reporting. The insurance exchanges will be issuing information Form 1095 A so if you receive one of these please be sure to provide it to us. Our take on this for 2014 is that we will all do the best we can and the reporting will not be perfect, but we will learn from this season and it will get easier and better for future years. Hopefully the IRS sees it this way, too, but you never know with them. pg. 4

5 Here are the major elements of The Affordable Care Act that impact taxpayers and our 2014 reporting. With limited exceptions, all of us were required to have health insurance coverage during all of Taxpayers at the low to middle income levels who purchased insurance through an insurance exchange may be eligible for a credit to help pay for the cost of insurance. This credit may have been paid directly to the insurance company during the year or may be received by the taxpayer after the return is filed. If the credit was paid during the year to the insurance company the credit will be recomputed on the tax return to see if, based upon actual household income, there is an additional credit due or if the taxpayer was overpaid and now needs to return part of the credit as tax on the return. For taxpayers that are not exempt from coverage (there are a variety of exemptions for hardship, religious objection, etc.) and did not have it there will be a penalty computed and paid with the tax return. Our sense is that most clients will have full coverage for the year through their employer or private pay and that the insurance reporting will be fairly routine and easy. For those clients that obtained coverage through the exchanges without a credit the reporting will also be fairly routine and easy. For clients without full coverage for all months of the year and for those that obtained a credit through the exchange there will be a great deal of extra work to do. Clients that fall into these last two categories should assemble their tax information early and provide it to us as soon as possible and let us know in advance that you will have these reporting issues. Please note that the insurance mandate, the available credit, and the penalty provisions apply to all the taxpayers and dependents reported on the tax return, so parents should be thinking about insurance coverage for children. This could be problematic for divorced or separated parents who no longer communicate. Legislation extending some popular tax breaks was enacted in December making them available for 2014 filings, but only for This means we need to have another extender bill for 2015 and beyond. This creates uncertainty about which tax benefits will be available for The 2014 extender bill allows the sales tax deduction for itemizers, the educator above the line deduction for class room expenses and the personal residence exclusion for debt forgiveness income. The $100,000 IRA charitable distribution rules were also reenacted for % bonus depreciation for new business assets was reenacted and the Section 179 limit of $500,000 was also renewed. Our 2015 mileage rates have been published. They are 57.5 cents per mile for business vehicle use, 23 cents for medical miles and moving and 14 cents per mile for the charitable deduction. Employer mandated health insurance starts in 2015 for businesses with 100 or more full time equivalent employees. The threshold is lowered to 50 employees in There is a credit available to certain employers to help pay the cost of mandated employee coverage. pg. 5

6 The penalty assessed against individuals for not having insurance coverage will rise in The basic penalty increases to the greater of $365 per person or 2% of household income. Health insurance plans that reimburse workers for health insurance premiums they pay themselves now violate certain rules that can result in a $100 per day penalty. These penalties apply to pre and after tax plans, so no business should be using this type of health coverage for employees. These rules have also spilled over to impact the many S Corp clients that use the self employed health insurance above the line deduction. This benefit may no longer be available to firms with two or more individuals being reimbursed for health insurance costs. A request for guidance from IRS on this issue is pending. Reimbursement plans with a single participant are not impacted by these rules. For our Oregon filers, the special medical expense subtraction will now only be available for filers at least 63 years old. Also, the personal exemption credit and political contribution credit are now phased out for higher incomes. For our same sex filers the 2014 rules are the same as we used in If you are legally married in any state you must file as married in Oregon and on your federal return. If you have a Registered Domestic Partnership you file separate federal returns and a joint Oregon return. Estate and Inheritance Tax Updates The federal estate tax exemption amount has increased to $5,430,000 for 2015 and the estate tax rate remains at 40%. The gift tax exclusion amount remains at $14,000 per donee. The Oregon exemption amount remains at $1,000,000 and Washington s $2,000,000 exemption amount has also not changed. We once again want to thank all our clients and the individuals, professionals and businesses that continue to support our practice with referrals. We continue to see growth in all areas and greatly appreciate your business. Thank you! We Look Forward to Seeing You in 2015! pg. 6