GMS SURGENT 2014 YEAR-END TAX SAVING TIPS

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1 GMS SURGENT 2014 YEAR-END TAX SAVING TIPS As the days on the calendar grow short and the holiday season gets into full swing, we at GMS Surgent would like to provide you with some valuable ideas to reduce the income tax bite both right now and in the future. There are many tax-saving steps that can be taken before the end of this year. This letter is designed to create a general awareness of the tax landscape. We encourage you to reach out to us to discuss your own unique situation. FOR INDIVIDUALS Harvesting Capital Losses In plain English, the harvesting of capital losses means selling stocks, bonds and mutual funds that have lost value in order to reduce taxes on capital gains realized from winning investments. Tax-loss harvesting can be an important strategy, especially for high-income investors, because of last year s three tax increases: The highest tax rate on long-term capital gains increased from 15% to 20%; The new 3.8% Medicare surtax for high-income taxpayers pushed the highest effective long-term capital gains tax to 23.8%; and The top tax bracket is 39.6% for ordinary income, nonqualified dividends, and short-term capital gains. With the Medicare surtax, the effective rate can now be as high as 43.4%. If you plan to implement a tax-loss harvesting strategy to offset a portion of your gains, be sure to research your records carefully on any asset you are considering selling. You ll want to be certain about the cost basis (the price you paid to purchase a security plus any additional costs such as broker s fees or commissions) of your investments which determines the extent of your loss before you make your move. Be mindful of the wash sale rule. The wash sale rule can be triggered at any time and so this rule is not limited to year-end planning. However, it more often comes into play when you harvest losses at year end. The rationale behind the wash sale rule is to disallow a current tax loss if you haven t changed your economic position after a sale and repurchase of a security. If you sell securities at a loss and acquire or reacquire substantially identical securities within 30 days before or after the loss (total of 61 days), then this is a wash sale. The result is: Gallagher, McDevitt, Schalleur & Surgent, LLC 237 W. Lancaster Avenue Suite 1000 Devon, PA Tel: Fax:

2 The loss is disallowed currently; The disallowed loss is added to the basis of the reacquired securities, in effect deferring the loss until you sell those securities; and The holding period of the old securities carries over to the holding period of the reacquired securities. Worthless stock is an important consideration at year end. The general rule is that if a stock (or any security) becomes worthless during the year, it is treated as if you sold it for $0 on December 31, resulting in a capital loss. You must be able to prove the security is worthless. Bankruptcy might be such proof, but if the bankruptcy is a reorganization and the company might emerge as a continuing enterprise, then the security is probably not worthless. This rule is not optional. If the security becomes worthless, you must deduct it in the year it first becomes worthless or not at all. This can lead to a dilemma if you have an asset that might be worthless but it s not certain: If you deduct the security as worthless before it actually becomes worthless, the IRS can disallow the loss. The security must be totally worthless to get the write-off. If you wait too long to deduct the security as worthless, the IRS can claim it was first worthless in a prior year. If the statute of limitations for that prior year has expired, it would be too late to go back and amend the prior year s return to claim the loss. Apply Bunching Strategy to Itemized Deductions Bunching itemized deductions (such as miscellaneous itemized, medical expenses and certain other deductions) into one year or another can help utilize these deductions that would otherwise go unused in another year. Medical expenses are deductible as an itemized deduction only to the extent they exceed 10% of adjusted gross income (AGI). If you or your spouse are 65 or older, they are deductible only to the extent they exceed 7.5% of AGI. Miscellaneous itemized deductions are deductible only to the extent they exceed 2% of AGI. Miscellaneous itemized deductions include such items as subscriptions to professional journals, union or professional dues, enrollment and payment for job-related courses, tax preparation fees, certain legal fees and investment fees, etc. If your AGI is lower in one year than another, then these thresholds will also be lower for that year. If you make a deductible expenditure in the year in which your threshold is lower, you may obtain a larger tax deduction. If your expenditures don t exceed the threshold in a given year, then bunching them together in one year might allow you to exceed the threshold.

3 Deferring Year-End Bonuses If possible, arrange with your employer to defer any bonuses until This is a prudent strategy if the overall plan to defer taxable income makes sense based on other considerations such as bunching deductions, alternative minimum tax considerations and future anticipated tax rates. Charitable Gifting A gift to charity is normally deductible as an itemized deduction. However, you might not be able to deduct all of your charitable contributions. There are limitations based upon the type of the asset donated, to whom the asset was donated to, and your AGI. In addition to making contributions via cash or check, you may also make a charitable contribution of stock or other securities. A charitable contribution of appreciated long-term stock generally provides you with a charitable deduction equal to the full fair market value of the stock, and it allows you to avoid the realized capital gains tax you would have incurred if you instead sold the stock and then donated the proceeds to the charity. A charitable contribution of appreciated short-term stock provides you with a deduction equal only to your cost basis in the stock. For this reason it is generally more advisable to make a contribution of appreciated stock that has been held long-term. In the case of a gift of appreciated long-term stock to a private foundation, a deduction for the fair market value is allowed only if the stock is qualified appreciated stock. Generally that means publicly-traded stock. If the amount you contributed to charities this year is more than you can deduct because of the AGI limitations, the excess can be carried forward for up to five years. Make sure the deduction is in 2014 For a gift of cash - You may want to make a year-end charitable gift of money in order to take the deduction in Depending on how you make the gift, there are different rules governing the determination of what year you can take the deduction. If you deliver cash or a check, the charity must receive it by December 31, 2014, in order for you to take the deduction in If you mail a check, it must be postmarked by December 31 or earlier, and it must be received by the charity in the ordinary course of mail deliveries. You can control when you have an envelope postmarked but probably cannot control if/when the envelope will be received, so this isn t the best approach. If you use a credit card, the gift occurs when the charge is made, regardless of when you pay your credit card balance.

4 For a gift of stock - The date on which a gift of securities is completed depends on how the securities are delivered. Securities held by your broker - These are considered transferred on the date the brokerage firm transfers title, a process that normally takes one or two business days. Physical certificates you hold - If you have the physical stock certificate, your gift of those shares to charity is completed on the date you deliver an endorsed certificate to the charity. If you mail the certificate, the securities are considered gifted to the charity on the date of the mailing if they are received by the charity in the ordinary course of mail deliveries. Physical certificates held elsewhere - This would include securities held in a safe deposit box or trust department with your advisor/broker. If the advisor/broker is considered your agent, the transfer will not be considered complete until the date the transfer agent records the transfer, which can take several weeks. Substantiating charitable gifts is extremely important. In recent years, the documentation requirements you need to meet in order to claim a charitable deduction have become more stringent. Generally, for any monetary gift, you must have either a bank record (cancelled check) or a written communication from the donee charity. In addition, if the gift is more than $250, you must obtain a contemporaneous written acknowledgement from the charity containing certain required information. For a gift of property (such as a vehicle or art), certain additional valuation requirements apply. All of this must be in hand before you file your tax return. Contribute to a Retirement Plan One of the most effective ways to defer taxable income is to make a contribution into a retirement plan. How much an individual can contribute to a retirement plan is based upon what type of plan they are contributing to. The following are summaries of the most common retirement vehicles. SEP IRAs and Solo 401(k)s - For the self-employed and small business owners, the amount they can save in a SEP IRA or a Solo 401(k) is $52,000 in That s based on the amount they can contribute as an employer, as a percentage of their salary; the new compensation limit used in the savings calculation is $260,000, up from $255,000. Defined Benefit Plans - The limitation on the annual benefit of a defined benefit plan is $210,000 in (k)s - The $17,500 annual contribution limit for employees who participate in 401(k), 403(b), most 457 plans, and the federal government s Thrift Savings Plan, remains the same for 2014.

5 The 401(k) Catch-Up - The $5,500 catch-up contribution limit for employees age 50 or older in these plans remains the same. Even if you don t turn 50 until Dec. 31, 2014, you can make the additional $5,500 catch-up contribution for the year. IRAs - The $5,500 limit on annual contributions to an Individual Retirement Account remains the same for 2014 as it was in The catch-up contribution limit, which is not subject to inflation adjustments, remains at $1,000. Deductible IRA phase-outs Even if you earn too much to get a deduction for contributing to an IRA, you can still contribute; it s just non-deductible. Back door Roth contributions is a technique utilized by higher income taxpayers in order to avoid the contribution limits for Roth IRAs. This technique involves making a non-deductible contribution to a traditional IRA then "converting" it to a Roth IRA. This is a process which allows you to sidestep the MAGI limit on contributions to a Roth IRA. Once in a Roth IRA, all earnings are tax-free when later distributed. Care should be given to consider ALL IRA balances when planning a Roth IRA conversion. Taxable income may result because any conversion is considered to come from a prorated portion of all IRAs. Annual Exclusions for Personal Gifts For 2014, you can make a gift of up to $14,000 in value to any individual during the year without incurring gift taxes or reducing federal estate or gift tax exemptions. In order to qualify for this exclusion the recipient of the gift must have immediate access and enjoyment. The annual exclusion amount is indexed for inflation, but will remain at $14,000 for For a gift of cash - If you would like to make a gift by check and have it qualify for the $14,000 annual gift tax exclusion for 2014, two requirements must be satisfied: The donee must deposit the check in 2014; and It must clear in the ordinary course of business (which can happen in January). For a gift of stock - The rules for completing a gift of stock to a family member are the same as the rules set out above for a year-end gift of securities to a charity, with one exception. If you mail a properly endorsed stock certificate to a family member, the gift is not completed until received. A gift to a 529 Plans - Paying for a grandchild s college education can be a good way to transfer wealth and may be more appealing than just making gifts to a trust. A 529 college savings plan (a 529 plan ) offers a way to accelerate gifts and frontload a savings program. 529 plans allow you to make five years worth of $14,000 annual exclusion gifts in a single tax year. This is as much as $70,000 from a single donor, or $140,000 from a couple. Thus, contributions between $14,000 and $70,000 made to a 529 plan in one year can be prorated over a five-year period

6 without you incurring gift taxes or reducing your federal estate or gift tax exemption. If you contribute less than the $70,000 maximum, additional contributions can be made in subsequent years without you incurring federal gift taxes or reducing your federal estate or gift tax exemption, up to a prorated level of $14,000 per year. If the account owner dies before the end of the five-year period, a prorated portion of the contribution is included in the taxable estate. Be aware that such planning must be coordinated with all other gifting techniques, which might also affect how much of your $14,000 annual exclusion is available each year. If you make a gift of five years worth of annual exclusion gifts to a 529 plan, no additional annual exclusion gifts can be made to the beneficiary within this five-year period. If you are funding a 529 plan toward the end of 2014 and want to maximize the frontloading of the account, consider contributing only $14,000 ($28,000 for a couple) to the account this year. You could then frontload by contributing $70,000 ($140,000 for a couple) in January This will allow you to contribute a total of $84,000 by January 2015 ($168,000 for a couple). Be aware of the kiddie tax. Year-end planning often involves gifts to children. In general, making a gift of a financial asset to your children will cause them to be subject to income tax on the future earnings on that gift. However, under the kiddie tax, a certain amount of your children s investment income can be taxed at your highest income tax rate. The kiddie tax applies to children under 18 and to 18-year-olds if their earned income doesn t exceed one-half of the amount of their support. It also applies to 19- to 23-year-olds if they are full-time students and their earned income doesn t exceed one-half of the amount of their support. Interestingly, there is no surkiddie tax. That is, although your child s investment income might be taxed at your highest rate for regular income tax purposes, that income will not be taxed at your 3.8% surtax rate. Rather, your child will calculate his/her own surtax, using his/her own threshold of $200,000 for a single taxpayer. Alternative Minimum Tax Planning The alternative minimum tax (AMT) affects taxpayers with large amounts of tax exclusion and deferral preference items. These are tax benefits allowed for certain types of tax exempt interest, deductions for state taxes and accelerated depreciation, as examples. If you are subject to AMT, your marginal federal income tax rate is 26% or 28%, compared with a top marginal tax rate of 39.6% for regular tax purposes. Thus, once you are subject to AMT, it may actually be beneficial to accelerate income while in that tax bracket. Conversely, some deductions (such as charitable contributions and mortgage interest) are more valuable if your income tax rate is 39.6% than if your income tax rate is 28%. Other deductions (such as state income taxes) are not deductible for AMT purposes and therefore are wasted if incurred in a year you are subject to AMT.

7 If you will be paying AMT in 2014 but do not expect to do so in 2015, you might consider accelerating ordinary income into 2014 so that it is taxed at 28% rather than 39.6% or higher. For example, if you are considering exercising nonqualified stock options, exercising a portion in 2014 might reduce taxes overall if that income would be taxed at the marginal AMT rate of 28% in 2014 rather than, say, 39.6% in (You need to be careful not to exercise so many options that it causes you to no longer be subject to AMT.) Also, deferring certain deductions can also be beneficial. For example, it is common to pay estimated state income taxes in December, rather than January, in order to accelerate the deduction. If you are subject to AMT in 2014, state taxes paid in December 2014 will not be deductible and so paying those taxes in December would provide no tax benefit. Consider deferring payment until 2015 if that would provide more of a benefit. If you will not be subject to AMT in 2014 but expect to be in 2015, the suggestions in the previous paragraphs should be reversed consider accelerating deductions into 2014 and deferring income into FOR BUSINESS OWNERS Put Business Equipment in Service and/or Purchase Materials before Year-End If you own a business, think about making needed capital expenditures qualifying for the business property expensing election (the Section 179 expensing election) and/or bonus depreciation before year-end if economically feasible and practical. These types of expenditures provide an immediate deduction against taxable income in the form of accelerated depreciation. Generally, paying for these expenditures with the company s cash or obtaining financing will not limit the deduction. Increase Basis in S Corporation or Partnership This is a very important strategy if you have a business and you anticipate a loss for A shareholder can deduct his pro-rata share of S corporation losses only to the extent of the total of his basis in (a) the S corporation stock, and (b) debt owed him by the S corporation. This determination is made as of the end of the S corporation s tax year in which the loss occurs. Any loss or deduction that can't be used on account of this limitation can be carried forward indefinitely. If the loss exceeds the basis for his S corporation stock and debt, he can still claim the loss in full by lending the S corporation more money or by making a capital contribution by the end of the S corporation's tax year. It is important to note that a personal guarantee will not result in additional basis for an S Corporation shareholder. A partner's share of partnership losses is deductible only to the extent of his partnership basis as of the end of the partnership s tax year in which the loss occurs. The amount of this basis can be increased by a capital contribution, or in some cases by the partnership itself borrowing

8 money or by the partner's taking on a larger share of the partnership's liabilities before the end of the partnership's tax year (such as a personal guarantee of a partnership debt). Dispose of Passive Activities The utilization of passive losses (losses in which the taxpayer does not materially participate in the activity) are based upon the generation of passive income from other sources. One way to deal with passive activity losses may be to sell the activity generating them. If a taxpayer disposes of his entire interest in such an activity in a fully-taxable transaction, then any loss from the activity for the tax year of disposition (including losses carried over from earlier years), over any net income or gain for the tax year from all other passive activities (including carryover losses from earlier years), is treated as a loss that isn't from a passive activity. As such, passive losses can be utilized.