Tax Planning Considerations for 2015 Most strategies that could have an impact on your taxes need to be made by December 31 if you want them reflected on your 2015 tax return. Executive summary As the end of the year approaches, the time is right to take steps with your tax advisor to manage your tax liability for 2015. If your income has changed significantly in the last year or if you are managing multiple sources of income (investments, rental properties, businesses, etc.), you may want to avoid any unexpected surprises when filing your tax return early next year. Most strategies that could have an impact on your taxes need to be made by December 31 if you want them reflected on your 2015 tax return. No significant changes in the tax code have taken effect in 2015. There are still a number of relatively new provisions that first took effect in 2013 that may have a major impact on your tax planning. These changes caught some taxpayers by surprise when preparing 2013 and/or 2014 returns, and some ended up with higher tax bills than expected. Understanding the important laws that could have the greatest impact on your tax liability is the first step in the planning process. Next, work with your tax advisor to determine what actions you should consider in an effort to minimize your tax liability for 2015. Be sure that you also consider the longer-term ramifications of any decisions you make as you continue your tax planning process. One key benefit of assessing your tax liability now is that it can help ensure that you pay an appropriate amount of tax on a timely basis. In that way, you can reduce the risk of incurring a penalty for underpayment of taxes. This paper provides a summary of important tax laws that may impact you and provides strategies to discuss with your tax advisor to help you plan and make decisions that will impact your 2015 tax return. Understanding tax brackets and your real tax rate A concept gaining increasing importance in today s tax world is the need for tax bracket management. In other words, what steps can be taken to manage income to avoid moving into a higher tax bracket. Investment products and services are: NOT A DEPOSIT NOT FDIC INSURED MAY LOSE VALUE NOT BANK GUARANTEED NOT INSURED BY ANY FEDERAL GOVERNMENT AGENCY [ 1 ] Important disclosures provided on page 7.
The income levels that apply to various tax brackets are listed below. Here are important facts you need to know as you consider these numbers and the impact they might have on you: 1. The income levels listed here apply after all exemptions and deductions are accounted for. Exemptions and deductions reduce taxable income. 2. In 2015, the personal exemption is $4,000 for an individual (or $8,000 per couple for personal exemptions). 3. The standard deduction for 2015 is $6,300 per person (or $12,600 per couple), but if you itemize deductions, then you may be able to reduce your taxable income even further. For example, for a married couple filing a joint return and claiming a standard deduction, the first $20,600 of income earned is, in essence, taxed at a 0 percent rate. The income levels listed under each bracket, in addition to the total of deductions and exemptions, then applies. After accounting for that $20,600 (which in effect is eliminated from taxable income), a married couple would see the first $18,450 of income taxed at the 10 percent rate. The next $56,450 is taxed at the 15 percent rate and so forth. An important distinction to note is that even if your total income level puts you into a certain tax bracket, not all income you earned is taxed at that level. Federal income tax applies on a graduated basis as your income level rises. Therefore, your effective tax rate on all income is lower than the tax bracket you are in based on your total income. 2015 Federal income tax rates Unmarried/individual returns Taxable Income % on Of the Over But not over Tax + excess amount over $0 $9,225 $0 10% $0 9,225 37,450 922.50 15% 9,225 37,450 90,750 5,156.25 25% 37,450 90,750 189,300 18,481.25 28% 90,750 189,300 411,500 46,075.25 33% 189,300 411,500 413,200 119,401.25 35% 411,500 413,200..... 119,996.25 39.6% 413,200 Married/joint returns and surviving spouses Taxable Income % on excess Of the amount over Over But not over Tax + $0 $18,450 $0 10% $0 18,450 74,900 18,450 15% 18,450 74,900 151,200 10,312.50 25% 74,900 151,200 230,450 29,387.50 28% 151,200 230,450 411,500 51,577.50 33% 230,450 411,500 464,850 111,324.00 35% 411,500 464,850..... 129,996.50 39.6% 464,850 Managing income levels to avoid a higher tax bracket in a given tax year is one of the important planning steps individuals should consider as the year comes to a close. This is particularly important for those who may reach the 39.6 percent tax bracket. This rate, affecting the highest income earners, was restored in 2013 and remains the highest tax rate. This is one of the critical income cutoff points that individuals may want to avoid because it results in other complications. Managing income also comes into play in regard to other important income thresholds, including a Medicare surtax, the net investment income tax, higher taxes on qualifying dividends and long-term capital gains, and potential limits on itemized deductions and exemptions. Medicare surtax For those who are working and have earned income, a 0.9 percent Medicare surtax on wages applies for: Single tax filers with earned income above $200,000 Married couples with combined earned income above $250,000 For each $1,000 above those threshold levels, an additional $9 of FICA taxes will apply to all wages that are currently subject to the standard Medicare portion of the FICA tax of 1.45 percent. [ 2 ] Important disclosures provided on page 7.
Net investment income tax Higher-income individuals also need to be prepared for the impact of a 3.8 percent tax on net investment income. This tax applies to a variety of forms of investment income, including: Interest Dividends Capital gains Rental and royalty income Non-qualified annuities Income from businesses involved in trading of financial instruments or commodities Income from businesses that are considered passive activities The 3.8 percent net investment income tax is applied to the lesser of the taxpayer s net investment income or the taxpayer s modified adjusted gross income above: $200,000 for single tax filers $250,000 for married couples filing a joint return This is an issue to consider as part of your investment planning process. For example, if you are subject to the net investment income tax, selling an investment for a capital gain would potentially be subject to both the long-term capital gains tax of 15 percent (or 20 percent for some taxpayers, see below) plus the 3.8 percent net investment income tax. The tax implications of such a sale may affect your decision on the timing of the sale. If the net investment income tax applies, for every $1,000 of gain realized in the sale of an asset, an additional $38 in taxes will be applied above the tax already due on the capital gain. 20 percent tax rate on long-term capital gains and qualifying dividends An important reason individuals and couples want to try to avoid the 39.6 percent tax bracket is that it will have a dramatic impact on taxes applied to investments. The tax rate on long-term capital gains and qualifying dividends (dividends paid to shareholders of stock of domestic firms) is 15 percent for most, but it rises to 20 percent for those in the 39.6 percent tax bracket. In that case, it adds $50 of tax for every $1,000 of capital gains realized or of qualifying dividend income received. Phaseout of itemized deductions and personal exemptions Another threshold level that can have an impact on the ultimate tax bill for 2015 is the one that applies to the phaseout of itemized deductions and exemptions. Individuals may be subject to this phaseout if income levels exceed: $258,250 for single tax filers $309,900 for married couples filing a joint return The specific impact of the phaseout is not simple to calculate. For example, a married couple with income of $310,900, or $1,000 above the threshold level, would see itemized deductions reduced by 3 percent of the income that exceeds the threshold amount, or $30. Likewise, the personal exemption of $4,000 per person is reduced by 2 percent ($80/person) for each $2,500 of income earned above the threshold amounts. Ultimately, personal exemptions are completely phased out for married couples earning more than $432,400 and single tax filers earning more than $380,750. Strategies to defer income If your income will bring you close to threshold amounts for a higher tax bracket or any of the other tax considerations listed above, you may want to consider deferring income (if possible) into 2016. This could result in a notable tax savings. Strategies to defer earned income include: Initiate or increase pre-tax contributions to your employer-sponsored retirement plan such as 401(k) or 403(b). This will reduce your taxable income. Make maximum pre-tax contributions to a Health Savings Account (if you are covered by one), another strategy to reduce taxable income. [ 3 ] Important disclosures provided on page 7.
If you own a business, consider delaying income to yourself before the end of the year, particularly if your company uses a fiscal year that is not related to the calendar year. Find ways to boost deductions that can be claimed on your next tax return, including accelerating mortgage payments into 2015, making other deductible payments before December 31 (such as property tax and state income tax payments) and directing additional contributions to qualified charities before year-end (see below). Keep in mind, however, if you are subject to Alternative Minimum Tax (AMT), deductions such as property taxes and state income taxes paid in 2015 will not reduce your AMT taxable income and tax liability. Strategies to manage investment income include: Managing asset sales in a tax-efficient manner. Carefully coordinating sales of assets to limit capital gains and potentially to harvest capital losses that can be used to offset gains and even offset earned income (see section on tax loss harvesting below) can be a beneficial strategy. Note that before selling any asset, it should make sense from an investment standpoint, not simply as a tax-saving measure. Investing in municipal bonds. Income generated by these bonds is generally exempt from federal income tax and is not subject to the new 3.8 percent tax on net investment income. Again, investors with AMT concerns should be certain to invest in bonds generating income that is not subject to AMT. Income from bonds subject to AMT may increase your AMT tax liability. Harvesting tax losses in your portfolio Using loss positions in your existing portfolio to offset other types of income can be an effective strategy to implement before year-end. Here are key guidelines that may help you in using realized losses for tax purposes: Short-term capital losses (selling assets held for 12 months or less) must first be used to offset short-term capital gains. If there are net short-term losses, they can be used to offset any net long-term capital gains. Long-term capital losses (selling assets held longer than 12 months) are first applied against long-term capital gains, with any excess used to offset short-term capital gains. If additional capital losses have been accrued, they can be used to offset up to $3,000 of ordinary income, with any unused capital losses carried forward for an unlimited number of years during the taxpayer s life. Note that tax losses need to be tracked for each individual of a married couple on a joint tax return. Options for charitable contributions A staple of the closing months of every year is a deluge of requests from charitable organizations to attract donations that can be deducted in the current tax year. Cash donations should be made by December 31, 2015 to claim the charitable deduction in the current year. Specific strategies to consider, to help maximize the impact of your donations beyond direct cash gifts include: Contributing appreciated stock (or certain other investments that have appreciated in value) directly to a qualified charity. If the stock has been held for longer than 12 months, you are allowed to deduct its current value, but are not required to pay capital gains tax on the appreciated value. This is particularly important if you are near threshold levels where higher tax rates might apply to the sale of your asset. Note that if the stock was held 12 months or less, you can only deduct the cost you paid for the stock when you gift it to a charity. Create a donor-advised fund. This is a strategy that allows you to make a large contribution in 2015 (and in later years) while continuing to recommend which charities will receive assets and the timing of those gifts. The donor is eligible to receive a full tax deduction in the year contributions were made to the fund even if they are not immediately disbursed to charities. Establish a family foundation, a non-profit entity designed to make grants to charitable organizations. The full amount of cash or publicly held stock contributed to the foundation in 2015 can be deducted [ 4 ] Important disclosures provided on page 7.
on your 2015 tax return. The foundation is required to distribute at least 5 percent of its assets to qualified charities each year and also must file an annual tax return. Create a charitable remainder trust (CRT) or charitable lead trust (CLT). These are irrevocable trusts that involve splitting interests between yourself and designated charities. With a CRT, assets are transferred to a trust, creating an immediate tax deduction equal to the charity s interest in those assets. For a period of years or until your death, the trust provides for annual payments to you, either fixed or variable. You may also opt for another individual to continue receiving payments for their life upon the expiration of your interest. Upon the expiration of the term or your death, and the death of the succeeding individual if so opted, the remaining assets pass to the charity. In a CLT, the process is reversed. Annual payments, either fixed or variable, are made to the charity for a period of years with the remaining value after that term expired, gets paid from the trust as directed by you to either yourself, your heirs, or other individuals or trusts. The present value equal to the charity s interest in the trust can be deducted from your taxes in the year the CLT is established. The deduction is allowed if the trust is properly structured as a grantor trust (which causes the CLT income to be reported directly on your tax return). Under current law, a tax-saving charitable strategy that was available in previous years is no longer applicable. It allowed individuals over age 70-1/2 to make qualified charitable distributions of up to $100,000 per year directly from their IRA to a qualified public charity. This was a tax-efficient way to manage a required minimum distribution from an IRA. However, the law allowing direct IRA rollover to charities expired at the end of 2014. In the past, this provision has been extended, and that could yet happen for 2015. You and your advisors should remain alert for the possible extension of this charitable provision. Be aware of limits of charitable contributions. Most donations to a public charity cannot exceed 50 percent of the donor s adjusted gross income (AGI). If donating longterm appreciated property to a public charity, donations are limited to 30 percent of AGI based on fair market value of the property. The limits are even more restrictive (30% of AGI for cash donations, 20% for appreciated stock) for donations made to a private foundation, such as a family foundation. Be sure to consult your tax advisor to determine how your own charitable contributions may be affected by these income limits. Tax considerations for business owners Business owners often have more flexibility to manage income in a way that will reduce their current tax liability. If you have an ownership interest in a business, here are several specific steps you should consider before 2015 comes to a close: If the business needs to purchase new equipment, doing so before the end of the year qualifies for an immediate expensing of up to $25,000 of the purchase from taxes. Any additional equipment expense can be depreciated based on tax laws. Your ownership in an S corporation could affect your exposure to the 3.8 percent net investment income tax. If your interest is considered a passive activity, your share of the S corporation s earnings could be subject to the 3.8 percent tax. The same is true of any passively owned partnership or limited liability company (LLC) interest. It may be possible to expand your involvement in such investments to allow the treatment to change from passive to active, thereby avoiding the 3.8 percent tax. Dividends paid from a privately held C corporation can be subject to the 3.8 percent tax just like dividends from publicly traded stock. But the shareholders of privately held C corporations have the ability to elect to not pay out dividends. This may help mitigate the tax liabilities of shareholders. [ 5 ] Important disclosures provided on page 7.
If considering selling a business, one option to limit the tax impact in a given year is to structure the transaction as an installment sale. In this way, the realized gain from the sale is spread out over a number of years to reduce the tax liability and avoid moving into the highest tax brackets and exceeding other income thresholds that will increase your tax liability in a single year. Estate planning considerations Under current law, the individual estate tax exemption is increased each year based on an inflation assumption. In 2015, the first $5.43 million of an individual s estate is exempt from taxes. For a couple, this makes the effective exemption amount $10.86 million. This amount is reduced by any gifts made in excess of the annual gift tax exclusion in a given year. In 2015, individuals can make gifts of up to $14,000 to any other individual with no gift tax consequences. Any gifts in excess of that amount will reduce the lifetime gift and estate tax exemption. It should be noted that federal estate tax laws today may be as favorable as they have been in generations. Yet these laws have been subject to significant change from time to time. This may be an opportune time to implement strategies designed to limit or eliminate estate taxes at the federal level. Keep in mind, estate tax laws at the state level often vary from federal law, so exemption amounts at the state level may be lower. Specific strategies to discuss with your legal advisor include: Grantor retained annuity trusts (GRATs) Virtually any sum can be placed in this type of trust for a set period of time. The principal and a relatively modest assumed rate of interest (set by the IRS) are redirected to you as the grantor in the form of annuity payments over the term of the trust. Any earnings the assets generate above that assumed interest rate can be passed on to beneficiaries free of gift tax, provided you survive the term of the GRAT. If you do not survive the term of the trust, assets in the GRAT are included in the grantor s estate, eliminating any potential gift tax benefit. Assuming you survive the term of the trust, this is a particularly effective strategy to use with an asset that has significant appreciation potential. This is because much of the appreciation can ultimately pass to heirs without gift or estate tax consequences. Intentionally defective grantor trusts (IDGTs) By placing assets in this type of trust, the value of the estate is reduced. However, such a trust is created with a specific flaw you continue to pay income taxes on earnings generated by assets placed in the trust. By doing so, you have, in effect, transferred wealth to the trust without gift tax consequences. This may be a particularly effective tactic with assets that are believed to have significant future appreciation potential. Spousal access trusts The annual gift tax exclusion ($14,000 in 2015) and the lifetime exemption ($5.43 million in 2015) can be combined to fund an irrevocable trust to benefit a spouse. The assets are removed from your estate, but cash flow generated by the gifted assets can benefit your spouse during his or her lifetime. Qualified personal residence trusts (QPRTs) Although you can choose to continue living in your primary or secondary home (rent free) during your lifetime, you can transfer ownership to a QPRT. While the gift is considered taxable (it can count against your lifetime gift and estate tax exemption), the value of the gift is reduced because of the rights you retain to live in the home. The trust can be set to last for a period of years, and if you survive that term, the home can pass to beneficiaries free of gift and estate tax. If you die before the term expires, the property is included in your estate and is subject to tax. [ 6 ] Important disclosures provided on page 7.
Conclusion Proper tax planning before the end of the year can result in significant tax savings. Due to the complexity of tax laws and the fact that they can change from time to time, it is important to review your tax planning strategies on an annual basis. The most appropriate approach needs to be personalized to your specific circumstances and financial objectives. Be sure to consult with your tax and financial advisors and, if necessary, legal advisors, to help determine the strategies suitable for your circumstances. Rely on the professionals at U.S. Bank to work with you and your other advisors to develop a tax plan that complements your primary wealth planning objectives. Contributed by: John Grayson Vice President, Senior Product Manager, Advisory Consulting Services U.S. Bancorp Investments Scott Mahon Managing Director, Wealth Strategy Ascent Private Capital Management of U.S. Bank Dave Rau Vice President, Senior Tax Manager U.S. Bank Wealth Management Trust Tax Services Robert Webster Senior Vice President, National Director of Wealth Planning The Private Client Reserve of U.S. Bank U.S. Bank, U.S. Bancorp Investments and their representatives do not provide tax or legal advice. Each individual s tax and financial situation is unique. You should consult your tax or legal advisor for advice and information concerning your particular situation. This information is not intended to be used as the primary basis of investment decisions. Because of individual client requirements, it should not be construed as advice designed to meet the particular investment needs of any client. For U.S. Bank: Credit products are offered by U.S. Bank National Association. Deposit products are offered by U.S. Bank National Association, Member FDIC. U.S. Bank is not responsible for and does not guarantee the products, services or performance of U.S. Bancorp Investments. For U.S. Bancorp Investments: Investment products and services are available through U.S. Bancorp Investments, the marketing name for U.S. Bancorp Investments, Inc., member FINRA and SIPC, an investment adviser and a brokerage subsidiary of U.S. Bancorp and affiliate of U.S. Bank. This information represents the views of the authors, but not necessarily those of U.S. Bancorp Investments. Such opinions are subject to change without notice. 2015 U.S. Bank N.A. (11/15) [ 7 ] reserve.usbank.com