Year-End Tax Planning: Are You Reactive or Proactive?

Posted On December 29, 2015
by Gene Schindler

When was the last time you gave some real thought to the amount of taxes you pay on an annual basis? I think it is safe to say that we all complain that we pay too much, but exactly how much is too much? What if I told you that there was a way to help control and possibly reduce the amount of tax you had to pay, or at the very least push the tax liability to a future year, and all you had to do was be a little proactive? Your Federal, State, and Local income taxes represent one of the (if not the largest) expenses you pay every year, but it is also one of the few expenses we make active effort to try to manage. We simply just accept the fact that we are going to have to pay tax, and there’s nothing we can do about it.

This simply is not the case. With a little year-end tax planning it is possible to save thousands. Let’s look at the simplest of examples to see how some year-end planning could save a single person, who only earns a W-2 wage could save a substantial amount of tax, and save money for their retirement.

The following examples are for the tax year ending December 31, 2015:  

Taxpayer ‘Jane,’ is single and a resident of the State of Ohio, she is paid $200,000 a year in the form of a salary, and is also due a year-end bonus of $25,000; giving her a total of $225,000 in earned income for the calendar year ending December 31, 2015. Jane has the availability to make contributions to the employer sponsored 401(k) retirement plan, yet has not done so prior to being paid her year-end bonus, but is considering the option; she just doesn’t know if it is worth doing. What would it mean in terms of available cash flow? Are there any tax savings to be had?

With a small investment into a properly prepared year-end tax plan, she could have the information she needs to make an informed decision, and know what to expect come April 15 when she files her 2015 tax returns.

Example 1:

tax-planning-chart-2015-401(k)

If Jane elects to use a portion of her year-end bonus to make the maximum allowed 401(k) contribution for the year, she could save $7,045 in Federal and State taxes, and at the same time save money for her retirement. This is an overly simplified example, but it is one that shows you really do have some control over the amount of taxes you pay during the year if you are being proactive instead of reactive.  

Another key item to be proactive with is your ‘State Income Tax Payments,’ since they are deductible as an itemized deduction if they are paid before the end of the year. By having a detailed tax projection prepared you can calculate the potential tax savings this could have, or because of the  Alternative Minimum Tax (AMT), that there is no benefit at all, and it is better to hold onto your cash and just pay the balance due come April 15th.

Let’s look at another scenario. Using the same facts as given in the Example 1, let’s assume that Jane decides she wants to make a maximum contribution to her 401(k) retirement plan, but now she is wondering if it would make sense to pay her State of Ohio income tax of $8,372 before December 31, 2015. By paying this balance before year end she could take the deduction on her 2015 Schedule A (Itemized Deductions). This deduction may or may not yield an actual tax savings. If Jane is caught in the Alternative Minimum Tax calculation, any potential prepayment savings will be reduced dollar for dollar with an addition of Alternative Minimum Tax.   

Example 2:  

tax-planning-chart-2015-state-tax

Since Jane is not caught in the Alternative Minimum Tax System, the prepayment of her State of Ohio income tax of $8,372, which is due regardless when she pays it, yields her an additional tax savings of $684. Jane was able to save a total of $7,570 in income tax by simply being proactive and investing in a year-end tax projection.

A year-end tax projection is especially useful for any shareholder in an S-Corporation (S-Corp), or Member in a Limited Liability Company (LLC) or Partnership, since these entities are considered ‘Flow-Through’ entities, and do not actually pay income taxes. The actual tax liability of the Company flows through to individual owners, and it is the owner’s responsibility to monitor the entity’s tax position. By having a tax projection prepared, the owner will have the information he or she needs need to make informed decisions regarding available cash flow, the capital needs of the Company, and outstanding tax liabilities.

Thankfully, on Thursday, December 17, 2015, Congress passed the ‘Protecting Americans from Tax Hikes Act of 2015 (PATH)’, extending many of the tax provisions individual taxpayers and business owners have come to rely on, and making other critical provisions permanent fixtures in our complicated tax code.

Two of the most important tax provisions that most small businesses have come to depend on were affected by the Act; one being the Internal Revenue Code (IRC) §179 business asset expensing election, and the other being IRC § 168(k) Bonus Depreciation. For planning purposes, both of these provisions carry the exact same effect and application as they did for the prior year (tax year ending December 31, 2014). The Section 179 expensing limit was restored to the tax year 2014 amount of $500,000 (up from the $25,000 amount it had reverted to when the provision expired), and Bonus Depreciation returns at 50% of the purchase price for acquisition of ‘new’ assets. The good news is that the §179 business asset expensing election was made a permanent provision, and business owners no longer have to wait to see what Congress decides to do at the end of every year, but the Bonus Depreciation was only extended through the end of December 31, 2019.

A few other key provisions that were made permanent and have a direct effect on a large amount of small businesses include:  

  • §41 Credit of Increasing Research Activities;’ commonly referred to as the Research & Experimentation (R&E) Credit.
  • §168 Accelerated Cost Recovery System (ACRS);’Qualified Leasehold, Restaurant, and Retail Improvements’ will continue to be classified as depreciable property over a 15-year period.
  • §1202 Partial Exclusion for Gain from Certain Small Business Stock; the sale of what is considered ‘Qualified Small Business Stock (QSBS)’ will remain to be 100% tax-free.
  • §1375 Tax Imposed on Certain Built-In Gains (BIG); for Corporations that have been in existence and wishes to make an S-Corporation Election, the period during which former ‘C’-Corporation earnings and profits (E&P) would be subject to the Built-In Gains tax will remain at 5-years, not the 10-year period that was previously applicable.

One other provision that was not made permanent, but rather just extended through the 2019 tax year is the Work Opportunity Tax Credit (WOTC):  

  • §51 Amount of Credit; this provision was extended, and starting in tax year 2016 a new class of targeted individuals was added. The new class is referred to as “Qualified Long-Term Unemployment Recipients,” and is aimed at individuals that have been unemployed and receiving unemployment compensation for 27 straight weeks.

To discuss how the ‘Protecting Americans from Tax Hikes Act’ potentially affects your particular tax situation, and to see if a tax projection would help you make proactive and informed decisions, please contact us.