Even though tax season is getting close to the end, there are still some important tips that accountants and tax preparers can share with their clients by April 15, and beyond.
Greg Rosica, a tax partner at Ernst & Young and a contributing author to the EY Tax Guide 2015, pointed to the impact of the Affordable Care Act and the 3.8 percent Net Investment Income Tax that began to take effect in 2013 for taxpayers over a certain income threshold.
“With the Net Investment Income Tax, people may not have been subject to it in the initial year it came out, and they may be this year,” said Rosica during a visit to the Accounting Today offices last week. “Maybe they didn’t have capital gains last year, and they do this year. For people to understand their situation, identify what kind of life changes you had during the year, whether you had higher income, lower income, you changed jobs, you got married, you got divorced, any of those kinds of things, and what the tax ramifications of that are.”
In general, Rosica is seeing higher tax rates for many of EY’s clients, who are typically high income.
“Overall people are experiencing higher effective rates, between the higher ordinary rates and the Net Investment Income Tax, either on investments and gains of 3.8 percent, or even on their wages of 0.9 percent” with the Additional Medicare Tax. The higher effective rate of 20 percent for capital gains is also adding to the tax bills of many clients.
Rosica urges clients to look at tax-efficient savings and retirement plans.
“I think it’s always important to focus on doing tax-efficient savings, whether you’re investing or saving for the future,” he said. “It can be investing in the right types of investments, taking the appropriate level of risk, but also making sure that you do have a tax overlay on that. And with the higher capital gains rates, the higher ordinary income rates, and the Net Investment Income Tax rates that we have on there, I think it’s as important as ever to focus on that. It doesn’t make sense to convert 20 percent tax rates to 40 percent tax rates if you can avoid it, and that’s what you do when you invest certain ways in IRAs and 401(k)s. You’re bringing everything to the top ordinary tax rate. To the extent you’ve got fixed income outside your deferred plans, meaning in taxable accounts and all capital assets appreciating at long term inside those, you’re getting a negative rate play on that.”
He acknowledged that there is some benefit to tax deferral, however. “You’re obviously getting some tax deferral, and so you have to balance the tax deferral benefit versus the rate conversion that you get. Because every stock that you buy or every mutual fund that you buy inside your retirement plan that appreciates, when you take it out, is going to appreciate at whatever the highest tax bracket is, the highest bracket being close to 40 percent in doing that, versus some of that could be taxed at lower rates,” said Rosica.
“Make sure that you’re looking at not just your asset allocation, but your asset location as you go through and do investments with a tax sense as well,” he added. “Also take advantage of some of those programs that exist like Roth IRAs that offer no tax on them when structured and used properly. Withdrawing from those is at even a better tax rate, which is zero. Make sure that you’re paying attention to those kind of things and doing them early, that families are paying attention to their family members and taking advantage of those. Parents may have kids that are working that aren’t going to put money into their 401(k) or their IRA because they’re just starting out and they want to save their money. Maybe that’s the time that parents can gift the IRA limits to them, $5,500 or so, for them to then take and put aside into retirement savings. You’re helping the kid’s future in that case, not just giving them money on the current basis. That can help parents if they have an estate that they are trying to deal with or want to pass money to the kids. It also gives the money to the kids but doesn’t really give it to them because they’re putting it into a deferred retirement plan.”
Even though Congress only extended the traditional tax extender items for another two weeks until the end of 2014, Rosica still sees some tax planning that can be done.
“Certainly when there are items that have already expired during the year, you’re in hope that they’re going to be extended this year,” he said. “It gives you pause as to whether you’re going to act on those things or not. For 2014, we did get an extension on many of those provisions towards the end of the year. There’s still some time to act on those, but not a whole lot. If you did certain things in 2014 and the provisions passed, you can take advantage of that. An example would be the sales tax. That’s a deduction that’s particularly attractive to people that don’t have a lot of state income or live in a state that doesn’t have an income tax.”
He pointed to the above-the-line deduction of $250 that schoolteachers can take for items they bought for their classrooms.
“I think teachers do such a fabulous job in our schools,” said Rosica. “They probably bought those things regardless of whether they were getting a tax deduction anyway for it, and now they get that, so that’s helpful.”
He also sees benefits in withdrawing money from an IRA to contribute to a charity. “You have the ability to take $100,000 out of an IRA and have it go directly to a charity,” said Rosica. “That one obviously required a little bit of timing to be able to do that, but that’s something that became more important last year, and the year before that as well, once the phase-out of itemized deductions was back in play. Now because you do have itemized deductions and other items being phased out based on income levels, that dollar of income you take from an IRA, and if you turn around and give it away, doesn’t always match up dollar for dollar because of the phase-outs. The dollar you gave away, maybe your deduction is in the 90-cent range or something like that, so you still have some additional tax that you have to pay. With a provision like this that was extended that allowed you to make the contributions directly, it takes the income off your return and it takes the deduction off your return, which is the equivalent of getting a fully efficient tax deduction dollar for dollar.”