August 2014

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To Our Clients and Friends:

Despite recent tax increases, the current federal income tax environment remains relatively favorable by historical standards. This letter presents some tax planning ideas to consider this summer while you have time to think. Some of the ideas may apply to you, some to family members, and others to your business.

2014 Income Tax Rates

The ordinary federal income tax rates for 2014 will be the same as last year: 10%, 15%, 25%, 28%, 33%, 35%, and 39.6%.

For 2014, the top 39.6% rate affects taxpayers with taxable income above $406,750 for singles, $457,600 for married joint-filing couples, $432,200 for heads of households, and $228,800 for married individuals who file separate returns.

Higher-income individuals may also be impacted by the 0.9% Medicare tax and the 3.8% Net Investment Income Tax (NIIT), both of which were enacted initially for the 2013 tax year.

Leverage Standard Deduction by Bunching Deductible Expenditures

Are your 2014 itemized deductions likely to be just under or just over the standard deduction amount? If so, consider the strategy of bunching together expenditures for itemized deduction items every other year, while claiming the standard deduction in the intervening years.

Following this strategy will cut your taxable income by a meaningful amount over the two-year period (this year and next).

Take Advantage of 0% Rate on Investment Income

For 2014 the federal income tax rate on long-term capital gains and qualified dividends is 0%, when those gains and dividends fall within the 10% or 15% federal income tax rate brackets. (If your taxable income, including long-term capital gains and qualified dividends, does not exceed $73,800 for married joint-filing couples or $36,900 for singles).

While your income may be too high, you may have children, grandchildren, or other loved ones who will be in the bottom two brackets. If so, consider giving them some appreciated stock or mutual fund shares that they can then sell and pay 0% tax on the resulting long-term gains.

Time Investment Gains and Losses

As you evaluate investments held in your taxable brokerage firm accounts, consider the tax impact of selling appreciated securities (currently worth more than you paid for them).

For most taxpayers, the federal income tax rate on long-term capital gains is still much lower than the rate on short-term gains. Therefore, it often makes sense to hold appreciated securities for at least a year and a day before selling in order to qualify for the lower long-term gain tax rate.

Biting the bullet and selling some loser securities (currently worth less than you paid for them) before year-end may be a good idea as well. The resulting capital losses will offset capital gains from other sales this year, including short-term gains from securities owned for one year or less.

Consider Deferring Income

It may be beneficial to defer some taxable income from this year into next year, especially if you expect to be in a lower tax bracket in 2015, or affected by unfavorable phase-out rules that reduce or eliminate various tax breaks (child tax credit, education tax credits, and so forth) in 2014.

By deferring income every other year, you may be able to take more advantage of these breaks every other year.

Invest in Tax-free Securities

The most obvious source of tax-free income is tax-exempt securities, either owned outright or through a mutual fund.

Whether these provide a better return than the after-tax return on taxable investments depends on your tax bracket and the market interest rates for tax-exempt investments.

With the additional layer of net investment income taxes on higher income taxpayers, it might be a really good time to compare the return on taxable and tax-exempt investments. In some cases, it may be as simple as transferring assets from a taxable to a tax-exempt fund.

Make Sure You Qualify to Exclude Principal Residence Gain

Gains up to $500,000 on the sale of a principal residence are completely tax-free for married couples who file joint returns. A still-generous $250,000 is the limit for singles and married individuals filing a separate return.

To qualify for this break, you normally must have owned and used the house as your principal residence for a total of at least two years in the five-year period prior to the sale. You'll definitely want to take these rules into consideration if you're planning on selling your home.

Sell Loser Shares and Give Away the Resulting Cash; Give Away Winner Shares

Say you want to make some gifts to favorite relatives and/or favorite charities. You can make gifts in conjunction with an overall revamping of your holdings of stocks and equity mutual fund shares held in taxable brokerage firm accounts.

Read More about how to get the best tax results from your generosity.

Watch out for Alternative Minimum Tax

The alternative minimum tax (AMT) consequences of all tax planning strategies must be considered before actually making any moves. Because the AMT rules are complicated, you may want our assistance.

Consider Selling Rather Than Trading-in Vehicles Used in Business

Although a vehicle's value typically drops fairly rapidly, the tax rules limit the amount of annual depreciation that can be claimed on most cars and light trucks. Thus, when it's time to replace a vehicle used in your business, it's not unusual for its tax basis to be higher than its value.

Selling the vehicle (and taking the deductible loss) may be more beneficial from a tax perspective than accepting the trade-in value.

Retirement Plans

If your business doesn't offer a retirement plan, now might be the time to take the plunge. Current retirement plan rules allow for significant deductible contributions.

Even if your business is only part-time or something you do on the side, contributing to a SEP-IRA or SIMPLE-IRA can enable you to reduce your current tax load while increasing your retirement savings.

Employing Your Children

If you are self-employed, you might want to consider employing your child to work in the business. Doing so has tax benefits in that it shifts income (which is not subject to the Kiddie tax) from you to your child, who normally is in a lower tax bracket or may avoid tax entirely due to the standard deduction.

Don't Overlook Estate Planning

For 2014, the unified Federal gift and estate tax exemption is a historically generous $5.34 million, and the federal estate tax rate is a historically reasonable 40%. (The State of WA's estate tax exemption is currently $2,012,000.)

Even if you already have an estate plan, it may need updating to reflect the current estate and gift tax rules. Additionally, it's a good time to review beneficiary designations on life insurance and retirement accounts.

Conclusion

As we said at the beginning, this letter is intended to help you begin thinking about tax planning matters for the rest of this year. Please don't hesitate to contact us if you want more details, or if you would like to schedule a tax planning strategy session sometime through the end of the year.

Best regards,

Wittenberg CPA, PS
360-426-0230
www.WittenbergCPA.com