Taxpayers should consider a variety of tax planning steps before the end of the year, including evaluating whether to make any $14,000 annual exclusion gifts. The exclusion applies to both gift tax and generation-skipping transfer tax, making it particularly valuable for gifts to grandchildren. This annual exclusion amount does not carry forward to the next year if unused, so taxpayers must make these gifts each year in order to take maximum advantage of the exclusion. Remember that a taxpayer can make exclusion gifts to an unlimited number of individuals and that a taxpayer and his spouse each have their own $14,000 exclusion amount. Gifts can be made directly to college savings accounts and to trusts (but trusts involve some technical rules, so be sure to contact us for assistance).
Taxpayers who have realized capital gain income, particularly short-term capital gain income, should examine their portfolios to determine whether they have any unrealized losses they would like to harvest before the end of the year. Note, however, that a taxpayer who sells a stock at a loss and buys the same stock within 30 days before or after the sale will have that loss disallowed under what is referred to as the “wash sale” rule.
It is also advisable to consider whether tax-deductible items, such as charitable contributions and state income taxes, should be paid before the end of the year. The alternative minimum tax makes this planning complex. Many itemized deductions, including the deduction for state income taxes, are not allowed for purposes of computing the alternative minimum tax. Therefore, a taxpayer who pays the alternative minimum tax should defer these deductions when possible. Other deductions, including the charitable contribution deduction, are allowed against alternative minimum taxable income as well as against regular taxable income and do not need to be deferred.
A taxpayer who makes a charitable contribution during a year in which he pays alternative minimum tax will realize less value than if the contribution had been made during a year in which the alternative minimum tax was avoided. Unfortunately, many taxpayers pay the alternative minimum tax virtually every year and have no choice. This is often the case for taxpayers who reside in states with high income tax rates, such as California and New York. Fortunately, a taxpayer can increase the benefit of the charitable contribution deduction by making a charitable gift of highly appreciated capital assets held long term, such as stocks. These contributions allow the taxpayer to deduct the capital asset’s fair market value without recognizing the unrealized tax gain, and thus receive a form of double benefit. Taxpayers who have stock and want to continue to own it can contribute the stock, then use cash to buy equivalent shares and obtain the higher cost basis. The wash sale rule noted above does not apply in this situation.
Taxpayers with unusually high income this year should evaluate whether it would be beneficial to pay related state income taxes during 2014 rather than waiting until early 2015. Taxpayers sometimes have the opportunity to pay more state income tax before reaching the alternative minimum tax in a high-income year. Additionally, taxpayers may derive a greater benefit from charitable contributions made during high-income years. Of course, careful planning is required because higher income will cause more itemized deductions to be phased out. It is a good idea to review all of these matters with an accounting advisor.