In honor of the end of 2014, here's a look at the Tax Extenders passed by Congress that were in effect for approximately 12 days before they expire at midnight tonight.
Happy New Year from your friends at Knapp, Craig and Rugg, P.A.!
All I Want for Christmas is Another Bulldozer
Last year I wrote a post discussing the tax benefit of buying a piece of equipment by 12/31. As I predicted, the depreciation rules were not extended at the end of 2013, and taxpayers marched into 2014 with no provision for bonus depreciation and only $25,000 of Section 179 available. But, thanks to Congress' call to action with the Tax Extenders bill signed into law December 19th, these great depreciation provisions are back for 2014.
Although it might not be too late to ring the register on a new capital acquisition for 2014 if you both need and have the funds to purchase equipment or other assets, the following information can help determine the impact bonus and Section 179 depreciation will have on your tax situation for 2014.
50% Bonus Depreciation
Bonus depreciation permits a taxpayer to expense 50% of the cost of an asset in the first year, plus normal depreciation on the remaining 50%. Bonus depreciation can only be taken on assets that are new or being used in a new way in the hands of the user. Simply, a new computer is eligible for bonus, but a used delivery truck that is purchased to be used as a delivery truck is not eligible for bonus. Bonus is "automatic", meaning that in order to not take bonus on new assets you must classify the asset as "used" or elect out of bonus, which must be done by class life. Bonus cannot be limited either by income or other factors, and bonus can put the taxpayer into a loss.
Section 179
For 2014, taxpayers can elect to expense 100% of an asset in 2014 using Section 179. Taxpayer's can elect up to $500,000 of Section 179, but this amount is limited by taxable income and also by the amount of purchases eligible for Section 179 made during the year. The asset can be new or used. Section 179 cannot be utilized if the taxpayer does not have a profit, and any elected 179 that is unused is carried forward to future periods. Once a taxpayer has made $2 million worth of eligible purchases, the amount of 179 available is reduced. Unlike bonus depreciation, Section 179 is an election the taxpayer must make.
Special considerations
One of the methods above is not necessarily better than the other, because all taxpayers have different motives. But there are a few things to consider when accelerating depreciation:
- Depreciation taken now cannot be taken later. Taxpayers should consider their 2015 income and capital acquisition budget when determining how much accelerated depreciation to take in 2014.
- Cars are special, especially luxury cars, SUV's or trucks. The amounts of bonus and 179 in some cases are limited.
- Cash flow planning is essential. Utilize credit cards or short-term financing to purchase the asset before 12/31 and pay it off in January or in 2015.
- Don't purchase new equipment simply to avoid taxes. If you were planning to purchase the new equipment then do it before 12/31 to take advantage of the depreciation rules. But remember some deductions do not create a dollar-for-dollar reduction in taxes.
Beware the wash sale rules
December is a popular time for most investors to review their investment portfolio to see how their year turned out. During this process, the investor might be encouraged to sell some of their investments by means of "capital gains harvesting". Capital gains harvesting in simplest terms is the process of selling investments positions with a gain and positions with a loss at the same time in order to generate cash with no tax impact. Investors will then take this cash and reinvest in other investments.
However, due to an intricate tax rule that is becoming more well known, there is a possibility that what the investor reinvests their cash in could result in the loss generated by the initial sale being disallowed. This is known as the "wash sale rule", and states that if an investor sells an investment at a loss and then purchases an identical investment within 30 days before or after the sale (60 days total), then the loss generated on the sale is disallowed and is added to the cost basis of the subsequent purchase.
For example, let's say I own 100 shares of ABC Inc and 100 shares of XYZ inc. In December, my ABC stock has a $100 gain, and my XYZ stock has a $100 loss. I decide to sell them both and generate cash, with a net capital gain of $0. This is great because I now have cash to reinvest and I have no tax impact. Then on January 3 of the following year, I hear on CNBC that XYZ has developed a new product that is going to make them much more profitable, so I go to my investment account and purchase 100 shares of XYZ again. Because I sold XYZ at a loss in December, and then repurchased an identical security within 30 days, my $100 loss generated in December is disallowed for tax purposes, and instead the $100 is added to the cost basis of the shares I purchased in January.
Fortunately, due to new reporting requirements for brokerages, wash sales will be automatically reported on a taxpayer's year-end Form 1099-B. Investors should watch their investment transactions closely during December and January and be aware of any sales that might be subject to the wash sale rule.
Additional information on sales of investments and wash sales can be found here at the IRS website.
Paying your taxes
I remember my very first bank account. At a young age before I was driving, I somehow managed to obtain a job as a child disc jockey on a local kids radio program. I worked 2 hours a week for $5 per hour and my job was to record a series of trivia snippets that were later aired on the radio. After my dad got tired of toting me down to the bank every month to cash a $40 check, he helped me open a bank account. I handed the teller my money, she put it in a drawer and handed me back a checkbook. In order to get money out, I had to go into the bank and make a withdrawal.
My how times have changed. Now, 15 years later, 99% of my expenses are done automatically over the internet and I probably couldn't tell you where my checkbook was without looking for a minute. What's more is that this is common for a fair amount of the population now. So if you're a taxpayer and you owe taxes and you're having a hard time finding your checkbook, what are your options?
With the increasing popularity of electronic filing of tax returns, it seems that the IRS has also become open to the idea of receiving payments electronically as well. Short of mailing in a paper check to pay taxes, the IRS also has other options available to taxpayers.
Taxpayers can use one of a number of approved payment processors to pay their taxes with a debit or credit card. The catch is that there are fees associated with the transaction that vary depending on which processor you choose. For example, Pay1040.com will process your transaction for a flat fee of $2.79 if you use a debit card and 2.35% of the amount if you use a credit card. This is a good option for taxpayers that are willing to pay the fee for the convenience factor and want to earn a couple of extra points on their credit card.
Electronic Federal Tax Payment System (EFTPS)
EFTPS provides a taxpayer with online access to a tax payment account. The taxpayer can attach their EFTPS to a bank account, view previous payments, and schedule future payments. The EFTPS system is free and available to all types of taxpayers. In fact, some businesses are required to use EFTPS. Once a taxpayer signs up for EFTPS, they will receive a confirmation with a PIN in the mail, which they will use when they login. EFTPS is a good option for all businesses, and individuals that make large payments or estimated tax payments. The EFTPS system allows you to schedule future payments, reducing the risk that a taxpayer will forget to make their quarterly tax payments.
Direct Pay is a new option offered by the IRS. Instead of using a card, Direct Pay allows a taxpayer to draft their taxes directly out of their bank account. The process requires the taxpayer to verify their identity and enter bank information, and it has no cost to the taxpayer. This is a good option for individual taxpayers that owe any amount and do not want to go through the EFTPS process. Currently Direct Pay is only available to individual taxpayers, not businesses.
Of course, taxpayers can always use the conventional method to pay their taxes by writing a check.
Going on extension
Including today, there are 22 days left to file a Form 1040 individual tax return. But what about taxpayers that have complex transactions, are still waiting on some information, or simply "ain't got time fo dat"?
Filing an extension is not a bad thing. In fact, depending on the complexity of the taxpayer's transactions and the availability of information, filing an extension might be the best option to avoid filing an inaccurate or incomplete tax return.
What does an extension do?
An individual that needs additional time to file can file Form 4868 by April 15, 2014. Now let's dispel a few myths about extensions:
Do I get in trouble or does my account get flagged if I file an extension?
No, extensions are perfectly legal and do not cause a taxpayer to get extra special attention from the IRS.
Do I have to wait for my extension to get accepted?
No, by filing Form 4868 by April 15, the taxpayer's return is automatically extended for 6 months, making the new due date October 15. However, this is only an extension of time to file, not an extension of time to pay (discussed later).
What is the benefit?
The benefit of an extension is that the taxpayer will have the time needed to file an accurate and complete return. Failing to do so could result in penalties, interest, IRS notices and possible IRS examinations.
Why get an extension?
There are a variety of reasons for taxpayer's to consider getting an extension. The most common is delays in receiving necessary information to prepare the return. Taxpayer's that have significant investment accounts might received "amended" 1099's late in tax season, or even during the summer or later in the year. Taxpayers that have investments in passive activities such as partnerships or S-corporations might not receive their Schedule K-1 until after the filing date. In these cases, the taxpayer will need to file an extension until they have all the information needed to file an accurate return.
Taxpayers that have complex transactions might consider filing an extension in order to verify their calculations are correct. For example, significant sales of assets, inheritance, death, or even moving could be reasons to file an extension.
Another common reason for taxpayer's to file an extension is time, or lack thereof. If a taxpayer prepares their own taxes, they might be too busy to devote the attention necessary to file an accurate return. But if a taxpayer uses a paid preparer and takes their information in during the last week of tax season, be prepared to file an extension.
Paying with an extension
As mentioned above, filing an extension is an automatic extension of time to file, but not an extension of time to pay. If the taxpayer expects to owe taxes on their return, they will need to pay those taxes when filing their Form 4868. The taxpayer must also consider that filing an extension does not exempt them from making quarterly estimated tax payments for the next year, the first one being due on April 15.