Over the last several years, a whirlwind of tax changes has brought a number of implications for taxpayers. The American Taxpayer Relief Act (ATRA) and the Affordable Care Act (ACA) resulted in higher taxes for some individuals. On the bright side, these acts also made many tax laws permanent, providing some level of income tax stability for 2014 and 2015.

Nevertheless, there are more tax changes in the near-term with broad ramifications, from how individuals pay for health care to how much they can deduct for college costs. In addition, a tax reform proposal currently on the table in Congress promises even greater change, especially for high wage earners. Although major reform is doubtful over the next several years, it is important that we keep an eye on and plan for potential changes.

Considerations for 2014 Tax rates and brackets are unchangedIn 2014, all major personal income tax schedules remain in place with most indexed for inflation. The seven-tier income tax bracket structure also remains in place. Those in the higher tax brackets may be subject to the 3.8% tax on net investment income, the 0.9% Medicare tax on earned income, and a 20% long-term capital gains tax rate.

TAXABLE INCOME BRACKETS AND RATES*

Rate Single Married filing jointly

Head of household

10% $0 – $9,075 $0 – $18,150 $0 – $12,950

15% $9,076 – $36,900 $18,151 – $73,800 $12,951 – $49,400

25% $36,901 – $89,350 $73,801 – $148,850 $49,401 – $127,550

28% $89,351 – $186,350 $148,851 – $226,850 $127,551 – $206,600

33% $186,351 – $405,100 $226,851 – $405,100 $206,601 – $405,100

35% $405,101 – $406,750 $405,101 – $457,600 $405,101 – $432,200

39.6% $406,751+ $457,601+ $432,201+

STANDARD DEDUCTION AND PERSONAL EXEMPTION*

Filing Status Deduction

Single $6,200

Married filing jointly $12,400

Head of household $9,100

Personal exemption (per person) $3,950

“...there are more tax changes in the near term with broad ramifications, from how individuals pay for health care to how much they can deduct for college costs.”

* Source: Internal Revenue Service

Year-End Tax PlanningImplications for 2014 and Beyond

F I N A N C I A L P L A N N I N G U P D A T E

BMO PRIVATE BANK www.bmoprivatebank.com By Carl Hibben, CFP®, BMO Private Bank

Limitations will affect high wage earnersIn addition, higher income taxpayers will continue to see increased taxes due to the personal exemption phase-out (PEP) and the so-called Pease limitations (Pease, named after former Senator Donald Pease). PEP phases out the personal exemption, and Pease limitations reduce itemized deductions once a taxpayer’s adjusted gross income (AGI) reaches a certain point.

If your taxable income is close to the thresholds shown in the tables, it is important to review your tax situation before year end. Proper planning to defer or reduce your taxable income may provide substantial tax savings.

PERSONAL EXEMPTION PHASE-OUT*

Filing Status Phase-out Begins Phase-out Complete

Single $254,200 $376,700

Married filing jointly $305,050 $427,550

Head of household $279,650 $402,150

PEASE LIMITATIONS ON ITEMIZED DEDUCTIONS*

Filing Status Income Threshold

Single $254,200

Married filing jointly $305,050

Head of household $279,650

* Source: Internal Revenue Service

The ACA will continue to impact many AmericansThe following are a few of the implications:

• Individualsearningmorethan$200,000orcouplesearningmorethan$250,000havefeltthefirstfinancialeffectsofthisact—the3.8%taxonnetinvestmentincome.

• Individualswhohavewagesandself-employmentincomeexceeding$200,000peryear,or$250,000forcouples,havetopayanadditional0.9%Medicaretaxontheirearnedincome.

• Thoseunderage65withsignificantmedicalcostsarealsoaffected,asthethresholdforclaiminganitemizeddeductionformedicalexpenseshasrisenfrom7.5%to10%ofAGI.

• AllU.S.citizensandlegalresidentsmustmaintainandprovideproofofhealthinsurancecoverageorpayapenaltyfornon-compliance.Beginningin2015,ifyouoryourdependentsfailtoprovideproofofminimumessentialcoverage,theIRSwillimposeataxpenalty.Familiesandindividualswithmoderateincomemayqualifyforassistancewiththeirhealthcarepremiums.

Certain provisions that have expired could be extended againWe have become accustomed to Congress kicking the tax can down the road. Last year was no exception. The tax code has dozens of temporary tax provisions that were last extended in 2012. In fact, it has become customary for Congress to continue these so-called “tax extenders” for one to two years at a time rather than letting the provisions expire as scheduled.

Here’s a list of a few individual tax extenders that expired at the end of 2013 and will not be available in 2014 unless Congress extends them again:

• Qualifiedcharitabledistribution(QCD)provisions:tax-freedistributionsofupto$100,000fromanindividualretirementaccountpaiddirectlytoaqualifiedcharitybyindividualswhohavereachedage70½

• Above-the-linedeductionsforcertainelementaryandsecondaryschoolteacherexpenses

• Above-the-linedeductionsforqualifiedtuitionandrelatedexpenses

• Deductionsforstateandlocalsalestaxes

• Premiumsformortgageinsurancedeductibleasqualifiedinterest

We have become accustomed to Congress kicking the tax can down the road. This year is no exception.

A look at future tax reform In February 2014, House Ways and Means Chairman Dave Camp (R-MI) released the Tax Relief Act of 2014 discussion draft. This proposal was considered dead upon arrival because of the divided Congress. However, it will likely become the foundation for significant future tax reform. Most lawmakers — both Republicans and Democrats — consider the draft a starting point for further debate.

In its current state, the act would significantly overhaul the income tax system. It would not only reduce the number of tax brackets from seven to three (10%, 25% and 35%) but also eliminate or modify a number of tax credits, deductions and other provisions. We touch on a few of the changes below:

Mortgage deductionThe proposal reduces the principal cap for the home mortgage interest deduction on new mortgages from $1 million to $500,000 over four years (for debt after 2014). As a result, buyers of high-value homes would have less of a tax incentive to take out a large mortgage.

Residential gain exclusionThe proposal changes the $500,000 gain exclusion for couples on the sale of a principal residence ($250,000 for single filers) by increasing the holding period to 5 of the prior 8 years (rather than 2 of 5 years), permitting use of the exclusion only once every 5 years (instead of every 2 years), and phasing out the exclusion for couples with income over $500,000 ($250,000 for single filers).

Long-term capital gains and dividendsTaxpayers would pay ordinary income tax rates on capital gains and qualified dividends. However, they would be able to deduct 40% of their capital gains and qualified dividends directly from their taxable income. If adopted as proposed, this provision would slightly increase taxes for those in higher tax brackets.

Charitable deductionsThe proposal extends the deadline for making tax-deductible charitable contributions for a given tax year to April 15 of the following year. It also simplifies income limits on deductibility (40% of AGI for all gifts except to private foundations), but stipulates that taxpayers can only deduct charitable contributions exceeding 2% of AGI. While the proposal gives the charitably inclined taxpayers greater control to make opportunistic contributions up until April 15, it also sets a much higher bar on deductibility.

Retirement plansHigher income earners would finally be able to contribute directly to Roth IRAs but, along with all taxpayers, they would face a lower limit on pre-tax contributions to their employer retirement plans. The proposal clearly looks to expand the use of Roth accounts in both individual retirement accounts and employer-sponsored plans.

• ForIRAs,theacteliminatestheincomelimitsoncontributionstoRothIRAsandprohibitsfuturecontributionstotraditionalIRAs.

• Foremployer-sponsoredplans,theproposalcutsinhalfthemaximumpre-taxcontributionthatemployeescanmake(currentlylimitedto$17,500)andfreezesallcontributionlimitsuntil2024.Employeescouldcontributeadditionalamounts,butonlytoRothaccounts.Theproposalalsogenerallyrequiresemployerswithmorethan100employeestoofferaRothaccount.

• Theproposallargelyeliminatesthestretch-outofretirementplans(Rothortraditional)afterthedeathoftheemployeeoraccountownerbyrequiringfulldistributionoftheretirementaccountwithin5yearsofdeathunlessthebeneficiaryisaspouse,achildunderage22,oranindividualwhoiseitherdisabled,chronicallyillornotmorethan10yearsyoungerthantheemployeeorowner.

While it’s impossible to predict the direction of future tax reform or how tax changes will influence each individual’s situation, it is possible to plan for tax uncertainty.

Certified Financial Planner Board of Standards Inc. owns the certification marks CFP®, CERTIFIED FINANCIAL PLANNER™ and CFP® in the U.S.BMO Private Bank is a brand name used in the United States by BMO Harris Bank N.A. Member FDIC. Not all products and services are available in every state and/or location.This information is not intended to be tax or legal advice. This information cannot be used by any taxpayer for the purpose of avoiding tax penalties that may be imposed on the taxpayer. This information is being used to support the promotion or marketing of the planning strategies discussed herein. BMO Harris Bank N.A. and its affiliates do not provide legal or tax advice to clients. You should review your particular circumstances with your independent legal and tax advisors.

November 2014

Planning for tax uncertaintyWhile it’s impossible to predict the direction of future tax reform or how tax changes will influence each individual’s situation, it is possible to plan for tax uncertainty. For example, many investors devote considerable time to asset diversification but fewer have given much thought to tax diversification. A solid financial plan should include various tax buckets:

• Traditionalpre-taxretirementaccounts,suchasIRAs,401(k)plansanddeferredcompensationplans,provideataxdeductionatthetimeofcontributionbutaccountownerspayordinaryincometaxondistributions.

• RothIRAsandRoth401(k)plansprovidenotaxbenefitatthetimeofcontributionbuttheyallowforfederallytax-freedistributionsduringretirement.(Taxesmaystillapplyatthestateandlocallevel.)

• Taxableinvestmentsarenotshelteredfromtax,butlong-termcapitalgainsonstocksandqualifieddividendsgetpreferentialtaxtreatmentunderthecurrenttaxlaws(15%formost).Anallocationtomunicipalbondscanalsobeusedtoprovidefederallytax-freeinterest.

A strategy that uses all three tax buckets gives taxpayers income options and allows them to adjust distributions during retirement after considering current tax laws and other less-flexible income sources, such as pensions or annuities. In short, the three-bucket strategy provides individuals with flexibility to control their effective tax rate.

No one can predict how tax laws will change over the next five years, let alone over 30 or 40 years. Planning for tax uncertainty can offer taxpayers flexibility to control income taxes and provide long-term tax savings. In 2014, as in years past, it is important to meet with your tax advisor and other professionals to assure you have a tax-smart strategy in place.

CarlHibbenspecializesinproviding

customizedfinancialplanning

solutionstohighnetworthindividuals

andfamiliesaspartofanoverall

personalwealthmanagement

strategy.Hejoinedtheorganization

in2010,andhasover11yearsofexperienceinthe

financialindustry.

CarlearnedhisB.S.inFinancialPlanningfrom

PurdueUniversity.HeiscurrentlypursuinghisMaster

ofScienceinWealthManagementfromDePaul

University–Chicago,IL.HeisaCERTIFIED

FINANCIALPLANNER™.

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