By Benjamin Humphreys,CPA
December 12, 2016
As 2016 is coming to a close and the political winds are changing, tax planning becomes more of an uncertain science. With promised tax law changes indicated by President-Elect Donald Trump, it will be important to analyze how this could impact your possible tax situation. Looking at your tax situation with the tax laws currently scheduled to run through the remaining 2016 calendar year would be a good starting point.
Individuals
Balancing the impact of existing tax rates on a variety of transactions during the year at year-end can be challenging. Federal ordinary tax rates currently have a range of 10%, 15%, 25%, 28%, 33%, 35% to a top tax bracket of 39.6%. The top tax bracket only affects singles with 2016 taxable income above $415,050, married joint-filing couples with income above $466,950, and heads of households with income above $441,000. The proposed tax rates under our current President-Elect calls for rates of 12%, 25%, and 33% for taxable income breaks at $75,000, $75,000 to $225,000, and above $225,000 respectively. These brackets would be halved for single filers.
Net Investment Income Tax (NIIT) is currently an additional 3.8% investment income, including long-term capital gains and dividends. NIIT does not apply unless your modified adjusted income is over $200,000 if you are single, $250,000 if you are married filing joint. The President-Elect is proposing a 100-day plan which includes repealing the Affordable Care Act (Obamacare or ACA). If the repeal is successful, then this tax may be repealed in 2017.
Additional Medicare Tax is currently an additional 0.9% Medicare tax on wages and self-employment income above $200,000 if you are single and above $250,000 if you are married filing joint. This is another provision in the ACA law which could be eliminated in 2017 if the repeal movement is successful.
Long-term capital gains and qualified dividends tax rates are currently 0% for filers in the 10% and 15% income tax brackets, 15% for filers in the 25%-35% income tax bracket, and 20% for those filers in the 39.6% income tax bracket. It is presumed that our current President-Elect would maintain these same Capital Gains Rates, and it is further assumed that the taxable income breaks would be at $75,000, $75,000 to $225,000, and above $225,000 respectively.
Alternative minimum tax (AMT) would be eliminated under the President-Elect’s plan.
The personal exemption for tax year 2016 rises $50 to $4,050, up from the 2015 exemption of $4,000. However, the exemption is subject to a phase-out that begins with adjusted gross incomes of $259,400 ($311,300 for married couples filing jointly). It phases out completely at $381,900 ($433,800 for married couples filing jointly.) The President-Elect’s tax plan would eliminate personal and dependent exemptions in favor of increasing the standard deduction to $30,000. With such an increased standard deduction many tax returns would no longer get benefits for itemized deductions, such as state taxes paid, real estate taxes, mortgage interest deductions, and charitable donations to name a few.
These are not the only changes listed by our current President-Elect’s proposals and some are significant changes and potentially controversial when matched up against the House’s Tax Reform Blueprint. There is no way to tell what will happen in 2017.
Individual Year-End Planning Tips
Based on the information provided above with the included proposed tax law changes desired by the current President-Elect, here are some tax-saving strategies to consider before the end of the year.
1. Exceed the standard deduction allowance – If you are close to itemizing your deductions for 2016, consider making enough additional expenditures (some of which are listed below) to increase your current year deduction. This will lower the 2016 tax bill.
- Making an additional payment on your home and or vacation home will give you 13 months of deductible home mortgage interest amounts in 2016.
- Prepaying state and local income and property taxes can increase your itemized deductions in the current year. Beware, if you are in AMT this will not help your current year tax situation.
- If you have medical costs which are close to exceeding 10% of your Adjusted Gross Income (AGI) or 7.5% of your AGI for those age 65 or over, then it might be prudent to prepay medical expenses if possible.
- Consider paying additional charitable donations.
Note: The standard deduction could be significantly higher in 2017 if tax reform legislation is approved. If you expect the increased standard deduction, then increasing your itemized deduction for 2016 while claiming the more generous standard deduction in 2017 would lower taxes in both years.
2. Prepay tuition bills – If you have someone in college and your 2016 AGI qualifies you for the American Opportunity tax credit ($2,500 maximum credit per eligible student) or the Lifetime Learning tax credit ($2,000 maximum credit per family), consider prepaying tuition bills if it can generate a larger credit on the 2016 tax return. Realize this might affect your education tax credit calculations in 2017.
- American Opportunity tax credit phases out if your Modified Adjusted Gross Income (MAGI) ranges from $80,000 to $90,000 for unmarried individuals and $160,000 to $180,000 for married joint filers.
- Lifetime Learning tax credit phases out if your MAGI ranges from $55,000 to $65,000 for unmarried individuals and $111,000 to $131,000 for married joint filers.
3. Defer income recognition – If you have the option of deferring recognition of taxable income without financial detriment, then this can be a viable way to lower the current year’s tax bill. Realize this could have negative tax impacts on your 2017 tax return if tax rates remain the same.
4. Sell stocks held in taxable accounts if they are at a loss – If investment losses exceed gains for the 2016 tax year you will have a net capital loss for the year. Deductions up to $3,000 of net capital loss, or $1,500 if you are married filing separately, are allowed on the 2016 tax return against ordinary income from salary, self-employment activities, alimony, interest, and other types of income. Any excess net capital loss is carried forward to future years and could help create tax savings in future years.
5. Postpone Roth IRA conversions until next year – If it is expected that tax rates will be lower in 2017, then postponing converting a traditional IRA (or other qualified retirement plan) into a Roth account could be a smart tax-planning move. Conversions create taxable income.
6. Defer Retirement distributions until next year– If you have the option of deferring recognition of retirement distribution, which is taxable income, without financial detriment, then this can be a viable way to lower the current year’s tax bill. If you are 70 ½ or older, Required Minimum Distributions (RMDs) from IRAs could limit your ability to defer distributions without incurring penalties.
7. Donate appreciated stock to charity – If you own appreciated stock or mutual fund shares for over a year, consider donating them to an IRS-approved charity. Assuming you are itemizing deductions, you will generally be allowed to deduct the fair market value of the donation as a deduction while avoiding any capital gains tax hit. Conversely, if you have depreciated stock, consider selling the stock to claim the loss and then donate the proceeds to get the itemized deduction from the cash contribution.
8. Make charitable donations from IRAs – Those that have reached age 70 ½ are allowed to make donations totaling up to $100,000 to IRS-approved charities directly out of their IRAs. This can be good for those needing to meet the RMD requirement. While following this strategy, you wouldn’t be able to claim a charitable donation; beneficially you wouldn’t have to recognize the income. Having to first report the income before making the donation puts other deductions on your tax return at risk of being phased out with a higher adjusted gross income (AGI).
9. Contribute to qualified Retirement plan – Traditional IRA, SEP IRA, SIMPLE IRA, 401(k), 403(b), and 457(b) retirement plans all are types of retirement plans with income deferral benefits.
Businesses
Year-end tax planning strategies used for individuals are similar for business trying to defer income and accelerate deductions. Traditional timing techniques for income and deductions, in addition to the impact of the impending expiring tax provisions should be considered when looking at year-end tax planning strategies.
Currently the President-Elect has made mention of reducing tax rates to 15% on C corporations, pass-through entities such as LLCs and S corporations, and sole proprietors who report income on Schedule C of the IRS Form 1040. These proposed changes differ from the House blueprint, and it will be interesting to see what any final legislation looks like.
Realize that year-end tax planning does not occur in a vacuum. It must take into account each taxpayer’s particular situation and planning goals with the aim of legally minimizing taxes to the greatest extent possible.
Please contact us for a one-on-one consultation to help determine the best tax planning strategy.
Benjamin Humphreys, CPA
“Industry, perseverance, and frugality make fortune yield.” – Benjamin Franklin
The topics in this newsletter are not intended to be used and cannot be used by any taxpayer, for the purpose of avoiding accuracy-related penalties that may be imposed on the taxpayer.
Benjamin Humphreys, CPA 