As the end of the year approaches, it is a good time to think of tax planning moves that will help lower your tax bill for this year and possibly the next. Factors that compound the planning challenge this year include political and economic uncertainty, and Congress’ all too familiar failure to act on a number of important tax breaks that will expire at the end of 2016.
Change in Filing Deadlines:
Please be aware that there are a number of changes to filing deadlines which go into effect beginning January 1, 2017. While the majority of these changes affect businesses, there are changes that are applicable to individuals and trusts as outlined below:
Trusts: While trust returns are still due on April 15th, the extension deadline will change from September 15th to September 30th. This extension will help those who receive their partnership K-1s on September 15th. While it is a short extension it does give taxpayers a bit more time to include their K-1s and file their returns.
Foreign Bank Account Reports (FBARs): The deadline for filing FBARs is being moved from June 20th to April 15th.
Tax Breaks:
Some of the expiring tax breaks will likely be extended, but perhaps not all of them. As in the past, Congress may not decide the fate of these tax breaks until the very end of 2016 (or later). For individuals, these breaks include: the exclusion of income on the discharge of indebtedness on a principal residence, the treatment of mortgage insurance premiums as deductible qualified residence interest, the 7.5% of adjusted gross income floor beneath medical expense deductions for taxpayers age 65 or older, and the deduction for qualified tuition and related expenses. There is also a host of expiring energy provisions, including the nonbusiness energy property credit, the residential energy property credit, the qualified fuel cell motor vehicle credit, the alternative fuel vehicle refueling property credit, the credit for 2-wheeled plug-in electric vehicles, the new energy efficient homes credit and the hybrid solar lighting system property credit.
Year End Tax Planning Strategies:
Below we have outlined a checklist of additional actions, based on current tax rules, which may help you save tax dollars if you act before year-end.
Realize losses on stock while substantially preserving your investment position. There are several ways this may be done. For example, you can sell the original holding, and then buy back the same securities at least 31 days later. However, it is advisable for us to meet to discuss year-end trades you may consider making.
Postpone income until 2017 and accelerate deductions into 2016 to lower your 2016 tax bill. This strategy may enable you to claim larger deductions, credits and other tax breaks for 2016 that are phased out over varying levels of adjusted gross income (AGI). These include child tax credits, higher education tax credits and deductions for student loan interest. Postponing income is also desirable for those taxpayers who anticipate being in a lower tax bracket next year due to changed financial circumstances.
If you believe a Roth IRA is better than a traditional IRA, and you are eligible to convert a traditional IRA to a Roth IRA, consider converting traditional-IRA money invested in beaten-down stocks (or mutual funds) into a Roth IRA. Keep in mind, however, that such a conversion will increase your AGI for 2016.
If you converted assets in a traditional IRA to a Roth IRA earlier in the year, and the assets in the Roth IRA account declined in value, you could end up paying a higher tax than is necessary if you leave things as is. You may back out of the transaction by re-characterizing the conversion, by transferring the converted amount (plus earnings, or minus losses) from the Roth IRA back to a traditional IRA via a trustee-to-trustee transfer. You can later reconvert to a Roth IRA.
It may be advantageous to try to arrange with your employer to defer, until early 2017, a bonus that may be coming your way.
Consider using a credit card to pay deductible expenses before the end of the year. Doing so will increase your 2016 deductions even if you don’t pay your credit card bill until after the end of the year.
If you expect to owe state and local income taxes when you file your return next year, consider asking your employer to increase withholding of state and local taxes. Or, you may pay estimated tax payments for state and local taxes before year-end to pull the deduction of those taxes into 2016, if you won’t be subject to alternative minimum tax (AMT) in 2016.
Take an eligible rollover distribution from a qualified retirement plan before the end of 2016 if you are facing a penalty for underpayment of estimated tax and having your employer increase your withholding is unavailable or won’t sufficiently address the problem. Income tax will be withheld from the distribution and will be applied toward the taxes owed for 2016. You can then timely roll over the gross amount of the distribution, (i.e., the net amount you received plus the amount of withheld tax), to a traditional IRA. No part of the distribution will be includible in income for 2016, but the withheld tax will be applied pro rata over the full 2016 tax year to reduce previous underpayments of estimated tax.
Estimate the effect of any year-end planning moves on the AMT for 2016, keeping in mind that many tax breaks allowed for purposes of calculating regular taxes are disallowed for AMT purposes. These include the deduction for state and local property taxes on your residence, state income taxes, miscellaneous itemized deductions and personal exemption deductions. Other deductions, such as for medical expenses of a taxpayer who is at least age 65 or whose spouse is at least 65 as of the close of the tax year, are calculated in a more restrictive way for AMT purposes than for regular tax purposes. If you are subject to the AMT for 2016, or suspect you might be, these types of deductions should not be accelerated.
You may be able to save taxes this year and next by applying a bunching strategy to “miscellaneous” itemized deductions, medical expenses and other itemized deductions.
For 2016, the “floor” beneath medical expense deductions for those who are 65 or older is 7.5% of adjusted gross income (AGI). Unless Congress changes the rules, this floor will rise to 10% of AGI next year. Taxpayers age 65 or older who can claim itemized deductions this year, but won’t be able to next year because of the higher floor, should consider accelerating discretionary or elective medical procedures or expenses (e.g., dental implants or expensive eyewear).
You may want to pay contested taxes before the end of the year, so as to be able to deduct them this year while continuing to contest them next year.
You may want to settle an insurance or damage claim in order to maximize your casualty loss deduction this year.
Take required minimum distributions (RMDs) from your IRA or 401(k) plan (or other employer-sponsored retirement plan). RMDs from IRAs must begin by April 1 of the year following the year you reach age 70-½. That start date also applies to company plans, but non-5% company owners who continue working may defer RMDs until April 1 following the year they retire. Failure to take a required withdrawal can result in a penalty of 50% of the amount of the RMD not withdrawn. Although RMDs must begin no later than April 1 following the year in which the IRA owner attains age 70-½, the first distribution calendar year is the year in which the IRA owner attains age 70-½. Thus, if you turn age 70-½ in 2016, you can delay the first required distribution to 2017, but if you do, you will have to take a double distribution in 2017-the amount required for 2016 plus the amount required for 2017.
Increase the amount you set aside for next year in your employer’s health flexible spending account (FSA) if you set aside too little for this year.
If you become eligible in or before December of 2016 to make health savings account (HSA) contributions, you can make a full year’s worth of deductible HSA contributions for 2016.
If you are thinking of installing energy saving improvements to your home, such as certain high-efficiency insulation materials, consider doing so before the close of 2016. You may qualify for a “nonbusiness energy property credit” that won’t be available after this year, unless Congress reinstates it.
Make gifts sheltered by the annual gift tax exclusion before the end of the year and thereby save gift and/or estate taxes. The exclusion applies to gifts of up to $14,000 made in 2016 and 2017 to each of an unlimited number of individuals. You can’t carry over unused exclusions from one year to the next. The transfers also may save family income taxes where income-earning property is given to family members in lower income tax brackets who are not subject to the kiddie tax.
In addition to the items above, higher-income earners have unique concerns to address when mapping out year-end plans. They must be wary of the 3.8% surtax on certain unearned income and the additional 0.9% Medicare (hospital insurance, or HI) tax.
Next Steps:
If you would like to discuss any of these year-end strategies, please contact us at your earliest convenience so that we may advise you on which tax savings moves to make. Once 2016 is over, tax savings that are specific to 2016 may be gone forever.
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