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Year End Tax Planning for 2016

12/15/2016

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By April Mitchell and Andrew McCreary

2016 was another eventful year in the tax world, with plenty of new legislation and the strong possibility of some big changes as a result of our newly elected President.  Considering some simple tax planning ideas could make your income tax filing season much smoother and less stressful.

New Items for 2016

PATH Act – Tax Provisions

In previous years, we spent time at the end of the year trying to accomplish year-end tax planning without knowing if certain tax incentives would be extended and available to us.  Thanks to the PATH Act of 2015, many of the provisions that get extended at the end of each year have been made permanent or extended for several years.  Below are some of the major provisions that were made permanent by the PATH Act that are relevant to tax planning:

  • Section 179 depreciation – expense up to $500,000 of certain assets placed in service in your business in 2016.This amount will be indexed for inflation each year. The bonus depreciation deduction is extended through 2019.
  • State and local sales tax itemized deduction
  • Tax-free IRA distributions to charity after age 70 ½
  • Exclusion of 100% gain on certain small business stock.

PATH Act - New Due Dates

In an effort to try and minimize the difficulties that taxpayers encounter with filing dates relating to pass-through entities, several of the due dates and extended due dates for tax forms have changed.  The new due dates include the following (assuming a December 31st year-end):

PATH Act - New Due Dates

Impact of Election

Donald Trump’s win in the Presidential election combined with the Republicans maintaining control of Congress indicates that significant tax reform is highly likely.  Below are some of the proposals President-elect Trump mentioned during his campaign that could impact individuals in the near future.  House Speaker Paul Ryan has similar proposals with some differences noted below:

  • Compress the seven current tax brackets into three: 12%, 25%, and 33%
  • Increase standard deductions to $30,000 for married couples filing jointly and $15,000 for single filers (which contrasts to the current $12,600 for married couples filing jointly and $6,300 for single filers).Ryan’s plan would double the current amounts.
  • Cap itemized deductions at $200,000 for married couples and $100,000 for single filers.Ryan’s plan would eliminate all itemized deductions except for charitable gifts and mortgage interest.
  • Eliminate the net investment income tax, estate and gift tax, and alternative minimum tax (AMT)
  • Eliminate Head of Household filing status and personal exemptions
  • Repeal the Affordable Care Act

Traditional Tax Planning Items

Even with the uncertainty of what will happen to the tax code in the future there are still plenty of tax planning opportunities that are available to take advantage of at the end of 2016. 

Itemized Deductions

Taxpayers that might lose some of their itemized deductions due to reaching income thresholds should consider bunching itemized deductions.  In many cases, taxpayers can lower their tax burden by accelerating certain itemized deductions they have control over so that they can itemize in the current year and take the standard deduction in the following year, or vice-versa. 

Some things to consider when making decisions regarding itemized deductions at the end of the year are:

  • Paying state tax payments, property tax payments, and donations to charity in the current year or delaying payment to next year
  • Consider gifting appreciated publicly traded securities that have been held long-term.There are two benefits to doing this – you get a deduction for the fair market value of the securities instead of the lower cost basis and you do not have to pay tax on capital gains from the ultimate sale of the appreciated securities.
  • Taxpayers who give heavily, but don’t want the charity to get the donation this year might consider a Donor Advised Fund. These funds allow givers to take deductions for a contribution in one year, and make grants from the fund over time.
  • The effect of the AMT should be calculated when considering whether to accelerate deductions.

Health Savings Accounts

Very few people get to deduct their medical expenses due to the 10% of AGI threshold.  Contributing to a Health Savings Account (or HSA) is a way for you to be able to get an “above the line deduction” for your health care costs without exceeding the AGI threshold above.  Contribution limits for 2016 are $3,350 for an individual, $6,750 for a family, and an additional $1,000 for those 55 or older.  You must have a high deductible health plan to contribute to an HAS.

Required Minimum Distributions

If you are age 70 ½ or older, you will generally have to take Required Minimum Distributions (RMD’s) from your retirement account or face a stiff penalty for not doing so. 

You must take your first required minimum distribution for the year in which you turn age 70½. However, the first payment can be delayed until April 1 of the year following the year in which you turn 70½.  This results in a choice between two tax years in which to take your first RMD.  You can plan to take your first RMD in the tax year that results in the least amount of additional tax.  Be careful if you decide to take your first RMD in the following year, as that will result in two RMD payments to be reported on one year’s tax return.

Rather than using other funds to donate, you may make a tax-free distribution of up to $100,000 directly to a charity from your retirement account after age 70 ½. 

Alternative Minimum Tax

The Alternative Minimum Tax can be easy to trigger.  Below are some situations that could cause an unexpected trigger of the AMT:

  • Large long term capital gains and qualified dividends
  • Taxpayers who exercise incentive stock options and decide to hold the shares
  • Tax-exempt interest earned on private activity bonds
  • Accelerated depreciation adjustments
  • A portion of excluded gain on sale of qualified small business stock
  • Sales tax, property tax, or state tax deduction reported on Schedule A
  • Miscellaneous itemized deductions reported on Schedule A

If you are projected to owe AMT for 2016, you should consider delaying any state income tax payments, property tax payments, and various miscellaneous itemized deductions such as investment advisory fees to 2017.  These deductions do not provide any tax benefit in a year that the AMT is owed.

Net Investment Income Tax

The Net Investment Income Tax (NIIT) is something that you should be aware of if your income is over $250,000 (married filing joint) or $200,000 (single).  The surtax is 3.8% of the lesser of net investment income or the excess of modified adjusted gross income (MAGI) over the above thresholds.  Below are some strategies to help mitigate the NIIT:

  • If you have investment income and your income exceeds the above thresholds, you should consider deferring any additional income to the next year if possible.
  • Increase participation in passive activities to become an active participant.
  • Consider grouping elections that may be available.Grouping activities can help you satisfy material participation rules and therefore exclude some activity from being subject to NIIT.
  • Consider utilizing installment sales to spread out income.
  • Recognize losses to offset earlier gains, but watch out for wash sale rules.

Other Planning Items

Below are a few other strategies that can be utilized in traditional tax planning:

  • Maximize retirement plan contributions
  • Defer or receive bonuses before January
  • Hold or sell appreciated or depreciated securities or other investments to accelerate recognition of capital gains or losses.
  • Accelerate income if possible to utilize losses that have been carried forward
  • Timing of exercising stock options
  • Enter into installment contracts to defer income
  • Consider converting retirement accounts to a Roth account
  • Timing and amounts of retirement distributions and withholding
  • Consider trust distributions to beneficiaries as trusts meet the maximum tax rate at only $12,400 of taxable income.Taxing the income on the beneficiary’s tax return could save a lot in tax.Distributions for 2016 can be made through March 6, 2017.

2016 Tax Rates

The individual income tax rates for 2016 are unchanged and the tax brackets have been slightly adjusted to account for inflation.  This leaves us with a top tax rate of 39.6% on ordinary income, 20% top tax rate on capital gain and qualified dividend income, and 3.8% net investment income tax on investment income.

Estimated Tax Payment Requirements

Make sure that your estimated tax payments are up to date.  Individuals generally are required to make estimated tax payments if they expect to owe tax of $1,000 or more when their return is filed.

The estimated tax payment requirement is to pay the lesser of 90% of the tax shown on your 2016 income tax return or 110% of the tax shown on your 2015 return (100% for taxpayers with less than $150,000 of income).

If your income is primarily salaries and wages, but you also have investment income, you can avoid being underpaid by filing a new Form W-4 with your employer to withhold additional tax to cover the shortfall.  Tax withheld from wages is considered to be withheld evenly throughout the year, so you might be able to pay in any deficiency via a larger withholding towards the end of the year and avoid any penalty on underpayment of estimated tax.

If your income is earned unevenly throughout the year, the annualized method could be an option where you pay tax based on when your income is earned. 

The last estimated tax payment for 2016 is due on January 17, 2017. 

Cash Flow Needs

If cash flow might be an issue, you should work with your tax advisor to estimate how much cash you will need to make the appropriate federal and state tax payments in the near future (January and April 2017) as these amounts can add up quickly.

Gift Tax Issues

Individuals may generally give up to $14,000 per person without generating a gift tax filing requirement.  Any gift over the $14,000 exclusion is reportable for gift tax purposes.  There are a variety of planning strategies available to taxpayers to help mitigate the risk of owing gift taxes.  Some of the best ways to avoid the gift tax are:

  • Consider the timing of a gift.If you are considering making a gift of over $14,000, you might make part of the gift at the end of December and the other part at the beginning of January.
  • If you are making a gift to a child that is married, consider making a gift to their spouse as well.
  • Payments directly to the provider of medical services or tuition fees made directly to a school are additional ways to give without making a taxable gifts.

Conclusion

The tax landscape could be dramatically changing soon under our new President.  Make sure to use the tools available to you while you still can.  Your tax advisors at LBMC can help guide you through your end of year tax planning and determine which steps are right for your specific situation. 

The LBMC Wealth Advisors Team wishes you and your family a very Merry Christmas and a prosperous New Year!

EXECUTIVE SUMMARY:

  • Unprecedented changes to tax legislation are on the horizon due to President-elect Trump and a Republican controlled Congress.
  • There are various new and traditional income tax planning strategies available, depending on your individual circumstance. Your tax advisors can help you determine which strategy is right for you.
  • Don’t forget about year-end gift tax planning.