2016 Tax Issues Review - Things to do before year end

Thanks to the Protecting Americans from Tax Hikes Act (PATH) which passed in 2015, there are several precautions to take when it comes to tax rates, exemptions, and even deductions. Let's look at a few of those opportunities that come with tax planning and the tax issues to review before year-end.

Income Tax Reduction

For 2016, there are a number of new legislation's that impact individuals including the tax rate just shy of 40%, the 20% gains rate, as well as the Medicare tax and net investment income tax. For this reason, there is now a greater incentive to reduce the liability of tax for the year ahead. To start with individuals will need effective tax planning; which includes reporting all income while also calculating credits and deductions. In essence, time your income for lower tax rates. Claim deductions once they to offset that. If you expect to hit a lower tax bracket next year, defer receipts until then. If the opposite is true, it would be beneficial to accelerate income and defer deductions.

Generally speaking, three guidelines impact tax strategies.

• Income should be recognized when at a low tax rate
• Deductions should be recognized when at a high tax rate
• Postpone tax wherever possible

Exclusions

Overall, many items can be excluded from income totals including;

• Employer-paid insurance
• Gifts or inheritances
• Injury compensation
• Withdrawals from particular medical savings accounts
• Business expense reimbursements
• Interest on some bonds and other funds

Social Security

At either 50% or 85% depending on income, some who receive Social Security will see a tax on benefits. This year, those who earn a modified adjusted gross income (MAGI) of over $32,000 will see 50% tax while $44,000 is the minimum for 85% tax. In the brackets mentioned above, this applies to joint filters while single filers change slightly to $25,000 and $34,000 respectively.

If possible, other income can be deferred to avoid tax on Social Security benefits. Additionally, some retirees will have the option of receiving a lump sum or even transferring to an IRA in order to avoid tax. Bonds will generally avoid tax but include it in the calculation of tax on Social Security benefits. Qualified distributions from Roth IRA accounts, however, will not affect Social Security Benefits.

Social Security Changes

In 2016, Social Security benefits reduce for those under 65 years of age by one dollar for every two dollars earned - earnings must be over $15,720. Furthermore, the Bipartisan Budget Act also came into effect this year with two significant changes for couples. Before, those who reached retirement age could suspend benefits while accumulating retirement credits up until the age of 70. However, family members can no longer collect on an individual’s earnings while suspending benefits. In the second change, someone who qualifies for retirement benefits and a spousal benefit could elect a spousal benefit after reaching retirement age. Again, this strategy ended as it used to allow people to grow their retirement benefit until the age of 70. Known as ‘Restricted Application,' this option is only available for those born before 1954.

For those born after January 2, 1954, both retirement and spousal benefits will be applied at the same time and the higher of the two will be paid immediately. With this in mind, it is important to note that widows still have the chance to restrict an application to keep only retirement benefits or switch at a later date.

Postponing Income

To reduce tax this year, postponing income for a lower tax bracket next year is an option. There are a number of ways to accomplish this;

• For self-employed individuals, this is easy because due to the ability to effectively shift and defer billing.
• Arrange with an employer for bonuses to be paid at a later date.
• Make more contributions to retirement plans.
• When selling a property, split the income into installments, spreading out over different years. Coupled with all other income, it could land you in a high tax bracket.
• If you earn interest any interest on bank certificates or T-bills, delay this income until maturity.
• Interest deferral is also available if funds are invested and then shifted to investments.
• Finally, the point of income recognition helps to delay by moving assets to an annuity.

Accelerating Income

On the flip side, one might be attempting to accelerate certain sources of income. Perhaps you already know the next year will be a high tax rate. Again, there are many ways that to achieve this;

• If self-employed, aim to complete all billing before the end of the year. For those who pay tax on a cash basis, the income does not count until received.
• For company owners, pay out dividends early.
• Although Incentive Stock Options see no taxes, they are considered to be a ‘tax preference’ item. That means a possible increase in the Alternative Minimum Tax (AMT). With this in mind, tax liability increases.
• For non-qualified options, alter the timing of income. If exercised currently, taxation will be regular but in some cases, individuals receive restricted stock. However, employee termination is subject to forfeiture. For employees, they may decide to claim the stock as income when received or when they remove the restrictions. For many, this is a tough decision because any tax paid cannot be later reclaimed.

Deductions

When calculating income, there are many deductions to consider, including employment agency fees, casualty losses, charity contributions, home interest deduction, IRA fees, health insurance premiums, and investment safe deposit box charges. However, there are also items that do not fall into this category including attorney’s fee, political campaign expenses, depreciation of property, personal residence properties, and expenses for commuting.

As well as the clear-cut expenses, there are costs to partially claim, such as unreimbursed medical expenses (over 65) and casualty losses. Even after this, the amount involves more calculations. Only consider the amount that exceeds 2% of Adjusted Gross Income (AGI). Regardless of age, all unreimbursed medical expenses will only be deductible should they exceed 10% of AGI. Currently, under 65s receive 10% while over 65s see 7.5%, but give consideration if procedures/appointments see a payment within the current year.

Elderly Care

Additionally, note that those who have a parent within a nursing home can deduct many of their expenses. Also, consider medical insurance here. Depending on age, the allowable deduction varies and is set to increase in 2017. Ultimately, if AGI is higher than $311,300 (JF)/$259,400 (SF), itemized deductions will be phased out. Again, this is set to increase in 2017 and deductions will decrease by around 3% for every dollar that sits above the threshold.

Tax Savings

For others, there is an option to pay the January 2017 mortgage payment early and even property taxes in the same light. For 2016, this can lead to savings for tax. Sometimes, unreimbursed business expenses also enter as a deduction from income; especially as a statutory employee such as a salesperson.

For both 2016 and 2017, the personal and dependency exemption sets just above $4,000, but this is modified slightly if MAGI is above the pre-determined limits. For every $2,500 chunk above the limit, the exemption comes down 2%. Regarding timing deductions, prepare a check and send before the turn of the year as a cash basis taxpayer. Because the year in question is the vital piece of information, a note or promise is not sufficient.

Home Ownership

During 2016, we have seen a year of refinancing thanks to the low-interest rates. On the whole, deductible costs include the points paid by a buyer to buy a property. In addition to this, an owner obtains points after refinancing. If using those for renovations a percentage of this amount is deductible. When an owner pays points through the refinancing process, that allows amortization over the loan’s life. If a second refinance took place, any outstanding points are immediately deductible. Also, any cash received after refinancing (under $100,000) is deductible. Essentially the same as a home equity loan; even if you use the money for personal purchases. If the cash is more than $100,000, the home improvement section will be the only deductible amount.

Regarding interest, include it on a mortgage loan below $1 million. With a holiday home, interest calculations and all rental income are tax-free (if less than 15 days). Don't plan to count maintenance and repairs as deductions if rented for less than 15 days. However, if the property rents for more than 15 days over the course of one year, the expenses will be deductible. As long as the personal use doesn’t exceed 10% of the rental period or two weeks, this is will remain true.

Charitable Contributions

Over the course of a year, charitable donations are very flexible and a great way of reducing tax. As before, the year of the contribution is essential because a promise is not applicable. If you give a gift in the shape of stock or any other type of appreciating property, deduct the full appreciated value for AMT and income tax calculations. Furthermore, avoid capital gains with no purchasing process from one party to the next. To consider charitable contributions, keep printed records including vital information about the charity or a bank record.

After donating property to charity, a deferred gift annuity is an option in return. Most commonly, individual are given annuities at retirement. Therefore, in this scenario, the difference between the gift and the promised annuity is calculated for deductions. In any given year, charitable contributions cannot exceed 50% of AGI but can spread over a period of five years.

For those who are older than 70 and six months, up to $100,000 can be gifted per year with no consequences for tax thanks to the PATH inclusions. While no deduction is officially ‘recognized,' there will also be no income reported. Effectively, this reduces AGI because of its use as a minimum distribution from an IRA account. For Social Security payments, this can also cause them to fall.

Retirement

In this year and the next, $5,500 is the maximum contribution for IRA accounts but over the 50s are allowed an additional $1,000. However, a traditional IRA contribution can be used by those with earned income, but it won’t be a deductible expense. Furthermore, no deduction is allowed for those who have a certain MAGI while participating in their employer’s retirement plan. For SF, $71,000 is the limit while JF can reach $118,000. If the MAGI falls in between a certain bracket in 2016, only a certain percentage will be deductible. If the value falls below the smaller amount, all will be deductible. For taxes in 2016, contributions will continue right up until April 17 next year. Additionally, Roth IRA contributions will have their MAGI ‘phase-out’ where the criteria must be met.

When it comes to various retirement plans, there are certain elective deferral limits in place. Here's the list;

• 401(k), Salary Reduction SEPs, 403(b), and 457(b) - $18,000 ($24,000 for over 50s)
• SIMPLE Plans - $12,500 ($15,500 for over 50s)
• SEP - Lower of $53,000 or 25% of compensation
• Self-Employed - only takes into account net self-employment income

Although there are some extensions, the tax filing date will be the limit for SEP contributions. Whichever is less, 100% of compensation or $53,000, use this as the limit on annual additions. However, there is a limit for consideration, $265,000. Under a defined benefit plan, the limit for the annual benefit will be $210,000. Finally, all solo 401(k) and Keogh plans must be in place by the end of the year, but they can be funded up until the tax return. In 2017, many of these figures will be increasing.

Roth IRA

In 2016, many people attempted to reduce the amount of tax paid by converting to a Roth IRA from a traditional account. When this occurs, it provides valuable analysis but more is still required as to whether the new account will negate taxable earnings. For example, should this be re-characterized to reverse or simply undo the first transaction? For a conversion in 2016, this re-characterization can take place as late as October 2017.

This year, there is no longer a tax on income from retirement received after 1995; all in all, this includes SEPs, IRAs, and many other plans. This year, many retirees moved states where the income tax is low or even non-existent. By doing this, the tax paid will only account for the amount of time in the previous residence. After paying benefit out, only the new state has access to the taxable amount. If done by a custodian to a custodian, there are no limits to the amount of transfers from IRA accounts that can take place. However, only one rollover within 60 days of an initial transaction can occur per year regardless of how many IRAs someone owns.

Business

Normally called an ‘Internal Revenue Code Section 179 deduction, businesses have the option to include depreciation of personal property as deductions during a year; it is important to note that this is not an adjustment or preference for AMT. Instead of using regular depreciation, use a one-time expense deduction. With an investment limit of $2,010,000, the maximum deductibility is $500,000. According to Section 179, bonus depreciation is an option when using depreciation.

Kiddie Tax

For children under 19 years of age with no earned income, anything above $2,100 is taxed at the same rate as their parents’. Furthermore, the tax includes those in full-time education (aged between 19-23), have income that doesn’t exceed half of support, and don’t file a joint tax return.

When looking to reduce the impact of kiddie tax, many people look to make changes to the portfolio. By using long-range options like stocks and Savings Bonds, current earnings reduced. For kiddie tax, 529 plan investments do not include the calculations.

Tax Credits and Adjustments

Nowadays, tax credits exist for adoption, elderly and permanent disability, child and dependent care, earned income, Lifetime Learning, Hope Scholarship, as well as foreign tax credits. In all cases, carefully assess the credit because they offset the amount of tax due. If you had more than one employer in any given period, you might have paid more Social Security tax which pushes it past the maximum compensation base ($118,500). If this occurs, success contributions may result in more tax credits. Not only is the Medicare 1.45% still applicable, those who have a MAGI of more than $200,000 for SF and $250,000 for JF will also see 0.9% tax added on top.

Investments

Perhaps above all else, the 3.8% Net Investment Income (NII) tax is highly valued. That is important for those who meet the requirements. For individuals, changes in the amount in any way for inflation and the threshold is the same as the MAGI seen in the section above. Undistributed net investment income of estates or trust fall into the NII tax bracket. However, certain trusts are free from tax such as grantor trusts and many charitable trusts. Net investment income is one of the following;

• capital gains from selling bonds
• dividends
• capital gains from selling mutual funds
• interest
• capital gains from selling stocks

Net Investment Income Rules

If you sell a principal residence, taxes from the gains on this sale depend on the extent to which the gains surpass the $250,000 for SF and $500,000 for JF amount laid out by the IRC Section 121. Included in this; royalty income, rental income, any business trading commodities or financial instruments, passive activities for businesses, non-qualified annuities. However, certain items do not qualify as NII including tax-exempt interest, Social Security benefits, alimony, self-employment income, and any IRA distributions as well as most other plans.

For a final NII figure calculation, take all deductions from the income seen above. For deductions, these could include any expenses for royalty or rental income, investment interest expenses, brokerage fees, investment advisory, and local income taxes. Although you cannot take from wages, NII does abide by ordinary tax rules.

Capital Assets

If a capital asset sells after owning for over one year, add a 15% tax onto any gains. However, it is a 20% rate for those in the 39.6% band while boasting an income of over $466,950 for JF and $415,050 for SF. For coins, stamps, and other collectibles, a standard 28% capital gains rate applies. Because the date of the asset disposal is part of the holding period, the day after the trade date is the start of the holding period. When the securities finally sell, the holding period ends.

For short-term capital assets (those that held for less than 12 months), losses apply against the gains. If a balance remains, it applies to the same equation in the long-term. If there is still a short-term gain, treat it is as income and tax the normal amount. In 2016, this could be as high as 39.6%. For long-term losses not netted against gains in the long-term, offset this usually by an ordinary income of $3,000 in the year. If some remain, apply in future years.

Business and Inherited Property

For any dividends received from a US business, capital gains rates apply. So do stock dividends received via a mutual fund. For any stock purchased near the ex-dividend date, there will be a holding period. Starting 60 days before this date, you need to hold a stock for 61 days of the 121-day period.

When dealing with an inherited property, deeming the sale as a long-term gain is possible. A lower holding period still means, the person inheriting the property owns the asset for more than twelve months. If someone experiences a capital loss that is higher than all capital gains plus $3,000, they will often choose to sell the capital gain property. If the previous year showed excess capital gains, this year’s capital losses might offset this amount.

Within 30 days of the sale date of security, you cannot take a loss deduction under the wash sale rule (IRC 1091(e)). If a security is a gift, the donor’s original basis will generally apply. If the security sells for a loss, the fair market value on the date of receiving the gift is then the basis. Finally, keep in mind that a zero-coupon bond not held in a tax-deferred account accrues reportable interest.

Alternative Minimum Tax (AMT)

Despite popular belief, this is an entirely separate tax regime and leads to the calculation of taxes for both regular income and AMT. In this scenario, you pay the higher amount of the two. If one holds AMT credits, this offsets future tax burdens. In recent years, calls for the abolition of the AMT are increasing. However, we don't have a solution yet. For 2016 and joint filers, measure the tentative AMT by combining two things;

• 26% of the first $186,300 over the taxable amount.
• Tax the remaining 28% of income.

Over the years, AMT has avoided inflation adjustments, and in 2013, Congress announced a permanent exemption. For SF, the amount of this exemption stands at $53,900 while at $83,000 for MF. Even though they might not take part in activities related to AMT items, some high-income individuals will be subject to AMT. Due to the fact they do not allow Schedule A deductions; this includes deductions on property taxes, state and local taxes, personal exemptions, and more. To calculate AMT income add these to income totals.

Future Planning

If you visit Congress-related material, they have a ‘roadmap’ for all future tax changes. Furthermore, they are currently considering changes to Roth conversions. That may mean no Required Minimum Distribution for those over 70 1/2. In addition to this, an evaluation of the 3.8% surtax on NII is likely to occur. Perhaps more importantly, there could be an introduction of more tax-sensitive mutual funds. In 2016, federal tax exclusion set just under $5.5 million. Any unused amount is ‘portable’ for the surviving spouse when considering estate and gift tax. With this likely to change, this could be a huge bonus for those passing a business down to the next generation. That keeps them from paying huge amounts of taxes. Furthermore, the recipient would see fewer consequences in the long run too - annual gift exclusion is currently $14,000 per person.

Back in 2013, the Supreme Court ruled significantly in the Windsor case about same-sex marriage. With this in mind, the benefits offered to married couples applies to same-sex couples as well. Previously, joint tax returns were not possible for this group. The impact of many financial decisions and including retirement are still unknown. Careful financial planning is necessary moving forward.

With changes in the government, especially the new President, there's no certainty when it comes to tax changes. The next few years are wait and see, but the information we offer here is vital for tax-saving strategies now.

Summary

There you go, a complete review of the current tax issues. You now know how to hold income back or bring it forward to minimize tax over a given period. If you're looking for help, we hope we provided some. However, you should also still contact a tax professional before making any big decisions. Since they can get to know your unique situation and offer personal advice, this is the best option.

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