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Year-End Tax Advice for Individuals for 2016

Believe it or not, tax season is just around the corner.  As you prepare to celebrate the holidays, we recommend you consider a few actions that you can take as an individual to save on this year’s taxes come April.

Upcoming Expiring Tax Breaks

A few factors compound the tax planning challenge this year, including political and economic uncertainty, and Congress’s all too familiar failure to act on a number of important tax breaks that will expire at the end of 2016.  Some of these will be extended, but some will not, and as it has in the past Congress may not decide on which to extend until the very end of 2016 (or later).

For individuals, these expiring tax breaks include:

  • 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.

Concerns for Higher-Income Earners

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.  This applies to the lesser of: (1) net investment income, or (2) the excess of modified adjusted gross income over an unindexed threshold amount ($250,000 for joint filers or surviving spouses, $125,000 for a married individual filing a separate return, and $200,000 in any other case).  This could be minimized by deferring net investment income for the balance of the year, or by minimizing modified adjusted gross income, or a mix of both.

Higher-income earners must also be wary of the additional 0.9% Medicare (hospital insurance) tax.  This applies to individuals for whom the sum of their wages received with respect to employment and their self-employment income is in excess of an unindexed threshold amount ($250,000 for joint filers or surviving spouses, $125,000 for a married individual filing a separate return, and $200,000 in any other case).  Employers must withhold the additional Medicare tax from an employee’s wages that exceed $200,000.  If your income will exceed $200,000, and you have multiple sources of income (e.g., from employment as well as self-employment), you may consider asking your employer to withhold the additional Medicare tax to avoid the underpayment of tax penalty.

Other Tax Planning Moves To Make

Regardless of your income level, the following actions could help you save tax dollars if you act before year-end.  We can narrow down which of these actions apply to you or your family, and actions you can take, once we meet to tailor a specific plan.  Take a look at the following list and consider calling and scheduling an appointment with us to discuss the opportunities that could apply to you.

  • Realize losses on stock while substantially preserving your investment position. There are several ways this can be done.  For example, you can sell the original holding, then buy back the same securities at least 31 days later.
  • 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.  These include child tax credits, higher education tax credits, and deductions for student loan interest.  Postponing income also is desirable for those taxpayers who anticipate being in a lower tax bracket next year due to changed financial circumstances.  Note, however, that in some cases it may pay to actually accelerate income into 2016.
  • 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 adjusted gross income 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 wind up paying a higher tax than is necessary if you leave things as is. You can back out of the transaction by recharacterizing the conversion—that is, 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 pay estimated tax payments of 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 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 alternative minimum tax for 2016, keeping in mind that many tax breaks allowed for purposes of calculating regular taxes are disallowed for alternative minimum tax 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 alternative minimum tax purposes than for regular tax purposes.  If you are subject to the alternative minimum tax 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 age 65 or older is 7.5% of adjusted gross income. Unless Congress changes the rules, this floor will rise to 10% of adjusted gross income 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 from your IRA or 401(k) plan (or other employer-sponsored retirement plan). Required minimum distributions from IRAs must begin by April 1 of the year following the year you reach age 70½.  That start date also applies to company plans, but non-5% company owners who continue working may defer required minimum distributions 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 required minimum distribution not withdraw.  Although required minimum distributions must begin no later than April 1 following the year in which the IRA owner attains age 70½, the first distribution calendar year is the year in which the IRA owner attains age 70½.  Thus, if you turn age 70½ 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.  Think twice before delaying 2016 distributions to 2017, as bunching income into 2017 might push you into a higher tax bracket or have a detrimental impact on various income tax deductions that are reduced at higher income levels.  However, it could be beneficial to take both distributions in 2017 if you will be in a substantially lower bracket that year.
  • Increase the amount you set aside for next year in your employer’s health flexible spending account if you set aside too little for this year.
  • If you become eligible in or before December of 2016 to make health savings account contributions, you can make a full year’s worth of deductible health savings account contributions for 2016.
  • If you are thinking of installing energy saving improvements to your home, such as certain high-efficiency insulation materials, do 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.

These are just some of the year-end steps that can be taken to save taxes.  Bauer Gravel Farnham tailors plans to appropriately fit clients’ needs.