2016 Year End Tax Planning
As the end of the year approaches, it is a good time to think of 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’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 expiring tax breaks will likely be extended, but perhaps not all. 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 new energy efficient homes credit, and the hybrid solar lighting system property credit.
In addition to the above tax law changes there are some additional changes to the due dates for many of the tax returns and information returns. Below is a chart of the new due dates for the various tax forms.
||New Due Date
||New Extended Due Date
|Partnership (Form 1065)||March 15||September 15|
|S Corporation (Form 1120S)||March 15||September 15|
|C Corporation (Form 1120)||April 15||September 15|
|Trust and Estate (Form 1041)||April 15||September 30|
|Individual (Form 1040)||April 15||October 15|
|FinCEN||April 15||October 15|
In addition, the government copies of Forms W-2 and 1099-MISC, which were previously due February 28 (or March 31 if filed electronically), must now be filed by January 31. As in prior years, copies must still be provided to employees and payees by January 31.
We have compiled a checklist of additional actions based on current tax rules that may help you save tax dollars if acted upon before year-end. Not all actions may apply in your particular situation, but you (or a family member) will likely benefit from a number of them. As always, we are available to help you narrow down specific action steps to reduce your tax liability.
While this tax planning letter focuses on tax moves you can make based on current tax law as well as anticipated changes, you may also want to take into consideration potential tax policy changes as result of the presidential election. See our post-election Tax Advisor sent November 11.
Year-End Tax Planning Moves for Individuals
Lessen the impact of the 3.8% surtax on net investment income. 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. As year-end nears, taxpayers should consider ways to minimize the 3.8% surtax by reducing their Modified Adjusted Gross Income, their Net Investment Income, or both.
Harvest Capital Losses. Realize losses on stock while substantially preserving your investment position. There are several ways this can be done. For example, the original holding can be sold, then buy back the same securities at least 31 days later. It may be advisable for us to meet to discuss year-end trades you should 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. Note that in some cases, it may pay to accelerate income into 2016. For example, this may be the case when a person’s marginal tax rate is much lower this year than it will be next year, or where lower income in 2017 will result in a higher 2017 tax credit for an individual who plans to purchase health insurance on a health exchange and is eligible for a premium assistance credit.
Consider a Roth IRA. Roth IRA contributions are a good way to put money away for retirement however, there is not a current year tax deduction when you put money into the Roth. The good news is that when you do take money out of the Roth, it comes out tax free, including all the earnings. Due to the income limitations on putting money into a Roth many people are excluded. One way around this is to do a Roth conversion which converts money from your traditional IRA to a Roth IRA. The money you convert is subject to taxation in the year of conversion, but it will grow tax free and will not be taxable when you withdraw the money for retirement as long as it is a qualified distribution.
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. But you have the options to back out of the transaction by re-characterizing 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. This would need to be completed by the due date of your tax return including extensions. You can later convert back to a Roth IRA.
Defer compensation. 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.
Pay state income taxes before year-end. 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. Be sure to measure any alternative minimum tax implications of accelerating state and local tax deductions before exercising this planning strategy.
Consider a qualified plan rollover to help avoid estimated tax penalties. 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 can be withheld from the distribution and be applied toward the taxes owed for 2016. You can then timely roll over the gross amount of the distribution (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.
Watch out for the alternative minimum tax (AMT). Estimate the effect of any year-end planning moves on your AMT for 2016, keeping in mind that many tax breaks allowed for the 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. If you are subject to the AMT for 2016 or suspect you might be, these types of deductions should not be accelerated.
Bunch expenses. You may be able to save taxes both this year and next by applying a bunching strategy to “miscellaneous” itemized deductions, medical expenses and other itemized deductions.
Consider accelerating elective medical expenses. For 2016, the “floor” beneath medical expense deductions for those age 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).
Don’t forget to take your required minimum distributions (RMDs) from your retirement accounts. These include your IRA, 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. 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 reaches age 70 ½, the first distribution calendar year is the year in which the IRA owner reaches age 70 ½. So if you turn age 70 ½ in 2016, you can delay the first required distribution to 2017. But in doing so, you will then 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 level. However, it could be beneficial to take both distributions in 2017 if you will be in a substantially lower bracket that year.
Flexible Spending Accounts (FSA). Increase the amount you set aside for next year in your employer’s FSA if you set aside too little for this year.
Health Savings Accounts (HSA). If you become eligible in or before December 2016 to make HSA contributions, you can make a full year’s worth of deductible HSA contributions for 2016.
Residential energy improvements. 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.
Take advantage of the annual gift tax exclusion. 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 might also 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.
Year-End Tax-Planning Moves for Businesses & Business Owners
Maximize tax breaks for purchasing equipment and software. If you’re planning to purchase any property such as computers, software, equipment, furniture, or make certain property improvements, consider doing so before year-end to take advantage of generous depreciation rules for 2016.
- You may make a “Section 179 election” which allows you to expense (i.e. deduct) otherwise depreciable property if placed in service in 2016. You may elect to expense up to $500,000 of equipment costs (with a phase-out for purchases in excess of $2.01 million) and the deduction is subject to a business income limitation. If the cost of your §179 property placed in service during 2016 is $2.51 million or more, you cannot take a §179 deduction.
- Above and beyond the §179 deduction, your business can also claim first-year bonus depreciation equal to 50% of the cost of most new (not used) equipment and software placed in service before year-end. In years going forward, the bonus depreciation percentage is scheduled to be phased down. The applicable percentage will remain at 50% in 2017, but will drop to 40% in 2018 and 30% in 2019, and is phased out in 2020.
Take advantage of the “de minimis safe harbor election.” Businesses may be able to take advantage of the “de minimis safe harbor election” (also known as the book-tax conformity election) to expense the costs of lower-cost assets and materials and supplies, assuming the costs don’t have to be capitalized under the Code Section 263A uniform capitalization (UNICAP) rules. To qualify for the election, the cost of a unit of property can’t exceed $5,000 if the taxpayer has an applicable financial statement (AFS; e.g., a certified audited financial statement along with an independent CPA’s report). If there’s no AFS, the cost of a unit of property can’t exceed $2,500. Where the UNICAP rules aren’t an issue, purchase such qualifying items before the end of 2016.
R&D Credit and AMT. Beginning in 2016, eligible small businesses ($50 million or less in gross receipts) may claim the research and development (R&D) tax credit against an alternative minimum tax (AMT) liability. In prior years, the R&D credit could not offset AMT and would be carried forward until the taxpayer was out of AMT. (Credits generated prior to 2016 cannot offset AMT and must still be carried forward.) As an additional incentive, the credit can also be used by certain small businesses against the employer’s payroll tax (i.e. FICA) liability.
Review your inventory for subnormal goods. Subnormal goods are goods that are unsalable at normal prices or unusable in the normal way due to damage, imperfections, shop wear, changes of style, odd or broken lots, or other similar causes. If your business has subnormal inventory as of the end of 2016, you can take a deduction for any write-downs associated with that inventory provided you offer it for sale within 30 days of the inventory date. The inventory does not need to be sold within the 30-day timeframe.
Review accounting methods. Conduct a review of your tax methods of accounting to determine if you are using the optimal methodologies to maximize tax deductions. Some common areas of opportunity include deducting certain prepaid items, accelerating deductions for company paid payroll taxes and reviewing all depreciation methods.
Bunch expenses if on cash method. Many businesses, especially service-based business utilize the cash method of accounting. These businesses should accelerate deductions into the current year by bunching expenses to the extent possible.
Utilize an IC-DISC. If your business has foreign sales, consider utilizing an IC-DISC. A business that has export sales and utilizes an IC-DISC can create a tax benefit in which a portion of its income is taxed at the long-term capital gains rate.
Be mindful of state and local taxes. States are becoming increasingly aggressive in trying to capture tax revenue from out-of-state businesses. We are seeing changes from both a legislative and audit approach. Specific state and local tax areas to be mindful of include income tax, sales and use tax, payroll tax and property tax.
Consider triggering suspended passive losses. To reduce 2016 taxable income, consider disposing of a passive activity in 2016 if it will allow you to deduct suspended passive activity losses.
Increase your tax basis. If you own an interest in a partnership or S corporation where losses may be limited due to basis limitations, consider whether you need to increase your basis in the entity so you can deduct a loss from it for this year.
These are just some of the year-end steps that can be taken to save taxes. Again, by contacting us, we can tailor a particular plan that will work best for you. Additional ideas and information can be found in our 2016 Tax Planning Guide.
Please contact us if you would like to review any of the items we’ve mentioned, would like to schedule a tax planning strategy session or to discuss potential implications of the various tax law changes.
Cindy H. Mitchell?>
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