As the end of the year approaches, it is a good time to consider tax planning strategies that will help lower your tax bill for this year and possibly the next. Our office can help you prepare such a strategy, and the earlier we get started, the greater the potential maximization of benefits.
We have compiled a checklist of additional actions based on current tax rules that may help you save tax dollars if you act before year-end. Not all actions will apply in your particular situation, but you will likely benefit from many of them. We can narrow down the specific actions that you can take once we meet with you to tailor a particular plan. When the new Administration moves into Washington in January 2017, the current tax rates and rules provided in this letter may be affected and are subject to change. The impact that these changes will influence your long-term tax situation remains to be seen. In the meantime, please review the following list and contact us at your earliest convenience so that we can advise you on which tax-saving strategies may be beneficial to you:
For tax year 2016, the 10%, 15%, 25%, 28%, 33%, 35%, and 39.6% tax brackets will remain. The tax rate of 39.6 percent affects single filers whose taxable income exceeds $415,050 ($466,950 for married taxpayers filing a joint return), up from $413,200 and $464,850, respectively.
President-elect Trump outlined a consolidation of the seven current individual income tax rates by proposing three rates: 12, 25, and 33 percent. The top rate would be significantly less than the current top rate of 39.6%. If Trump’s proposal is enacted, this change would not go into effect until the 2017 tax year at the earliest.
Medicare surtax or Net Investment Income Tax
A 3.8% surtax applies to the lesser of (1) net investment income or (2) the excess of modified adjusted gross income (MAGI) over the threshold amount ($250,000 for joint filers or surviving spouses, $125,000 for a married individual filing a separate return, and $200,000 for other taxpayers). MAGI is adjusted gross income (AGI) increased by the amount excluded from income as foreign earned income (net of the deductions and exclusions disallowed with respect to the foreign earned income). The 3.8% surtax applies to gross income from interest, dividends, annuities, royalties, and rents, unless those items are derived in the ordinary course of a trade or business to which the Medicare contribution tax doesn’t apply. The tax also applies to income generated from a trade or business if it is a passive activity of the taxpayer. Hence, the tax doesn’t apply to active businesses conducted by a sole proprietor, partnership, or S corporation. Investment income does not include any amount subject to the self-employment tax, and doesn’t include amounts distributed from retirement plans. As year-end nears, a taxpayer’s approach to minimizing or eliminating the 3.8% surtax will depend on his estimated MAGI and net investment income (NII) for the year. Some taxpayers should consider ways to minimize (e.g., through deferral) additional NII for the balance of the year, others should try to see if they can reduce MAGI other than unearned income, and others will need to consider ways to minimize both NII and other types of MAGI. One way to reduce NII is to recognize losses on stocks and use them to offset other gains taken earlier this year. In addition, taxpayers that own interests in a number of passive activities also should reexamine the way they group their activities. Taxpayers expecting significant gains on sale of property may want to consider using the installment method to spread out the taxable gain on sale if applicable.
President-elect Trump promised during the campaign that if elected he would repeal the Patient Protection and Affordable Care Act. If this act is fully repealed, the Medicare surtax, net investment income tax, and additional Medicare tax would presumably be eliminated. If enacted, these changes would not take effect until 2017 at the earliest.
Additional Medicare Tax
The Additional Medicare Tax increases the employee share of Medicare tax by an additional 0.9% of covered wages in excess of certain threshold amounts. The threshold amounts are $200,000 for single individuals and heads of household; $250,000 for married couples filing a joint return; and $125,000 for married individuals filing separate returns. This is now the fourth year the Additional Medicare Tax has been around. If you feel you do not have enough income tax withholding to cover this tax, you may request that your employer takes out an additional amount of income tax withholding from your income.
The standard deduction stays the same at $6,300 for singles and married persons filing separate returns and $12,600 for married couples filing jointly. The standard deduction for heads of household rises to $9,300, up from $9,250 in tax year 2015. The limitation for itemized deductions claimed on tax year 2016 returns of individuals begins with incomes of $259,400 or more ($311,300 for married couples filing jointly).
President-elect Trump has proposed to increase the standard deduction to $15,000 for single individuals and to $30,000 for married couples filing a joint return. For itemizers, Trump has proposed capping itemized deductions at $100,000 for single individuals and at $200,000 for married couples filing a joint return. If enacted, these changes would not take effect until 2017 at the earliest.
Conversion from Traditional IRA to Roth IRA
The 3.8% surtax makes Roth IRAs look like a more attractive alternative than traditional IRAs for higher-income individuals. Qualified distributions from Roth IRAs are tax-free and thus won’t be included in MAGI or in NII. By contrast, distributions from traditional IRAs (except to the extent of after-tax contributions) will be included in MAGI, although they will be excluded from NII. However, taxpayers who are thinking of converting regular IRAs to Roth IRAs this year should do so with care, as the move will increase MAGI, and therefore potentially expose – or expose more of – their NII to the 3.8% surtax.
The personal exemption rises to $4,050, up from the 2015 exemption of $4,000. However, the exemption is subject to a phase-out that begins with adjusted gross incomes of $259,400 ($311,300 for married couples filing jointly). It phases out completely at $381,900 ($433,800 for married couples filing jointly.)
President-elect Trump has proposed to eliminate the personal exemption deduction. If enacted, this change would not take effect until 2017 at the earliest.
Alternative Minimum Tax
Like the NII tax, the alternative minimum tax (AMT) also requires personalized attention. The AMT is now permanently “patched” and this has brought some certainty to AMT planning. The patch permanently increases the exemption amounts and indexes the exemption amounts for inflation. For 2016, the exemption amounts are $53,900 for single individuals and heads of household; $83,800 for married couples filing a joint return and surviving spouses; and $41,900 for married couples filing separate returns. There are steps that taxpayers subject to AMT can take to reduce its effect on their tax liability. For instance, taxpayers can undertake to eliminate certain tax preferences. Certain deductions, including the accelerated depreciation deduction on real property, as well expensed research and development costs and expensed mining exploration and development costs, are tax preference items only to the extent that they exceed an otherwise allowable deduction.
President-elect Trump has proposed to eliminate the alternative minimum tax. If enacted, this change would not take effect until 2017 at the earliest.
Medical Savings Account
For tax year 2016 participants who have self-only coverage in a Medical Savings Account, the plan must have an annual deductible that is not less than $2,250, up from $2,200 for tax year 2015; but not more than $3,350, up from $3,300 for tax year 2015. For self-only coverage the maximum out of pocket expense amount remains at $4,450. For tax year 2016 participants with family coverage, the floor for the annual deductible remains as it was in 2015 — $4,450, however, the deductible cannot be more than $6,700, up $50 from the limit for tax year 2015. For family coverage, the out of pocket expense limit remains at $8,150 for tax year 2016 as it was for tax year 2015.
Capital Gains and Qualified Dividends Rates
The tax rate on net capital gain is no higher than 15% for most taxpayers. Net capital gain may be taxed at 0% for taxpayers in the 10% or 15% ordinary income tax brackets. However, a 20% rate on net capital gain applies to the extent that a taxpayer’s taxable income exceeds the thresholds set for the 39.6% ordinary tax rate ($415,050 for single; $466,950 for married filing jointly or qualifying widow(er); $441,000 for head of household, and $233,475 for married filing separately). Strategies for matching capital gains and capital losses to make the most of these rules should be considered. However, the 3.8% surtax on net investment income may apply. Qualified dividend income is taxed at the same favorable tax rates that apply to long-term capital gains.
The annual exclusion for gifts remains at $14,000 for 2016. Make gifts sheltered by the annual gift tax exclusion before the end of the year and thereby save gift and estate taxes. The exclusion applies to gifts of up to $14,000 made in 2016 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.
Complex Trusts and Estates
There is a special election available for estates and complex trusts for distributions made to a beneficiary within 65 days following the end of a tax year. The fiduciary can elect to treat any such distribution or part of a distribution as having been made in the prior year. The effect of this election is that the deduction for the distribution can be taken by the estate or trust in the year before the distribution was actually made. However, the beneficiary receiving the distribution must also be taxed on the distribution in the year before the distribution was actually received.
The amount covered by the 65-day election is limited to the greater of:
• the amount of the estate’s or trust’s income; or
• the estate’s or trust’s DNI, reduced by amounts paid or required to be distributed during the tax year, other than amounts subject to the 65-day election.
This election is made on Form 1041. Once made, the election is irrevocable, but is binding only for that year. The 65-day election is not available for accumulation distributions.
During the campaign, Trump called for the repeal of the federal estate tax. Repeal is expected to receive a warm reception in the GOP-controlled House but would face an uncertain future in the Senate. Trump has also proposed to require a carryover basis regime for assets inherited from estates above certain amounts.
Affordable Care Act
No year-end tax plan can ignore the Affordable Care Act (ACA). The ACA, as the past six years has shown, impacts almost every individual, starting with the requirement to have minimum essential health coverage or make a shared responsibility payment, unless exempt. On 2015 returns filed in 2016, individuals reported if they had minimum essential coverage and that reporting requirement will again be on 2016 returns filed in 2017. Individuals who may be liable for a shared responsibility payment should carefully review the significant number of exemptions available, which cover many different circumstances. It is also possible to project the amount of any payment. Closely related are changes to the medical expense deductions, health flexible spending arrangements (and similar arrangements), insurance coverage for children, and more. Our office can assist you in both understanding these complex ACA provisions and planning for their impact, if applicable.
President-elect Trump promised during the campaign that if elected he would repeal the Patient Protection and Affordable Care Act (PPACA). Presumably, this includes all of the various components of the measure, including the Health Insurance Marketplaces, the SHOP Marketplace, tax credits for small employers, the premium assistance tax credit, and reporting requirements for employers and insurers. More details are expected in the upcoming days and weeks about the President-elect’s repeal plans. If repealed, the changes would not take effect until 2017 at the earliest.
PATH Act “Extenders” and More
The Protecting Americans from Tax Hikes Act of 2015 (PATH Act), enacted immediately before the start of 2016, permanently extended many tax incentives that were previously temporary, removing for the first time in many years the year-end concern over whether these incentives will be extended either retroactively for the current year or prospectively into the coming year. Not all of these “extenders” provisions were extended beyond 2016, however; and some were modified in the process. Others were extended for up to five years, deferring to “tax reform” a more lasting solution. Here’s a list of the major changes made by the PATH Act, especially focused on how they impact year-end transactions:
• permanent American Opportunity Tax Credit
• permanent teachers’ $250 “classroom” expense deduction
• permanent state and local sales tax deduction election, in lieu of state income taxes
• permanent exclusion for direct, charitable donation of IRA funds of up to $100,000
• permanent 100-percent gain exclusion on qualified small business stock
• permanent conservation contributions benefits
• five-year solar energy property
• nonbusiness energy property credit through 2016
• fuel cell motor vehicle credit through 2016
• mortgage insurance premium deduction through 2016
• tuition and fees deduction through 2016
Residential Energy Efficient Property Credit
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.
California Tax Rates
The rate of inflation in California, for the period from July 1, 2015, through June 30, 2016, was 2.1%. The 2016 personal income tax brackets are indexed by this amount
• The maximum rate for individuals is 12.3%
• The AMT rate for individuals is 7%
• The Mental Health Services Tax Rate is 1% for taxable income in excess of $1,000,000.
• California voters approved a statewide ballot initiative that extends the 10.3%, 11.3%, and 12.3% personal income tax rates for single taxpayers with taxable income over $250,000 ($500,000 for joint filers, $340,000 for head-of-household).
• These rates were set to expire after the 2018 tax year; but with the passing of this proposition, they now will not expire until after the 2030 tax year.
College Access Tax Credit
This tax credit is available for the 2014 through 2017 tax years for contributions made to the College Access Tax Credit Fund. The credit will be available to taxpayers who make cash contributions to the fund and who receive a credit certification and allocation from the California Educational Facilities Authority (CEFA) in the State Treasurer’s Office. The fund will be used to bolster the dwindling resources used to provide Cal Grants to low-income college students.
Taxpayers may claim credits in the following amounts:
• 50% of the amount contributed that is certified and allocated for the 2016 taxable year.
• 50% of the amount contributed that is certified and allocated for the 2017 taxable year.
The credit can be used to offset tax, including reducing the tax below tentative minimum tax. You must receive a certificate from CEFA before you can claim the credit on your state income tax return. You may also be able to claim a charitable deduction on your federal tax return. If you do this, you must add back the amount of the charitable deduction taken on your federal return as a state adjustment on your California tax return. You cannot claim a deduction and a credit for the same contribution.
You can get an application and more information about how to make a contribution on CEFA’s website at http://www.treasurer.ca.gov/cefa/catc/index.asp.
Please feel free to call our offices if you have any questions about how year-end tax planning might help you save taxes. Our tax laws operate largely within the confines of “the taxable year.” Once 2016 is over, tax savings that are specific to 2016 may be gone forever. Again, by contacting us, we can tailor a particular plan that will work best for you.