Year End Tax Planning Strategies

Posted by on Nov 5, 2016 in Uncategorized | 1 comment

Tax planning strategies for individuals this year include postponing income and accelerating deductions, as well as careful consideration of timing related investments, charitable gifts, and retirement planning.

General tax planning strategies that taxpayers might consider include the following:

  • Sell any investments on which you have a gain or loss this year. For more on this, see Investment Gains and Losses, below.
  • If you anticipate an increase in taxable income in 2016 and are expecting a bonus at year-end, try to get it before December 31. Keep in mind, however, that contractual bonuses are different, in that they are typically not paid out until the first quarter of the following year. Therefore, any taxes owed on a contractual bonus would not be due until you file a tax return for tax year 2017.
  • Prepay deductible expenses such as charitable contributions and medical expenses this year using a credit card. This strategy works because deductions may be taken based on when the expense was charged on the credit card, not when the bill was paid.

For example, if you charge a medical expense in December but pay the bill in January, assuming it’s an eligible medical expense, it can be taken as a deduction on your 2016 tax return.

  • If your company grants stock options, you may want to exercise the option or sell stock acquired by exercise of an option this year if you think your tax bracket will be higher in 2017. Exercising this option is often but not always a taxable event; sale of the stock is almost always a taxable event.

Caution: Keep an eye on the estimated tax requirements.

Accelerating Income and Deductions

Accelerating income into 2016 is an especially good idea for taxpayers who anticipate being in a higher tax bracket next year or whose earnings are close to threshold amounts ($200,000 for single filers and $250,000 for married filing jointly) that make them liable for additional Medicare Tax or Net Investment Income Tax (see below).

In cases where tax benefits are phased out over a certain adjusted gross income (AGI) amount, a strategy of accelerating income and deductions might allow you to claim larger deductions, credits, and other tax breaks for 2016, depending on your situation.

The latter benefits include Roth IRA contributions, conversions of regular IRAs to Roth IRAs, child credits, higher education tax credits and deductions for student loan interest.

Caution: Taxpayers close to threshold amounts for the Net Investment Income Tax (3.8 percent of net investment income) should pay close attention to “one-time” income spikes such as those associated with Roth conversions, sale of a home or other large assets that may be subject to tax.

Tip: If you know you have a set amount of income coming in this year that is not covered by withholding taxes, increasing your withholding before year-end can avoid or reduce any estimated tax penalty that might otherwise be due.

Tip: On the other hand, the penalty could be avoided by covering the extra tax in your final estimated tax payment and computing the penalty using the annualized income method.

Here are several examples of what a taxpayer might do to accelerate deductions:

  • Pay a state estimated tax installment in December instead of at the January due date. However, make sure the payment is based on a reasonable estimate of your state tax.
  • Pay your entire property tax bill, including installments due in year 2017, by year-end. This does not apply to mortgage escrow accounts.
  • It may be beneficial to pay 2017 tuition in 2016 to take full advantage of the American Opportunity Tax Credit, an above-the-line deduction worth up to $2,500 per student to cover the cost of tuition, fees and course materials paid during the taxable year. Forty percent of the credit (up to $1,000) is refundable, which means you can get it even if you owe no tax.
  • Try to bunch “threshold” expenses, such as medical and dental expenses–10 percent of AGI (adjusted gross income)–and miscellaneous itemized deductions. For example, you might pay medical bills and dues and subscriptions in whichever year they would do you the most tax good.

Threshold expenses are deductible only to the extent they exceed a certain percentage of adjusted gross income (AGI). By bunching these expenses into one year, rather than spreading them out over two years, you have a better chance of exceeding the thresholds, thereby maximizing your deduction.

Health Care Law

If you haven’t signed up for health insurance this year, do so now and avoid or reduce any penalty you might be subject to. Depending on your income, you may be able to claim the premium tax credit that reduces your premium payment or reduces your tax obligations, as long as you meet certain requirements. You can choose to get the credit immediately or receive it as a refund when you file your taxes next spring. Please contact the office if you need assistance with this.

Additional Medicare Tax

Taxpayers whose income exceeds certain threshold amounts ($200,000 single filers and $250,000 married filing jointly) are liable for an additional Medicare tax of 0.9 percent on their tax returns, but may request that their employers withhold additional income tax from their pay to be applied against their tax liability when filing their 2016 tax return next April.

High net worth individuals should consider contributing to Roth IRAs and 401(k) because distributions are not subject to the Medicare Tax.

If you’re a taxpayer close to the threshold for the Medicare Tax, it might make sense to switch Roth retirement contributions to a traditional IRA plan, thereby avoiding the 3.8 percent Net Investment Income Tax as well (more about the NIIT below).

Alternate Minimum Tax

The Alternative Minimum Tax (AMT) exemption “patch,” which was made permanent by the American Taxpayer Relief Act (ATRA) of 2012, is indexed for inflation and it’s important not to overlook the effect of any year-end planning moves on the AMT for 2016 and 2017.

Items that may affect AMT include deductions for state property taxes and state income taxes, miscellaneous itemized deductions, and personal exemptions. Please call if you’re not sure whether AMT applies to you.

Note: AMT exemption amounts for 2016 are as follows:

  • $53,900 for single and head of household filers,
  • $83,800 for married people filing jointly and for qualifying widows or widowers,
  • $41,900 for married people filing separately.

Charitable Contributions

Property, as well as money, can be donated to a charity. You can generally take a deduction for the fair market value of the property; however, for certain property, the deduction is limited to your cost basis. While you can also donate your services to charity, you may not deduct the value of these services. You may also be able to deduct charity-related travel expenses and some out-of-pocket expenses, however.

Keep in mind that a written record of your charitable contributions–including travel expenses such as mileage–is required in order to qualify for a deduction. A donor may not claim a deduction for any contribution of cash, a check or other monetary gift unless the donor maintains a record of the contribution in the form of either a bank record (such as a cancelled check) or written communication from the charity (such as a receipt or a letter) showing the name of the charity, the date of the contribution, and the amount of the contribution.

Tip: Contributions of appreciated property (i.e. stock) provide an additional benefit because you avoid paying capital gains on any profit.

Investment Gains and Losses

This year, and in the coming years, investment decisions are likely to be more about managing capital gains than about minimizing taxes per se. For example, taxpayers below threshold amounts in 2016 might want to take gains; whereas taxpayers above threshold amounts might want to take losses.

Caution: In recent years, extreme fluctuations in the stock market have been commonplace. Don’t assume that a down market means investment losses. Your cost basis may be low if you’ve held the stock for a long time.

If your tax bracket is either 10 or 15 percent (married couples making less than $75,300 or single filers making less than $37,650), then you might want to take advantage of the zero percent tax rate on qualified dividends and long-term capital gains. If you fall into the highest tax bracket (39.6 percent), the maximum tax rate on long-term capital gains is capped at 20 percent for tax years 2013 and beyond.

Minimize taxes on investments by judicious matching of gains and losses. Where appropriate, try to avoid short-term capital gains, which are usually taxed at a much higher tax rate than long-term gains–up to 39.6 percent in 2016 for high-income earners ($415,050 single filers, $466,950 married filing jointly).

Where feasible, reduce all capital gains and generate short-term capital losses up to $3,000.

Tip: As a general rule, if you have a large capital gain this year, consider selling an investment on which you have an accumulated loss. Capital losses up to the amount of your capital gains plus $3,000 per year ($1,500 if married filing separately) can be claimed as a deduction against income.

Tip: After selling a securities investment to generate a capital loss, you can repurchase it after 30 days. This is known as the “Wash Rule Sale.” If you buy it back within 30 days, the loss will be disallowed. Or you can immediately repurchase a similar (but not the same) investment, e.g., and ETF or another mutual fund with the same objectives as the one you sold.

Tip: If you have losses, you might consider selling securities at a gain and then immediately repurchasing them, since the 30-day rule does not apply to gains. That way, your gain will be tax-free; your original investment is restored, and you have a higher cost basis for your new investment (i.e., any future gain will be lower).

Net Investment Income Tax (NIIT)

The Net Investment Income Tax, which went into effect in 2013, is a 3.8 percent tax that is applied to investment income such as long-term capital gains for earners above certain threshold amounts ($200,000 for single filers and $250,000 for married taxpayers filing jointly). Short-term capital gains are subject to ordinary income tax rates as well as the 3.8 percent NIIT. This information is something to think about as you plan your long-term investments. Business income is not considered subject to the NIIT provided the individual business owner materially participates in the business.

Please call if you need assistance with any of your long term tax planning goals.

Mutual Fund Investments

Before investing in a mutual fund, ask whether a dividend is paid at the end of the year or whether a dividend will be paid early in the next year but be deemed paid this year. The year-end dividend could make a substantial difference in the tax you pay.

Example: You invest $20,000 in a mutual fund at the end of 2016. You opt for automatic reinvestment of dividends, and in late December of 2016, the fund pays a $1,000 dividend on the shares you bought. The $1,000 is automatically reinvested.

Result: You must pay tax on the $1,000 dividend. You will have to take funds from another source to pay that tax because of the automatic reinvestment feature. The mutual fund’s long-term capital gains pass through to you as capital gains dividends taxed at long-term rates, however long or short your holding period.

The mutual fund’s distributions to you of dividends it receives generally qualify for the same tax relief as long-term capital gains. If the mutual fund passes through its short-term capital gains, these will be reported to you as “ordinary dividends” that don’t qualify for relief.

Depending on your financial circumstances, it may or may not be a good idea to buy shares right before the fund goes ex-dividend. For instance, the distribution could be relatively small, with only minor tax consequences. Or the market could be moving up, with share prices expected to be higher after the ex-dividend date.

Tip: To find out a fund’s ex-dividend date, call the fund directly.

Please call if you’d like more information on how dividends paid out by mutual funds affect your taxes this year and next.

Summary

These are just a few of the steps you might take. Please contact the office for assistance with implementing these and other year-end planning strategies that might be suitable to your particular situation.

One Comment

  1. Hello! Cool post, amazing!!!

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