Implementing tax strategies at year-end always presents challenges. This year is no different, due to the impact of IRS rule changes and uncertainty over proposed changes due to the recent presidential election. While it is difficult to forecast the impact of tax law changes that could be made in 2017, it is important to consider techniques that are available today and lock in those tax savings before time runs out.
Planning for Individuals
The Protecting Americans from Tax Hikes Act of 2015 (PATH Act) was passed at the end of last year. It permanently extended previously expired tax breaks such as: the option to deduct state and local sales and use taxes instead of state and local income taxes, tax-free distributions by those age 70-1/2 or older from IRAs for charitable purposes (the limit is $100,000), the American Opportunity Tax Credit for qualified tuition and related expenses, and the deduction for expenses of elementary and secondary school teachers. The PATH Act extended certain provisions through 2016, including the “above the line” deduction for higher education tuition and related fees, deduction of mortgage insurance premiums on a personal residence, qualified principal residence mortgage debt discharged exclusion from gross income, the tax credit for residential energy efficient property credit, and the tax credit for solar energy property.
The Path Act also created a new type of savings account for individuals with disabilities and their families. For 2016, you can contribute up to $14,000 to an Achieving a Better Life Experience (ABLE) account. Distributions from this account are tax-free if used to pay the beneficiary’s qualified disability expenses.
Basic Numbers You Need to Know
One of the most significant changes in the past few years is the creation of the 39.6 % tax bracket. While proposed tax cuts were discussed by President-Elect Donald Trump – which would reduce the upper tax bracket for those individuals currently in the 33%, 35%, and 39.6% bracket, down to the 33% tax bracket – it is anyone’s guess if and when such a change would happen.
Taxpayers should keep these possible tax rate cuts in mind. If they have the option of deferring income into next year or accelerating deductions into the current year, this may prove advantageous. However, they need to monitor spikes in taxable income when utilizing this strategy, to avoid pushing income into the upper brackets. Careful planning can help maximize the utilization of the tax brackets when straddling tax years.
When considering the deferral or acceleration of income or deductions, individuals can generally employ a variety of strategies, which may include:
– Consider selling appreciated stocks. If a taxpayer has losses from stock sales, realizing gains may make sense. By selling stocks that have gone up in value, and repurchasing identical shares, the cost basis is “reset” at the higher purchase price (“wash sale” rules only apply to losses). The resulting gain would be offset by the available stock losses, and wouldn’t create an increase in the tax liability. Be careful to work with your tax advisor to determine the maximum levels available, and consider loss carryforwards, if applicable.
– Prepay deductible expenses such as charitable contributions and medical expenses this year using a credit card. The expense is still deductible this year even if the credit card balance is paid in the following year.
– Keep good records. In particular, make sure to have the required documentation for charitable contributions. For cash donations of more than $250, this includes a copy of the canceled check and the receipt from the charitable organization. For donated property, a detailed listing, with the fair market value of each item, along with the receipt from the organization will be needed. You will also need to be able to demonstrate that the donated property was in “good” shape for the deduction to count. Additional documentation is required for noncash donations of more than $5,000 — including a qualified written appraisal along with acknowledgments from the appraiser and the charitable organization.
– Keep in mind donations of appreciated stock that have been owned for more than one year provides unique benefits. An individual can generally deduct the full fair market value of those shares without paying tax on the appreciation. As an added bonus, donations of publicly-traded securities are exempt from the requirement to obtain a written appraisal – which saves the cost of obtaining the appraisal.
– Get tuition payments in the mail by the year end. Payments made in 2016 for tuition for a school year beginning in 2016 or that begins during the first three months of 2017 will qualify for the education credit on your 2016 tax return. There are limitations on the deductibility of the education credits, however, so you may want to consult with your tax advisor prior to prepaying these expenses.
– Subject to limitations that could be imposed due to the alternative minimum tax rules, you might also benefit from the following:
- Pay state estimated tax installments in December instead of at the January due date. However, make sure the payments are based on a reasonable estimate of the state tax liability.
- Pay the full amount of property tax bills, including installments due in year 2017, by year-end. This does not apply to mortgage escrow accounts, which are prepayments of the “reserve” rather than actual property tax assessments.
– Miscellaneous Itemized Deductions, such as expenses for financial planning, tax preparation, and unreimbursed employee business expenses, are deductible only if the total of these items exceeds two-percent of an individual’s adjusted gross income. Grouping these deductions in alternating years can be an effective tax-planning strategy to reach the threshold level.
– U.S. persons holding any financial interest in, or signature or other authority over, a foreign financial account exceeding $10,000 at any time in a calendar year must file a Report of Foreign Bank and Financial Accounts (FBAR) with the Treasury Department. The due date for 2016 is the same as the U.S. tax filing deadline of April 15, 2017 (unless extended by a weekend or holiday), with a maximum six-month extension to October 15.
Planning for Businesses
Businesses seeking to maximize tax benefits should be sure to consider the impact of the tax extenders and make sure that capital purchases are a part of their plans.
Business Tax Provisions
The PATH Act made permanent several business-related provisions, including: the exclusion of gain from the disposition of qualified small business stock (Sec. 1202 stock); reduction in the recognition period (to 5 years) for reporting of built-in gains taxes by S-corporations; 15-year straight-line cost recovery for qualified leasehold improvements, restaurant property and retail improvements; Sec. 179 expensing; the research credit; and the charitable deduction for the contribution of food inventory. Furthermore, the Act allowed a five-year extension for certain provisions, such as bonus depreciation and the work opportunity tax credit, among other provisions. The energy efficient commercial buildings deduction was not extended past 2016. However, it is possible that it could be extended to future years.
Bonus Depreciation and Code Sec. 179 Expense Deductions
The PATH Act extended the 50-percent bonus depreciation deduction through the 2017 tax year (the amount decreases to 40% in 2018 and 30% in 2019). Because this bonus depreciation can be elected on the 2016 return when it is filed in 2017, business owners do not have to make an immediate decision if they wish to use this accelerated method. Bonus depreciation is optional and businesses can elect not to use it – which may be appropriate in certain circumstances if deductions need to be spread more evenly over future years. What is important is that any qualifying property must be purchased and placed in service by the end of 2016 in order to be prepared to take advantage of this provision. Therefore, businesses should evaluate their equipment needs now and take action to acquire and place in service qualified property while there is still time.
Under enhanced Code Section 179 expensing rules for 2016, businesses can write off up to $500,000 in qualifying expenditures and would not have to reduce this amount unless total purchases of all equipment exceeds $2,010,000 this year. There is no proration of this deduction based upon the time of the year that the asset is placed in service. In other words, as long as the asset is truly placed in service by the year end a last minute purchase of equipment will result in an immediate deduction under this provision. Caution, however, that there are additional restrictions for cars and trucks.
Tax planning involves making wise tax decisions for the current year while not creating a large tax bill in future years. Obviously, taxes are not the only issue to consider when making decisions about your financial plans. In many cases, tax strategies need to be evaluated to determine the effect on your specific set of facts and circumstances. Either way now may be the time to call your advisor at MarksNelson to discuss the tax planning strategies that may benefit you.