2016 Year-end Tax Planning Tips for Individuals
Every year has its own set of challenges when it comes to tax planning. And 2016 will be no exception. In fact, it could be tougher than usual, given recent political developments. With the same party in control of both houses of Congress and the White House, most people expect substantial changes to the tax code.
Some of the changes experts are watching for include:
- Compression and reduction of individual income tax rates
- Increased standard deduction
- Additional limitations on itemized deductions
- Repeal of the Alternative Minimum Tax (“AMT”)
- Repeal of the Estate Tax
- Repeal of the Affordable Care Act (“ACA”)
And then, there are the potential ripple effects of these changes. For example, if the ACA is repealed, the Net Investment Income Tax (“NIIT”) would automatically be repealed along with it. This tax applies a 3.8% tax on investment income of high-income taxpayers that exceeds certain thresholds.
If even some of these proposed tax reductions pass, it will probably make a big difference to your 2017 tax liability – hopefully for the better! With these potential changes in mind, considering your options before the end of the year is more important than ever.
In an attempt to make your year-end tax planning a little easier, we’ve taken some of our best tips and organized them into seven different categories.
1. Bracket Management
Bracket management refers to minimizing the tax rate that your income will be subject to after considering five different taxing regimes now in effect:
- Ordinary income
- Capital gains
- Alternative Minimum Tax (“AMT”)
- The Pease Limitation (limitation on itemized deductions based on a percentage of adjusted gross income) and Personal Exemption Phase-out
The trick is to receive the income or deduction in the year that will result in the lowest overall tax. Right now, it looks like that will be 2017 for most people. But, your circumstances may be different.
You can often influence the year you recognize income. You cannot postpone income by merely putting a check in a desk drawer until after New Year’s Eve. However, you can mail invoices out later in the month, which could result in your customers paying you during 2017 rather than 2016. While this may have a negative impact on immediate cash flow, if you expect your tax rate to be lower next year, it may be worth the delay in receiving payment.
You can claim most deductions other than interest in the year you make your payments. If you prepay state and local taxes, you can deduct those payments in the current year. The same goes for charitable contributions, investment expenses, and most other itemized deductions and business expenses. Accelerating itemized deductions so you can claim them on your 2016 return may be particularly attractive this year, if you expect your itemized deductions for 2017 to be either lower than $15,000 or higher than $200,000 and you are not subject to the AMT. This is because the president-elect’s tax plan would prevent you from benefitting from itemized deductions that are outside those thresholds.
2. Review of Investments
You can save money by choosing whether to sell stock in 2016 or 2017. If you have net long-term capital gains during 2016, your federal tax rate could be as high as 23.8%.
If you expect to have net capital gains for 2016, consider selling stocks that have depreciated while you held them to offset this gain. And if you expect to have net capital losses for 2016, consider selling stock that has appreciated. This could be a smart move, since capital losses can only shelter limited amounts of ordinary income.
If you expect to have net capital gains for the year, postponing additional sales of appreciated stock could save you tax dollars – particularly if the NIIT is repealed. However, the potential tax cost needs to be weighed against the economic risk of holding onto a security that might decrease in value.
Be sure to watch out for mutual fund distributions. Mutual funds typically distribute their capital gains close to year end. If you are planning to sell a mutual fund, consider selling the fund before it makes its year-end distributions.
Perhaps most importantly, consider your holding period. The preferential capital gains tax rate only applies to net long-term gains, which are gains on capital assets that were held for more than a year. If you’re thinking of selling appreciated stock that you held for 360 days, consider whether you are willing to take the economic risk of holding the stock for an extra six days. If the gain will not be offset by losses, this could let you qualify for long-term capital gains rates.
3. Charitable Giving
Charitable contributions made during 2016 can be deducted on your income tax return. Since lower tax rates and limits on what can be deducted are both being talked about for next year, many people are accelerating contributions that they would otherwise make during 2017. One option is to use your credit card to make a donation before December 31. You can claim the deduction for 2016 even though you don’t pay the credit card bill until next year.
If you aren’t ready to give large amounts to a particular charity yet, think about setting aside money in a vehicle such as a donor-advised fund or private foundation. These choices allow you to claim a charitable deduction in 2016 before additional limitations are added. But you would have extra time to decide which charity ultimately receives the money and when.
While a cash donation is always welcome, you may have assets, such as marketable securities, that have appreciated in value and that you have held for more than a year. You could sell them, pay tax on the gain, and donate the proceeds. Instead, consider donating the asset to a qualified charity. This allows you to claim a deduction for the full value of the asset without paying tax on the gain. Then, the charity can sell the asset without paying tax on the gain. This means both you and the charity end up with more money in your pockets!
Remember to get proper documentation if you contribute more than $250 to a charity. The type of documentation depends on the amount of the contribution and whether it is cash or property. But, you can’t claim a deduction without that receipt.
If you are over 70 and a half years old, you can fund contributions to qualified public charities with distributions directly from your IRA. Amounts contributed in this way count towards your required minimum distributions but are not included in your income. Since certain deductions and taxes are affected by your adjusted gross income, making donations directly from your IRA may reduce your income tax bill even though the amount cannot be claimed as a charitable deduction.
4. Retirement Plan Distributions
If you turned 70 and a half this year, you have until April 1, 2017, to begin making required minimum distributions (“RMDs”) from your IRAs and other qualified retirement plan accounts. Consider whether to take your initial RMDs before the end of 2016 or wait until after year end. While waiting may defer the tax on the distribution for a year, accelerating the distribution into 2016 may result in a lower tax if your tax rate is lower than you expect next year.
A stiff penalty applies if you don’t withdraw enough from your retirement accounts. The penalty is 50 percent of the excess of the amount that should have been withdrawn but wasn’t. So, make sure you take at least the RMD. This requirement also applies to inherited Roth IRAs. There is no penalty for taking more than your RMD if you are at least 59 and a half years old.
5. Watch Out for the NIIT
Since a key component of the Republican Party platform has been the repeal of the ACA, it’s possible that the NIIT will be repealed. Even if the ACA is not fully repealed, the president-elect’s tax plan specifically calls for the repeal of this tax. If you can reduce your exposure to this tax for 2016, it may become a permanent saving of 3.8 percent.
The tax generally applies to investment income if your adjusted gross income is above certain thresholds. The thresholds are $200,000 if you are single or head of household, $125,000 if you are married filing separately, and $250,000 if you are married filing jointly or are a qualifying widow(er) with a dependent child.
6. Maximize Retirement Savings
Have you taken full advantage of your retirement saving opportunities? You could benefit from more than just receiving a deduction for the amounts you set aside for future retirement and watching your money grow tax free. The tax you pay on the distributions will often be less than the tax benefit received when you made the contribution, because many people find themselves in lower tax brackets upon retirement.
The 2016 contribution limit for 401(k) plans is $18,000. An additional $6,000 is allowed as a catch-up contribution if you are age 50 or older. IRA limits for 2016 are $5,500 ($6,500 as catch-up contributions if you are age 50 or older). While IRA contributions can be deducted if paid by April 15 of the following year, contributions to 401(k) plans generally must be made prior to December 31. Certain plans must be legally established prior to December 31, but you can receive a current year deduction for contributions made prior to the due date of your return.
Depending on your tax bracket, a contribution to a Roth IRA or a rollover from a traditional IRA to a Roth IRA could be a good idea. While contributions to a Roth IRA are not deductible, and a rollover of a traditional IRA to a Roth IRA requires you to pay tax on the conversion, growth within the plan and future distributions are usually tax free.
7. Check Your Withholding and Estimated Tax Payments
Reduce or avoid penalties by calculating how much tax you will owe next April and whether you have enough tax paid through withholding and estimated tax payments. If it appears that you have not paid enough, consider increasing your withholding for the balance of the year. The increase will be treated as though it was withheld and paid evenly throughout the year. But withholding cannot exceed your actual compensation. If you have no income subject to withholding, you can reduce your potential underpayment penalty by increasing your fourth-quarter estimate.
In contrast, if your 2016 income has decreased from what it was in 2015, you may be able to improve your cash flow by reducing your fourth-quarter estimated payment.
At a minimum, we can help you estimate your 2016 income tax liability, so you can plan for any amounts you may owe on April 15.
Next Action Steps
These are just a few of the many planning strategies that could help you before year end. For additional questions about your specific situation, as well as help with the calculations, reach out to your local Cherry Bekaert tax advisor. They can help you get more concrete answers and recommend strategies that will work best for you and your family not only for this year but in the years to come.