2016 Tax Planning Guide For Individuals
As expected, Congress has made very few changes to the tax code in this election year 2016. With the exception of extending and making permanent expiring tax breaks such as the tuition and fees deduction, most taxpayers will not notice significant federal law changes affecting the 2016 returns to be filed in 2017. But they will notice new return due dates, particularly earlier deadlines for partnerships and FBAR reporting.
However, with a Trump presidency and a Republican-controlled Congress on the horizon, there’s a real chance we may see some significant tax reform in 2017. What does this mean for tax planning? It means that deferring income to 2017 and accelerating deductions into 2016 may result in significantly higher tax savings for some taxpayers this year.
The current individual income tax rate structure consists of seven brackets (10, 15, 25, 28, 33, 35, and 39.6 percent). Most experts are predicting a reduction in the number of rates to only three brackets (12%, 25% and 33%) in 2017.
The current long-term capital gain rates (0%, 15% and 20%) are expected to remain in effect or be reduced. The House Republicans have proposed legislation which provides for a 50% exclusion on long-term capital gains, dividends, and interest before applying the three new income tax rates which effectively would reduce the rates on this investment income to 6%, 12.5% or 16.5%.
Further, the alternative minimum tax and the 3.8% “Obamacare Tax” on investment income (and the .9% Medicare tax on wages and self-employment income) is likely to be repealed as well. Other potential tax proposals include significant changes to itemized deductions and exemptions in 2017; changes to the estate and gift laws in 2017 ranging from complete repeal to an increase in the maximum exemption.
In summary, there is still time to do some tax planning for 2016 and it’s likely that this planning could lead to significant tax savings given the likelihood of a major tax law overhaul in 2017 not seen since the Reagan Tax Reforms.
This guide highlights several potential tax-saving opportunities for you to consider. If you have any questions, please do not hesitate to call. We would be happy to meet with you at your convenience to discuss these strategies. While we are getting very close to the end of the year, there is still time to implement these strategies to minimize your 2016 tax liability.
Apply Traditional Techniques
Individuals should take a look at traditional year-end tax planning techniques. One traditional technique is, if possible, to delay the recognition of income from 2016 to 2017. This may come into play for individuals who are able to postpone year-end bonuses, maximize deductible retirement contributions, and delay year-end billings. Individuals may want to consider the prepayment of real estate taxes or mortgage interest. Timing the recognition of capital gains and losses at year-end may help to minimize an individual’s net capital gains tax and maximize deductible capital losses. Life changes can also impact traditional year-end tax planning. Individuals who married or divorced, changed jobs, retired, or experienced other life events in 2016 need to review how these events may have revised their tax planning. A change in employment, for example, may bring about severance pay, sign-on bonuses, stock options, moving expenses, and COBRA health benefits, which all must be taken into account in year-end tax planning. For additional life cycle changes and year-end tax strategies, see the last few sections of this guide.
Retirement savings strategies are among other traditional year-end planning techniques. Individuals can contribute up to $5,500 to an IRA or Roth IRA for 2016. Qualifying individuals age 50 and older can make additional so-called “catch-up contributions” up to $6,500. Individuals have until April 15, 2017, to make an IRA contribution for 2016. Code Sec. 401(k) plans and similar arrangements, including new IRA accounts, should be explored to determine the maximum allowed contribution.
Gift-making should be part of a year-end review. Individuals can make tax-free gifts of $14,000 per recipient (unlimited in number) for 2016. Married couples may combine their gift-tax exclusion amounts and make tax-free gifts per recipient of up to $28,000 for 2016. There is an important and often overlooked provision affecting gifts. An individual can make unlimited tax-free gifts used for qualified tuition or medical expenses of another person. The expenses must be paid directly to a medical or educational institution to qualify.
Planning for Net Investment Income Tax
The Affordable Care Act created the net investment income tax to help fund health care reform. The law imposes the tax above certain income thresholds: $200,000 for single taxpayers; $250,000 for married couples filing a joint return; and $125,000 for married couples filing separately. For some individuals, the net investment income tax has become part of their year-end tax planning. Net investment income is comprised of interest, dividends, annuities, royalties and rents, if the income is not derived in a trade or business; passive activity “trade or business” income, with some exceptions; and net gains from the sale of property, unless the property is held in a non-passive trade or business. There are opportunities to mitigate the application of the net investment income tax, which we are happy to discuss with you if you are subject to the tax.
Considerations from Affordable Care Act
The Affordable Care Act requires all individuals to carry health insurance or make a shared responsibility payment, unless exempt. For many, employer-provided health insurance or Medicare and Medicaid coverage will satisfy the individual mandate. Uncovered individuals who are not exempt will need to make a shared responsibility payment when they file their 2016 returns in 2017.
Generally, the shared responsibility payment amount is the greater of a percentage of the individual’s income or a flat dollar amount. The amount is 1/12th of the annual payment for each month that a person or the person’s dependents are not covered and are not exempt. For 2016, the payment amount is the greater of:
- 5 percent of the person’s household income that is above the tax return threshold for their filing status; or
- A flat dollar amount, which is $695 per adult and $347.50 per child.
The individual shared responsibility payment is capped at the cost of the national average premium for the bronze level health plan available through the Marketplace in 2016.
The lack of health insurance does not automatically mean an individual must make a shared responsibility payment. There are broad exemptions. For example, an individual may have no affordable coverage options because the minimum amount he or she must pay for the annual premiums is more than eight percent of household income. An individual also may have a hardship that prevents him or her from obtaining coverage.
Some twenty million individuals have obtained health insurance through the Affordable Care Act Marketplace. Many qualified for a special tax break to help offset the cost of coverage (the Code Sec. 36B credit) and took advance payments of the credit. These individuals must reconcile the amount received in advance with the amount of the actual credit computed when they file their tax returns. Any life changes in 2016 not communicated to the ACA Marketplace may impact the final credit amount.
Estate and Gift Taxes
After a number of years of significant uncertainty over the federal estate and gift tax system, ATRA, passed in 2012, provides a permanent structure under which planning can now take place. ATRA permanently provides for a maximum federal unified estate and gift tax rate of 40 percent with an inflation-adjusted $5 million exclusion for gifts made and estates of decedents dying after December 31, 2012.
ATRA also preserved the annual gift tax exclusion. This exclusion allows taxpayers to give up to an inflation-adjusted $14,000 to any individual, gift tax free and without counting the amount of the gift toward the lifetime $5 million exclusion, adjusted for inflation. The 2016 lifetime exclusion is $5.45 mil. A married couple would be able to shield $10.9 mil from Estate Tax. For Massachusetts residents, the exemption remains at $1mil.
As mentioned in the introduction, there could be major changes in the estate and gift tax provisions in 2017. The changes range from complete repeal to an increase in the maximum exemption.
Avoid a Growing Problem: Tax-Related Identity Theft
Nearly 3 million people were the victims of tax-related identity theft in a recent year, according to a report from the U.S. Treasury Inspector General for Tax Administration. In a typical case, scammers use your Social Security number to get a fraudulent refund. You may not be aware that it’s happened until you file your own return and are told by the IRS that another return has already been filed in your name. In the meantime, the scammer has collected your refund. In other cases, taxpayers receive collection notices from the IRS for taxes they don’t owe or refer to employers they never worked for. Victims of these scams should act immediately, contacting law enforcement, the Federal Trade Commission and the credit rating agencies. In addition, we can offer advice on how to respond to any tax notice you receive and on how to avoid falling prey to identity theft.
Life Cycle Changes Important to Year-End Strategies
In addition to changes in the tax law, year-end tax strategies should also consider personal circumstances that changed during 2016. These “life cycle” changes include:
- Change in filing status: marriage, divorce, death or head of household changes
- Birth of a child
- Child no longer young enough for child credit
- Child who has outgrown the “kiddie” tax
- Casualty losses
- Changes in medical expenses
- Moving/relocation
- College and other tuition expenses
- Employment changes
- Retirement
- Personal bankruptcy
- Large inheritance
- Business successes or failures
Traditional Year End Strategies
Year-end 2016 presents unique challenges. At the same time, traditional year-end planning techniques nevertheless remain important both to maximize benefits in connection with what’s new and to do so within the usual ebb and flow of the taxpayer’s personal economy. The following traditional income and deduction acceleration techniques and their reciprocal deferral strategies should be considered:
Income Deferral/Acceleration:
- Enter into/Sell installment contracts
- Defer/Receive bonuses before January
- Hold/Sell appreciated assets
- Accelerate income to use available carry forward losses
- Hold/Redeem U.S. Savings Bonds
- Accumulate/Declare special dividend
- Postpone/Complete Roth conversions
- Delay/Accelerate debt forgiveness income
- Minimize/Maximize retirement distributions
- Delay/Accelerate billable services
- Structure/Avoid mandatory like-kind exchange treatment
Deductions and Credits Acceleration/Deferral
- Bunch itemized deductions into 2016 and take standard deduction in 2017/reverse steps
- Pay bills in 2016/postpone payments until 2017
- Pay last state estimated tax installment in 2016/delay payment until 2017
- Accelerate economic performance/postpone performance
- Watch AGI limitations on deductions/credits
- Watch net investment interest restrictions
- Match passive activity income and losses
Planning for Self-Employed Business Owners
- Please refer to our outline “Year End Strategies for Business 2016”