As a Morgan Stanley advertisement in 2006 aptly put it: “You must pay taxes. But there’s no law that says you gotta leave a tip.” Timely tax planning can help ensure that you don’t leave that “tip”. Tax planning is an important tool for both individuals and businesses to maximize tax efficiency. In other words, to manage the timing of income and deductions to minimize taxes. While it is ideal to employ tax planning throughout the year, year-end tax planning is more crucial as income and expenses already realized, and expected to be realized for the balance of the year, are more identifiable. So be sure to contact your tax professional to discuss some of the planning tips and strategies below.
Year-End Tax Planning Tips for Individuals
- Consider harvesting tax losses in your non-retirement investment portfolio. Realized losses from the sale of a security can be used to offset realized taxable capital gains. If your capital losses exceed your capital gains for the year, up to $3,000 of net capital losses can be deducted against your ordinary income, and any remainder will be carried over for use in future years. However, be aware of the wash sale rules which disallow the loss from the sale of a security that is acquired/replaced with the same or substantially identical security 30 days before or after the sale.
- Postponing income and accelerating deductions. Postponing income until 2017 is desirable for those taxpayers who anticipate being in a lower tax bracket next year due to changes, or expected changes, in financial circumstances. It is worth noting, however, that in some instances, it may benefit you to actually accelerate income into 2016. For example, this may be the case where a person’s marginal tax rate is much lower this year than it will be next year or where lower income in 2017 will result in a higher 2017 tax credit for an individual who plans to purchase health insurance on a health exchange and is eligible for a premium assistance credit. Accelerating certain deductions into 2016 may allow you to claim larger deductions, credits, and other tax breaks for 2016 that are phased out over varying levels of adjusted gross income (AGI). These include child tax credits, higher education tax credits, and deductions for student loan interest.
- Be sure to take your required minimum distributions (RMDs) from your tax-deferred retirement accounts by December 31st. RMDs are generally required to begin in the year you reach age 70-½.You can, however, defer taking your entire RMD until April 1st of the following year, but by doing so you will have two RMDs to report on your tax return that year. You will also want to mark your calendar because failing to take a required withdrawal can result in a penalty of 50% of the amount of your RMD. Better yet, inquire with the custodian of your retirement accounts about setting up automatic distributions (on a monthly, quarterly or annual basis) to help ensure you are taking your RMDs on a timely basis.
- If you are philanthropic and over the age of 70 ½, you can donate up to $100,000 to charity directly from your individual retirement account (IRA) without including the distribution from the IRA as taxable income. This kind of charitable gift is known as a Qualified Charitable Distribution (QCD). What makes the QCD attractive is that it, in effect, moves the deduction for the donation “above the line” in arriving at your adjusted gross income (AGI) thus potentially minimizing itemized deduction phase-outs, personal exemption phase-outs, the Medicare surtax on net investment income, the taxable portion of Social Security benefits, among other things, which all drive off of AGI. In addition, QCDs can be used to satisfy your RMD and can be particularly beneficial for taxpayers who normally take the standard deduction.
- Medical expenses are deductible to the extent they exceed 10% of your AGI. For 2016, the threshold, or floor amount, for those age 65 or older is 7.5% of AGI and is set to rise to 10% of AGI next year, unless Congress extends it. So for taxpayers age 65 or older who can claim itemized deductions this year, but do not expect to be able to next year because of the higher floor amount, should consider accelerating discretionary or elective medical procedures or expenses (e.g., dental implants or expensive eyewear) into 2016.
- Review your year-to-date contributions to your employer-sponsored retirement plans (i.e., 401k plans), flexible spending account (FSA) and health savings account to be sure you are on track to contribute up to their respective annual contribution limits and maximize the tax benefits these tax-deferred accounts have to offer.
- Consider using a credit card to pay deductible expenses before the end of the year. Doing so will increase your 2016 deductions even if you don’t pay your credit card bill until after the end of the year.
- If you are thinking of installing energy saving improvements to your principal residence, such as certain high-efficiency insulation materials, windows and doors, 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. Keep in mind, there is a lifetime limitation of $500, of which only $200 may be used for windows.
Year-End Tax-Planning Strategies for Businesses & Business Owners
- Businesses should consider making expenditures that qualify for the Section 179 expensing election. For tax years beginning in 2016, the expensing limit is $500,000 and the investment ceiling limit is $2,010,000. Expensing is generally available for most depreciable property (other than buildings & structural components), new and used equipment, off-the-shelf computer software, and qualified real property—qualified leasehold improvement property, qualified restaurant property, and qualified retail improvement property. The generous dollar ceilings that apply this year mean that many small and medium sized businesses that purchase and place in service qualifying property before the end of 2016 will be able to currently deduct most if not all their outlays for such property.
- Businesses also should consider making expenditures that qualify for 50% bonus first year depreciation if bought and placed in service this year. The bonus depreciation deduction is permitted without any proration based on the length of time that an asset is in service during the tax year. As a result, the full 50% first-year bonus writeoff is available even if qualifying assets are in service for only a few days in 2016. Qualifying assets generally include property with a recovery period of 20 years or less, computer software and qualified improvement property. Also, qualifying property must be purchased new by the taxpayer. Keep in mind, the bonus depreciation percentage will remain at 50% for 2016 and 2017, but is scheduled to decrease to 40% in 2018 and 30% in 2019.
- Businesses may be able to take advantage of the “de Minimis safe harbor election” to expense the costs of lower-cost assets and materials and supplies, assuming the costs don’t have to be capitalized under the uniform capitalization rules. To qualify for the election, the cost of a unit of property can’t exceed $5,000 if the taxpayer has an applicable financial statement or $2,500 if there is no applicable financial statement.
- To reduce 2016 taxable income, consider disposing of a passive activity in 2016 if doing so will allow you to deduct suspended passive activity losses.
- If you own an interest in a partnership or S corporation, consider whether you need to increase your basis in the entity so you can deduct a loss from it for this year.
The points discussed above are just some of the many considerations that can be made in the tax planning process as most of the available strategies are specific to each individual and business’ situation. Contact Isdaner & Company today at 610-668-4200 to discuss tax planning strategies that may be right for you.