With the Presidential and Congressional elections of 2016 behind us and the end of the year approaching, now is a prudent time to consider tax planning strategies to reduce your tax bill for 2016 and possibly future years. The results of the recent election give us a general idea of where federal tax policy may be headed in the coming two years, however, at this point we can only speculate on the details. As such, this letter primarily focuses on tax provisions affecting tax year 2016 (which are unlikely to change at this point). Nonetheless, there are general references throughout to a few broad changes that may be down the road and how those changes affect tax year 2016 planning. Some factors continuing to compound the 2016 tax year planning challenge include turbulence in financial markets, economic uncertainty, and whether Congress will act on a number of important tax breaks set to expire for tax years after 2016. Under current law, tax breaks that won’t be available for tax years after 2016 unless Congress acts in some form include:
- The exclusion of income from discharge of indebtedness on a principal residence
- The treatment of mortgage insurance premiums as deductible qualified residence interest
- The 7.5% of adjusted gross income threshold for medical expense deductions for taxpayers age 65 or older will change to 10%
- The above-the-line deduction for qualified tuition and related expenses
- A host of energy provisions including the nonbusiness energy property credit, the residential energy property credit, the credit for 2-wheeled plug-in electric vehicles, the new energy efficient homes credit, and the hybrid solar lighting system property credit
The following is a listing of some key tax provisions that may apply to you in minimizing your taxes. The information is broken up into three sections: Year-End Tax Planning Moves for Businesses & Business Owners, Year-End Tax Planning Moves for Individuals, and Unique Aspects of Planning for Higher Income Individuals.
Year-End Tax Planning Moves for Businesses & Business Owners
- Businesses should consider making expenditures that qualify for the business property expensing option (“Section 179”). For 2016, the expensing limit is $500,000 and the investment ceiling limit is $2,010,000. Expensing is available for most depreciable property (other than buildings), off-the-shelf computer software, and a limited amount of real property. The deduction is not prorated for the time the property is placed in service during the year. The make-up of the incoming Congress and administration suggests these thresholds are likely to remain as generous as 2016 if not more so for 2017 and 2018.
- If Section 179 cannot be used, 50% first-year bonus depreciation should be considered. Like Section 179, the amount deductible as bonus depreciation is not prorated for the time of year the property is placed in service.
- Concerning capitalization versus expense treatment for purchases of items expected to last longer than one year, businesses may be able to take advantage of the “deminimis safe harbor election.” The election permits businesses to expense each “unit of property” with a cost of $5,000 or less for those with an applicable financial statement and $2,500 or less for those without a financial statement. Elected costs may still have to be capitalized under the UNICAP rules.
- If your business qualifies for the domestic production activities deduction (DPAD) for 2016, consider whether the 50% of W-2 wages limitation on that deduction applies. If it does, consider ways to increase 2016 W-2 income to owner-shareholders whose compensation is allocable to domestic production gross receipts.
- Consider disposing of a passive activity with suspended passive losses if reducing 2016 income makes sense keeping in mind that with the results of the recent election there is a likelihood that the rates that apply to you may change in 2017 or 2018.
- If you own an interest in a partnership or S corporation, consider whether you need to increase your basis in your partnership interest or S corporation stock so that you can deduct a loss from the entity this year.
- There are new filing deadlines for C corporations and partnerships. Formerly, the original filing deadline for calendar year-end C corporations was March 15th and the original filing deadline for calendar year-end partnerships was April 15th. Going forward, this will be reversed. The original filing deadline for calendar year-end C corporations will be April 15th; it will be March 15th for calendar-year partnerships. The extended deadline for calendar year-end partnerships and calendar year-end C corporations will continue to be September 15th, changing to October 15th for C corporations in 2025. S corporations will continue to have March 15th as the original filing deadline and September 15th as the extended deadline.
- The Research & Development Credit has been made permanent and has also been enhanced. Beginning in 2016, the credit is partially refundable against payroll taxes for businesses with less than $5 million in annual gross receipts who did not generate any gross receipts prior to 2012 (new businesses). The maximum benefit an eligible company is allowed to claim against payroll taxes is $250,000.
- For tax years beginning in 2018, major changes have been made to the partnership audit process. Generally, the partnership itself will be required to pay any tax resulting from an audit adjustment or make an election to issue adjusted information statements to all partners passing the audit adjustment on to them. Also, the partnership’s designated representative has been granted much greater authority to make decisions on behalf of the partnership. Partnerships may want to review or revise their partnership operating agreement in light of these changes.
- For Ohio Schedule C and pass-through businesses, the Ohio business income tax deduction will be 100% of business income up to $250,000 ($125,000 for married filing separately) and will no longer be subject to a percentage reduction.
- Businesses conducting transactions in other states need to keep abreast of ever-changing rules in both the sales and income tax arena for those states in which they do business. Developments that can have a big impact depending on the circumstances are occurring rapidly in this area.
- Businesses filing Ohio city income tax returns should consider the impact of HB5. HB5 is intended to provide a uniform tax base across all Ohio cities and generally reduce the complexity associated with each City having wide latitude in setting their own tax rules. Most provisions of the legislation went into effect January 1, 2016. One such provision is that a withholding requirement for employees working in another city begins at twenty days rather than twelve days. Changes made by HB5 concerning the application of city net operating losses go into effect January 1, 2017.
Year-End Tax Planning Moves for Individuals
- Postpone income until 2017 and/or accelerate deductions into 2016 while keeping in mind the various phase-outs for many deductions and credits at certain levels of income. Note that depending on varying individual circumstances there may be times when the opposite strategy is appropriate, such as when you expect to be in a higher tax bracket the following year. However, given the results of the recent election, for most people with relatively stable income year to year the benefits of a general deferral strategy are likely to be enhanced.
- Remember that charitable gifts of $250 or more may only be deducted if you have a statement from the charitable organization that shows 1) the amount of money contributed or a description of the property donated and 2) whether the organization did or did not give you any goods or services in return for your contribution.
- Consider a traditional to Roth IRA conversion if you expect to be in a higher tax bracket when eventually taking distributions from the Roth, you do not expect to take distributions from the account for a substantial period of time, and/or your income was much lower in 2016 than is typical. A Roth IRA conversion will increase your adjusted gross income (AGI) in the year converted absent a unique tax attribute such as a net operating loss (NOL).
- Consider using a credit card to pay deductible expenses before the end of the year. The credit card charges are considered to be a 2016 deduction even when the charges are paid in a future year.
- Your exposure to alternative minimum tax (AMT) must be kept in mind for 2016 as many tax breaks allowed for regular income taxes are disallowed for AMT purposes. These include the deduction for property taxes on your residence, state and local income taxes, miscellaneous itemized deductions, and personal and dependency exemptions.
- If you expect to owe state and local income taxes consider increasing your withholding of these taxes (or make or increase state estimated income tax payments) before the end of the year to pull this deduction into 2016. However, keep in mind AMT as the state and local income tax deduction is added back for AMT purposes.
- If you are just under a threshold for the allowance of a deduction such as miscellaneous itemized deductions or medical expenses consider “bunching” these expenses into one year to get over the threshold.
- Remember to take into account the required minimum distributions (RMDs) from your IRA or 401(k)/403(b) account(s) if you are over age 70 ½ at the end of 2016. The penalty for failure to take a distribution during the year is 50% of the RMD amount.
- Consider ways to maximize income taxed at lower capital gain and qualified dividend rates. Consult your investment advisor to develop a strategy to match capital gains and losses and to make investments that pay income as qualified dividends.
- Shelter gifts by using the annual gift tax exclusion before the end of the year to reduce possible gift and estate taxes. The annual exclusion applies to gifts of up to $14,000 made in 2016 to each of an unlimited number of individuals.
- Consider filing status as a way to save taxes. Ohio taxpayers can often save by filing separate tax returns and head of household status can save taxes in certain situations. However, retired persons over 65 should also account for the negative impact that married filing separate can have on the cost of Medicare Part B.
- There are a number of home improvements you can make that qualify for tax credits, mostly related to improving the energy efficiency of your home. Examples of such improvements include installation of material specifically designed to reduce heat loss, exterior windows, skylights, exterior doors, some special types of roofing, electric heat pump water heaters, some forms of central air conditioning, an advanced main air circulating fan, and natural gas, propane or oil hot water boilers. Each of these must meet detailed energy efficiency requirements. Keep in mind the lifetime limits and other limitations associated with these credits – for example, the nonbusiness energy credit has a lifetime limit of $500 with no more than $200 from windows and skylights.
Unique Aspects of Planning for Higher Income Individuals
- Higher-income individuals must take into account the 3.8% net investment income tax on certain unearned income. The tax applies to individuals with income over $250,000 who use the filing status of married filing jointly or qualifying widow, $125,000 for the married filing separately status, and $200,000 for any other filing status. Strategies to minimize the tax include having investments that generate tax-exempt income (such as municipal bonds) and maximizing investments in qualified retirement plans where income taxes are deferred. Income from activities in which you materially participate is not subject to the tax and your business activities should be carefully analyzed in classifying the income as net investment income versus income from an active trade or business. Going forward into 2017, there is a chance the net investment income tax may be eliminated.
- Like the 3.8% net investment income tax, the 0.9% Medicare tax applies to individuals for whom the sum of their wages and self-employment income is in excess of $250,000 for joint filers (or the qualifying widow filing status), $125,000 for those with the filing status married filing separate, and $200,000 for any other filing status. Self-employed individuals must take this into account in figuring quarterly estimated taxes due. Also, individuals and married couples who have two or more employers may have a disparity in their withholding if one or more W-2’s are under $200,000 (the amount where employers must withhold the tax) but combined with the other earned income the total earned income exceeds the threshold. Alternatively, tax may also be over-withheld where, for instance, a couple files married filing jointly but one spouse has wages over $200,000 and is required to withhold but the combined income does not exceed $250,000. Again like the net investment income tax, there is a chance this tax will be eliminated going forward.
- Plan for estate taxes based on current law, but allow for the possibility of dramatic changes from new legislation in this area. As of now, the current effective estate tax exemption due to the unified credit is $5.45 million and a married couple can pass an estate valued at $10.9 million on to their heirs without paying federal estate tax because of a provision allowing for the unlimited portability of a deceased spouse’s unused exclusion amount between spouses.
If you would like to discuss any of the above or any other ideas and/or strategies you may have in achieving your tax objectives, please contact us so that we can help. Remember, most smart tax moves concerning tax year 2016 will need to be done before the end of the year. After the year ends, it’s often too late.
Very truly yours,
Certified Public Accountants – Akron, Ohio