Courtesy Whittemore, Dowen & Ricciardelli LLP
While the election is over, and the next president and Congressional leaders known, the changes to policies and tax laws to come will be uncertain for a while.
The first 100 days of a new presidential term brings an aggressive agenda and the potential for many proposals. Only time will tell what new policies will be enacted and tax laws approved and how they will impact you financially. While there is still a lot of uncertainty on what the next year will bring, there are tax changes and laws in place now that you should be aware of for year-end planning and the start of 2017.
Tax planning increasingly centers around knowing your income level or at least a good projection since many tax benefits are capped by your Adjusted Gross Income (AGI and modified AGI) or phased out at certain levels. Some of the more common benefits that get phased out as income goes up are itemized deductions, personal exemptions, student loan interest deduction and education credits. For example, the American Opportunity Tax Credit (AOTC) for tuition and college expenses is a tax credit of up to $2,500, but begins to get phased out for a couple at $160,000 and is reduced to zero at $180,000.
The AOTC credit for a single person starts to be reduced at $80,000 and is fully lost at $90,000. The student loan interest deduction has even lower thresholds where the deduction starts to get phased out at $130,000 for a couple and $65,000 for an individual.
When possible, pushing income into 2017 or later to squeeze below the income phase out limits may significantly reduce your tax liability by allowing for more deductions or tax credits. Deferring income through a 401k or other retirement plan at work is one way to reduce your taxable income as your income rises. The maximum contribution for a 401k, 403b and 457 plan is $18,000 for both 2016 and 2017 tax years.
An additional catch-up contribution of $6,000 is allowed for an employee aged 50 and over for a total contribution of $24,000. If not covered by a retirement plan at work and even for some who are, a Traditional IRA contribution will have the same income reducing impact. The IRA deduction for 2016 is limited to earned income up to $5,500 plus a catch up contribution of $1,000 for those over age 50 and you have until April 15 to make the contribution for 2016. In some cases, a year-end bonus can be pushed into early 2017 to reduce income if the employer has some flexibility.
If deferring income is not possible, there are other ways to reduce your AGI and this year’s income tax.
Maximizing contributions to a Health Savings Account (HSA) will reduce income for those of you currently covered by a high deductible health insurance plan. The 2016 HSA contribution limits are $6,750 for a family and $3,350 for an individual with an additional $1,000 catch up contribution allowed for those aged 55 or over. Similarly, contributing to an employer’s Flexible Spending Account for out of pocket medical expenses or a dependent care plan for child care expenses will reduce taxable wages, help get you below phase out limits and pay costs on a pre-tax basis.
Another income reducing strategy is to recognize investment losses in non-retirement accounts by Dec. 31 and hold off on selling investments in a gain until January. A capital loss will not only reduce capital gains recognized during the year, but any net losses will then be able to reduce other income (wages, etc.) up to $3,000 per year ($1,500 if married filing separately).
The remaining capital loss will then carry into next year and be available to reduce future income. To harvest a tax loss on an investment, a substantially identical investment must not be acquired 30 days prior to the sale or 30 days after, otherwise the loss will be limited under the wash sale rules.
A tax law change made permanent at the end of 2015 gives an exclusion for a direct charitable donation from an IRA to a charity for an individual aged 70½ or older. The transfer must be completed by Dec. 31 to the charity to be excluded and is limited to $100,000 per individual.
Making the direct IRA distribution means the money does not have to be reported as income on the tax return and can be a significantly better result than receiving a cash distribution, reporting the income and trying to deduct a charitable donation as an itemized deduction.
When income in 2016 is lower than expected in future years, the strategy of accelerating income and postponing deductions can be adopted. With lower income, it may make sense to recognize capital gains on investments outside of retirement accounts, which despite increasing income, may result in no federal tax.
Long-term capital gains for investments held greater than a year are taxed at a zero percent federal rate for taxpayers in the 10% and 15 percent marginal tax brackets creating an opportunity to sell an investment and pay no federal tax or to gift the investment to a family member in a lower tax bracket to sell. Best to check with your tax advisor to estimate how much of a gain can be recognized before selling and make sure no other tax liabilities will arise such as the “kiddie tax” for minors or Alternative Minimum Tax (AMT) that often surprises people at tax time.
Another income acceleration technique is to convert part or all of a taxable retirement account to a non-taxable Roth IRA.
Converting money from a taxable Traditional IRA or 401k account to a Roth IRA when income is low, may result in no tax despite recognizing income for the amount converted. Once converted, the Roth IRA can provide future non-taxable distributions, which is especially valuable if income is expected to increase in the future.
While we do not know what new tax proposals will be passed next year, there are many moves that can be done before year-end for laws already in place to trim your tax bill for this and possibly next year.
Mullin is a partner with Whittemore, Dowen & Ricciardelli LLP in Queensbury.