While tax legislation for 2016 provided some permanent tax extenders, there were not many significant new changes. However, 2017 promises to be a very busy year. With the House, Senate and the Oval Office virtually under Republican control, we can expect a very different landscape by the time next December rolls around.
Here is a brief summary of current tax law and planning tools to help reduce your tax burden, as well as some thoughts about tax law under a new administration.
Individual marginal tax rates for 2016 are unchanged (10%, 15%, 25%, 28%, 33%, 35%, 39.6%), but there is increasing political support for only three tax rates in 2017 (12%, 25%, 33%). For those in a higher bracket, postponing recognition of income into 2017 and taking more deductions in 2016 is probably your best strategy.
For 2016, long-term capital gain and qualified dividend rates of 0%, 15% and 20% remain and for now there is no proposal to change this.
The 3.8% Medicare surtax on Net Investment Income (NII) was enacted to pay for the cost of the Affordable Care Act (Obamacare). President-Elect Trump has promised to do away with Obamacare and the 3.8% surtax as well. Since NII includes capital gains, under a Trump tax plan you would be better off postponing recognition of capital gains until 2017.
The .9% Additional Medicare Tax on wages over $250,000 for joint filers and $200,000 for single filers was also enacted to pay for the Affordable Care Act and likewise would be a candidate for elimination by President-Elect Trump.
The Alternative Minimum Tax (AMT) remains 26% and 28% for 2016, depending on income levels, and this too is targeted for elimination under a Trump administration. If so, you will want to shift expenses that trigger AMT into 2017. Examples include your fourth quarter estimated state income tax payment and property tax payments.
The personal exemption for 2016 is $4,050, but it is phased out by 2% for income above $311,300 if married ($259,400 if single). The Trump proposal is to eliminate the personal exemption, but beef up the standard deduction.
The 2016 standard deduction amounts stay at $12,600 for married filing joint and $6,300 for single taxpayers, but increases $50 to $9,300 for head of household. President-Elect Trump proposes a flat $30,000 standard deduction ($15,000 if single).
Itemized deductions are currently phased out at the rate of 3% of income above $311,300 if married ($259,400 if single). The Trump proposal is to limit itemized deductions to $200,000 if married ($100,000 if single).
Those in Congress concerned about deficit spending might not go along with all the tax proposals suggested by President-Elect Trump, so the safest tactic is to hedge your bets. For those in a high tax bracket (not subject to AMT), you’ll be best off accelerating as many deductions into 2016 as possible and postponing income recognition until next year. For those in a lower tax bracket, no dramatic steps are required.
If you are considering converting your traditional IRA to a Roth IRA, or you are expecting one-time transactions that will produce significant income, moving the recognition of that income into 2017 is probably your best strategy.
For all tax brackets, tax loss harvesting is an important year-end strategy. International stocks and stock mutual funds decreased in value in 2016 and so did long-term bonds. Selling those investments will establish a loss for tax purposes. You can replace these securities with an investment that is somewhat similar, but to avoid the “wash” sale rule, you can’t buy back the same or substantially same security within the following 30-day period.
When developing your 2016 year-end planning strategy, also be sure to consider the following Alternative Minimum Tax (AMT) and Net Investment Income (NII) surtax wrinkles:
· For taxpayers who typically have significant AMT, regular tax rate increases are not likely to cause an overall tax increase. In this situation, when the regular tax bill increases, the AMT bill decreases, resulting in the exact same net tax bill. However, the NII surtax is computed without regards to AMT and will increase your overall tax bill, if the applicable income threshold is exceeded.
· Although harvesting long-term capital gains to capture lower favorable tax rates is generally a good idea, for taxpayers who typically incur AMT this strategy may not work well, as lower tax rates on investment income can increase AMT. In addition, if the applicable income threshold is met, all or a portion of the gains generated might be subject to the 3.8% NII surtax.
FICA taxes (the combined rate for Social Security and Medicare) remain at 7.65% (15.3% for self-employed persons). The Medicare tax is increased by .9% to 2.35% for married taxpayers with combined wages over $250,000 and for single taxpayers with wages over $200,000.
The maximum Social Security earnings limit of $118,500 for 2016 increases to $127,200 for 2017. Medicare tax payments continue on all wages.
The age at which full benefits are available (full retirement age) has been increased from age 65 to 67, on a phased-in schedule. This affects everyone born after 1937 and varies based on the year of birth. For those born between 1943 and 1954, the full retirement age is 66. Although early retirement at age 62 is still possible, benefits are substantially reduced.
Retirees who have reached full retirement age may work without any reduction in Social Security benefits. However, the earnings limit still applies to workers who have not reached full retirement age. In 2017, benefits are reduced $1 for every $2 earned over $16,920 for those age 62 to full retirement age. In the year full retirement age is reached, benefits are reduced $1 for every $3 earned over $44,880, but only earnings before the month you reach full retirement age are subject to the reduction.
There has been no change in the computation of how much Social Security will be taxed for 2016. For those with "provisional" income above $44,000 ($34,000 if single), you will be taxed on 85% of those benefits. The 50% tax rate remains for income between $32,000 and $44,000 ($25,000 and $34,000 if single). This differential in tax rates makes it very important to plan receipt of income to take advantage of the 50% rate.
In 2016, for children under 18 and full-time students under 24, the “kiddie tax” rules are as follows:
· Income of up to $1,050 is tax-free.
· Investment income of between $1,051 and $2,100 is taxed at the child's lower tax rate (as low as 0% for qualified dividends and capital gains).
· Investment income of more than $2,100 is taxed at the parent's marginal tax rate.
These “kiddie tax” rules mean you need to be careful before shifting income to children. However, hiring your children in your business may still yield good results.
Retirement contributions (whether 401(k), 403(b), profit sharing, pension, SEP, or SIMPLE) still provide a major opportunity to reduce your tax bill. If you have an employer sponsored salary deferral plan, in most situations it makes sense to maximize your contributions. Contribution limits to 401(k) and 403(b) plans for 2017 remain unchanged at $18,000. For those age 50 or older, the additional annual allowable “catch-up” contribution remains unchanged at $6,000.
For business owners, the maximum you can contribute to a qualified retirement plan for 2016 is the lesser of $53,000 ($59,000 with “catch-up”), or 25% of your compensation. For 2017, the limit increases to $54,000 ($60,000 with the catch-up). The maximum compensation level for computing your contribution is $265,000 for 2016 and $270,000 for 2017.
The maximum Individual Retirement Account (IRA) deduction is $5,500 for 2016 and 2017, but if you are age 50 or older by year-end, you can contribute up to $6,500 for 2016 and 2017.
For married filing joint taxpayers, traditional IRA contributions are not deductible if you and your spouse are covered by a company retirement plan and your combined income exceeds $118,000 in 2016 and $119,000 in 2017. However, a deductible IRA is allowed if one spouse is covered by an employer-sponsored plan, but the other is not, as long as Adjusted Gross Income (AGI) is less than $194,000 in 2016 and $196,000 in 2017.
For single taxpayers, traditional IRA contributions are deductible, but not if you are covered by a company retirement plan and your combined income exceeds $71,000 for 2016 and $72,000 in 2017.
If you are prohibited from deducting IRA contributions, you may still fund nondeductible contributions. Earnings on these contributions accumulate tax-free until they are withdrawn. If you make nondeductible IRA contributions, keep a record of contributions using IRS Form 8606 to be certain that you are not taxed on this money when it is withdrawn.
Don’t forget that non-working spouses are allowed to contribute the full amount to an IRA account, whether deductible or not, as long as the other spouse has sufficient earned income. This is an excellent opportunity to shelter additional income and allow earnings to accumulate tax-free.
If your AGI in 2016 is below $194,000 if married ($132,000 for singles), a Roth IRA should be chosen instead of a nondeductible traditional IRA, because earnings on a Roth IRA can escape taxation when withdrawn.
Section 529 plans (like Edvest in Wisconsin) remain a popular way to save for college. Contribution limits are generous, there are no income limitations, and withdrawals used to pay college costs are tax-free as long as funds are used for post-secondary education. Contributions can be on behalf of any individual, not just dependents or grandchildren, nieces and nephews.
In Wisconsin, contributions made up until April 18th of 2017 can be counted for 2016. Also for Wisconsin:
· Contributions over $3,100 per beneficiary may be carried forward and deducted in a future year
· Rollovers from other state plans are acceptable and the principal portion is eligible for tax deduction
· Funds contributed must be kept in the account at least 365 days before being used to qualify for deduction
· The maximum account balance per beneficiary is $440,300
· Computers and related technology costs, such as Internet access fees and printers are qualified expenses
Qualifying dividends and long-term capital gains continue to be taxed at a lower, more favorable rate of 15% (or 0% if your tax rate is 15% or less). However, for 2016, if taxable income is greater than $466,950 for joint filers or $415,050 for single filers, the top tax rate increases to 20%. In addition, dividends and capital gains are subject to a 3.8% Net Investment Income surtax for married filers with modified adjusted gross income (MAGI) exceeding $250,000 and single taxpayers with MAGI exceeding $200,000.
The best strategy is as follows:
· In retirement (sheltered) accounts, you want to own investments that are not eligible for lower tax rates, such as taxable bonds, Real Estate Investment Trusts (REITs), high turnover stock funds and short-term stock holdings.
· In your taxable (unsheltered) accounts, you want to hold state and municipal bonds (or municipal bond funds) to take advantage of federally tax-free (and sometimes also state tax-free) income generated from these investments, as well as appreciating securities being held more than 12 months, as gains from long-term holdings still enjoy a slightly lower tax rate.
Generally, it is not a good idea to make after-tax investments in mutual funds near year-end because mutual fund companies distribute capital gains to shareholders near the end of the year. This means that you could end up paying tax on an entire year of capital gains even if you did not receive any cash, and even if you owned the fund for only a few days. Many stock mutual funds experienced gains in 2016 despite the volatility of the market, and are likely to post substantial capital gains. To find out when capital gains will be posted, call your broker, or look at the website for your mutual fund company.
As always, look for losses in your portfolio that can be sold to help offset recognized capital gains.
Keep in mind that short-term and long-term gains and losses are netted together, and net losses are deductible to a maximum of $3,000 per year, with an indefinite carry-forward. Net capital losses exceeding $3,000 cannot be used to reduce other types of investment income for purposes of the 3.8% Net Investment Income surtax computations. Also remember that brokerage costs decrease your taxable gain and bonds purchased between interest dates require an interest adjustment for tax purposes.
The Internal Revenue Service allows one extra payment of monthly interest in one year. Therefore, if you make your January loan payment before December 31, it can be deducted this year. Be sure to verify that your lender has reported this payment correctly when they mail you your statement at year-end. Because of mail delays, process your payment on or before December 23rd to allow enough time for it to be credited to your account before year-end.
You may deduct 14 cents per mile for travel in providing services to a charitable organization.
If payment for a charitable contribution is mailed or charged to a credit card before December 31, the deduction can be taken in the current year.
There is a bonus if you donate, to a qualified charity, investments that have increased in value and have been held for more than 12 months. You can deduct the full fair market value of the security and avoid paying capital gain tax on the appreciation. The strategy of donating securities works best for investments that have increased significantly in value, or for which you have no record of the original cost. If you have investments that have dropped in value, you are better off selling them to recognize a tax loss, and then contributing the cash to charity.
Every cash donation must be supported by a cancelled check, credit card receipt or written communication from the charity. Moreover, to be deductible, non-cash clothing and household donations must be in at least “good condition”. Remember, if you have total non-cash contributions of $500 or more during the year, some additional information is needed about the donations, such as how you determined the worth of the donated property, what it originally cost, and how you acquired the property. If your gift is over $5,000, a qualified appraisal is required. Finally, specific rules about the value of your deduction apply to donations of vehicles and watercraft.
Keep in mind, you must obtain a written receipt from charities for all gifts over $250, as a cancelled check is not considered sufficient support. Also, for non-cash gifts, the receipt must describe the gift in detail, but it need not confirm its value. You are required to have your receipt in hand, before your return is filed.
(1) Raffle winnings are taxable and the cost of a raffle ticket is not deductible.
(2) Donation of a week’s stay at your second home to a charity auction is not deductible.
(3) If you bid on an auction item, you can only deduct what you paid above fair market value. And if the charity marks it “priceless,” it isn’t. Everything has a cost or market value.
Finally, if you receive something in exchange for your donation, say a meal or a complimentary ticket, the charity must tell you in writing what portion of your donation is deductible. If no goods or services are received in exchange for your donation, the receipt must state so. If this wording is missing, notify the charity and obtain a corrected document. We have noticed several well-known charities that do not have proper wording in their acknowledgements.
The threshold for deduction of medical expenses is 10% of Adjusted Gross Income. However, taxpayers who are age 65 or older before the end of the tax year use the 7.5% threshold. Starting in 2017, everyone is subject to the 10% threshold.
The standard mileage rate for use of your car for medical reasons (or when computing deductible moving expenses) is 19 cents per mile for 2016, and decreases to 17 cents per mile for 2017.
Casualty losses (such as flood damage) are allowed, but only if losses exceed 10% of Adjusted Gross Income.
Miscellaneous deductions (such as IRA fees, subscriptions to trade magazines, tax and investment advice, safe deposit box fees and unreimbursed employee business expenses) must exceed 2% of Adjusted Gross Income before they are deductible.
Most rental real property is considered a “passive” investment. For Adjusted Gross Income under $100,000, up to $25,000 of losses are deductible, but only if you actively participate in managing the property.
For Adjusted Gross Income over $100,000, the rental loss is phased out, with no current deduction available for taxpayers having income over $150,000. However, if you spend over half your total working time (at least 750 hours a year) on realty development or management, you can deduct all rental real estate losses from regular income and the $25,000 loss limit does not apply.
Although rental losses may be phased out, they are not lost. Such losses are postponed and are used to offset future gains, or deducted in full when the property is disposed of.
Rental income is subject to the 3.8% Net Investment Income surtax if modified adjusted gross income exceeds $250,000 for joint filers and $200,000 for single filers, unless the income is from a rental trade or business (i.e. you qualify as a real estate professional with respect to this income).
For 2016 and 2017, individuals are eligible to give $14,000 per calendar year to as many persons as they wish and avoid gift tax filings. Married couples can contribute up to $28,000 per year to one individual and avoid having to file a gift tax return. In addition to these limits, tuition and medical expenses paid on someone’s behalf also avoid gift and estate tax, regardless of the dollar amount, as long as the payments are made directly to the educational or medical institution.
Most people do not realize that life insurance proceeds paid to your beneficiary may be taxed as part of your estate when you die. In addition, proceeds from IRAs and retirement plans can be taxed twice when you die; once as part of your estate, and once on the beneficiary’s tax return. Consult your estate planning attorney for details and techniques to avoid double-taxation.
For 2016, the federal estate tax is imposed on assets of $5.45 million or more at a maximum tax rate of 40%. For 2017, the exclusion amount increases to $5.49 million. Lifetime gift tax and generation skipping tax exclusion amounts now follow these same exclusion figures.
President-Elect Trump has promised to entirely do away with estate taxes and it looks like Congress will support this. This means that assets won’t receive a step-up in basis on death, so capital gain taxes will be due when estate assets are sold. Once tax law has been finalized for estates and trusts, we suggest having your situation reviewed by an estate planning attorney.
The deduction for business meals and entertainment continues to be 50%, but you may not claim any part of club dues, even if your membership is solely for business reasons. In addition, business travel deductions are limited to expenses for yourself and your employees. You are not allowed to claim expenses for a non-employee spouse, dependent or other traveling companion.
Receipts are not required (but are highly recommended) for business expenses under $75. However, upon audit you still need some evidence to support the expense.
The standard mileage rate for business use of an automobile is 54 cents per mile for 2016, and decreases to 53.5 cents per mile for 2017.
Form 1099-MISC is required for all purchases of services over $600, unless you paid the money to a corporation. One exception - Form 1099-MISC needs to be issued for legal services, even if the law firm is a corporation. Penalties for not filing have increased substantially.
President-Elect Trump wants all business income to be taxed at a flat rate of 15%. This would cover self-employment income, LLC income and S-Corporations. However, the GOP blueprint calls for a 20% corporate tax rate, 25% for self-employed and businesses that pass income through.
Don’t forget that Wisconsin and most other states continue to have a strong focus on "Use Tax". If you make any out-of-state purchases (using the Internet or catalogs for example) without the payment of sales tax, you should be reporting Use Tax on your state tax return. In an attempt to increase revenues many states continually update sales and use tax legislation, so careful attention should be given to what items are considered taxable. For example, in Wisconsin, Use Tax applies to the sale, storage or use of digital goods. This means that iTunes and movie downloads are taxable.
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Happy holidays and best wishes for the start to a healthy new year!
Arnow & Associates
3966 North Lake Drive
Shorewood, Wisconsin 53211
Notice and Disclosure
The information contained in this document does not cover all tax strategies that may apply, is not a complete guide to tax planning, and does not constitute the rendering of legal, accounting, or other professional advice or opinions on specific facts or matters. Before implementing any ideas suggested here, consult with your tax advisor regarding your specific tax situation.
LJA xtax2 11/23/16