As January 1, 2017 gets closer, year-end tax planning considerations should be starting to take shape. New tax legislation has brought greater certainty to year-end planning, but has also created new challenges. The number of changes made to the tax code and the opportunities these changes bring may seem overwhelming. However, early planning will help you to maximize your potential tax savings and minimize your tax liability. This letter is intended to be a mile-high view of some key year-end tax planning strategies.
Personal Tax Considerations
As the tax law grows more complex, year-end becomes an increasingly important time to take inventory of your tax situation and to then take action. Income and deductions for the entire year usually become more clear as we move ever closer to the end of the year. The final months of the year provide a valuable “last chance” to change the course of your tax year before it closes for good. Launching some traditional year-end techniques designed to accelerate deductions and delay income (or vice versa, depending upon prospects for next year) may help to maximize your tax savings and minimize your tax liability for 2016.
Year-end has also become a time when there is an increasing need to take inventory of what has changed within the tax law itself since the beginning of the year. Opportunities and pitfalls within these recent changes should not be overlooked since they may impact your unique situation. This is particularly the case during year-end 2016. Last year, Congress passed a far-reaching tax bill: the Protecting Americans from Tax Hikes Act of 2015 (PATH Act). The impact of the PATH Act was not limited to 2015. Many of its provisions could play an important role in your year-end tax planning for 2016.
There have been several due date changes for both California and federal tax returns. Please review the Resources section of our website for these specific changes.
PATH Act “extenders”
The PATH Act plays a particularly prominent role in year-end tax planning for 2016. Enacted immediately before the start of 2016, the PATH Act permanently extended many tax incentives that were previously temporary, removing a lot of uncertainty.
However, not all of these “extenders” provisions were extended beyond 2016, and some were modified in the process. Others were extended for up to five years, deferring to “tax reform” a more lasting solution.
Here is a list of some of the major changes made by the PATH Act, especially focused on how they impact year-end transactions: For individual taxpayers, these include (among others) the:
- American Opportunity Tax Credit (made permanent)
- Educators’ $250 “classroom” expense and professional development expense deduction (made permanent)
- State and local sales tax deduction election, in lieu of state income taxes (made permanent)
- Exclusion for direct charitable donation of IRA funds of up to $100,000 for qualified individuals (made permanent)
- Code Sec. 25C residential energy property credit (generally through 2016 only but with special rules for some solar property)
- Fuel cell motor vehicle credit (through 2016 only)
- Mortgage insurance premium deduction (through 2016 only)
- Tuition and fees “above-the-line” deduction (through 2016 only).
Of course, there are always complexities in the Tax Code. In 2013, two new Medicare taxes kicked-in (3.8-percent net investment income (NII) surtax and a 0.9-percent Additional Medicare Tax) for higher tax-paying individuals, explained further below. In addition, the U.S. Supreme Court ruled that the federal government’s denial of recognition of same-sex marriage was unconstitutional, opening the door to allowing married same-sex couples to file joint federal tax returns and take advantage of other tax benefits available to married couples. Beginning in 2014, some of the most far reaching provisions of the Affordable Care Act became effective: the individual mandate, the start of Marketplaces to obtain insurance and a special tax credit to help offset the cost of insurance.
Planning for taxes and rates
One of the most significant changes over three years ago that still causes anxiety with many taxpayers is the creation of the 39.6% bracket, up from a top 35% rate. The Net Investment Income (NII) Tax is 3.8% on the lesser of net investment income or the excess of modified adjusted income over the threshold amount ($250,000 for joint filers and $125,000 for single filers).
For 2016, the starting points for the 39.6 percent bracket are $466,950 for married couples filing jointly and surviving spouses, $441,000 for heads of households, $415,050 for single filers, and $233,475 for married couples filing separately.
Planning for health care changes
Before year-end, individuals and businesses need to review how the Affordable Care Act will impact them. Despite several delays and legislative changes, the basic structure of the ACA for businesses, both large and small, generally remains intact. Applicable large employers (ALE), one with 50 or more full-time employees, must offer coverage to 95% of its full-time employees or pay a penalty. This penalty has increased tremendously since it was first enacted.
Planning for gifts
Gift-giving is often overlooked as a year-end planning strategy. For 2016, individuals can make tax-free gifts (no tax consequences for the giver or the recipient) of up to $14,000 to any individual. Married couples may “split” their gifts to each recipient, which effectively raises the tax-free gift to $28,000. Gifts between spouses are always tax-free unless one spouse is not a U.S. citizen.
There are special rules for gifts made for medical care and education that can be a valuable component of a year-end tax strategy, especially for individuals who want to help a family member or friend. Monetary gifts given directly to a college to pay tuition or to a medical service provider are tax-free to the person making the gift and the person benefiting from education or medical care.
Gifts to charity also are frequently made at year-end. Through the end of 2016, taxpayers age 70 ½ and older can make a tax-free distribution from individual retirement accounts to a charity. The maximum distribution is $100,000. Individuals taking this option cannot claim a deduction for the charitable gift.
Planning for retirement savings
Year-end is a good time to review if your retirement savings plans and tax strategies complement each other. For 2016, the maximum amount of contributions that can be made to an IRA is $5,500, with a $1,000 catch-up amount allowed for individuals over age 50. Keep in mind that the maximum amount that can be contributed to a Roth IRA begins to decrease once a taxpayer’s adjusted gross income crosses a certain threshold. Please note that 2016 contributions, for tax purposes, may be made until April 17, 2017.
If you are an employee and have not fully funded your 401(k) plan for the year, you might consider doing so by December 31, 2016.
Business Tax Considerations
This year end provides unique opportunities for virtually every business to reassess their business plan with an eye toward maximizing tax savings for the 2016 tax year and beyond. It is good to keep in mind the requirements and opportunities surrounding the tax treatment of repairs, improvements, acquisition costs and other common business expenses.
For businesses, the PATH Act extender provisions include (among others):
- Code Section 179 expensing (made permanent)
- Bonus depreciation (five years, with phase-out)
- Work Opportunity Credit (through 2019)
- 100-percent gain exclusion on qualified small business stock (made permanent)
- Reduced, five-year recognition period for S corporation built-in gains tax (made permanent)
- 15-year straight-line cost recovery for qualified leasehold improvements, restaurant property and retail improvements (made permanent)
- Film and TV production expense elections (through 2016 only)
- Energy efficient commercial buildings deductions (through 2016 only)
- Mine safety equipment expense elections (through 2016 only)
- Additional depreciation for biofuel plant property (through 2016 only)
Bonus depreciation was extended for five years and applies to qualifying new property placed in service before January 1, 2016. Unlike regular depreciation, a taxpayer is entitled to 50-percent bonus depreciation irrespective of when during the year the asset is purchased. Under current regulations, bonus depreciation is subject to phase-out over the next three years with decreasing deductions each year and expiration in the year 2019.
Code Section 179 expensing
Section 179 expense deduction was made permanent in the PATH Act and is available until for taxpayers (other than estates, trusts or certain non-corporate lessors) that elect to treat the cost of qualifying property as an expense rather than a capital expenditure. The current section 179 dollar cap for 2016 is $500,000. For tax years beginning after 2016, that dollar limit is indexed to inflation. For tax years beginning in 2016, the overall investment limitation is $2,010,000 and the deduction is subject to dollar-for-dollar phase-out, completely eliminated $2,510,000.
Revised Repair/Capitalization Rules
Back in January 2014, the final tangible property regulations (TPRs) became effective for all taxpayers. The purpose was to reduce controversy of whether repair expenses could be deducted in the current year or capitalized, but these regulations have created a substantial amount of controversy as well as changes.
De Minimis Safe Harbor Election
The de minimis safe harbor election allows a taxpayer, without an Applicable Financial Statement (AFS), to consider as a current expense the acquisition or production of a unit of property with a cost of $2,500. This was a big boost that occurred in 2016. Previously, it was $500. While taxpayers without an AFS are not required to have a written accounting procedure, it is recommended that the procedure be documented in writing to avoid any question as to whether or not the policy existed. For taxpayers with an AFS, the amount of the de minimis safe harbor remains at $5,000.
There are a number of California laws that do not comply with federal tax law. Please feel free to contact our office if you have any specific questions.
We have reviewed only some of the many year-end tax planning strategies that could help you minimize your 2016 tax bill and maximize savings. Please contact our office to schedule an appointment to personalize your 2016 year-end tax planning.