Thinking Through Year End and New Year Taxes

As we approach the end of 2016, we at Strauss Attorneys, PLLC would like to remind you of measures you can take to minimize your income tax liability. By taking proactive steps to secure credits and deductions, or accelerating or postponing income or deductions, a savvy taxpayer can significantly lower his income tax liability. This letter begins by highlighting a few changes to the tax landscape in 2016 and proceeds to summarize a number of strategies that can be employed to save money.

Changes to the Tax Landscape

The change in the tax landscape in 2016 that will affect the largest number of Americans is the increased Affordable Care Act tax penalty on Americans lacking health insurance. In 2016, the penalty jumped to the greater of $695 per adult and $347.50 per child or 2.5 percent of income above the tax-filing threshold. After 2017, the percentage will remain at 2.5 percent of income, but the flat rate penalty will be indexed for inflation.

Other changes to the tax code that will affect many Americans are the annual increases in amounts of certain available deductions and credits. The IRS website provides the following information about the contribution limits for retirement plans phase-outs for 2017:

• For single taxpayers covered by a workplace retirement plan, the phase-out range is $62,000 to $72,000, up from $61,000 to $71,000.
• For married couples filing jointly, where the spouse making the IRA contribution is covered by a workplace retirement plan, the phase-out range is $99,000 to $119,000, up from $98,000 to $118,000.
• For an IRA contributor who is not covered by a workplace retirement plan and is married to someone who is covered, the deduction is phased out if the couple’s income is between $186,000 and $196,000, up from $184,000 and $194,000.
• For a married individual filing a separate return who is covered by a workplace retirement plan, the phase-out range is not subject to an annual cost-of-living adjustment and remains $0 to $10,000

The income limits for contributing to a Roth IRA will increase to $118,000 to $133,000 for singles and heads of household, up from $117,000 to $132,000 in 2016. For married couples filing jointly, the income phase-out range is $186,000 to $196,000, up from $184,000 to $194,000. The phase-out range for a married individual filing a separate return who makes contributions to a Roth IRA is not subject to an annual cost-of-living adjustment and remains $0 to $10,000.

Finally, what hasn’t changed:

• The contribution limit for employees who participate in 401(k), 403(b), most 457 plans, and the federal government’s Thrift Savings Plan remains unchanged at $18,000.
• The catch-up contribution limit for employees aged 50 and over who participate in 401(k), 403(b), most 457 plans, and the federal government’s Thrift Savings Plan remains unchanged at $6,000.
• The limit on annual contributions to an IRA remains unchanged at $5,500. The additional catch-up contribution limit for individuals aged 50 and over is not subject to an annual cost-of-living adjustment and remains $1,000.

Credits and Deductions

Most year-end income tax planning strategies fall into two broad categories: first, maximizing available credits and deductions, and second, accelerating and postponing income and deductions. Perhaps the best way to minimize your tax liability is to be aware of all tax credits and deductions for which you may qualify. If you file your own taxes, this entails properly understanding credits and deductions to which you are entitled. But even if you work with a tax professional, it is important that you be sure to fully inform them on changes in your life that may help you qualify.

The following are among the life changes that often significantly impact your income tax liability:

• Marriage, divorce or death of a spouse.
• Birth of a child
• Child aging out of child credit
• Casualty losses
• Medical procedures
• Moving
• Increased College or Tuition Expenses
• Employment changes
• Retirement
• Bankruptcy
• Inheritance
• Business Success of Failure

If any of these may apply to you, be sure to investigate how they may affect your eligibility for credits or deductions and, therefore, your overall income tax liability.

Common Deductions

While an in depth discussion of available credits and deductions is beyond the scope of this letter, but it is helpful briefly to review some of the most significant. Major deductions include the following:

• Business Use of Car – you may deduct the entire cost of operation if you use it only for work (subject to limits), or only the cost of its business use if you use the car for both business and personal purposes.
• Business Use of Home – you can take a deduction for the value of portions of your house used exclusively and regularly as principal place of business for your trade or business; as a place where you meet and deal with your patients, clients, or customers in the normal course of your trade or business; as business storage or as rental space.
• Home Related Expenses – deductible expenses for business use of your home include the business portion of real estate taxes, mortgage interest, rent, casualty losses, utilities, insurance, depreciation, maintenance, and repairs. You may not deduct expenses for lawn care in general or for painting a room not used for business.
• Business Travel Expenses – the ordinary and necessary expenses of traveling away from home for your business, profession or job.
• Bad Business Debt – you may be entitled to a deduction if there was an intention at the time of the transaction to make a loan and not a gift AND you have no reasonable expectation that the nonbusiness bad debt will be repaid.
• Depreciation – for certain capital expenditures, machinery, equipment, buildings, vehicles, and furniture, you can deduct a part of the cost every year until you fully recover its cost.
• Taxes – you may be able to deduct certain non-business taxes if you itemize deductions using Form 1040: state, local and foreign income or real estate taxes, as well as state and local personal property and general sales taxes.
• Medical Expenses – you can deduct the part of your medical and dental expenses that is more than 10% of your adjusted gross income (AGI), or if either you or your spouse was born before January 2, 1950, you can deduct the amount that is more than 7.5% of your AGI.
  • This extends to the costs of diagnosis, cure, mitigation, treatment, or prevention of disease, and the costs for treatments affecting any part or function of the body.
  • Payments for legal medical services rendered by physicians, surgeons, dentists, and other medical practitioners, including the costs of equipment, supplies, and diagnostic devices needed for these purposes. These can generally include medical expenses you pay for yourself, your spouse or your dependent either when the services were provided or when you paid for them. But medical care expenses must be primarily to alleviate or prevent a physical or mental defect or illness.
  • Mileage: The standard mileage rate allowed for operating expenses for a car when you use it for medical reasons is 17 cents per mile driven for medical or moving purposes.
• Student Loan Interest – you can reduce your income subject to tax by up to $2,500 by deducting the cost of interest paid on your student loan. The student must be you, your spouse, or your dependent and enrolled at least half-time in a degree program. The loan must have been taken out solely to pay qualified education expenses and cannot be from a related person. This deduction phases out at $160,000 if married filing a joint return or $80,000 if single, head of household, or qualifying widow(er).
• Educational Savings Plans – if you participate in a qualified tuition program (QTP) or “529 plan,” earnings from the plan are generally tax-free if the total distribution is less than or equal to adjusted qualified education expenses.

In addition to deductions, which lower the amount of your taxable income, you may also qualify for tax credits, which can further chip away at the total tax owed.

• Earned Income Tax Credit – you may qualify for this credit if you work, have a Social Security number and have an income below specific thresholds. EITC is a refundable tax credit, which means you may get money back even if you have no tax withheld. For tax year 2016, both earned income and adjusted gross income (AGI) must each be less than:
  • $15,010 ($20,600 married filing jointly) with no qualifying children;
  • $39,617 ($45,207 married filing jointly) with one qualifying child;
  • $45,007 ($50,597 married filing jointly) with two qualifying children;
  • $48,340 ($53,930 married filing jointly) with three or more qualifying children.
• Child Tax Credit – you may be able to claim the child and dependent care credit if you paid expenses for the care of a qualifying individual to enable you and your spouse filing a joint return to work or actively look for work.
  • The dollar limit on the amount of the expenses you can use to figure the credit is $3,000 for the care of one qualifying individual or $6,000 for two or more qualifying individuals.
  • The amount of your credit is a between 20 and 35 percent of your allowable expenses, depending on the amount of your adjusted gross income.
• Adoption Credit – if you adopted a child, you may be eligible for a credit of up to $13,400 per child for qualified adoption expenses paid and an exclusion for employer-provided adoption assistance. The credit is nonrefundable, which means it is limited to your tax liability for the year.
  • For both the credit and the exclusion, qualified adoption expenses, defined in section 23(d)(1) of the Code, include reasonable and necessary adoption fees, court costs and attorney fees, traveling expenses (including amounts spent for meals and lodging while away from home), and other expenses that are directly related to and for the principal purpose of the legal adoption of an eligible child.
• Education Credits – if you, your spouse, a student you claim as a dependent on your return, or a third party paid qualified tuition expenses in 2016, you may be eligible for either the American Opportunity Tax Credit or the Lifetime Learning Credit.
  • The American Opportunity Tax Credit is a credit for the first four years of higher education. You can get a maximum annual credit of $2,500 per eligible student. If the credit brings the amount of tax you owe to zero, you can have 40 percent of any remaining amount of the credit (up to $1,000) refunded to you.
    • To claim the full credit, your modified adjusted gross income must be $80,000 or less ($160,000 or less for married filing jointly). You receive a reduced amount of the credit if your MAGI is over $80,000 but less than $90,000 (over $160,000 but less than $180,000 for married filing jointly).
  • The Lifetime Learning Credit is for qualified tuition and related expenses paid for eligible students enrolled in an eligible educational institution. This credit can help pay for undergraduate, graduate and professional degree courses, including courses to acquire or improve job skills. There is no limit on the number of years you can claim the credit. It is worth up to $2,000 per tax return and is not refundable.
    • To claim the full credit, your modified adjusted gross income must be $55,000 or less ($110,000 or less for married filing jointly). If your modified adjusted gross income is over $55,000 but less than $65,000 (over $110,000 but less than $130,000 for married filing jointly), you receive a reduced amount of the credit. If your MAGI is over $65,000 ($130,000 for joint filers), you cannot claim the credit.
    • Qualified expenses are amounts paid for tuition, fees and other related expense for an eligible student that are required for enrollment or attendance at an eligible educational institution, including student activity fees you are required to pay to enroll or attend.
  • Miscellaneous Educational Deductions – you may also be able take advantage of several other educational incentives:
    • You can make early distributions from any type of individual retirement arrangement (IRA) for education costs without paying the 10% additional tax on early distributions;
    • Savings bonds can be cashed in for education costs without having to pay tax on the interest;
    • Educational benefits from your employer are tax free; and
    • You can claim a business deduction for work-related education.
• Credit for the Elderly or Disabled – if you are aged 65 or older or retired on permanent and total disability and received taxable disability income for the tax year and meet certain income limits, you may qualify for a credit of between $3,750 and $7,500.
• Mortgage Interest Credit – in North Carolina, first time home buyers and veterans who meet certain income requirements may qualify for a Mortgage Credit Certificate from your local or state government that allows you to claim a tax credit for a portion of your annual mortgage interest expense.
  • You can claim 30% of the interest you pay on your mortgage if you purchase an existing home or 50% of the interest for a new home (never occupied) – up to $2,000 for every year you live in your home – as a tax credit on your federal income taxes.
  • Your deduction is generally limited if all mortgages used to buy, construct, or improve your first home (and second home if applicable) total more than $1 million ($500,000 if you use married filing separately status).
  • You can also generally deduct interest on home equity debt of up to $100,000 ($50,000 if you’re married and file separately) regardless of how you use the loan proceeds.
• Residential Energy Efficient Property Credit – if you buy certain home energy efficiency equipment, including solar hot water heaters, solar electric equipment and wind turbines, you can qualify for a credit of 30 percent of the expenditures made by a taxpayer during the taxable year for qualified equipment.
  • There is no dollar limit on the credit for most types of property. If your credit is more than the tax you owe, you can carry forward the unused portion of this credit to next year’s tax return.
  • Nonbusiness Energy Property Credit – if you make certain qualifying energy efficient improvements to you home, such as insulation, water heaters or air systems, you may qualify for a credit of up to $500, only $200 of which can be for windows.
  • Electric Vehicle Credits – purchases of a qualifying electric vehicle can result in a credit of as much as $7,500 against your income tax. To qualify, you must purchase a new vehicle made by a manufacturer that complies with the Clean Air Act and weighs 14,000 pounds or less.

The deductions and credits listed above are among the most significant for the average taxpayer, but there are many others that may apply to specific circumstances.

Timing Your Income and Deductions

Aside from simply taking credits and deductions, a significant aspect of year-end tax planning, and one that many people fail adequately to utilize, is taking measures to shift income or deductions from one year to another. This is especially important for taxpayers who know they will be in different income brackets in different years; by shifting income into years in which you are in a lower bracket or shifting deductions into a year in which you are in a higher bracket, you can significantly reduce your overall, combined taxable income for those years. For instance, if you are nearing the end of your career and expect to transition from a high annual income to a lower annual income, you may be able to delay some income until after January 1st. But even if you are likely to be in the same bracket, you can still benefit from postpone income and accelerate deductions by taking advantage of the time value of money.
One can utilize a number of strategies to postpone income:

• Arrange with your employer to have a bonus delayed until 2016
• Delay billable services
• Delay debt forgiveness income
• Hold on to appreciated assets until next year
• Structure or avoid mandatory like-kind exchange treatment
• Minimize retirement distributions
• Take an eligible roll over distribution from a qualified retirement plan
• Postpone a conversion from a traditional IRA to a Roth IRA
• Enter into installment contracts to postpone income.

Similarly, there are many ways to accelerate deductions into the current year:

• Maximize Health Savings Account contributions
• Maximize IRA charitable contributions
• Bunch itemized deductions into 2016
• Pay expenses on credit to generate current deductions
• Settle insurance claims to maximize casualty loss deductions
• Make energy saving improvements before January 1st.
• Pre-pay state, local or foreign taxes
• Charitable deductions – donate appreciated long term capital gain property
• Pre-pay higher education costs

As we approach the end of 2016, thinking through these matters with your professional advisors – CPAs, financial advisors and attorneys – can help you minimize your income tax liability and may save you considerable money. If you have any questions about these matters, or indeed, about any of your estate planning, business, tax or legal matters, we would be happy to assist. Please contact our Asheville office at 828-258-0994 or our Hendersonville office at 828-696-1811 to schedule an appointment.
We at Strauss Attorneys, PLLC, wish you a wonderful New Year!

Sincerely,

Lorin G. Page, Esq.