It’s that time of year when we should think about preparing an estimate of your current year tax liability and see if there are any ways we can reduce your tax liability. If you know of anyone else who may benefit from some tax planning, please feel free to forward the e-mail or have them contact me.
There are several things to consider when doing year-end tax planning: taking advantage of expiring tax provisions, deferring income into the following year and accelerating expenses into the current year. The proper strategy depends on whether or not you anticipate a significant change in income or expenses next year.
In addition, the following are some changes in the law that took effect this year, as well as some popular deductions and credits to which you may be entitled.
- Top Tax Rate
For 2015, the top tax rate of 39.6 percent applies to taxable income in excess of $464,850 (joint returns), $413,200 (single).
- Tax Rate on Certain Capital Gains and Dividends
For taxpayers in the 10%-15% brackets, the capital gains rate is zero. For those in the 25% to 35% tax bracket, the capital gains rate is 15%. For those in the 39.6% tax bracket, the rate goes up to 20% with an additional 3.8% tax imposed on net investment income.
- Taxes Still in Effect in 2015
A 3.8 percent tax on net investment income above a threshold amount, and a .9 percent additional tax on wages and self-employment income above a threshold amount. For both taxes, the threshold amount is $200,000 ($250,000 if married filing jointly). Income taken into consideration in calculating net investment income includes most rental income and net gain attributable to the disposition of property other than property held in a trade or business. Thus, this generally covers sales of interests in a partnership or S corporation.
- Increased Threshold for Deducting Medical Expenses
Medical and dental expenses that exceed a certain percentage of your adjusted gross income (AGI) for the year are deductible. For year 2015 the deduction floor is 10 percent. However, for any tax year ending before January 1, 2017, the floor is 7.5 percent if you or your spouse have reached age 65 before the end of that year.
- Reduction in Personal Exemptions and Itemized Deductions for High-Income Taxpayers
In addition, there is a reduction in personal exemptions and itemized deductions for taxpayers with adjusted gross income over $258,250 (single), $309,900 (joint returns) which has the effect of increasing taxes on affected taxpayers. We need to consider whether these new taxes affect you and, if so, whether you have paid a sufficient amount of taxes through withholdings and estimated tax payments so as to avoid any underpayment of estimated tax penalty. For those with second homes with a mortgage or with high itemized deductions, this could be a significant tax hike.
- Deduction for Eligible Teacher Expenses
Another provision that expires this year is the deduction for eligible teacher expenses. Eligible educators (i.e., teachers) can deduct from gross income up to $250 of qualified expenses they paid during the year.
- Student Loan Interest Deduction
If you had any student loans during the year and your modified adjusted gross income (MAGI) is within certain limits, you may deduct up to $2,500 of interest paid on that loan in computing adjusted gross income. For 2015, the deductible amount is phased out if your MAGI is between $65,000 and $80,000 ($130,000 and $160,000 if filing a joint return). You cannot take a student loan interest deduction if your MAGI is $80,000 or more ($160,000 or more if filing a joint return). The deduction is not available if your filing status is married filing separately.
- American Opportunity Tax Credit
If you paid any qualified education expenses during the year, you may be eligible for the American Opportunity tax credit. The maximum credit amount is $2,500 per year for each eligible student. The amount of the credit for each student is calculated as 100 percent of the first $2,000 of qualified education expenses paid for the student and 25 percent of the next $2,000 of such expenses paid. The credit may be reduced, however, depending on your modified adjusted gross income (MAGI).
For 2015, MAGI between $80,000 and $90,000 ($160,000 and $180,000 for joint filers) is used to determine if there is any reduction. If your MAGI is in excess of $80,000 ($160,000 for joint filers), the amount of the credit is phased out by multiplying the otherwise allowable credit by a fraction, the numerator of which is the amount by which your MAGI exceeds $80,000 ($160,000 for joint filers), and the denominator of which is $10,000 ($20,000 for joint filers). No credit is allowed if your MAGI is $90,000 or more ($180,000 or more for joint filers).
- Alternative Minimum Tax
If you are subject to the alternative minimum tax (AMT), your deductions may be limited. Thus, if we anticipate that you will be subject to the AMT, we need to consider the timing of deductible expenses that may be limited under AMT.
- Other Steps to Consider Before the End of the Year
The following are some of the additional actions we should review before year end to see if they make sense in your situation. The focus should not be entirely on tax savings. These strategies should be adopted only if they make sense in the context of your total financial picture.
- Accelerating Income into 2016
Depending on your projected income, it may make sense to accelerate income into 2015. Besides harvesting gains from your investment portfolio, other options for accelerating income include:
(1) if you own a traditional IRA or a SEP IRA, converting it into a Roth IRA and recognizing the conversion income this year;
(2) taking IRA distributions this year rather than next year only if absolutely needed;
(3) selling stocks or other assets with taxable gains this year;
(4) if you are self employed with receivables on hand, trying to get clients or customers to pay before year end; and
(5) settling lawsuits or insurance claims that will generate income this year.
- Deferring Income into 2016
There are also scenarios (for example, if you think that your income will decrease substantially next year) in which it might make sense to defer income into the 2016 tax year or later years. Some options for deferring income include:
(1) if you are due a year-end bonus, asking your employer to pay the bonus in January 2016;
(2) if you are considering selling assets that will generate a gain, postponing the sale until 2016;
(3) delaying the exercise of any stock options you may have;
(4) if you are selling property, considering an installment sale;
(5) consider parking investments in deferred annuities;
(6) establishing an IRA, if you are within certain income requirements; and
(7) if your employer has a 401(k) plan, consider putting the maximum salary allowed into it before year end.
- Deferring Deductions into 2016
Once again, if we expect tax rates to increase next year, or if you anticipate a substantial increase in taxable income, we may want to explore deferring deductions into 2016 by looking at the following:
(1) postponing year-end charitable contributions, property tax payments, and medical and dental expense payments, to the extent you might get a deduction for such payments, until next year; and
(2) postponing the sale of any loss-generating property.
- Accelerating Deductions into 2015
If you expect your income to decrease next year, we should accelerate what deductions we can into the current year to offset the higher income this year. Some options include:
(1) consider prepaying your property taxes in December;
(2) consider making your January mortgage payment in December;
(3) if you owe state income taxes, consider making up any shortfall in December rather than waiting until your return is due;
(4) since medical expenses are deductible only to the extent they exceed 10 percent (7.5 percent if you or your spouse are 65 before the end of the year) of your adjusted gross income (AGI), if you have large medical bills not covered by insurance, bunching them into one year may help overcome this threshold;
(5) making any large charitable contributions in 2015 rather than 2016;
(6) selling some or all of your loss stocks; and
(7) if you qualify for a health savings account, consider setting one up and making the maximum contribution allowable.
- Life Events
Certain life events can also affect your tax situation. If you’ve gotten married or divorced, had a birth or death in the family, lost or changed jobs, or retired during the year, we need to discuss the tax implications of these events.
- Miscellaneous Items
Finally, these are some additional miscellaneous items to consider:
(1) If you have a health flexible spending account with a balance, remember to spend it before the deadline.
(2) If you own a vacation home that you rented out, we need to look at the number of days it was used for business versus pleasure to see if there is anything we can do to maximize tax savings with respect to that property. For example, if you spent less than 14 days at the home, it may make sense to spend a couple more days and have the house qualify as a second residence, with the interest being deductible. As a rental home, rental expenses, including interest, are limited to rental income.
(3) We should also consider if there is?any income that could be shifted to a child so that the income is paid at the child’s rate.
(4) If you have any foreign assets, there are reporting and filing requirements with respect to those assets. Noncompliance carries stiff penalties.
(5) If you are age 62, please call us about the changes to social security rules.
Please contact me at your convenience if you would like to estimate your tax liability for the year and discuss any questions you may have. Let me know a couple of days and times that work for you.