There is a lot of speculation about how tax law may change after the recent elections, with the incoming administration being very vocal about the need for tax reduction.
With the proposed tax cuts, traditional wisdom of accelerating deductions and deferring income still makes sense. Push your income into 2017 wherever possible, with the hope that the promised tax cuts materialize. The proposed changes would indeed lower tax rates across the board and potentially repeal the 3.8% tax on Net Investment Income (part of the Affordable Care Act). There is more to the picture and there are a few key items to consider for your year-end tax planning.
Capping Itemized Deductions
Itemize deductions would be capped at $100,000 for single and $200,000 for married filers. For high net worth individuals, this change could be significant. One of the major deductions for higher income taxpayers is the charitable contribution deduction. Many have charity that would push them over these proposed limits. Would they still be as charitable if the tax benefit were limited in this way? Maybe. Many will continue to give since their main motivation is not the tax benefit, but it may give others pause.
Taxpayers whose charity may push them over the proposed limits could consider paying some of their planned 2017 contributions early, during the 2016 year.
Those who are subject to Required Minimum Distributions (RMD) from their IRA accounts have another option, in that they can make qualified charitable contributions directly from their IRA accounts. These contributions do not get counted as a deduction on your personal tax return, thus lessening the chance itemized deductions will be over the new proposed threshold. In addition, charity paid from an IRA will count toward the taxpayer’s RMD for the year, thus reducing the amount required to be distributed and counted in income during that year.
The state income tax deduction could also be an issue if these new limits are set in place. In high tax states, such as California and New York, the state income tax paid and deducted is often a sizable portion of itemized deductions, making it more likely taxpayers in these high tax states will be above the proposed thresholds.
Does this mean these taxpayers should prepay state taxes to take the deduction in the 2016 year? Maybe not. Many will find themselves in a situation where they are subject to the Alternative Minimum Tax. In this alternative tax calculation, state taxes are not deducted, so prepaying them may not be the answer.
Alternative Minimum Tax
The Alternative Minimum Tax (AMT) was originally meant to ensure the wealthy pay their fair share of tax. In recent years, this tax has become common in middle-income households, which was not the original intent. Current proposals call for eliminating AMT.
The National Taxpayer Advocate office has been calling for repeal of the AMT for several years, stating on their website “The AMT is complicated and burdensome and it does not achieve its intended goal.”
The earliest any repeal of AMT could be effected would be for the 2017 year, so for now, AMT will need to be considered in your 2016 tax plans.
Long term capital gains and qualified dividends would retain favorable tax treatment under the proposed plans. They are currently taxed at a maximum 20% rate, but could also be subjected to the 3.8% Net Investment Income Tax, bringing that rate to 23.8%. The current proposals call for eliminating the Net Investment Income Tax.
Short term gains would still be taxed at normal ordinary income rates. For 2016, taxpayers in the top bracket are taxed at 39.6%, plus would be subjected to the 3.8% Net Investment Income Tax, for a total of 43.4%. The new proposals call for a maximum tax rate of 33% and eliminate the Net Investment Income Tax. The savings for pushing these sales into 2017 could be substantial.
Head of Household Filing Status
Head of Household filing status would be eliminated under the proposed plans. Current Head of Household filers would file as either Single or as Married Filing Separately, depending on their situation. Currently, both of those statuses have higher tax rates than the Head of Household status.
Current proposals call for collapsing the current seven tax brackets into three, with a top rate of 33%. This is down from the current top rate of 39.6%.
|Proposed Individual Rates|
|Rate||Joint filers||Single filers|
|12%||up to $75,000||up to $37,500|
|25%||$75,000 – $225,000||$36,500 – $112,500|
|33%||above $225,000||above $112,500|
With the potential of lower rates, it makes sense to push earnings into 2017 wherever possible. But there are limits to what can be deferred. Just holding checks to deposit after the year end will not accomplish deferring the income. Tax law recognizes “constructive receipt”, meaning if you had control over the funds then it is yours.
Some ways to successfully defer income would be:
- A cash basis business is not taxed on earnings until they are paid. A business could delay issuing an invoice, so the customer payment would not be received until after the end of the year.
- If you are an employee and typically receive a bonus at the end of the year, your employer may be willing to issue your bonus in January instead of December.
This is just a broad overview of only some points in the draft proposals, items to consider while you are doing your year-end tax planning. While it is not certain that these proposals will become law, it does seem clear that there will be a push to implement change early in the 2017 year, and that any change would focus on tax cuts.
There are also proposed changes that would encompass taxes for businesses, and an overhaul of estate tax laws. Your tax professional can help you plan for potential changes and keep you informed as these proposals work their way through congress.
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