Articles from January 2017

Many tax breaks are reduced or eliminated for higher-income taxpayers. Two of particular note are the itemized deduction reduction and the personal exemption phaseout.

Income thresholds

If your adjusted gross income (AGI) exceeds the applicable threshold, most of your itemized deductions will be reduced by 3% of the AGI amount that exceeds the threshold (not to exceed 80% of otherwise allowable deductions). For 2016, the thresholds are $259,400 (single), $285,350 (head of household), $311,300 (married filing jointly) and $155,650 (married filing separately). The limitation doesn’t apply to deductions for medical expenses, investment interest, or casualty, theft or wagering losses.

Exceeding the applicable AGI threshold also could cause your personal exemptions to be reduced or even eliminated. The personal exemption phaseout reduces exemptions by 2% for each $2,500 (or portion thereof) by which a taxpayer’s AGI exceeds the applicable threshold (2% for each $1,250 for married taxpayers filing separately).

The limits in action

These AGI-based limits can be very costly to high-income taxpayers. Consider this example:
Steve and Mary are married and have four dependent children. In 2016, they expect to have an AGI of $1 million and will be in the top tax bracket (39.6%). Without the AGI-based exemption phaseout, their $24,300 of personal exemptions ($4,050 × 6) would save them $9,623 in taxes ($24,300 × 39.6%). But because their personal exemptions are completely phased out, they’ll lose that tax benefit.

The AGI-based itemized deduction reduction can also be expensive. Steve and Mary could lose the benefit of as much as $20,661 [3% × ($1 million − $311,300)] of their itemized deductions that are subject to the reduction — at a tax cost as high as $8,182 ($20,661 × 39.6%).

These two AGI-based provisions combined could increase the couple’s tax by $17,805!

Year-end tips

If your AGI is close to the applicable threshold, AGI-reduction strategies — such as contributing to a retirement plan or Health Savings Account — may allow you to stay under it. If that’s not possible, consider the reduced tax benefit of the affected deductions before implementing strategies to accelerate deductible expenses into 2016. If you expect to be under the threshold in 2017, you may be better off deferring certain deductible expenses to next year.

For more details on these and other income-based limits, help assessing whether you’re likely to be affected by them or more tips for reducing their impact, please contact us.

© 2016

Until recently, estate planning strategies typically focused on minimizing federal gift and estate taxes, such as by giving away assets during life to reduce the taxable estate. Today, however, the focus has moved toward income taxes, making the coordination of income tax planning and estate planning more important.

Why the change?

Since 2001, the federal exemption has grown from $675,000 to $5.45 million, meaning that fewer people have to worry about gift and estate tax liability. In addition, the top gift and estate tax rate has decreased from 55% to 40%, while the top individual income tax rate has increased to 39.6% — nearly as high as the top gift and estate tax rate.

The heightened importance of income taxes means that holding assets until death may be advantageous. If you give away an appreciated asset, the recipient takes over your tax basis in the asset, triggering capital gains tax should he or she turn around and sell it.

When an appreciated asset is inherited, on the other hand, the recipient’s basis is “stepped up” to the asset’s fair market value on the date of death, erasing the built-in capital gain. So retaining appreciating assets until death can save significant income tax.

Year end strategy

It is, however, possible to transfer appreciated assets now without your family taking a capital gains tax hit. Such a strategy can be beneficial if you have appreciated assets you’ve held more than one year that you’d like to sell, but you’re concerned about the impact on your 2016 tax bill.

You just need to have family members who are in the 10% or 15% regular income tax bracket and thus eligible for the 0% long-term capital gains rate. Then you can transfer the appreciated assets to them and they can sell the assets tax-free (to the extent the gains don’t push them into a higher bracket).

The transfer won’t create gift tax liability, either, as long as you can apply your $14,000 per year per recipient gift tax annual exclusion or a portion of your lifetime exemption. But before transferring the assets, make sure the recipient won’t be subject to the “kiddie” tax.

Of course, depending on the outcome of the November elections, gift and estate taxes could again surpass income taxes in estate planning importance for some families. If you have questions about coordinating your income tax planning with your estate plan, please contact us.

© 2016

Smart timing of deductible expenses can reduce your tax liability, and poor timing can unnecessarily increase it. When you don’t expect to be subject to the alternative minimum tax (AMT) in the current year, accelerating deductible expenses into the current year typically is a good idea. Why? Because it will defer tax, which usually is beneficial. One deductible expense you may be able to control is your property tax payment.

You can prepay (by December 31) property taxes that relate to 2016 but that are due in 2017, and deduct the payment on your return for this year. But you generally can’t prepay property taxes that relate to 2017 and deduct the payment on this year’s return.

Should you or shouldn’t you?

As noted earlier, accelerating deductible expenses like property tax payments generally is beneficial. Prepaying your property tax may be especially beneficial if tax rates go down for 2017, which could happen based on the outcome of the November election. Deductions save more tax when tax rates are higher.

However, under the President-elect’s proposed tax plan, some taxpayers (such as certain single and head of household filers) might be subject to higher tax rates. These taxpayers may save more tax from the property tax deduction by holding off on paying their property tax until it’s due next year.

Likewise, taxpayers who expect to see a big jump in their income next year that would push them into a higher tax bracket also may benefit by not prepaying their property tax bill.

More considerations

Property tax isn’t deductible for AMT purposes. If you’re subject to the AMT this year, a prepayment may hurt you because you’ll lose the benefit of the deduction. So before prepaying your property tax, make sure you aren’t at AMT risk for 2016.

Also, don’t forget the income-based itemized deduction reduction. If your income is high enough that the reduction applies to you, the tax benefit of a prepayment will be reduced.

Not sure whether you should prepay your property tax bill or what other deductions you might be able to accelerate into 2016 (or should consider deferring to 2017)? Contact us. We can help you determine the best year-end tax planning strategies for your specific situation.

© 2016