Although the year is ending soon, it's not too late to implement some planning moves that can improve a client's tax situation for 2016 and beyond. This article reviews some actions that clients can take before December 31 to improve their overall tax picture.
Observation: Taxpayers and their advisers engaged in year-end tax planning for 2016 may still be challenged by the uncertain fate of several expiring "extender" provisions—"temporary" tax rules that have a termination date specified in the Code, but have been routinely extended for a year or two. While late 2015 legislation eliminated much of the uncertainty by making many extender provisions permanent, some of them are still scheduled to expire at the end of 2016 or later. The planning moves below apply whether or not there is legislation to retroactively extend these expiring extender provisions.
Make HSA contributions. Under Code Sec. 223(b)(8)(A), a calendar year taxpayer who is an eligible individual under the health savings account rules for December 2016, is treated as having been an eligible individual for the entire year. Thus, an individual who first became eligible on, for example, Dec. 1, 2016, may then make a full year's deductible above-the-line contribution for 2016. If he makes that maximum contribution, he gets a deduction of $3,350 for individual coverage and $6,750 for family coverage (those age 55 or older also get an additional $1,000 catch-up amount).
Nail down losses on stock while substantially preserving one's investment position. A taxpayer may have experienced paper losses on stock in a particular company or industry in which he wants to keep an investment. He may be able to realize his losses on the shares for tax purposes and still retain the same, or approximately the same, investment position. This can be accomplished by selling the shares and buying other shares in the same company or another company in the same industry to replace them, or by selling the original holding then buying back the same securities at least 31 days later.
Accelerate deductible contributions and/or payments of medical expenses. Individuals should keep in mind that charitable contributions and medical expenses are deductible when charged to their credit card accounts (e.g., in 2016) rather than when they pay the card company (e.g., in 2017). Additionally, for 2016, itemizing taxpayers age 65 or older can deduct medical expenses to the extent they exceed 7.5 percent of adjusted gross income, but that "floor" will rise to 10 percent in 2017 (i.e., to the same floor that currently applies to taxpayers under age 65). Thus, it may pay for itemizing taxpayers who are 65 or older to accelerate discretionary or elective expenses into this year.
Solve an underpayment of estimated tax problem. Because of the additional 0.9 percent Medicare tax and/or the 3.8 percent surtax on unearned income, more individuals may be facing a penalty for underpayment of estimated tax than in prior years. An employed individual who is facing a penalty for underpayment of estimated tax as a result of either of these new taxes or for any other reason should consider asking his employer—if it's not too late to do so—to increase income tax withholding before year-end. Generally, income tax withheld by an employer from an employee's wages or salary is treated as paid in equal amounts on each of the four estimated tax installment due dates. Thus, if an employee asks his employer to withhold additional amounts for the rest of the year, the penalty can be retroactively eliminated. This is because the heavy year-end withholding will be treated as paid equally over the four installment due dates.
Retirement plan distribution. Individuals can take an eligible rollover distribution from a qualified retirement plan before the end of 2016 if they are facing a penalty for underpayment of estimated tax and the increased withholding option is unavailable or won't sufficiently address the problem. Income tax will be withheld from the distribution at a 20 percent rate and will be applied toward the taxes owed for 2016. They can then timely roll over the gross amount of the distribution, as increased by the amount of withheld tax, to a traditional IRA. No part of the distribution will be includible in income for 2016, but the withheld tax will be applied pro rata over the full 2016 tax year to reduce previous underpayments of estimated tax.
Accelerate big ticket purchases into 2016 to get sales tax deduction. Taxpayers who itemize their deductions rather than take the standard deduction have the option of deducting state and local sales taxes in lieu of state and local income taxes. As a result, individuals who are considering the purchase of a big-ticket item (e.g., a car or boat) should consider whether it is advantageous to elect on their 2016 return to do so.
Prepay qualified higher education expenses for the first quarter of 2017. Unless Congress extends it again, the above-the-line deduction for qualified higher education expenses will not be available after 2016. Thus, individuals should consider prepaying in 2016 eligible expenses for 2017 courses if doing so will increase their 2016 deduction for qualified higher education expenses. Generally, a 2016 deduction is allowed for qualified education expenses paid in 2016 in connection with enrollment at an institution of higher education during 2016 or for an academic period beginning in 2016 or in the first three months of 2017. The deduction is limited to $4,000 for taxpayers with modified adjusted gross income of not more than $65,000 ($130,000 for married taxpayers filing joint returns), and $2,000 for taxpayers with modified AGI of not more than $80,000 ($160,000 for married taxpayers filing joint returns).
Potential to earn tax-free gains. An individual may exclude all (or, in some cases, part) of the gain realized on the disposition of qualified small business stock, QSBS, held for more than five years. For QSBS acquired after Sept. 27, 2010, an individual can exclude all of the gain on the disposition of QSBS stock. For QSBS acquired after Feb. 17, 2009 and before Sept. 28, 2010, individuals can exclude 75 percent of any gain realized on the disposition of QSBS. For QSBS acquired before Feb. 18, 2009, individuals can exclude 50 percent of the gain on the disposition of QSBS. Taxpayers should consider these rules in determining which stock to sell to maximize their exclusion for 2016 or to not sell if the holding period hasn't yet been satisfied.
Be sure to take required minimum distributions. Taxpayers who have reached age 70-½ should be sure to take their 2016 RMD from their IRAs or 401(k) plans (or other employer-sponsored retired plans). Failure to take a required withdrawal can result in a penalty of 50 percent of the amount of the RMD not withdrawn. Those who turned age 70-½ in 2016 can delay the first required distribution to 2017. However, taxpayers who take the deferral route will have to take a double distribution in 2017—the amount required for 2016 plus the amount required for 2017. That could make sense if the taxpayer will be subject to a lower tax rate next year.
Use IRAs to make charitable gifts. Taxpayers who have reached age 70-½, own IRAs and are thinking of making a charitable gift should consider arranging for the gift to be made directly by the IRA trustee. Such a transfer (not to exceed $100,000) will neither be included in gross income nor allowed as a deduction on the taxpayer's return. But, since such a distribution is not includible in gross income, it will not increase AGI for purposes of the phaseout of any deduction, exclusion or tax credit that is limited or lost completely when AGI reaches certain specified level.
Make year-end gifts. A person can give any other person up to $14,000 for 2016 without incurring any gift tax. The annual exclusion amount increases to $28,000 per donee if the donor's spouse consents to gift-splitting. Annual exclusion gifts take the amount of the gift and future appreciation in the value of the gift out of the donor's estate and shift the income tax obligation on the property's earnings to the donee who may be in a lower tax bracket (if not subject to the kiddie tax).
A gift by check to a noncharitable donee is considered to be a completed gift for gift and estate tax purposes on the earlier of:
1. The date on which the donor has so parted with dominion and control under local law as to leave in the donor no power to change its disposition, or
2. The date on which the donee deposits the check (or cashes it against available funds of the donee) or presents the check for payment, if it is established that:
• The check was paid by the drawee bank when first presented to the drawee bank for payment;
• The donor was alive when the check was paid by the drawee bank;
• The donor intended to make a gift;
• Delivery of the check by the donor was unconditional; and
• The check was deposited, cashed or presented in the calendar year for which completed gift treatment is sought and within a reasonable time of issuance.
Thus, for example, a $14,000 gift check given to and deposited by a grandson on Dec. 31, 2016 is treated as a completed gift for 2016 even though the check doesn't clear until 2017 (assuming the donor is still alive when the check is paid by the drawee bank).