10 Tax-Saving Strategies for 2016
2016 has been an interesting year. We suspect for many of us it has or will invoke much change. As the end of 2016 nears, it’s time to consider the impact tax will have on your business and life. As your tax advisor, we want to share these essential tax saving strategies with you.
The “Trump Effect”
In light of the November election and highly likely changes to the tax code in 2017, there are a few additional tax strategies to consider in addition to some of the normal “tried and true” methods. We won’t know the full impact of the pending political influence but until we do, here are ten essential tax saving strategies for you to consider.
Accelerate deductions
Traditional tax planning has always focused on accelerating deductions to obtain a current tax benefit. This strategy takes on even more significance as tax rates are expected to go down for many individuals and businesses based on the Congressional proposals being floated around. For taxpayers in the top tax bracket of 39.6%, we are looking at a maximum rate of 33% in 2017 and beyond. Additionally, limitations or caps on itemized deductions are being proposed. Moving deductions forward to 2016 from 2017 could result in a nearly 7% savings over waiting until 2017, or more.
Defer Income
Again traditional year end tax planning tells us to defer income to a later year whenever possible. With expected lower tax rates in 2017, this strategy can result in large tax savings. Not only are the new tax proposals considering lower income tax rates, we are also looking at potential repeal of the 3.8% Net Investment Income Tax or “Obamacare Tax”. This can result in major tax savings for large gains.
Consider the Increased Standard Deduction Impact on You
A significant piece of the 2017 tax proposals is an increase in the standard deduction for married couples from $15,000 to $30,000. This is a major increase. Any married taxpayers who are currently itemizing deductions in the $15,000 to $30,000 range are now receiving a tax benefit for common itemized deductions such as charitable contributions, mortgage interest, and real estate taxes. If the limit is increased to $30,000, those expenses no longer generate incremental tax savings for you as they previously did. Consider moving charitable donations planned for 2017 or later years into 2016. Think about paying off that mortgage if the tax savings no longer factor into the equation.
Donate Appreciated Securities in Lieu of Cash Donations
One often overlooked tax saving strategy is to make charitable donations of appreciated securities held by you in lieu of making cash donations. There is a double benefit for this strategy. One, you do not need to recognize income tax on your unrealized gain in the security upon donation and two, you receive a charitable donation for the current market value of the stock. This is the equivalent of a double benefit and you should be taking advantage of it. Special rules apply if these are shares acquired from your employer in an employee stock purchase plan, and remember, you must have held the shares long-term in order to qualify, otherwise you are limited to your income tax basis in the shares.
Do a Roth Conversion in a Low Income Year
Converting your pre-tax retirement assets to a Roth account, which results in tax-free distributions in retirement, is often a gamble. You are paying tax now on the converted amount in order to receive tax-free distributions later. There are so many variables in this to consider it makes it hard to know what the right answer is. Tax rates now, tax rates later, investment performance, the character of your income in retirement, life expectancy and most unpredictable of all, tax law in the future. That being said, if you find yourself in a year where you are in a low or no tax situation, then doing a Roth conversion makes a lot of sense. In these situations you are recognizing income on the amount converted, but if done properly paying no tax. There is zero downside to doing a conversion if you are not paying tax. If your pre-tax retirement assets are substantial, aim high on your conversion amount. You can always undo or “re characterize” a portion of the conversion at any point before you finalize your tax filing for the year
Liquidate an Aging Parent’s Pre-Tax Retirement Accounts
Ok, don’t literally go out and do this, but there are circumstances where this makes sense. We often see situations where aging parents have large medical deductions for nursing home care that effectively wipe out all income for the year. If the taxpayer still has pre-tax retirement assets on which you are currently taking just the required minimum distributions, consider taking more up the point where taxable income is zero (instead of negative) or even paying a little tax. If these assets are inherited, the beneficiary must take distributions over their life expectancy or shorter, and the distributions will be taxable income taxed at the beneficiary’s rates. Contrast this with inheriting cash or investments held outside of a pre-tax retirement account, which is tax-free to the beneficiary. As with everything, the devil is in the details.
Maximize Retirement Contributions
If you have not maximized your 401(k) or other employer sponsored retirement plan contributions, do so before year end as many do not have an opportunity to do so after the New Year.
Exercise Incentive Stock Options
Exercising incentive stock options (ISO) shares granted by your employer has no impact for regular tax, but can trigger the dreaded alternative minimum tax (AMT). The difference between the current market value of the stock and your strike price is considered income for AMT purposes. While making this decisions requires careful consideration and planning if you find yourself subject to AMT each year, if you are having a particularly high or low income year where AMT does not apply, you may want to consider purchasing the shares. You will still trigger AMT income on the exercise, but if this does not result in you owing any additional tax, then the decision is a little easier. We can prepare an analysis for your AMT “break-even” point and structure the decision around that.
Put your Spouse and Kids on the Payroll, Literally
If you are self-employed, consider adding your spouse and working age children as employees of your business. You will be able to take a wage deduction against your business income for wages paid, and if you put your spouse in a 401(k) plan established for your sole proprietorship, you can shelter the wages from tax. For your children, you can pay them each up to the standard deduction amount and they will owe no income tax on the wages. You can then teach them fiscal discipline by turning around and putting these wages into a Roth IRA. Not only will that Roth IRA have a lifetime to grow tax-free, you will start the 5 year clock on Roth IRA contributions. After 5 years, you can withdraw the principal amount from your Roth IRA tax and penalty free. This could be used to help fund a first time home purchase, for example.
Form a Solo 401(k) Before Year End
If you are self-employed, you may already have a retirement plan such as a SEP-IRA in place. A SEP-IRA permits you to contribute approximately 20% of your net earnings from self-employment into the SEP-IRA account and generate some tax savings. For some sole proprietors, forming a solo 401(k) may be a more attractive alternative. A solo 401(k) permits you to contribute the elective deferral amount of $18,000 (plus $6,000 catch up if over age 50) or up to your net self-employment income, whatever is higher. If your net income is higher than $18,000 or $24,000, then you can contribute 20% of your net earnings on top of the elective deferral amount. For many sole proprietors this effectively results in a higher percentage of your income being sheltered from tax than you can do under a SEP-IRA plan. Establishing the plan is time sensitive and must be done before December 31st, though the account need not be funded until you file your tax return for the year.
ShareThis