It’s time to review your year-end tax plans for strategies to minimize your 2016 income tax liability. With a few exceptions, almost all of the decisions that affect your taxes have to be made by December 31, 2016.
Defer Income Recognition – Consider if there is an opportunity to defer income to 2017.
- Defer a year-end bonus or delay the collection of payments for services or rents to January.
- Accelerate deductible business expenditures into this year by charging them on a credit card or paying by check by December 31.
- Harvest tax losses in taxable brokerage accounts. You can sell those investments to offset either capital gains on other investments or up to $3,000 against your regular taxable income. Any losses not used can be carried forward to offset gains in future tax years. However, be wary of the wash sale rules which disallow the loss if the same stocks or securities are acquired within the period beginning 30 days before the date of the loss sale and ending 30 days after that date.
It only makes sense to defer income if you think you will be in the same or a lower tax bracket in 2017. If you anticipate being in a higher tax bracket, you may want to accelerate income into 2016 so you pay tax on it in a lower tax bracket sooner, rather than a higher tax bracket later.
Accelerate Deductions – If you itemize deductions consider accelerating deductible expenditures by charging the expenses on a credit card or paying by check by December 31.
- Medical expenses - Consider paying deductible medical expenses and/or scheduling elective procedures if you are at or near the threshold required for a deduction. Medical expenses in excess of 10% of your adjusted gross income (7.5% for individuals age 65 and older) are deductible. Those 65 and older should carefully consider this as the threshold for deducting medical expenses increases to 10% of adjusted gross income in 2017.
- Charitable contributions – Make charitable contributions prior to year-end. Consider donating shares of appreciated stock. Provided you’ve owned the property for more than a year, you can take the deduction for the fair market value of the donated shares without realizing a capital gain on the sale. However, don’t contribute property that has fallen in value as the capital loss is wasted. It is better to sell it, claim the capital loss on your tax return and donate the proceeds to the charity.
- Pre-payment of state income taxes – Since state income taxes are deductible, payment of state income taxes can result in a higher deduction in the current year. If considering this strategy, be sure to also assess the impact of the AMT as deductions for state taxes are completely disallowed under the AMT rules.
- Pre-payment of home mortgage – Making the January mortgage payment in December gives you a month’s extra interest to deduct.
Avoid the Estimated Tax Penalty – Individuals who have underpaid their estimated tax quarterly installments cannot avoid the penalty by increasing their estimated tax payments at year end. However, there are still ways to avoid or decrease the estimated tax penalty.
- Increase your tax withholding on W-2 income for the remainder of the year or on a year-end IRA payout since withholding is considered ratably paid throughout the year.
- Take a rollover distribution from a retirement plan. When you take a rollover distribution from a retirement plan, income tax is withheld from the distribution and treated as ratably paid throughout the tax year. Make sure to roll over the distribution’s gross amount (including the withheld amount) to an IRA within 60 days so that the distribution is not treated as income.
- Minimize estimated tax penalties by making any catch up of estimated tax payments as soon as possible.
Contribute the maximum to retirement accounts – If possible, contribute the maximum amount of money allowed to your retirement accounts.
- 401(k) plan - Participants can set aside $18,000 ($24,000 if age 50 or older).
- Traditional IRA - The contribution limit for a traditional IRA is $5,500 ($6,500 if age 50 or older). You have until April 17, 2017 to make contributions for 2016. However, keep in mind that the deduction for taxpayers making contributions to a traditional IRA is phased out above certain AGI levels if covered by a workplace retirement plan.
Required Minimum Distributions (RMD) – If you’ve reached age 70 ½ before 2016 be sure to take the RMD by December 31 from any retirement plan except for a 401(k) at a company where you’re currently employed. Not taking the RMD will result in a tax penalty of 50% plus interest on withdrawals you should have taken. RMDs from your IRA cannot be combined with RMDs from your employer plan as each must be calculated and distributed separately.
529 Contributions – Contributions to a Colorado state-sponsored college savings plan made by state residents are deductible for Colorado state income taxes. The funds withdrawn for qualified higher education expenses will be free of federal and state income taxes for any investment gains.
Energy Tax Credits – A limited tax credit is available if you install energy-efficient windows, insulation, roofs and doors by December 31, 2016.
The credit is 10% with a $500 maximum. Any credits taken in prior years count against the $500. Many items are capped: $50 for circulating fans, $150
for furnaces and $200 for windows. However, the full 30% credit for residential solar energy systems applies through 2019 and then phases out until
it ends after 2021.
Please call us to set up an appointment to discuss your personal year-end tax planning opportunities.