Year-End Tax Planning

As 2016 draws to a close it’s time to turn our attention to some year-end tax to-do tasks.   In many ways this year is no different than any other – the same conventional wisdom applies as it always has in the past:  less tax is better tax.  Here’s some conventional (tax) wisdom to help you get started on your year-end tax planning:

Individuals

Defer income into 2017.  Paying tax next year is almost always a better plan than paying tax this year.  If you taxable income is consistent year to year, consider taking a monthly IRA distribution in January rather than December.  You will be able to defer the tax on the distribution for an entire year.

Retirement plans for employees.  If you have not already deferred the maximum amount for your plan, use your last few paychecks to defer as much income as possible into the plan at work. Many plans match up to 4% of the wages you defer.  The deferrals must be on paychecks issued during 2016.   For 2016 the maximum that can be deferred into retirement plans is shown below:

Elective deferrals to 401(k), 403(b), 457 plans – $18,000 (plus $6,000 age 50)

Elective deferrals to SIMPLE plans – $12,500 (plus $3,000 if age 50)

If you are not participating in an employer retirement plan, consider making a contribution to an IRA.  IRA contributions for 2016 are limited to $5,500 (plus $1,000 if age 50) and can be made any time during the year all the way up to the tax filing deadline (April 18, 2017).  IRA contributions are limited to the amount of earned income for the year and the deductibility is subject to a phase-out if your income exceeds thresholds.  The thresholds are different for each filing status and whether either the taxpayer or spouse is an active participant in an employer-sponsored retirement plan.  If your spouse does not have any earned income, they can “borrow” some of yours to allow for a contribution to their IRA.


Review your investment portfolio. 

If you are holding investments that are currently valued at less than when you acquired them it may be a good time to sell and recognize a capital loss in 2016.  Capital losses can be used to offset any capital gain income (including capital gain distributions from mutual funds) plus an additional $3,000 each year that can be used to offset other income.

Long-term capital gains are taxed at favorable rates.  Consider selling investments with gains that will be taxed in the lower tax brackets.  For taxpayers in the 10% and 15% marginal tax brackets (under $75,300 married joint; $50,400 head of household; $37,650 single) the federal tax rate on long-term capital gains is 0%. That’s not a typo – it is a zero.  California does not have a special rate for long-term capital gains so there still may be state tax on a gain recognized this year.  Qualified dividends are also included in this special 0% rate.

Accelerate deductions into 2016.

A tax dollar saved is a tax dollar earned (with apologies to Benjamin Franklin).   Accelerating deductions usually means spending cash…but not always.

Some of the most common ways to bring a deduction into the current year:

Pay both of your property tax installments in December.  The second installment is not due until April, but paying it about 100 days early will allow you to deduct the payment in 2016.  The same goes for the last state estimated tax payment.  It is due on January 15th, 2017.  But if you pay it just a couple of weeks early you can deduct it on your 2016 return.  A quick note of caution on both of these ideas – if you are subject to alternative minimum tax (AMT) these will not give you any benefit as they are considered preference items.

Pay any outstanding medical bills.  In order for deductible medical expenses to provide any tax benefit they must total more than a floor equal to 10% of your adjusted gross income (AGI).  If you (or your spouse) are fortunate enough to be at least age 65 by year end the floor is only 7.5%.  If you have been unfortunate enough to have high medical expenses this year, pay as many outstanding bills as possible.  It’s not every year that you will be able to have medical expenses that exceed the floor (hopefully).

Think charitably.  Charitable contributions of cash are deductible in the year paid.  If you give more than $250 in any single contribution you must have a contemporaneous written acknowledgment from the charity.  This requirement is satisfied only if you get the acknowledgment before you file your tax return.  For all contributions under $250 you will need a bank record of the contribution, a receipt from the charity, or a paystub if the contribution was deducted from your paycheck.  Noncash contributions are deductible in the year that they are given to the charity.  It’s time to go through the closet (or the garage, the storage unit, the shed, the extra bedroom, you get the idea) to find all of those items that you no longer need.  Remember to get a receipt for the items you are donating.  If the value of the items exceeds $500 there are some additional substantiation requirements, but the donation will give you a tax deduction for the fair market value of whatever you donate.


Businesses

New due dates.  Some business tax returns have new due dates.  Form 1065 for partnerships is now due on March 15th rather than April 15th.  C corporations are have been pushed back one month from March 15th to April 15th, unless their tax year ends June 30th (the later due date does not apply until 2025).  One significant change is the due date for Forms W-2 – Wage and Tax Statements and Forms W-3 – Transmittal of Wage and Tax Statements; these forms are now required to be filed by January 31st each year.  In the past these forms were only due to the employees by January 31st and the government filing copy was due on February 28th.  Beginning with tax year 2016, both copies are due on January 31st.  The same holds true for Forms 1099-MISC that have amounts reported in Box 7 – Non-employee Compensation.  All of these 1099-MISC forms are required to be filed with the IRS by January 31st.

PATH Act.  With the passage of the Protecting American from Tax Hikes (PATH) Act last year, many of the “extenders” that businesses waited for each year were made permanent.  The increased dollar limitation for Section 179 deductions was permanently increased to $500,000 and is now indexed for inflation.  Bonus depreciation was extended at 50% through 2017 and will phase out at 40% in 2018 and 30% in 2019.  The increase in first-year bonus depreciation for vehicles was also extended at $8,000 for the first year allowing for a deduction of up to $11,160 for the purchase of a new vehicle.  Research and development credit was also made permanent and a new provision allows businesses to transfer up to $250,000 of the credit to offset some of their payroll taxes.

For businesses looking for the end-of-year big tax deductions, the purchase of assets in 2016 may be the answer.  Section 179 deductions can be claimed up to the amount of business income.  Bonus depreciation does not have any income-based limitation.  For either deduction the asset must be placed in service prior to the end of the year.

Section 179 expensing for qualified real property was made permanent by the PATH Act and the previous $250,000 limitation was removed for 2016.  Along with making these expenditures eligible for Section 179 expensing the PATH Act made bonus depreciation eligibility and the 15-year recovery period permanent.  Qualified restaurant property however is still not eligible for bonus depreciation.   A new category of qualified real property was added for bonus depreciation – “qualified improvement property.” This new category is eligible for bonus depreciation, but is not eligible for either section 179 expensing or the shortened 15-year recovery period.

Welcome to California.  The changes to Section 179 and bonus depreciation generally do not apply for California.  California still has a Section 179 dollar limitation of $25,000 and does not conform to bonus depreciation.


De Minimis Safe Harbor Election.  Tangible property regulations, which became fully effective for all taxpayers in 2014, continue to provide benefits for businesses.  The de minimis safe harbor election (which allows for businesses to treat as an expense amounts paid under a certain dollar threshold) was modified to allow for expenditures up to $2,500 (up from $500) to be treated as de minimis and not be subject to capitalization.  In order to qualify for the de minimis safe harbor a business must have a capitalization policy in place at the beginning of the tax year.

Office in Home.  2016 is the third year that businesses operating from home can use a simplified method for a home office deduction.  The deduction is limited to $5 per square foot used regularly and exclusively for business, with a maximum of 300 square feet.  Benefits of a home office include a reduction of self-employment income (and self-employment tax), being able to claim business mileage starting from the home rather than having commuting mileage, and being able to deduct otherwise personal expenses such as utilities, homeowner’s insurance or rent.  With the simplified method there is no reduction of mortgage interest or real estate taxes as itemized deductions.  The simplified method does not impact the basis of the home and does not allow for depreciation – meaning there is no recapture as ordinary income when the property is sold.

Retirement plans for self-employed.  Retirement plans for self-employed individuals allow for contributions much greater than the employee deferrals.  The deduction for retirement plan contributions to these plans can be claimed even if the contribution is made after the end of the tax year.  To be deductible on your 2016 tax return the contribution to the plan must be made by due date of the tax return (including extensions).

Annual additions to defined contribution plans (such as a SEP) for 2016 are limited to $53,000 (plus $6,000 if age 50).

Defined benefit plans offer significantly greater deductions for employers (or the self-employed) and will take up to $265,000 of compensation into consideration for 2016.  Defined benefit plans must be initiated prior to the end of the tax year.

IRS will be looking for hobby losses.  After receiving a follow-up report from the Treasury Inspector General for Tax Administration (TIGTA), the IRS has indicated that the will be using their data analytics to identify and examine more reported business activities that are potential hobbies.  If your business activity has consistent losses being used to offset other income, it is a good time to make sure that the activity meets the criteria for being treated as a for-profit activity.  The IRS has set out nine factors to analyze whether an activity should be treated as engaged in for profit in Treasury Regulation section 1.183-2(b):

  1. Manner in which the taxpayer carries on the activity.
  2. The expertise of the taxpayer or his advisors.
  3. The time and effort expended by the taxpayer in carrying on the activity.
  4. Expectation that assets used in the activity may appreciate in value.
  5. The success of the taxpayer in carrying on similar or dissimilar activities.
  6. The taxpayer’s history of income or losses with respect to the activity.
  7. The amount of occasional profits, if any, which are earned.
  8. The financial status of the taxpayer.
  9. Elements of personal pleasure or recreation.