In this guide, we identify some of the more significant tax developments that may affect the tax planning considerations of individuals and businesses.
Year-end tax planning typically depends upon whether you expect to have more or less income in the coming year versus the current year, and whether the income tax rates are expected to change. This year is particularly difficult because it is anticipated that lower tax rates may be enacted and deductions limited under the future Trump administration, but there is no certainty as to when or the extent to which this may occur.
Thus, the best course of action in these uncertain times may be to follow the age-old strategy of deferring taxable income and gains to 2017 and accelerating deductions, losses, and credits to the current year, especially if you will be in the 39.6 percent tax bracket. Of course, this practice may have to be tweaked if, for example, you expect to have a large loss in 2016. In that case, you should consider accelerating the receipt of income into 2016 and applying the loss to reduce any resultant tax liability from the income. Taxpayers may also have the opportunity in 2016 to benefit from the “extender legislation” that was passed in December 2015 (the PATH Act) in which certain tax provisions were made permanent, enhanced, or amended to remain effective through 2016.
This communication will identify some of the more significant developments that may impact the tax planning considerations of individuals and businesses.
Key individual year-end tax considerations
The additional 3.8 percent NIIT and 0.9 percent Medicare tax
Individual taxpayers who are at or near the top tax brackets should be mindful of the income thresholds that may cause them to be subject to the additional 3.8 percent net investment income tax (NIIT) on investment income and the additional 0.9 percent Medicare tax on wages and other compensation. The thresholds for both taxes are $250,000 modified adjusted gross income (MAGI) for joint filers or a surviving spouse, $125,000 MAGI for married taxpayers filing separate returns, and $200,000 MAGI for single taxpayers.
To avoid the NIIT in 2016, consider deferring the sale of investment assets to 2017. If that is not possible, taxpayers should utilize the installment sale provisions of the tax code to limit the amount of gain that will be taxable in 2016, and defer most or all of the gain to 2017 or later years. Under the installment sale rules, you will only be taxed on the portion of the profit that relates to any payments received in 2016. You will have no tax liability for 2016 if no payments are received in that year.
To avoid the Medicare tax in 2016, taxpayers should request that their employers not pay any expected bonuses or other compensation until after year-end. Similarly, cash-basis independent contractor taxpayers should delay billing for services rendered to their clients until 2017.
Other individual income deferrals and exclusions
First-year RMDs — Taxpayers who reach age 70.5 in 2016 and who must begin taking first-year required minimum distributions (RMDs) from their IRAs or 401(k) plans by April of 2017, should delay taking the RMD until after year-end. Although this may result in two RMD withdrawals in 2017 (i.e., the first-year RMD and a subsequent RMD that must be withdrawn by December 31, 2017), this may be to your benefit if the tax rates decrease in 2017 or if you avoid the threshold of a higher tax bracket for 2016.
IRA transfers to charity — Taxpayers who are age 70.5 should also consider having up to $100,000 of their IRA transferred directly by the IRA trustee to charity in 2016. Although the taxpayer may not claim a charitable contribution deduction for the amount donated, such amount will be excluded from the taxpayer’s gross income and will also be counted towards any RMD requirement for 2016. By directly contributing from the IRA to charity (versus taking the income and writing a check to the charity), those who are sensitive to tax provisions based on MAGI will save tax. These provisions include the NIIT (see above), personal exemptions, itemized deductions, the amount of Social Security subject to tax, and others.
IRA conversions — Taxpayers should delay converting their traditional IRAs to Roth IRAs until 2017 so that the deemed distribution will be taxed next year. Taxpayers who already converted their IRAs to Roth IRAs in 2016 may consider whether to reconvert the Roth IRA back to a traditional IRA before year-end and plan to undertake the conversion in 2017.
IRA rollovers — If you take a distribution from your IRA, you may roll that amount over to a new or the same IRA tax-free within 60 days. Because only one rollover per year is permitted, taxpayers who plan to transfer funds between IRAs more than once in 2016 should use a direct trustee-to-trustee transfer for any subsequent transfers (which is not taxable) or risk being taxed on additional rollovers.
Exclusion of discharged mortgage debt — 2016 will generally be the final year in which taxpayers may exclude from their gross income discharged qualified principal residence indebtedness (unless a written arrangement is made by year-end and the mortgage debt is discharged in 2017). The exclusion is up to $2 million (or $1 million for married taxpayers filing separately). The debt discharge must be reported by the lender to the taxpayer on Form 1099-C.
Section 529 plans — The use of a section 529 plan to fund a student’s purchase of a computer or peripheral equipment, computer software, or internet access and related services, is now considered a tax-free qualified higher education expense.
Accelerating individual tax deductions and credits
AOTC tuition credit — By year-end, taxpayers with students in college should pay the tuition and related expenses for the academic period that begins within the first three months of 2017. Assuming you are otherwise eligible to claim the American Opportunity Tax Credit (AOTC) based on certain income limitations and other requirements, that payment will qualify for the 2106 AOTC even though it relates to the 2017 academic year.
Sales tax deduction — Because the PATH Act made the itemized deduction for state and local sales tax permanent (which is claimed in lieu of state income taxes), you should consider whether to make big ticket item purchases that are subject to significant sales tax before year-end (e.g., cars, boats, recreational vehicles, etc.).
Early miscellaneous expense prepayments — Taxpayers should also consider paying the following expenses by year-end: expenses for discretionary or elective medical procedures; charitable contributions; the mortgage payment due in January 2017; early payments of state income tax and local property tax. The effect on the alternative minimum tax (AMT) needs to be considered.
Gift and estate taxes
The Trump administration and the Republican-controlled Congress appear to be set on dismantling the estate and gift tax regime. However, at least through year-end, individual taxpayers can continue to make tax-free gifts utilizing the 2016 gift tax exclusion of $14,000 each to an unlimited number of individuals.
Key business year-end tax considerations
Like individual taxpayers, it is usually advantageous for businesses to defer income to the next year and to accelerate deductions, losses, and credits to the current year. Cash-basis business taxpayers have more flexibility in this regard. There are more restrictions placed upon accrual-basis business taxpayers in their ability to adjust the timing of their income recognition and the claiming of deductions and losses. However, certain provisions in the tax code do permit an accrual-basis business to claim early deductions and to defer the inclusion of income.
For example, in 2016, an accrual-basis taxpayer can deduct bonuses that are paid to certain non-owner employees within the first two and a half months of 2017 (or the next taxable year if a fiscal year taxpayer). This benefits the employee who, as a cash-basis taxpayer, will not recognize the income until received in 2017.
As another example, accrual-basis taxpayers who receive certain advance payments in 2016 may defer including such amounts in income until 2017 for tax purposes if the income inclusion is not later than it would be for financial reporting purposes. This special treatment applies to advance payments for services, goods, the use of intellectual property, subscriptions, and organizational memberships, among others. It does not generally apply to advance payments of rent, insurance premiums, payments on financial instruments, or payments for certain service warranty contracts.
The PATH Act provisions impacting businesses
The following items are some of the more significant items enacted by Congress in late 2015 that may impact a business’ tax liability for 2016.
Section 179 deduction — Businesses may now permanently avail themselves of this first-year depreciation deduction of $500,000 for depreciable property acquired during the year. The deduction generally applies to new or used equipment and specialized production facilities, but not to real estate (other than qualified real property, including certain leasehold improvements, restaurant property, and retail improvements). The deduction phases out if a taxpayer has more than $2 million of eligible asset additions in the year. Due to inflation adjustments, the relevant amounts are $500,000 and $2.01 million for 2016, and $510,000 and $2.03 million for 2017. Further, the $250,000 cap on qualified real property is eliminated beginning in 2016.
50 percent bonus depreciation — This additional first-year depreciation deduction, available to all businesses regardless of size, is also extended and ultimately phased out over a five-year period. It applies to new (not used) property placed in service during the calendar year, and remains at 50 percent through 2017. The deduction drops to 40 percent for calendar year 2018 and to 30 percent in 2019, before expiring in 2020. Beginning in 2016 and through the expiration at the end of 2019, a major enhancement has been made to bonus depreciation. Interior improvements to nonresidential buildings qualify for bonus depreciation, not merely a narrow category of leasehold improvements. For the first time, bonus depreciation can be claimed on improvements that otherwise have a 39-year recovery period. Business owners contemplating interior improvements in upcoming years should consider placing those in service while bonus depreciation remains in the law.
Enhanced research credit — The research and development (R&D) tax credit is now permanent. For tax years beginning after 2015, two improvements apply. A business with no more than $50 million in average annual gross receipts may claim the credit against alternative minimum tax (AMT) and regular income tax. Qualifying smaller businesses under $5 million in gross receipts may electively apply this credit against payroll taxes — a significant benefit if that small business is not yet profitable and paying income taxes.
Extended jobs credit — The Work Opportunity Tax Credit (WOTC) is extended through 2019. This credit rewards employers who hire various categories of disadvantaged workers. An additional category of eligible new hires is added beginning in 2016: Those who have been unemployed at least 27 consecutive weeks. Like many of the other new hire categories, the tax credit for this new category is 40 percent of the first $6,000 of wages (i.e., $2,400).
Other business provisions made permanent:
- The shorter five-year built-in gain period that applies to C corporations that elected S corporation status
- The 15-year recovery period for qualified leasehold improvements, restaurant property, and qualified retail improvements (versus the normal 39-year life for depreciable real estate)
- The 100 percent gain exclusion on the sale of certain small business C corporation stock acquired and held more than five years
- Shareholder’s basis reduction for S corporation’s charitable donations is limited to the basis of the donated property
- By making a charitable donation, the S corporation can transfer its appreciated property generally without recognition of gain. However, the fair market value (FMV) deduction that is passed through to its shareholders is reduced to the extent that any donated real estate would generate any Section 1245 or 1250 ordinary income if sold.
Increased small asset expensing — The repair regulations, effective in 2014, provide a safe harbor elective deduction for businesses under a two-tier system. Businesses with an applicable financial statement (AFS) (generally, a certified audit or a governmentally-mandated financial statement) are allowed to deduct small asset expenditures up to $5,000. Other businesses without an AFS have a lower-tier $500 de minimis safe harbor amount. The IRS increased the lower-tier limit from $500 to $2,500, effective for tax years beginning in 2016, provided that the business has a policy in place at the beginning of the tax year to use the de minimis safe harbor limit. Businesses should be sure to have such a policy by year-end to be effective for 2017.
How we can help
Our experienced tax professionals can help you with your year-end planning and advise how recent tax developments affect you and your business. Please contact your CLA tax advisor if you have questions.