2016 year-end tax strategies with potential tax reform on the horizonDecember 12, 2016
Crystal A. Germanese, CPA
With the Republicans in control of the Senate, House of Representatives and White House in 2017, there is uncertainty surrounding tax planning for 2017 and forward. While there are differences between the House GOP and the Trump tax reform plans and uncertainty regarding the timing and magnitude of any changes, the general direction seems to point to lower tax rates and limited deductions. Taxpayers should consider the potential impact of both to determine if there is any tax planning to do before December 31, 2016.
For taxpayers that are far into the highest tax bracket and out of the alternative minimum tax (AMT) the planning is similar to other tax years - defer income and accelerate deductions. However, it may be more relevant to consider these strategies before the end of 2016 since they would have a greater impact if tax rates decrease and itemized deductions are limited in 2017. Other taxpayers should do careful planning with their tax advisors to ensure the same strategy would work for them. Bunching income or deductions into one tax year could cause taxpayers to fall into a higher tax bracket or into AMT which could result in additional tax or loss of itemized deductions.
Deductions reduce your taxable income, which means they are more valuable in a year where your tax rates are higher. Trump's plan calls for an increase to the standard deduction and an itemized deduction cap of $200,000 for joint filers. The GOP plan eliminates many itemized deductions. Taxpayers may want to consider accelerating deductions in 2016 to receive the benefit.
Making charitable contributions, paying the last state estimated tax installment, and paying medical bills before the current year end are among time-tested techniques now elevated in importance to maximize itemized deductions. Taxpayers can write a check or can charge an item by credit card and treat these actions as payments. For taxpayers that may be subject to AMT or a phase-out of medical deductions, careful tax planning is necessary to determine if any benefit would be received from accelerating certain itemized deductions.
Taxpayers could also consider making a large donation to a donor-advised fund before the end of 2016. Donor-advised funds are popular charitable giving vehicles because taxpayers receive an immediate tax deduction at the time of the donation but the funds can be used to support charities over time and grow tax-free.
As in prior tax years, taxpayers should consider donating appreciated stock for a larger tax benefit. When a taxpayer donates appreciated stock they receive a deduction at fair market value without triggering a gain on the sale of that stock. Taxpayers should plan carefully since charitable donations are limited to certain percentages of income depending on the type of donation.
If tax rates decrease, deferring income to 2017 could be a useful tax planning strategy. Taxpayers should plan carefully though. In certain cases pushing income into 2017 could result in additional tax or a loss of itemized deductions if bunching income in 2017 causes the taxpayer to be subject to a higher tax bracket or AMT.
Bonuses. If an employer can be persuaded to delay paying out a bonus at year end until up to 2 ½ months into 2017, the employee will be taxed in 2017. For this strategy to work, however, the deferral must be made before the bonus is due and payable; and, generally, the bonus must be paid within the first 2 ½ months in 2017 to avoid tripping over the nonqualified deferred compensation rules.
Billing for services. Cash-basis taxpayers in the business of providing services might consider delaying the recognition of service income at year end by billing out late in the year or even into early 2017 for those services performed in late 2016.
First-year required minimum distributions. Individuals who first reached age 70 ½ in 2016 can delay taking required minimum distributions (RMDs) from qualified retirement plans otherwise due in 2016 until 2017. Of course, they will then be required to double-up in 2017 and take distributions for 2016 and 2017.
Roth IRA conversions. Conversions from traditional IRAs to Roth IRAs are taxable in the year of conversion. Individuals therefore should consider delaying conversions into 2017. Individuals who already converted to Roth IRAs in 2016 can reconvert back into a traditional IRA by year-end 2016 and avoid any 2016 income recognition. A follow up conversion, however, would then generally not be permitted for at least 30 days.
Installment contracts. Income on a sale reported under the installment method is realized pro-rata over the years in which the installment payments are made, under the tax laws applicable during those future years. This technique is particularly valuable if tax cuts are not made effective immediately in 2017 since installment payments in 2018 and beyond are all the more likely to be subject to lower tax rates.
Like-kind exchanges. Taxpayers who want to delay recognition of income on the sale of business or investment property should consider a like-kind exchange conforming to Code Sec. 1031. Proposals to limit the use of like-kind deferral to $1 million, and exclude art and collectibles from like-kind treatment, may be under consideration in the future, but are not applicable at the very least to 2016.
Debt forgiveness income. Determination of the time of debt forgiveness requires a practical assessment of the facts and circumstances relating to the likelihood of payment. Convincing the lender to postpone issuing a Form 1099-C, Cancellation of Debt, until the 2017 tax year, might form part of the process. Note that IRS final regulations in early November (T.D. 9793) removed the rule under which a deemed discharge of indebtedness, reportable on Form 1099-C, occurs at the expiration of a 36-month nonpayment testing period.
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