There is a strong possibility that federal tax cut legislation will become law sometime in 2017. It could also be delayed until 2018 due to difficult negotiations or intervening events, or it could eventually be tabled indefinitely, except for a few provisions, if momentum swings to other issues. The contents of a tax bill could vary, from a compromise between the House GOP’s A Better Way Blueprint and President-elect Trump’s Tax Plan as set forth during his campaign, to a significantly modified version if Senate Democrats and fiscally conservative House and Senate members are able to gain seats at the negotiating table.
What year end tax strategies should you implement before the 2016 tax year ends to take advantage of possible tax reduction in 2017 and beyond, without painting yourself into a corner if anticipated changes are not realized retroactively to January 1, 2017, or not in the magnitude expected?
The first assumption that needs to be made in year end strategy is whether any legislation in 2017 will be retroactive to January 1, thus providing more of an incentive to deferring taxable income into 2017 and beyond and accelerating deductions into 2016. If 2017 tax legislation only provides a mid-year tax cut, or is approved close enough to 2018 to delay any benefit until 2018, efforts now to lower 2016 taxable income at the expense of raising 2017 taxable income can end up costing overall tax dollars.
As with prior years, 2016 year end planning should start with data collection and a review of prior year returns. This includes losses or other carryovers, estimated tax installments, and items that were unusual. Conversations about next year should include review of any plans for significant purchases or dispositions, as well as any possible life cycle plans. If the general goal for year end planning has been to balance taxable income between the current and upcoming year to the extent tax bracket rates are equal, planning at year end 2016 presents a choice between using the new Trump/House blueprint rates as a target, or a more conservative approach that moves more taxable income beyond an ideal balance into 2017, but not necessarily counting on a final tax bill arriving at a 12, 25 and 33 percent rate structure for individuals; and a 15 or 25 percent rate level for businesses, depending upon the Trump or House blueprint versions. Within those goals, use of traditional techniques to delay income recognition into 2017 and beyond or to accelerate deductions into 2016 have particular relevance now.
Consider the following income deferral techniques:
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.
U.S. Savings Bonds. For cash-basis taxpayers, interest on series E, EE and I bonds is generally taxed at the earliest of disposition, redemption or final maturity of the bond (however, the taxpayer can elect to report the interest as it accrues).
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.
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 to 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.
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 April 1, 2017. Of course, you will then be required to double-up in 2017 and take distributions for 2016 and 2017 next year, which may be beneficial if tax rates drop.
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 the tax return due date or the due date plus extensions and avoid any 2016 income recognition. A follow up reconversion, however, would then generally not be permitted for at least 30 days.
Consider the following deduction acceleration techniques:
Bunch itemized deductions into 2016. This traditional technique designed to maximize both itemized deductions and the standard deduction may have even greater benefits since Trump has proposed a significant increase in the standard deduction to $15,000 for single taxpayers and $30,000 for joint filers. In addition, it may be more difficult for higher-income taxpayers to claim itemized deductions under a Trump proposal that would impose a dollar cap itemized deductions.
Prepay tuition bills for academic periods that will begin in January, February or March of 2017 (if it will make you eligible for a tax credit). If your 2016 adjusted gross income (AGI) qualifies you for the American Opportunity credit (maximum of $2,500 per eligible student) or the Lifetime Learning credit (maximum of $2,000 per family), consider prepaying tuition bills that aren’t due until early 2017 if it generates a bigger credit on this year’s tax return. You can claim a 2016 credit based on prepaying tuition for academic periods that begin in January through March of 2017. Bear in mind that both the American Opportunity credit and the Lifetime Learning credit can be reduced or eliminated if your modified adjusted gross income (MAGI) is too high. For the former, the current MAGI phaseout range for unmarried individuals is $80,000 to $90,000 and the range for married couples filing jointly is $160,000 to $180,000. For the latter, the phaseout range for unmarried individuals is $55,000 to $65,000, and for married couples filing jointly it’s $111,000 to $131,000. If you’re ineligible for these two higher education tax credits because your MAGI is too high, you might still qualify for a deduction of up to $4,000 of qualified higher education tuition. However, you can’t claim the deduction for the same year you claim an education credit or if anyone else claims an education credit for the same student for the same year.
Donate to your favorite charities. If reducing your taxable estate is an important estate planning goal for you, making lifetime charitable donations can help achieve that goal and benefit your favorite organizations. In addition, by making donations during your lifetime, rather than at death, you’ll receive income tax deductions. To take a 2016 charitable donation deduction, the gift must be made by December 31. According to the IRS, a donation generally is “made” at the time of its “unconditional delivery.” But what does this mean? Is it the date you, for example, write a check or make an online gift via your credit card? Or is it the date the charity actually receives the funds — or perhaps the date of the charity’s acknowledgment of your gift? The delivery date depends in part on what you donate and how you donate it. Here are a few examples for common donations:
- Check. The date you mail it.
- Credit card. The date you make the charge.
- Pay-by-phone account. The date the financial institution pays the amount.
- Stock certificate. The date you mail the properly endorsed stock certificate to the charity.
Incur deductible medical expenses (if your deductible medical expenses for the year already exceed the applicable floor). Consider bunching non-urgent medical procedures (and any other services and purchases with timing that you can control without negatively affecting your or your family’s health) into one year. Medical costs are deductible only to the extent they exceed 10% of AGI for people younger than age 65. However, if you or your spouse will be age 65 or older as of year end, the deduction threshold for this year is only 7.5% of AGI. (In 2017, this threshold will increase to 10% of AGI for people age 65 or older.) These taxpayers may want to bunch medical expenses into 2016 to potentially be able to take advantage of the 7.5% floor.
The above suggestions, along with paying the final state estimated tax installment or real estate tax bills early, are among time-tested techniques now elevated in importance to maximize itemized deductions.
Additional tax tips can be found at the links below:
Keep in mind that in certain situations these strategies might not make sense. We’d be pleased to help you determine the right steps to take now to lessen your 2016 tax bite.