2016 Year-End Tax Planning Letter
Dear BMSS Clients and Friends,
As 2016 draws to a close, you should give consideration to year-end tax planning strategies. This letter highlights some of the planning opportunities and challenges for individuals, estates, trusts and businesses regarding federal taxes.
For the last couple of years, year-end tax planning has been affected by uncertainty over whether Congress would pass year-end tax legislation. Given that 2016 is an election year, the passage of any tax legislation before the end of the year is highly unlikely. Thus, tax laws in effect for 2016 will not be changing before year end.
Uncertainty for 2016 tax planning, however, still exists to some degree. As mentioned below, effective income tax planning often includes consideration of the timing of income and deductions. A new administration and changes in Congress make predictions about 2017 tax law changes particularly troublesome. We can look to the President’s platform for guidance on what changes may occur, but the passage and timing of such provisions will make tax laws for 2017 and beyond a guessing game during 2016 year-end tax planning.
BMSS can help you navigate through uncertainties and develop a year-end tax strategy to help minimize your federal tax liability. Please call your BMSS trusted advisor for assistance with your year-end tax planning.
REMINDER REGARDING RETURN DUE DATE CHANGES
We use this communication to remind you of some very important changes regarding tax return due dates. Beginning with 2016 tax returns, the due dates for the following returns have changed.
- C corporation returns are now due the 15th day of the fourth month following the close of the corporation’s year (April 17, 2017 for calendar year C corporations). A six-month extension is allowed. (Special rules apply to C corporations with a June 30 year end.)
- Partnership returns are now due the 15th day of the third month following the close of the partnership’s tax year (March 15, 2017 for calendar year partnerships), with a six-month extension allowed.
- The due date for FinCEN Form 114 has changed from June 30 to April 15, and for the first time, taxpayers will be allowed a six-month extension.
- The due date for S corporation for calendar year returns remains March 15th.
OVERVIEW OF GENERAL GOALS AND OBJECTIVES OF YEAR-END TAX PLANNING
Most traditional income tax planning strategies focus on several key areas:
- planning the timing (deferral or acceleration) of particular items of income or deductions, to the extent that they can be shifted from one year to another in order to take advantage of possible differences in the effective tax rate for the current year and succeeding year(s);
- maximizing, within overall general planning, the character of income (for example qualified dividends and capital gains) that is subject to preferential, lower tax rates than ordinary income; and
- making use of special incentive provisions of the Internal Revenue Code when available such as Section 179 expensing, bonus depreciation, and various credits related to different business or personal activities.
To complicate matters further, these general planning strategies must also consider the impact of taxes other than the regular income tax, such as the alternative minimum tax, the net investment income tax, the Medicare surtax and applicable state and local taxes to name a few. The phaseout or limitation of itemized deductions must also be considered in planning for the timing of certain deductions.
As always, tax planning requires a combination of multi-layered strategies, taking into account a variety of possible scenarios and outcomes. There are various income and deduction items to review which your BMSS trusted advisor would be glad to assist you with in order to determine the most beneficial approach to take.
Tax Rates and Phaseouts – Individuals
The income tax rates and brackets for 2016 are:
Unchanged from 2015, the following rates generally apply to long-term capital gains and qualified dividends:
- 0% for taxpayers in the 10% and 15% income tax brackets
- 15% for taxpayers in the 25%, 28%, 33%, and 35% income tax brackets
- 20% for taxpayers in the 39.6% income tax bracket
These long-term capital gains rates apply to gains from the sale of investment assets held for longer than a year. Qualified dividends are those received from domestic corporations whose stock is held for more than 60 days.
In the special circumstances indicated below, the following capital gains rates apply:
- 25% for unrecaptured Code Section 1250 gains
- 28% for collectible gains and gains on qualified small business stock
Keep in mind the “wash sale rules” when reviewing year-end capital gains and dividends. Wash sales are sales of stock or securities in which losses are realized, but not recognized for tax purposes, because the seller acquires substantially identical stock or securities within 30 days before or after the sale. Non-recognition, however, applies only to losses; gains are recognized in full.
Higher-income taxpayers are subject to the Pease limitation. The Pease limitation reduces itemized deductions by 3% of the amount that the taxpayer’s adjusted gross income (AGI) exceeds the thresholds below, but not by more than 80%. For 2016, the threshold amounts are:
- $311,300 for MFJ and Surviving Spouses (SS);
- $155,650 for MFS;
- $285,350 for HOH; and
- $259,400 for single taxpayers.
The personal exemption phaseout requires taxpayers to reduce the amount of their exemptions when their AGI exceeds the same threshold levels as the Pease limitation above. The total amount of exemptions that may be claimed by a taxpayer are reduced by 2% for each $2,500 (2% for each $1,250 for MFS), or portion thereof by which the taxpayer’s AGI exceeds the applicable threshold.
Alternative Minimum Tax – Individuals
The possibility of being subject to alternative minimum tax (AMT) should not be ignored, as doing so may negate certain year-end tax strategies. The AMT, as its name signifies, is an alternative tax calculation that makes certain adjustments to regular taxable income and subjects the resulting AMT income that is in excess of certain exemptions amounts to a rate of either 26% or 28%, depending on the AMT income level. You pay the higher of the regular tax calculated or the AMT. As mentioned, the presence of AMT for a year might mean that tax planning strategies generally designed to reduce regular tax purposes will not yield the expected results. The possibility of AMT is one reason why the most effective approach to making sound year-end tax planning decisions is often to model your expected tax situation for the current year as well as the following year, to achieve an overall lower tax result.
Net Investment Income Tax (NIIT) – Individuals
The NIIT is a 3.8% Medicare surtax imposed on the lesser of an individual’s (a) net investment income (NII) or (b) the amount of modified adjusted gross income (AGI with foreign income added back) that exceeds the thresholds below:
- $250,000 for MFJ
- $125,000 for MFS
- $200,000 for single taxpayers and HOH
The NIIT generally applies to passive income and is not imposed on income derived from a trade or business or from the sale of property used in a trade or business. NII includes the following:
- Gross income from interest, dividends, annuities, royalties, and rents, provided this income is not derived in the ordinary course of an active trade or business;
- Gross income from a trade or business that is a passive activity for the taxpayer;
- Gross income from a trade or business of trading in financial instruments or commodities; or
- Gain from the disposition of property not held in an active trade or business.
Keeping income below the thresholds, spreading income out over a number of years or offsetting the income with both above-the-line and itemized deductions are possible approaches to avoid the NIIT. Of course, every taxpayer’s situation is different and planning for the NIIT requires a very personalized strategy. BMSS can help you develop a personalized response.
Additional Medicare Tax – Individuals
An additional 0.9% high income Medicare tax is imposed on wages and self-employment income that exceeds the same thresholds as the NIIT thresholds listed above. Although the thresholds are the same, this additional tax should not be confused with the 3.8% Medicare surtax on NII.
If federal income tax withholdings and estimated tax payments have not been made under a “safe harbor,” you can instruct your employer to withhold additional federal income taxes from your wages before year end to avoid an underpayment penalty related to this tax or the NIIT.
Child and Education Related Tax Benefits – Individuals
Adoption Credit and Adoption Assistance Programs
Most taxpayers can claim a credit for qualified expenses incurred in connection with the adoption of an eligible child. The credit for each adoption is limited to a maximum amount of $13,460 per child for 2016. Additionally, $13,460 received under an adoption assistance program may be excluded from gross income. Both the credit and gross income exclusion are phased out for higher income taxpayers. Different rules apply to domestic children, foreign children, and children with special needs.
Child and Dependent Care (CDC) Credit
Taxpayers who incur expenses to care for children under age 13 (or for an incapacitated dependent or spouse) in order to work or look for work can claim a credit for those expenses. The credit is calculated as a percentage of the expenses incurred, up to a maximum of $3,000 for taxpayers with one qualifying child or dependent and $6,000 for taxpayers with two or more qualifying children or dependents.
Child Tax Credit (CTC)
Taxpayers are allowed an income tax credit of $1,000 for each qualifying child under the age of 17 at the end of the calendar year. The child tax credit is refundable for some taxpayers, but begins to phase out for higher-income taxpayers at the thresholds below:
- $110,000 for MFJ (complete phaseout at $130,000)
- $75,000 for single taxpayers and HOH (complete phaseout at $95,000)
- $55,000 for MFS (complete phaseout at $75,000)
American Opportunity Tax Credit (AOTC)
The AOTC has now been made permanent beginning in 2016. The maximum credit that can be taken is $2,500 per eligible student for the first four years of higher education and up to $1,000 is refundable. The AOTC is phased out for single taxpayers with income ranging from $80,000 to $90,000, and for joint taxpayers with income ranging from $160,000 to $180,000.
Lifetime Learning Tax Credit
The lifetime learning credit is a nonrefundable credit for qualified students and is available for all years of postsecondary education. The maximum credit of $2,000 is phased out for single taxpayers with income ranging from $55,000 to $65,000 and joint taxpayers with income ranging from $111,000 to $131,000. The lifetime learning credit and American Opportunity credit cannot be taken in the same tax year.
Coverdell Education Savings Accounts (ESAs)
ESAs are trust or custodial accounts created exclusively to pay the qualified elementary, secondary and higher education expenses of a single named beneficiary. Annual contributions are limited to $2,000 per beneficiary, but this limit is phased out for higher-income contributors. Contributions may be made to an ESA up to the original due date of the return.
Qualified Tuition Programs (QTP)
A Qualified Tuition Program is an education savings plan designed to help families set aside funds for future college costs. Contributions to a QTP are not deductible, however, the earnings in the plan grow tax free, provided they are used for qualified expenses (e.g. tuition, fees, room and board, books, supplies, computers and software) while enrolled at an eligible educational institution.
Educational Assistance Programs
Employees are allowed to exclude up to $5,250 in annual educational assistance from gross income and wages provided under an employer’s nondiscriminatory “educational assistance plan.” Employer-provided educational benefits may also be excludable as a fringe benefit.
Any amount received as a qualified scholarship and used for qualified tuition and related expenses is excludable from income. The exclusion does not apply to any portion of the amount received which represents payment for teaching, research, or other services by the student required as a condition for receiving the qualified scholarship (with limited exceptions).
Student Loan Interest Deduction
Taxpayers may deduct from gross income, subject to certain conditions, interest payments made on qualified education loans. The deduction is an above-the-line adjustment to income that can be claimed by all individuals, not just those who itemize. The maximum deduction of $2,500 is reduced when modified AGI exceeds $65,000 ($130,000 for joint returns) and is completely eliminated when modified AGI reaches $80,000 ($160,000 for joint returns).
Affordable Care Act (ACA) – Individuals
Unless exempt, the ACA requires that all individuals carry minimum essential coverage or make a shared responsibility payment. Individuals with health insurance coverage should determine whether their coverage satisfies the ACA’s minimum essential coverage requirements. The following exemptions are available to qualified individuals:
- Religious conscience exemption
- Hardship exemption
- Exemption for members of federally-recognized Native American nations
- Exemption for members of a health care sharing ministry
- Exemption for incarcerated individuals
- Short coverage gap exemption
- Exemption for individuals not lawfully present in the United States
For 2016, the individual shared responsibility payment is the greater of 2.5 percent of household income that is above the tax return filing threshold for the individual’s filing status, or the individual’s flat dollar amount, which is $695 per adult and $347.50 per child, limited to a family maximum of $2,085. The shared responsibility payment is capped at the cost of the national average premium for a bronze level health plan available through the ACA Marketplace in 2016.
Additional Benefits – Individuals
The PATH Act of 2015 either extended or made permanent the following deductions and credits:
- Above-the-line deduction of up to $250 for certain expenses of elementary and secondary school teachers, including books, supplies, computers, and software
- Above-the-line deduction for qualified tuition and related expenses
- Exclusion of 100% of the gain on the sale or exchange of qualified small business (QSB) stock acquired and held for more than five years
- Credit for residential energy property
- Exclusion from gross income for discharge of indebtedness on qualified principal residences
- Exclusion from gross income of qualified charitable distributions up to $100,000 from individual retirement plans for individuals aged 70&½ or older
- Itemized deduction for mortgage insurance premiums as qualified residence interest
- Itemized deduction for state and local general sales taxes in lieu of state and local income taxes
- Alternative fuel vehicle refueling property credit (hydrogen refueling property)
ESTATE, TRUST AND GIFT TAXES
The maximum federal unified estate and gift tax rate is 40 percent with a $2,125,800 unified credit amount ($5,450,000 exemption amount) for gifts made and estates of decedents. The annual gift tax exclusion allows taxpayers to give up to $14,000 during 2016 to any individual ($28,000 for married individuals who split the gifts), gift-tax free and without counting the amount of the gift toward the lifetime $5,450,000 exemption, adjusted for inflation.
Exclusion for Educational and Medical Expenses
In addition to the $14,000 annual exclusion amount, expenditures may be made for certain educational and medical expenses with gift tax consequences. Any amount paid on behalf of an individual as tuition directly to certain educational organizations for the education or training of such individual is not treated as a transfer by gift for purposes of the gift tax. For medical expenses, the exclusion applies for certain medical expenses paid on behalf of an individual not reimbursed to the individual by insurance. The exclusion for educational and medical expenses is unlimited in amount, and can be made on behalf of anyone you choose, as long as the payments are made directly to the educational institution or health care provider.
Year-End Trust Distribution Planning
For certain trusts that are not required to make distributions, distribution planning is important in order to minimize the overall tax due on the trust’s income. In general, a trust not otherwise required to make distributions is liable for the tax on all of its income if no distributions are made to beneficiaries. If distributions are made, the beneficiary is taxed on the portion of the income distributed, not the trust. Trusts are subject to the top income tax rate of 39.6% for ordinary income in excess of $12,400 in 2016. For individuals, this amount is $415,051 for single filers, and $466,950 for joint filers. Due to the compressed tax bracket for trusts, distributions to beneficiaries often result in a lower overall tax burden. Of course, all factors should be considered as to whether a distribution is appropriate, not just income tax planning. If a trustee determines that distributions are appropriate, trusts have until 65 days after year end (March 6, 2017) to make a distribution and treat it as a distribution for the 2016 tax year.
Closely-Held Family Businesses
If you have been considering transferring your family business to your heirs, now may be the time to act. Earlier this year, the IRS issued proposed regulations that, if finalized, would have a far-reaching impact on the valuation of family-controlled entities. Specifically, the proposed regulations could reduce or eliminate the discounts that have, historically, been allowed in valuing interests in a family-controlled corporation, partnership or limited liability company, resulting in a higher tax burden in cases where the transferor’s estate is at a taxable level. Although we cannot know with certainty that the final regulations will mirror the proposed regulations, it is important for you to consider your situation and plan now while discounts may still be merited.
Deductions and Credits – Business
The very popular bonus depreciation provision was extended through 2019 by the PATH Act. A depreciation deduction equal to 50% of the basis of qualifying property is available in 2016 and 2017. The percentage is set to decrease to 40% in 2018 and 30% in 2019. In order to be eligible for bonus depreciation, qualifying property must be new (first-time use) tangible property.
Code Section 179 Expensing
Code Section 179 property includes new or used tangible personal property that is purchased to use in an active trade or business. Under the enhanced expensing, for 2016, businesses can expense up to $500,000 in qualifying expenditures, with no reduction unless expenditures exceed $2,010,000.
Taxpayers can defer the gain (or portion of that gain) on the exchange of like-kind property. A like-kind exchange can involve the exchange of one business for another business, one real estate investment property for another real estate investment property, as well as other qualifying assets. Both the relinquished property and the acquired property must be held for business or investment purposes.
Tangible Personal Property Regulations
The IRS issued final regulations in 2014 that refine and simplify the rules for expensing tangible personal property, including the de minimis safe harbor. For 2016, the safe harbor enables taxpayers to routinely deduct items whose costs are below $5,000 for taxpayers with an applicable financial statement (AFS) and $2,500 for taxpayers without an AFS.
The research credit provides a credit for 20% of qualified research expenses over a base amount. The research credit applies to any amounts paid or incurred for qualified research and experimentation. BMSS has a Research and Development team ready to meet with you to discuss your company’s R&D potential.
Standard Mileage Rate
The standard business mileage allowance rate for 2016 is 54 cents per mile (down from 57.5 cents per mile for 2015).
Health Care Reform – Businesses
Although the primary thrust of the Patient Protection and Affordable Care Act (PPAC) is health insurance reform, the tax law plays a key role in achieving this goal. Below are parts of the reform to health care that continue to impact businesses.
Small Employer Health Care Tax Credit
Eligible small employers that maintained a qualifying arrangement were able to claim a 50% tax credit (35% for eligible tax-exempt employers) for non-elective contributions (i.e., premiums) paid for health coverage for their employees. An employer must participate in an insurance SHOP exchange in order to claim the credit. The credit can only be claimed for two consecutive years.
Simple Cafeteria Plans
Certain small employers’ cafeteria plans can qualify as simple cafeteria plans. In order to qualify, an employer’s plan must meet strict contribution, eligibility, and participation requirements. The simple cafeteria plan’s benefit to the employer is that certain nondiscrimination requirements, particularly those that a classic cafeteria plan must meet, are deemed as satisfied.
Shared Responsibility Payments for Large Employers
“Applicable large employers”, employers with at least 50 full-time employees or a combination of 50 full-time and part-time employees, are subject to the employer mandate. Under these rules, if an applicable large employer does not offer minimum essential coverage, or offers coverage to fewer than 95 percent of its full-time employees, the employer’s assessed shared responsibility payment will be based on the total number of its full-time employees (minus 30) multiplied by $2,000. If it does offer such coverage, the assessed payment amount will be based solely on the number of employees who claimed a premium tax credit for purchasing coverage through the Health Insurance Marketplace. An employee can claim this tax credit because the employee was offered no coverage, the coverage offered was unaffordable or the coverage did not meet minimum value standards. Safe harbors are available both for counting full-time employees, and for affordable coverage.
The ACA also requires applicable large employers to file information returns with the IRS and provide statements to their full-time employees about the health insurance coverage the employer offered. This requirement applies even if an applicable large employer does not offer coverage to any of its full-time employees. In general, each applicable large employer may satisfy the information reporting requirement by filing a Form 1094-C (transmittal) and, for each full-time employee, a Form 1095-C (employee statement).
OTHER BUSINESS PLANNING CONSIDERATIONS
Although beyond the scope of this tax planning letter, there are a few other business planning considerations to remember. BMSS professionals are available to assist you in these areas as well.
Choice of Entity Planning
A primary consideration in setting up a business is the choice of entity in which to conduct the business. The decision has tax and nontax considerations. Choosing the initial business structure for the entity is the first step, but determining when, and if, to convert to another form involves an assessment of the company’s specific needs, circumstances, and plans. LLCs are advantageous in this regard, as they allow for increased flexibility for both the initial tax regime and later conversions to other tax regimes. If you have recently formed or are considering the formation of a new business entity or are considering changes in the tax regime for an existing entity, please contact BMSS to discuss choice of entity and tax regime considerations.
State and Local Tax (SALT) Planning
A comprehensive state and local tax strategy helps minimize your company’s compliance risk and its tax burden. SALT planning is more than just income tax planning. BMSS’s dedicated SALT professionals are available, upon request, to provide you with favorable, accurate and defendable tax solutions. Our clients benefit from our expertise in working with state and local jurisdictions. We even offer an all-inclusive “SALT Scrub” for companies looking to holistically review their business processes.
Mergers and Acquisitions Advisory Services
Acquisitions or dispositions of business entities or portions thereof raise a number of tax and nontax and accounting considerations for the participants. Transactions can take the form of taxable or nontaxable / deferred tax structures. BMSS can assist you in identifying the principal concerns that will determine the most advantageous structure for a transaction. We can assist with organizing and analyzing the complex range of factors including tax, legal, accounting and regulatory issues that will need to be considered together. We can also assist you in the modeling of disposition transactions to help you determine the after-tax consequences.
We’re Here to Help You
BMSS understands that the complexity of the tax law can make year-end tax planning overwhelming, but it is a necessity. This letter covered several of the high points, but there are many more strategies that can help reduce your tax liability over a period of time.
Additionally, this update discusses only federal tax planning. State taxes should also be considered since the tax laws of many states do not follow the federal tax laws.
Please contact BMSS if you have any questions regarding the opportunities presented in this letter or to schedule an appointment to develop a year-end tax plan considering your particular circumstances. We look forward to serving you in the future.