Year-End Income Tax Planning

There’s Still Time

With the Republicans controlling both Congress and the White House, individual income tax changes that could potentially reduce your tax bill are widely expected. But that doesn’t mean you shouldn’t do your regular year-end tax planning.

Both President-elect Donald J. Trump and House Republicans call for a 33% maximum ordinary tax rate and a 20% maximum capital gain rate. They both want to repeal the Net Investment Income Tax and Alternative Minimum Tax. And they agree on increasing the standard deduction and no personal exemptions.

However, they also want to cap itemized deductions. While Trump favors a monetary cap of $100,000 per taxpayer, House Speaker Paul Ryan wants to limit deductions to mortgage interest and charitable contributions only.

Even though the differences in the details still need to be hashed out, it clearly appears that the traditional tactics of deferring income into next year and accelerating deductions into this year remain as important as ever to use as 2016 comes to an end.

Minimize taxes on investment income

Since both Trump and House Republicans pledge to eliminate the 3.8% Net Investment Income Tax, deferring investment income makes sense. Here are a few common investment income deferral strategies:

• Defer capital gains — Although market conditions, strategic investment considerations and personal needs may outweigh the tax implications, the simplest way to defer capital gains is to postpone the sale of appreciated assets until next year. If the closing of a property sale cannot be deferred, the buyer may be pleased to accept installment payment terms that allow you to shift a large portion of the gain into the next year. Additionally, you’ll get interest income on the deferred payments.
• Recognize capital losses — Another basic strategy for minimizing taxable capital gains in the current year is to sell securities with losses to offset those gains, also known as tax-loss harvesting. However, you cannot buy a substantially identical security within 30 days before and after the date of sale of the diminished security.
• Defer year-end mutual fund purchases — Mutual funds are required to distribute their entire net ordinary income and capital gains to shareholders each year. If you purchase mutual fund shares late in the year and prior to the record date for the fund’s year-end distributions, you may well receive a portion of your investment back in the form of a taxable dividend. For this reason, it may be wise to defer December mutual fund investments until after the fund makes its year-end distributions.

Maximize tax-advantaged savings

If you’re a saver, you can enhance your investment returns by taking advantage of the variety of tax-deferred savings accounts that are available.

• 401(k)s — Use your year-end bonus to top off your annual 401(k) contributions. If you are under 50, you may contribute up to $18,000. The annual limit is $24,000 for employees who will be at least 50 years old by Dec. 31.
• IRAs — Often overlooked by high-income taxpayers because of the relatively low $5,500 annual contribution limit ($6,500 for those 50 and older) the tax-deferred growth that can build within the account remains attractive, even if your income is too high to qualify for the up-front income tax deduction. Remember, you can also make contributions up to the same limits for a non-working spouse.
• HSAs — Health savings accounts (HSAs) are sometimes confused with flexible spending accounts (FSAs) for which the contributions must be spent or lost each year. Rather, HSAs are perhaps better described as a variation of the IRA. For people with high-deductible health plans, annual contributions (up to $3,350 for individual health plan participants, $6,650 for family plan participants) are deductible, and taxpayers 55 and older can contribute an extra $1,000. Investments within the HSA grow tax-deferred and, if used to pay for qualified medical expenses, can be withdrawn tax-free. After age 65, monies distributed for nonqualified purposes continue to be subject to income tax, but avoid the 20% penalty tax.

Give appreciated securities to charity

Republican proposals for future limitations on itemized deductions make it even more important to determine whether charitable pledges and goals should be accelerated into 2016. Gifts of appreciated stock offer the dual benefits of shielding the unrealized gain from tax while, at the same time, providing an income tax deduction for the same amount.

Increase income tax withholding to avoid estimated tax penalties

Taxpayers who discover that their estimated taxes are underpaid for any of the first three quarters of the year may have the ability to cure the shortfalls by increasing withholding before year-end.

In addition to increasing the withholding rate on bonus compensation or that final paycheck of the year, you may be able to use eligible rollover distributions from a qualified retirement plan to meet the withholding target. If you ask your IRA custodian to distribute the funds to you directly, the firm will automatically withhold taxes at a standard rate. You can then use other money to meet the required IRA rollover contribution of an equivalent amount within 60 days of the distribution.

Although 2016 is rapidly closing on us, there’s still time to make changes to help minimize your tax bill for this year and next. In addition to what I’ve outlined above, there are other potential strategies. Your independent financial advisor can recommend the options that may work best for you (which you should confirm with your tax professional) and then help you execute them, so you can focus on family and fun this holiday season.