Individual income taxes, whether paid through employer withholding or quarterly estimates, are probably one of your largest annual expenditures. So, just as you would shop around for the best price for food, clothing or merchandise, you want to consider opportunities to reduce or defer your annual tax obligation. This Tax Letter is intended to assist you in that effort.
Your 2015 year-end tax planning begins with a projection of your estimated income, deductions and tax liability for 2015 and 2016. You should review actual amounts from 2014 to assist you with these projections. To the extent you can control the timing of income and deductions between 2015 and 2016, you should make decisions that will result in the lowest overall tax for both years. If shifting income and deductions between 2015 and 2016 does not reduce your overall tax liability, you should try to defer as much tax liability as possible from 2015 to 2016.
2015 Versus 2016 Marginal Tax Rates
Whether you should defer or accelerate income and deductions between 2015 and 2016 depends to a great extent on your projected marginal (highest) tax rate for each year.
The highest marginal tax rate for 2015 and 2016 is nominally 39.6%, but certain provisions that reduce deductions as income increases may also increase the effective marginal tax rates slightly. Also, an additional 3.8% tax on unearned income of high-income taxpayers applies for taxable years beginning after December 31, 2012. The tax brackets for 2015 and 2016 are included below. Projections of your 2015 and 2016 income and deductions are necessary to estimate your marginal tax rate for each year.
Tax Rate | Joint/Surviving Spouse | Single | Head of Household | Married Filing Separately | Estate &Trusts |
10% | $0 – $18,450 | $0 – $9,225 | $0 – $13,150 | $0 – $9,225 | – |
15% | $18,450 – $74,900 | $9,225 – $37,450 | $13,150 – $50,200 | $9,225 – $37,450 | $0 – $2,500 |
25% | $74,900 – $151,200 | $37,450 – $90,750 | $50,200 – $129,600 | $37,450 – $75,600 | $2,500 – $5,900 |
28% | $151,200 – $230,450 | $90,750 – $189,300 | $129,600 – $209,850 | $75,600 – $115,225 | $5,900– $9,050 |
33% | $230,450 – $411,500 | $189,300 – $411,500 | $209,850 – $411,500 | $115,225 – $205,750 | $9,050 – $12,300 |
35% | $411,500 – $464,850 | $411,500 – $413,200 | $411,500 – $439,000 | $205,750 – $232,425 | – |
39.6% | Over $464,850 | Over $413,200 | Over $439,000 | Over $232,425 | Over $12,300 |
Tax Rate | Joint/Surviving Spouse | Single | Head of Household | Married Filing Separately | Estate &Trusts |
10% | $0 – $18,550 | $0 – $9,275 | $0 – $13,250 | $0 – $9,275 | – |
15% | $18,550 – $75,300 | $9,275 – $37,650 | $13,250 – $50,400 | $9,275 – $37,650 | $0 – $2,550 |
25% | $75,300 – $151,900 | $37,650 – $91,150 | $50,400 – $130,150 | $37,650 – $75,950 | $2,550 – $5,950 |
28% | $151,900 – $231,450 | $91,150 – $190,150 | $130,150 – $210,800 | $75,950 – $115,725 | $5,950 – $9,050 |
33% | $231,450 – $413,350 | $190,150 – $413,350 | $210,800 – $413,350 | $115,725 – $206,675 | $9,050 – $12,400 |
35% | $413,350 – $466,950 | $413,350 – $415,050 | $413,350 – $441,000 | $206,675 – $233,475 | – |
39.6% | Over $466,950 | Over $415,050 | Over $441,000 | Over $233,475 | Over $12,400 |
You can shift taxable income between 2015 and 2016 by controlling the receipt of income and the payment of deductions. Generally, income should be received in the year with the lower marginal tax rate, while deductible expenses should be paid in the year with the higher marginal rate. If your top tax rate is the same in 2015 and 2016, deferring income into 2016 and accelerating deductions into 2015 will generally produce a tax deferral of up to one year. On the other hand, if you expect your tax rate to be higher in 2016, you may want to accelerate income into 2015 and defer deductions to 2016.
Planning Suggestion: The time value of money should be considered when making a decision to defer income or accelerate deductions. Comparative computations should be made to determine and evaluate the net after-tax result of these financial actions.
Moreover, you should consider whether you expect to be subject to the alternative minimum tax (“AMT”) for either or both years.
Controlling Income
Income can be accelerated into 2015 or deferred to 2016 by controlling the receipt of various types of income depending on your situation, such as:
For Business Owners
- Year-end interest or dividend payments from closely-held corporations;
- Rents and fees for services (delay December billings to defer income); and
- Commissions (close sales in January to defer income).
Caution: Income cannot be deferred to 2016 if you constructively receive it in 2015. Constructive receipt occurs when you have the right to receive payment or have received a check for payment even though it has not been deposited. Income also cannot be deferred if you effectively receive the benefit of the income; for example, if you are allowed to pledge a deferred compensation account balance to obtain a loan.
Bonuses for work performed in a particular year can be deferred to the next year if an election is made no later than the end of the year proceeding the year the work is to be performed. Accordingly, bonuses for work to be performed in 2016 can be deferred to 2017 if the required election is made before the end of 2015.
For Investors
- Interest on short-term investments, such as Treasury bills (“T-bills”) and certain certificates of deposit that do not permit early withdrawal of the interest without a substantial penalty, is not taxable until maturity.
Example: In November 2015, an investor buys a six-month T-bill. The interest is not taxable until 2016 assuming the T-bill is held to maturity.
Other than not being taxable until the proceeds are received, interest on issued Series EE bonds may be exempt from tax if the proceeds of the bond are used to pay certain educational expenses for yourself or your dependents, and the requirements of “qualified United States savings bonds” are met.
Planning Suggestion: Consider investments that generate interest exempt from the regular income tax. You must, however, compare the tax-exempt yield with the after-tax yield on taxable securities to determine the most advantageous investment. In addition, some tax-exempt interest may be subject to AMT (see page 15) which could lower the after-tax yield.
Other ways to defer income include installment sales and tax-free exchanges of “like-kind” investment or business property.
Planning Suggestion: If you made a 2015 sale that is eligible for installment reporting, you have until the due date of your 2015 return, including extensions, to decide if you do not want to use the installment method and, instead, report the entire gain in 2015.
Beginning 2013, the Health Care and Education Reconciliation Act imposes an additional 3.8% tax on net investment income in excess of certain thresholds for taxable years beginning after December 31, 2012. Examples of net investment income include non-business interest, dividends and capital gains. Net investment income also includes business income from an activity in which the taxpayer does not materially participate, including from partnerships and S corporations. Income excluded from net investment income includes wages, unemployment compensation, self-employment income, Social Security benefits, tax-exempt interest, distributions from certain qualified retirement plans and non-investment income from businesses in which the taxpayer is a material participant. The 3.8% tax is applicable to taxpayers with modified adjusted gross income for 2015 and 2016 exceeding $250,000 for married couples and surviving spouses, $125,000 for married individuals filing separate returns and $200,000 for single individuals. You should be aware that these statutory threshold amounts are not indexed for inflation. The tax is 3.8% of the lesser of your net investment income or the excess of your modified adjusted gross income over the applicable threshold amount stated above. This tax is also likely to apply to a significant portion of the net investment income of an estate or trust that is otherwise subject to income tax on such income.
Planning Suggestion: We strongly encourage you to consult your investment and tax advisors to maximize the after-tax returns if you believe your portfolio may not be currently aligned to account for increased tax exposure.
In addition, taxpayers who are subject to AMT and have significant investment earnings should consider prepaying their state income taxes to reduce their net investment income and lower their net investment income tax.
For Employees
Caution: The Service will scrutinize deferrals of income between owner-employees and their closely-held corporations. Additionally, if you own more than 50% of a taxable (C) corporation or any stock of an S corporation that reports its income on an accrual method of accounting, the corporation can deduct a year-end bonus to you only when it is paid.
Distributions from qualified retirement plans can be delayed.
Caution: Penalties may be imposed on early, late, or insufficient distributions.
All distributions from a regular individual retirement account (“IRA”) are subject to ordinary income taxes. This tax liability can be delayed until age 70½, at which time you are required to begin taking distributions from your IRA. The 10% early withdrawal penalty prevents distributions before age 59½ in most cases. However, if you are over 59½ you can take a penalty-free voluntary distribution if accelerating ordinary taxable income into 2016 is desirable. Penalty-free access to the funds is available prior to age 59½, to the extent the distribution is used to pay medical expenses in excess of 10% of your adjusted gross income (“AGI”) or to pay any health insurance premiums, provided you have received unemployment compensation for at least 12 weeks.
If you are planning to purchase a new home, you may withdraw up to $10,000 from your IRA to pay certain qualified acquisition expenses without having to pay the 10% early withdrawal penalty. The distribution is still subject to the regular income tax. The $10,000 withdrawal is a lifetime cap. If a taxpayer or spouse has owned a principal residence in the previous two years, this penalty-free provision is not available. An eligible homebuyer for this purpose can be the owner of the IRA, his or her spouse, child, grandchild or any ancestor. Also, penalty-free distributions can be made from IRAs for higher education expenses of a taxpayer, spouse, child or grandchild.
Subject to certain requirements, payments received under a life insurance policy of an individual who is terminally or chronically ill are excluded from gross income. If you sell a life insurance policy to a viatical settlement provider (regularly engaged in the business of purchasing or taking assignments of life insurance policies), these payments also are excluded from gross income.
An exclusion for employer-provided education benefits for non-graduate and graduate courses up to $5,250 per year is available.
Controlling Deductions
The phase-out of itemized deductions for high income individual taxpayers, called the “Pease” limitation, was reinstated for 2014 and succeeding taxable years. Under the Pease limitation, itemized deductions that would otherwise be allowable are reduced by the lesser of:
- 3% of the amount of the taxpayer’s AGI in excess of a threshold amount (see below); or
- 80% of the itemized deductions otherwise allowable for the taxable year.
For 2016, the Pease limitation AGI thresholds are as follows:
- $259,400 for single individuals;
- $285,350 for heads of household;
- $311,300 for married individuals filing jointly; and
- $155,650 for married individuals filing separately.
Deductions that may be accelerated into 2015 or deferred to 2016 include:
You must obtain written substantiation, in addition to a canceled check, for all charitable donations.
Charities are required to inform you of the amount of your net contribution, where you receive goods or services in excess of $75 in exchange for your contribution.
If the value of contributed property exceeds $5,000, you must obtain a qualified written appraisal (prior to the due date of your tax return, including extensions), except for publicly-traded securities and non-publicly-traded stock of $10,000 or less.
Planning Suggestion: If you are considering contributing marketable securities to a charity and the securities have declined in value, sell the securities first and then donate the sales proceeds. You will obtain both a capital loss and a charitable contribution deduction.
On the other hand, if the marketable securities or other long-term capital gain property have appreciated in value, you should contribute the property in kind to the charity. By contributing the property in kind, you will avoid taxes on the appreciation and receive a charitable contribution deduction for the property’s full fair market value.
If you contribute appreciated, publicly-traded stock (with no restrictions) to a private foundation, you are entitled to a charitable contribution deduction for the full fair market value of the stock.
If you wish to make a significant gift of property to a charitable organization yet retain current income for yourself, a charitable remainder trust may fulfill your needs. A charitable remainder trust is a trust that generates a current charitable deduction for a future contribution to a charity. The trust pays you income annually on the principal in the trust for a specified term or for life. When the term of the trust ends, the trust’s assets are distributed to the designated charity. You obtain a current tax deduction when the trust is funded based on the present value of the assets that will pass to the charity when the trust terminates. This accelerates your deduction into the year the trust is funded, while you retain the income from the assets. This method of making a charitable contribution can work very well with appreciated property.
If you volunteer time to a charity, you cannot deduct the value of your time, but you can deduct your out-of-pocket expenses. If you use your automobile in connection with performing charitable work, including driving to and from the organization, you can deduct 14 cents per mile. You must keep a record of the miles.
The allowable deduction for donating an automobile (also, a boat and airplane) is significantly reduced. The deduction for a contribution made to a charity, in which the claimed value exceeds $500, will be dependent on the charity’s use of the vehicle. If the charity sells the donated property without having significantly used the vehicle in regularly conducted activities, the taxpayer’s deduction will be limited to the amount of the proceeds from the charity’s sale. In addition, greater substantiation requirements are also imposed on property contributions. For example, a deduction will be disallowed unless the taxpayer receives written acknowledgement from the charity containing detailed information regarding the vehicle donated, as well as specific information regarding a subsequent sale of the property.
In addition to medical expenses for doctors, hospitals, prescription medications and medical insurance premiums, you may be entitled to deduct certain related out-of-pocket expenses such as transportation, lodging (but not meals), and home healthcare expenses. If you use your car for trips to the doctor during 2015, you can deduct 23 cents per mile for travel during 2015. Payments for programs to help you stop smoking and prescription medications to alleviate nicotine withdrawal problems are deductible medical expenses. Uncompensated costs of weight-loss programs and diet food to treat diseases diagnosed by a physician, including obesity, are also deductible medical expenses.
The deduction is limited to the extent of your medical expenses exceed 10 percent of your adjusted gross income for taxpayers under age 65. The AGI floor remains at 7.5% through 2016 for taxpayers over age 65. In the case of married taxpayers filing jointly, only one spouse needs to have attained the age of 65 before the end of the taxable year for the lower 7.5% AGI limit.
Planning Suggestion: If you pay your medical expenses by credit card, the expense is deductible in the year the expense is charged, not when you pay the credit card company. It is important to remember that prepayments for medical services generally are not deductible until the year when the services are actually rendered. Because medical expenses are deductible only to the extent they exceed 7½% or 10% of AGI as discussed above, they should, where possible, be bunched in a year in which they would exceed this AGI limit.
Under certain conditions, if you provide more than half of an individual’s support, such as a dependent parent, you can deduct the unreimbursed medical expenses you pay for that individual to the extent all medical expenses exceed the applicable AGI limit. Even if you cannot claim that individual as your dependent because his or her 2015 gross income is $4,000 or more, you are still entitled to the medical deduction. Please consult your client service professional for details.
Premiums you pay on a qualified long-term care insurance policy are deductible as a medical expense. The maximum amount of your deduction is determined by your age. The following table sets forth the deductible limits for 2016:
AGE | DEDUCTION LIMITATION |
40 or less | $390 |
41-50 | $730 |
51-60 | $1,460 |
61-70 | $3,900 |
Over 70 | $4,870 |
These limitations are per person, not per return. Thus, a married couple over 70 years old has a combined maximum deduction of $9,740, subject to the applicable AGI limit.
Generally, if your employer pays these premiums, they are not taxable income to you. However, if this benefit is provided as part of a flexible spending account or cafeteria plan arrangement, the premiums are taxable to you.
Medical payments for qualified long-term care services prescribed by a licensed healthcare professional for a chronically ill individual are also deductible as medical expenses.
The Patient Protection and Affordable Care Act (the “ACA”) provides that any plan that covers dependents must be extended to provide coverage of adult children until the day the child reaches age 26. The general exclusion from gross income also includes premiums from employer-provided health benefits to any employee’s child who has not attained age 27 as of the end of the taxable year is also extended under the ACA.
Interest as well as points paid on a loan to purchase or improve a principal residence is generally deductible in the year paid. The mortgage loan must be secured by your principal residence. Points paid in connection with refinancing an existing mortgage are not deductible currently, but rather must be amortized over the life of the new mortgage. However, if the mortgage is refinanced again, the unamortized points on the old mortgage can be deducted in full.
An “above-the-line” deduction (a deduction to arrive at AGI) is allowed for interest paid on qualified education loans. All student loan interest up to the $2,500 annual limit is deductible. However, in 2016 this deduction is phased out for single individuals with modified AGI of $65,000 to $80,000 ($130,000 to $160,000 for joint returns).
Caution: Interest paid to a relative or to an entity (such as a corporation or trust) controlled by you or a relative does not qualify for the deduction.
Non-business bad debts are treated as short-term capital losses when they become totally worthless. To establish worthlessness, you must demonstrate there is no reasonable prospect of recovering the debt. This might include documenting the efforts you made to collect the debt, including correspondence to the debtor to demand payment.
If your employer (including a tax-exempt organization) has a 401(k) plan or 403(b) plan, as applicable, consider making elective contributions up to the maximum amount of $18,000 or $24,000 if over age 50, especially if you are unable to make contributions to an IRA. You should also consider making after-tax, nondeductible contributions to a 401(k) plan if the plan allows, as future earnings on those contributions will grow tax-deferred. A nondeductible contribution to a Roth IRA can also be considered.
Planning Suggestion: If you are a participant in an employer’s qualified plan (which includes a 401(k) plan) and are at least 50 years old, you can elect to make a deductible “catch-up” contribution of $5,500 (increased to $6,000 in 2016) to the plan. To make a “catch-up” contribution, your employer’s plan must be amended to allow such contributions.
The total allowable annual deduction for IRAs is $5,500, subject to certain AGI limitations if you are an “active participant” in a qualified retirement plan. A non-working spouse may also make an IRA contribution based upon the earned income of his or her spouse. A catch-up provision for individuals age 50 or older applies to increase the deductible limit by $1,000 for IRAs to a total deductible amount of $6,500 (these amounts are unchanged for 2016).
Planning Suggestion: Consider making your full IRA contribution early in the year so that income earned on the contribution can accumulate tax-free for the entire year.
Planning Suggestion: If money is tight, consider the use of credit cards to make tax deductible year-end payments. However, interest paid to a credit card company is not deductible because it is personal interest.
Caution: If you choose to accelerate income into 2015 or defer deductions to 2016, make sure your estimated tax payments and withheld taxes are sufficient to avoid 2015 estimated tax penalties.
The tax rate for net long-term capital gains is 20% for taxpayers otherwise subject to the 39.6% marginal tax on ordinary income. The 15% tax rate continues to apply for taxpayers otherwise subject to the 25% to 35% ordinary marginal tax rate, and a 0% rate applies for taxpayers otherwise subject to the 10% to 15% ordinary tax rate.
Caution: The tax law contains rules to prevent converting ordinary income into long-term capital gains. For instance, net long-term capital gains on investment property are excluded in computing the amount of investment interest expense that can be deducted unless the taxpayer elects to subject those gains to ordinary income tax rates. Additionally, if long-term real property is sold at a gain, the portion of the gain represented by prior depreciation is taxed at a maximum 25% rate.
Capital losses are offset against capital gains. Net capital losses of up to $3,000 can be deducted against ordinary income. Unused capital losses may be carried forward indefinitely and offset against capital gains and up to $3,000 of ordinary income annually, in future years.
Planning Suggestion: Add up all capital gains and losses you have realized so far this year, plus anticipated year-end capital gain distributions from mutual funds (this amount should be presently available by calling your mutual fund’s customer service number). Then review the unrealized gains and losses in your portfolio. Consider selling additional securities to generate gains or losses to maximize tax benefits.
Caution: Do not sell a security simply to generate a gain or loss to offset other realized gains or losses. The investment merits of selling any security must also be considered.
Note: Capital gains and losses on publicly-traded securities are recognized on the trade date, not the settlement date. For instance, gains and losses on trades executed on December 31, 2015, are taken into account in computing your 2015 taxable income.
If a security is sold at a loss and substantially the same security is acquired within 30 days before or after the sale, the loss is considered a “wash sale” and is not currently deductible. However, this nondeductible loss is added to the cost of the purchased security that caused the “wash sale.” This basis adjustment will reduce gain, or increase loss, later when that security is sold.
Qualified dividend income from domestic corporations and qualified foreign corporations is taxed at the same reduced rates as long-term capital gains for regular tax and AMT purposes.
Planning Suggestion: For taxpayers who are owners of closely-held corporations or a corporation that was converted to an S corporation, there are some planning opportunities available in light of the lower dividend tax rates. Your client service professional can be consulted for further guidance.
For sales of a principal residence, up to $500,000 of gain on a joint return ($250,000 on a single or separate return) can be excluded. To be eligible for the exclusion, the residence must have been owned and occupied as your principal residence for at least two of the five years preceding the sale. The exclusion is available each time a principal residence is sold, but only once every two years. Special rules apply in the case of sales of a principal residence after a divorce and sales due to certain unforeseen circumstances. If a taxpayer satisfies only a portion of the two-year ownership and use requirement, the exclusion amount is reduced on a pro rata basis.
Example: Husband and wife file a joint return. They own and use a principal residence for 15 months and then move because of a job transfer. They can exclude up to $312,500 of gain on the sale of the residence (5/8 of the $500,000 exclusion).
Legislation enacted in 2008 modified the provisions affecting the exclusion of the gain. For sales or exchanges after December 31, 2008, a portion of the gain attributable to a period when the residence is not used as a principal residence will not be eligible for the exclusion. Periods of ineligible use prior to January 1, 2009, will not be considered.
Planning Suggestions: If you want to sell your principal residence but are unable to do so because of unfavorable market conditions, you can rent it for up to three years after the date you move out and still qualify for the exclusion. However, any gain attributable to prior depreciation claimed during the rental period will be taxed at a maximum 25% rate.
If you own appreciated rental property that you wish to sell in the future, you should consider moving into the property to convert it to your principal residence. You will need to live in the property for at least two of the five years preceding the sale of the property. As long as you haven’t sold another principal residence for the two years prior to the sale, a portion of the gain is excluded. Any gain attributable to prior depreciation claimed will be taxed at a maximum 25% rate.
The sale of a principal residence does not qualify for the exclusion if during the five-year period prior to the sale, the property was acquired in a tax-free like-kind exchange.
Retirement plans have many requirements regarding distributions, but taxpayers can exercise some authority over plan distributions that might facilitate income tax planning.
For instance, funds in a regular IRA can be accessed without additional early distribution penalties anytime after obtaining age 59½.
Therefore, anyone who would benefit from increased ordinary income in 2015 can take a distribution from regular IRAs. Once the IRA owner reaches age 70½, a minimum amount must be distributed from regular IRAs (Roth IRAs are not subject to any minimum distribution requirements) each year. The law allows, but does not require, a small delay of the first required minimum distribution until April 1 of the year after the attainment of age 70½. Therefore, if you reached age 70½ in 2015, you should evaluate the benefit of delayed tax liability on your first distribution compared with the spike in your 2016 taxable income that two distributions in 2016 could cause. Any failure to take the minimum required distributions (“MRDs”) before the annual deadline causes the IRA owner to owe a 50% excise tax on the amount that should have been distributed. Example: Individual reached age 70½ in 2015 and is required to make a minimum require distribution for the 2015 calendar year. This distribution could be made during 2015 based on the December 31, 2014, IRA balance but Individual waited until April 1, 2016, to take the required amount. Individual must also take a distribution by December 31, 2016, for the 2016 year based on the December 31, 2015, IRA balance, with certain adjustments. Therefore, individual is taxed on two distributions in 2016 which might result in an overall increase in income taxes.
Participants in qualified pension plans who are not 5 percent or more owners of the employer can delay taking distributions out of the plan beyond the minimum required distribution age of 70½ as long as they are still actively employed by the plan sponsor. If you are already receiving benefits, but have not yet retired, your plan may (but is not required to) allow you to stop receiving distributions until you retire.
If you received a taxable qualified retirement plan distribution that is not a part of a series of substantially equal payments over a specified period of ten years or more, over the life expectancy of the employee or over the joint life expectancies of the employee and the employee’s beneficiary, or does not satisfy the minimum required distribution rules, you can generally avoid immediate taxation by “rolling” the money into a regular IRA or other qualified plan. The rollover rules are utilized most often to move retirement funds between IRAs inasmuch as qualified plans are required to allow participants to elect a direct trustee-to-trustee transfer of distributions and to withhold a 20% income tax on distributions made directly to participants. Participants who elect to receive a plan distribution net of the required withholding will have to restore the funds from other sources in order to complete a tax-free rollover of 100% of the distribution. If 100% of the distribution is indeed rolled over within the 60-day timeframe required by law, the distribution is nontaxable but any overpayment of income taxes will be refunded only as a result of filing a Form 1040 for the year.
Example: Employee E retires at age 54 on January 1, 2015, and is entitled to receive a $100,000 lump-sum distribution from his employer’s profit-sharing plan. E does not elect a direct trustee-to-trustee transfer of his $100,000 to an IRA. At the time of the distribution, the employer must withhold $20,000 in federal income taxes from the distribution. E receives the remaining $80,000 on January 10, 2015, and transfers it to an IRA on January 11, 2015.
E will have $20,000 of gross income, unless he obtains $20,000 from another source and transfers it to the IRA by March 11, 2015 (within 60 days of receiving the distribution). The $20,000 will be refunded only after taking into account of all items reported on E’s Form 1040 for 2015. In addition, if E fails to transfer the additional $20,000 to an IRA, E will be liable for the ten percent early withdrawal penalty on the $20,000 because E was under age 55 (the minimum age for receiving penalty-free distributions upon a separation from service).
The adjusted gross income limitation that prevented many taxpayers from converting traditional IRAs to Roth IRAs is eliminated.
Prior to discussing conversions of regular IRAs and eligible employer plans we will first discuss regular annual contributions to Roth IRAs and the characteristics of a Roth IRA. Taxpayers with income under certain income limits are permitted to make contributions to a Roth IRA. Unlike regular IRAs, where contributions are deductible and later distributions are taxable, contributions to Roth IRAs are not deductible and later “qualified” distributions are not taxable. Qualified distributions are distributions made five or more years after the Roth IRA is established, provided the distribution is made after the account owner is at least age 59½, has died or become disabled or uses the money for a first-time home purchase, subject to a $10,000 lifetime cap. If the distribution is not qualified, a portion of the distribution may be included in gross income and may be subject to the 10 percent early withdrawal penalty. The penalty applies on the amount of the distribution that exceeds the taxpayer’s contributions to the Roth IRA. Roth IRAs are not subject to the MRD rules that apply to regular IRAs when the owner reaches age 70½.
For 2015 and 2016, taxpayers can contribute up to $5,500 to a Roth IRA (as long as you have compensation for the year at least equal to the contributed amount). Taxpayers age 50 or older can make additional contributions of $1,000. Thus, the limit is $6,500 a year for people who will be age 50 (or older) in the applicable taxable year. However, the maximum contribution allowance must be reduced by any other contributions (deductible or nondeductible) the taxpayer makes to IRAs.
For single and head of household taxpayers, and for married taxpayer filing separately who did not live together at any time during the tax year, if 2016 modified adjusted gross income is between $117,000 and $132,000 ($116,000 and $131,000 for 2015), the $5,500 maximum contribution is phased out. Modified AGI in excess of $132,000 ($131,000 for 2015) prevents a contribution to a Roth IRA for a single taxpayer. For married taxpayers filing jointly, no contribution can be made if AGI is $194,000 ($193,000 for 2015) or more, and the $5,500 maximum (per spouse) is phased out for AGIs between $184,000 and $194,000 ($183,000 to $193,000 for 2015). For married taxpayers filing separately who lived with their spouse at any time during the tax year, the allowable contribution is phased out for AGIs between $0 and $10,000.
As with regular IRAs, contributions to a Roth IRA may be made as late as the due date for filing your income tax return, excluding extensions. Thus, Roth IRA contributions may be made by most individuals for 2015 until April 15, 2016. Unlike regular IRAs, contributions to a Roth IRA may be made even if the taxpayer is over age 70½, and the taxpayer or spouse has earned income at least equal to the amount of the contribution.
If a taxpayer converts a regular IRA or eligible employer plan into a Roth IRA, the amount that must be included in the distributee’s gross income is the amount that would have been includible in gross income had the distribution not been part of a qualified rollover contribution. The entire taxable amount from a 2015 conversion must be recognized on the taxpayer’s 2015 income tax return. The converted amount is not subject to the 10% early withdrawal penalty, provided no distributions are made from the account during the five-year period after the initial conversion.
Establish a Simplified Employee Pension (“SEP”) Plan by the due date of your 2015 return, including extensions. The contribution to the plan must be made by that due date. For 2014 and 2015, the maximum allowable contribution to a SEP an employee can make independently of an employer is $5,500 ($6,500 if a catch-up contribution). However, the maximum combined deduction for an active participant’s elective deferrals and other SEP contributions is $53,000 for 2015 and 2016.
- Alternatively, establish a Keogh Plan in 2015, before December 31. The full contribution to the plan need not be made until the due date of your 2015 return, including extensions.
- Consider placing business assets in service in 2015. If qualified, Section 179 expense allows you to deduct the full cost of depreciable assets in the tax year they are placed in service subject to an expense level of $25,000 and the phase out threshold amount commences at $200,000 for 2015.
- For taxable year 2015, a taxpayer can deduct start-up expenditures up to $5,000 with the phase out threshold at $50,000.
- A self-employed individual generally may deduct the employer-equivalent portion of his or her self-employment tax in figuring adjusted gross income. This deduction only affects the taxpayer’s income tax. It does not affect net earnings from self-employment or self employment tax.
- 100% of medical and long-term care insurance premiums, subject to the limitations on long term insurance premiums paid by a self employed person are deductible from gross income to arrive at AGI.
- Effective for payments made on or after March 30, 2010, the Affordable Care Act allows the self-employed health insurance deduction to include an adult child who has not attained the age of 27 before the end of the taxpayer’s taxable year.
Planning Suggestion: If you are not eligible to make a Roth IRA contribution due to an income limitation, consider making a nondeductible contribution to a traditional IRA and then converting the entire balance to a Roth IRA. The conversion would be a fully nontaxable event if the conversion takes place immediately because the taxpayer would have basis in the full amount of conversion.
Planning Suggestion: It may be beneficial to convert an existing IRA into a Roth IRA even though income will be accelerated and taxes will have to be paid. The advisability of converting depends on various factors, including the age of the taxpayer, current tax bracket, whether the taxpayer has funds from other sources to pay the income taxes on the accelerated income and whether the taxpayer intends to withdraw funds from the account after age 59½, or after 70½. Two of the advantages of converting a regular IRA or eligible employer plan into a Roth IRA are avoiding the minimum distribution rules and avoiding income taxes on distributions after death to the beneficiary of the Roth IRA. Any decision to convert should also consider the estate tax effects.
Planning Suggestion: You may want to consider converting all or a portion of your traditional IRA to a Roth IRA if you have a net operating loss (“NOL”). You may be able to make a conversion without creating taxable income and make use of your NOL, especially if the NOL carryforward is due to expire soon.
Additional Planning: Regular IRAs can be converted to Roth IRAs. Roth IRA conversions for a year must be completed by December 31 of that year. You have until the extended due date of your return for the year of the conversion to recharacterize your Roth IRA back to a traditional IRA. You will treat the conversion as if it had never happened by recharacterizing it.
Deductible moving expenses are limited to the cost of moving household goods and personal effects, plus traveling (including lodging but not meals) from your old residence to your new residence. To be deductible, a taxpayer must satisfy a distance test, a length-of-employment test and a commencement-of-work test.
Moving expenses can be deducted “above-the-line” in computing AGI instead of as miscellaneous itemized deductions. Thus, these expenses are not subject to the various limitations applicable to itemized deductions and can be deducted in addition to itemized deductions or the standard deduction. Also, deductible moving expenses reduce AGI for purposes of calculating the various AGI-based limitations.
Interest Expense
Personal, Home Mortgage, Investment Interest details below.
Interest is not deductible on tax deficiencies, car loans, personal credit card balances, student loans (except for taxpayers eligible for the above-the-line deduction for interest paid on qualified education loans) or other personal debts.
Home Mortgage Interest
A full regular tax deduction is allowed for:
- Interest on debt used to acquire, construct, or improve a principal or secondary residence to the extent this debt does not exceed $1 million.
- Other mortgage interest on a principal or secondary residence to the extent the mortgage does not exceed $100,000. The loan proceeds may be used for any purpose, except to purchase tax-exempt obligations.
These $1 million and $100,000 limits are cut in half for a married taxpayer filing a separate return.
Caution: These debts must be secured by the principal or secondary residence such that your home is at risk if the loan is not repaid.A residence includes a house, condominium, mobile home, house trailer or boat containing sleeping space, commode and cooking facilities. If you own more than two residences, you can annually elect which one will be your secondary residence.
Planning Suggestion: Since there is no deduction for personal interest, consider replacing personal debt with a home-equity loan of up to $100,000 to obtain a deduction for the interest.
These rules apply to interest on debt incurred after October 13, 1987. Interest on mortgages established prior to October 14, 1987, is generally subject to less restrictive rules.
A full regular tax deduction is allowed for:
- Interest on debt used to acquire, construct, or improve a principal or secondary residence to the extent this debt does not exceed $1 million.
- Other mortgage interest on a principal or secondary residence to the extent the mortgage does not exceed $100,000. The loan proceeds may be used for any purpose, except to purchase tax-exempt obligations.
These $1 million and $100,000 limits are cut in half for a married taxpayer filing a separate return.
Caution: These debts must be secured by the principal or secondary residence such that your home is at risk if the loan is not repaid.A residence includes a house, condominium, mobile home, house trailer or boat containing sleeping space, commode and cooking facilities. If you own more than two residences, you can annually elect which one will be your secondary residence.
Planning Suggestion: Since there is no deduction for personal interest, consider replacing personal debt with a home-equity loan of up to $100,000 to obtain a deduction for the interest.
These rules apply to interest on debt incurred after October 13, 1987. Interest on mortgages established prior to October 14, 1987, is generally subject to less restrictive rules.
If you want to add to your investment portfolio through borrowing, consider borrowing from your stockbroker through a margin loan. The interest paid is investment interest expense and will be deductible to the extent of your net investment income (dividends, interest, etc.). Investment interest expense in excess of investment income may be carried forward indefinitely.
Planning Suggestion: Net long-term capital gain (long-term gains over short-term losses) and any qualified dividend income are not included as investment income for purposes of determining how much investment interest expense is deductible, unless you elect to subject the capital gain and dividend income to ordinary income rates.
You should consider switching your investments to those types of investments generating taxable investment income to absorb any excess investment interest expense.
Interest expense, to the extent that it is related to tax-exempt income, is not deductible. Interest expense relating to a passive activity, such as a limited partnership investment, is subject to the passive loss limitations on deductibility.
Unreimbursed employee business expenses, investment expenses, personal tax advice and preparation fees and most other miscellaneous itemized deductions, are deductible only if they exceed 2% of AGI.
Planning Suggestion: Consider bunching miscellaneous itemized deductions into a year in which the 2-percent-of-AGI limit will be exceeded. However, not all prepaid expenses, such as multi-year subscriptions to financial periodicals, are currently deductible.
Only 50% of an employee’s unreimbursed cost of business meals and entertainment qualifies as a miscellaneous deduction. Club dues generally are not deductible; however, dues paid to the following types of organizations generally continue to be deductible as business expenses:
- Professional associations;
- Civic or public service organizations, such as Kiwanis, Lions, Rotary or Civitan; and
- Business leagues, trade associations, chambers of commerce, boards of trade and real estate boards.
In prior years, the Service permitted salaried employees with unreimbursed business expenses as well as self-employed sole proprietors, partners and S corporation shareholders to deduct only actual expenses incurred with respect to leased automobiles. Now, the Service allows taxpayers, beginning in the first year a leased automobile is placed in service, to use the standard mileage rate for business activity (57.5 cents per mile for travel during 2015).
Planning Suggestion: Consider claiming the standard mileage rate for leased automobiles. There is less recordkeeping, and the standard mileage rate may result in a larger deduction.
The 2015 standard deduction is:
Filing Status | Amount |
Single | $6,300 |
Married filing joint return and qualifying surviving spouse with dependent child | 12,600 |
Married filing separate return | 6,300 |
Head of household | 9,250 |
The 2016 standard deduction is:
Filing Status | Amount |
Single | $6,300 |
Married filing joint return and qualifying surviving spouse with dependent child | $12,600 |
Married filing separate return | 6,300 |
Head of household | 9,300 |
An additional $1,250 standard deduction may be claimed by a married taxpayer ($1,550 by a single taxpayer who is not a surviving spouse) who is at least 65 years old or blind. A total additional deduction of $2,500 ($3,100 by a single taxpayer) standard deduction can be claimed if the taxpayer is at least 65 years old and blind.
Planning Suggestion: A taxpayer benefits from itemizing deductions only if the deductions exceed the standard deduction. If your itemized deductions fluctuate from year to year, consider bunching your itemized deductions in one year and claiming the standard deduction in other years.
For 2015, a $4,000 deduction is allowed for each personal exemption. The personal exemption is subject to an AGI phase-out as follows:
Married filing joint returns and surviving spouses | $309,900 – $432,400 (complete phase-out) |
Heads of Households | $284,050 – $406,550 (complete phase-out) |
Single Individuals | $258,250 – $380,750 (complete phase-out) |
Married filing separate | $154,950 – $216,200 (complete phase-out) |
For 2016, a $4,050 deduction is allowed for each personal exemption. The personal exemption is subject to an AGI phase-out as follows:
Married filing joint returns and surviving spouses | $311,300 – $433,800 (complete phase-out) |
Heads of Households | $285,350 – $407,850 (complete phase-out) |
Single Individuals | $259,400- $381,900 (complete phase-out) |
Married filing separate | $155,650 – $216,900 (complete phase-out) |
A child cannot claim an exemption on his or her return or qualify for a higher education credit if the child’s parents claim a dependency exemption for the child on their return.
Planning Suggestion: If you pay college tuition for your child, but you are ineligible for the American Opportunity Tax (Hope) Credit or Lifetime Learning Credit because your AGI is more than the allowed income limitation, it may be beneficial to forgo claiming an exemption for your child so that your child can claim the credit on his or her return.
Unearned income of a child under age 18, exceeding $2,100 for 2015 and 2016, is taxed at the parents’ top rate rather than at the child’s rate (“kiddie tax”). Earned (compensation) income received by a child under age 18 is taxed at the child’s rate.
The kiddie tax applies to full-time students who have not attained the age of 24 by the end of the taxable year and non-full-time students who have not attained the age of 19 by the end of the taxable year, but in either case, only if the child’s earned income does not exceed one-half of the amount of the child’s support.
A child with earned income may claim a standard deduction up to $6,200 for 2015 and may be eligible for the $5,500 deductible IRA contribution. Therefore, the child may earn $11,700 without paying federal income tax. The child should also consider a contribution to a nondeductible Roth IRA.
Planning Suggestion: If you own a business, consider hiring and paying a salary to your child. This income will be taxed at the child’s rates, and the payment will be deductible by your business. This technique can be used to fund a college education. Of course, the child must perform services to earn the compensation, and the compensation must be reasonable for the services provided.
If the child is 18 or over, this compensation will be subject to social security tax. It will also be subject to federal unemployment insurance tax if the child is 21 or older. The child’s compensation could also be subject to state and local income and payroll taxes.
For 2015, a child under age 18 is not required to file a tax return if the child only has interest and dividend income up to $1,050, has not made estimated payments, has total gross income less than $10,000 and is not subject to backup withholding. However, the parents must include the child’s income exceeding $2,100 on his/her tax return.
Caution: A child under 18 who has capital gains or earned income must file his or her own tax return. Estimated taxes may have to be paid during the year if withholding taxes are not sufficient to cover the child’s tax liability.
A child who can be claimed as a dependent on his or her parents’ return cannot claim an exemption on his or her own return. However, the child is allowed a standard deduction equal to the greater of (1) $1,050 or (2) the sum of $350 and the child’s earned income up to $6,300 for 2016.
If the child is age 18 or older (24 or older if a full-time student, but only if the child’s earned income does not exceed one-half of the child’s support), income exceeding the standard deduction or itemized deductions will be taxed at the child’s rates.
Planning Suggestion: Consider making gifts of growth stock or Series EE bonds (which can defer taxation of the interest until maturity) to a child under age 18 (or 24, if appropriate). These investments can be converted to investments producing current income after the child reaches 18 (or 24, if appropriate). The resulting income will be taxed at the child’s rates rather than the parents’ top rate. Further, parents in the higher tax brackets should consider making gifts of income-producing property to a child who is 18 (or 24, if appropriate) or older to take advantage of the child’s lower tax bracket.
Reminder: Your income tax return must report social security numbers for all children whom you claim as dependents. A social security number can be obtained by filing an application on Form SS-5 with your local Social Security Administration office.
If you claim a dependent care credit, you must report the service provider’s social security or employer identification number on your tax return. You should use IRS Form W-10 to obtain this number from the provider.
During 2015, if you paid $1,900 or more to a person 18 or over for household services, you are required to report his or her social security and federal unemployment taxes on your personal tax return. These amounts are reported on Schedule H.
These employment taxes must be paid by the due date of the return, April 15, 2016, without extensions. Inasmuch as these taxes are part of your tax liability, your estimated taxes or withholding must be sufficient to cover them.
Planning Suggestion: As the $1,900 amount applies to each household employee, if possible, try to keep payments to each person below $1,900 per year. In 2015, you can also give your household employee up to $130 per month for expenses to commute by public transportation without this amount counting toward the $1,900 threshold or being included in the employee’s gross income.
Caution: Payments to household employees may also be subject to state unemployment and other state taxes.
Generally, all individuals must make quarterly estimated tax payments if they have income that is not subject to withholding. This includes individuals who are self-employed or retired or who have investment income, such as interest, dividends and capital gains. It also includes partners and S corporation shareholders.
The law provides several safe harbors for determining the minimum estimated tax that must be paid to avoid penalties. In 2015, the safe harbor percentage remains at 100% of the 2014 tax for individuals with 2014 AGI under $150,000 ($75,000 for married filing separately), but increases to 110% of the 2014 tax liability for individuals with 2014 AGI over those amounts. In the converse situation where an individual expects 2015 income to be lower than 2014 income, the individual can avoid penalties by paying estimated taxes for 2015 in an amount equal to at least 90% of projected 2015 tax liability.
Planning Suggestion: Deferring a large gain from December 2015 to January 2016 may postpone all or a portion of the federal tax payment on that gain to April 15, 2016. While the gain deferral may postpone the timing of tax payment, the tax rates for 2015 should also be considered when making such decisions. Unless you are subject to AMT, it may be beneficial to pay estimated state income taxes on a 2015 gain prior to the end of 2015 in order to obtain an itemized deduction on your federal 2015 return.
Two other safe harbor exceptions are available to eliminate penalties for insufficient payments of estimated taxes. No penalty will be imposed for underpayment of estimated taxes if the unpaid tax liability for the year (after taking into account any withholding) is less than $1,000. In addition, if your income varies throughout the year, you may use an annualized installment method to reduce or eliminate potential penalties.
The same rules apply to certain estates and trusts.
Planning Suggestion: If you have underpaid an installment of 2015 estimated taxes, increasing a later installment will not completely eliminate the underpayment penalty. However, increased withholding on year-end salary or bonus payments may be used to make up the underpayment. That is because withholding on compensation is deemed paid evenly over all quarters of the year.
Note: Voluntary withholding of income taxes from social security payments and certain other federal payments is permitted. This withholding may eliminate the need to file quarterly estimated payments for certain retired persons.
As of December 5th, the date of the preparation of this letter, most of the temporary tax provisions generally referred to as “extenders” (because they are routinely extended by Congress on a one or two year basis) had generally expired as of the end of 2014. While there is support in Congress, it is uncertain whether the extender provisions will be extended by Congress on a permanent or temporary basis (and, if extended, whether any such extension would be made retroactive). These extender provisions may be dealt with as part of a broader tax reform effort package or it could be examined on an individual basis. If extended after year-end, there is sufficient precedent to allow for an earlier effective date back to January 1, 2015.
The expired individual extender provisions include:
- The deduction for state and local sales taxes;
- The $250 above-the-line deduction for certain expenses of teachers;
- The above-the-line deduction for qualified tuition and related expenses;
- The deduction for mortgage insurance premiums treated as qualified interest;
- The exclusion of up to $2 million ($1 million if married filing separately) of discharged principal residence indebtedness from gross income;
- The exclusion for employer-provided mass transit and parking; and
- The credit for construction of energy efficient houses.
- Research and experimentation credit (Sec. 41);
- Work opportunity tax credit (Sec. 51);
- Increase in expensing to $500,000 and in expanded definition of property (Sec. 179);
- Bonus depreciation (50% depreciation deduction under Sec. 168(k));
- Exceptions under Subpart F for active financing income (Sec. 953(e) (10));
- The special 100% gain exclusion for qualified small business stock (Sec. 1202);
- The reduction in S corporation recognition period for built-in gains tax from 10 years to 5 years (Sec. 1374(d)); and
- The 15-year straight line cost recovery for qualified leasehold property, qualified restaurant property, and qualified retail improvements (Sec. 168(e)(3)(E)).
The expired charitable provisions include:
- The enhanced charitable deduction for contributions of food inventory;
- Tax-free distributions for charitable purposes from individual retirement account (IRA) accounts of taxpayers age 70½ ;
- The basis adjustment to stock of S corporations making charitable contributions of property; and
- Special rules for contributions of capital gain real property for conservation purposes.
The end of the year is the traditional time for making gifts. For 2015 and 2016, you may give up to $14,000 to a person without incurring any federal gift tax liability. The $14,000 annual limit applies to each donee. Thus, you may make $14,000 gifts to as many people as you like. If you are married, you and your spouse can give $28,000 to each person, if your spouse consents to splitting the gift or if you give community property. To qualify for this annual exclusion, the property must be given outright to the donee or put into a trust that meets certain conditions.
In addition to the annual exclusion, the lifetime exemption (made available in the form of a credit against tax based on an exemption-equivalent amount) allows each person to transfer $5,430,000 for 2015 ($5,450,000 for 2016) by gift without incurring any gift tax liability (reduced by the amount of any lifetime exemption that may have been used in a prior year). Using this credit now will keep future appreciation on the transferred property out of your estate. However, using the lifetime credit against 2015 (or 2016) gifts reduces the credit available for future years.
A widow or widower may have an increased lifetime exemption if the deceased spouse died after 2010 with an unused exemption amount and an estate tax return was filed. Please note that an estate tax return must be filed on a timely basis for the surviving spouse to obtain the increased exemption. This is true even if an estate tax return was otherwise not required to be filed because the value of the gross estate was less than the threshold required for filing an estate tax return. A full discussion of the portability of the lifetime exemption between spouses is beyond the scope of this letter.
In addition to gifts subject to the annual exclusion and the lifetime credit, direct payments of tuition made on another person’s behalf to a university or other qualified educational organization are also excluded from gift tax, as are direct payments of medical expenses to a medical care provider.
Planning Suggestion: You should consider using appreciated property in making gifts. If the recipients are in lower income tax brackets than you, income from the transferred property, including any gain on sale, will be taxed at lower rates.
Planning Suggestion: It is generally unwise to give property that has declined in value. Rather, you should sell the property and realize the tax benefits of the loss.
All outright gifts to a spouse (who is a United States citizen) are free of federal gift tax. However, for 2015, only the first $147,000 ($148,000 for 2016) of gifts to a non-United States citizen spouse are excluded from the total amount of taxable gifts for the year. You should coordinate your year-end gift giving with your overall estate planning. Your client service professional can assist you with these matters.
Conclusion
An annual physical examination is important for maintaining good health. Likewise, an annual financial examination that includes year-end tax planning can enhance your financial well-being. Contact your Somerset advisor to help you achieve your tax and financial objectives.