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December 7, 2016
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Proper year-end planning can help alleviate any unnecessary tax burden. While little happened in the way of tax legislation in 2016, there are certain tax breaks from which you may benefit and certain strategies that can be employed to help minimize taxable income and your federal tax liability. For 2016, the top tax rate of 39.6 percent will apply to incomes over $415,050 (single), $466,950 (married filing jointly and surviving spouse), $233,475 (married filing separately), and $441,000 (heads of households). However, high-income taxpayers are also subject to the 3.8 percent net investment income tax. Finally, as discussed below, there are several tax breaks which expire this year.

Alternative Minimum Tax
The alternative minimum tax (AMT) continues to burden more than just high-income taxpayers; middle-income taxpayers can also be affected. Certain deductions taken on your personal tax return – such as personal exemptions, state income taxes, property taxes, miscellaneous itemized deductions – cannot be deducted in calculating the AMT. Since the calculation of the AMT begins with adjusted gross income, lowering your adjusted gross income by maximizing contributions to a tax-deferred retirement plan (e.g., 401(k)) or tax-deferred health savings account may be appropriate. Additionally, if you use your home for business, related expenses (e.g., a portion of your property taxes, mortgage interest, etc.) allocable to Schedule C will also reduce your adjusted gross income.

Avoiding the Net Investment Income Tax
A 3.8 percent tax applies to certain net investment income of individuals with income above a threshold amount. The threshold amounts are $250,000 (married filing jointly and qualifying widow(er) with dependent child), $200,000 (single and head of household), and $125,000 (married filing separately). In general, investment income includes, but is not limited to: interest, dividends, capital gains, rental and royalty income, non-qualified annuities, and income from businesses involved in trading of financial instruments or commodities. Thus, while the top tax rate for qualified dividend income is generally 20 percent, the top rate on such income increases to 23.8 percent for a taxpayer subject to the net investment income tax. If it appears you may be subject to the net investment income tax (NIIT), the following actions may help avoid the tax:

(1) Donate or gift appreciated property. By donating appreciated property to a charity, you can avoid recognizing the appreciation for income tax purposes and for net investment income tax purposes. Or you may gift the property so that the recipient can sell it and report the income. In this case, you’ll want to gift the property to individuals that have income below the $200,000 (single) or $250,000 (couples) thresholds.

(2) Replace stocks with state and local bonds. Interest on tax-exempt state and local bonds are exempt from the NIIT. In addition, because such interest income is not included in adjusted gross income, it can help keep you below the threshold for which the NIIT applies.

(3) If you are in the real estate business, you should review the criteria for being classified as a real estate professional. If you meet these requirements, your rental income is considered non-passive and thus escapes the NIIT.

(4) If you intend to sell any appreciated assets, consider whether the sale can be structured as an installment sale so the gain recognition is spread over several years.

(5) Since capital losses can offset capital gains for NIIT purposes, consider whether it makes sense to sell any losing stocks, keeping in mind the transaction costs associated with selling stocks.

(6) If you have appreciated real property to dispose of and are not considered a real estate professional, a like-kind exchange may be more advantageous. By deferring the gain recognition, you can avoid recognizing income subject to the NIIT.

New Compliance Requirement for Claiming Educational Tax Credits
Beginning in 2016, in order to claim an American Opportunity or lifetime learning credit or a deduction for education-related tuition and fees, you must have received a Form 1098-T. The form reports qualified tuition and related expenses received by the educational institution. The information reported on this form will be matched against the information reported to the IRS. If you have educational expenses eligible for the credit or deduction, you should receive Form 1098-T from the educational institution to which you made payments by January 31, 2017. While the form is supposed to report the aggregate amount of payments received by the educational institution, there is a one year transition period where institutions may report the amount billed for 2016 rather than the amount paid. Because the form only reports qualified tuition and related expenses, you may see a discrepancy between the amounts you paid and the amounts reported. This is due to the fact that certain expenses, such as fees for room, board, insurance, medical expenses, transportation, etc., are not considered qualified tuition and related expenses and thus are not reported on Form 1098-T.

Foreign Bank Account Reporting
If you have an interest in a foreign bank account, it must be disclosed; failure to do so carries stiff penalties. You must file a Report of Foreign Bank and Financial Accounts (FBAR) if: (1) you are a U.S. resident or a person doing business in the United States; (2) you had one or more financial accounts that exceeded $10,000 during the calendar year; (3) the financial account was in a foreign country; and (4) you had a financial interest in the account or signatory or other authority over the foreign financial account. The deadline for filing the form was moved up and it is now due April 15. However, a six-month extension is available. If an individual is abroad, the due date is automatically extended until June 15, with an additional four-month extension available until October 15.

Penalty for Failing to Carry Health Insurance
Under Obamacare, there is a penalty, known as the “shared responsibility payment,” for not having health insurance coverage. You may be liable for this penalty if you or any of your dependents didn’t have health insurance for any month in 2016. The penalty is 2.5 percent of your 2016 household income exceeding the filing threshold or $695 per adult, whichever is higher, and $347.50 per uninsured dependent under 18, up to $2,085 total per family. Depending on your income, you may be eligible for an exemption from the penalty.

Lower AGI Limitation on Medical Expense Deductions for Individuals 65 or Older
You can deduct medical and dental expenses that exceed a certain percentage of your adjusted gross income (AGI) for the year. In 2016, that percentage is 10 percent for most taxpayers. However, that floor is reduced to 7.5 percent if you or your spouse have turned 65 before the end of the year. Because that reduced AGI floor is scheduled to end after 2016, if this lower limitation applies to you for 2016, you should determine whether you can accelerate any medical expenses expected to be incurred in 2017 into 2016.

Deduction for Qualified Tuition and Related Expenses
If your modified adjusted gross income (MAGI) does not exceed a certain amount, 2016 is the last year that you may deduct qualified education expenses paid during the year for yourself, your spouse, or your dependents. You can deduct up to $4,000, $2,000, or $0 of tuition and fees paid, depending on the amount of your modified adjusted gross income (MAGI). The $4,000 limit applies if your MAGI does not exceed $65,000 ($130,000 on a joint return). The $2,000 limit applies if your MAGI exceeds $65,000 ($130,000 on a joint return) but does not exceed $80,000 ($160,000 on a joint return). No deduction is allowed if your MAGI exceeds $80,000 ($160,000 on a joint return).

Deduction for Mortgage Insurance Premiums
If you paid qualified mortgage insurance this year, it is deductible as qualified residence interest. The insurance must have been paid in connection with acquisition debt for a qualified residence. No deduction is available for amounts paid or accrued after December 31, 2016.

Gifting Appreciated Stock to Kids
If you have children, particularly college age kids, you should consider if there is any income that can be shifted to them so that the tax on the income is paid at the child’s tax rate. One strategy is gifting appreciated stock to the child. Where a child has earned income and is taxed at the bottom two income brackets, capital gains generated on the stock sale are taxed at 0 percent, instead of the 15 percent or more that the parent would pay. However, if the child has little or no earned income, the kiddie tax could be a factor. In this case, you will want to limit the child’s unearned income to $2,100 or less for 2016 in order to avoid having your top tax rate apply to the child’s income.

Deferring Income into 2017
Because of the possibility of lower income tax rates in 2017 with a Trump presidency, it may make sense to defer income into 2017 or later years. Some options for deferring income include: (1) if you are due a year-end bonus, having your employer pay the bonus in January 2017; (2) if you are considering selling assets that will generate a gain, postponing the sale until 2017; (3) delaying the exercise of any stock options; (4) if you are planning on selling appreciated property, consider an installment sale with larger payments being received in 2017; and (5) consider parking investments in deferred annuities.

Accelerating Deductions into 2016
Again because of the possibility of lower income tax rates in 2017 and also the possible elimination of some deductions, it may be worthwhile to accelerate deductions into the current year. Some options include: (1) prepaying property taxes in December; (2) making January mortgage payment in December; (3) if you owe state income taxes, making up any shortfall in December rather than waiting until the return is due; (4) since medical expenses are deductible only to the extent they exceed 10 percent (7.5 percent for individuals age 65 before the end of the year) of adjusted gross income, bunching large medical bills not covered by insurance into one year to help overcome this threshold; (5) making any large charitable contributions in 2016, rather than 2017; (6) selling some or all loss stocks; and (7) if you qualify for a health savings account, setting one up and making the maximum contribution allowable.

Health Savings Accounts
Spend any remaining health flexible spending account balances before year end (unless your employer allows you to go until March 15, 2017, in which case you’ll have until then). You should check with your employer to see if they give employees the optional grace period to March 15.

We at McNees hope you and your family have a Merry Christmas, Happy Hanukkah and a great New Year!

© 2016 McNees Wallace & Nurick LLC
McNees Insights is presented with the understanding that the publisher does not render specific legal, accounting or other professional service to the reader. Due to the rapidly changing nature of the law, information contained in this publication may become outdated. Anyone using this material must always research original sources of authority and update this information to ensure accuracy and applicability to specific legal matters. In no event will the authors, the reviewers or the publisher be liable for any damage, whether direct, indirect or consequential, claimed to result from the use of this material.