Unbelievably, we are within a few weeks of the end of 2015. Shortly thereafter, we will be preparing to file and pay our 2015 taxes. Rather than wait for the tax bill, we advise clients see if they can lower their potential tax bill by taking action now. We always preface our comments here with the reminder that you need to be working with your tax and investment advisors to be sure how each of these ideas specifically affect you. The tax code has intricacies beyond the scope of our newsletter. Here are some general techniques to be aware of.
If you are in a position to defer taxable income until next year, and if your income next year will likely be almost the same or lower, most clients try to defer the income to defer paying the tax on it for another year.
This might include such things as:
- Retirement Income distributions
- Sales of assets creating capital gains
- Stock options
- If you are self-employed, consider delay billings until late December
There is a caveat: don’t defer income if you are pretty sure your taxable income will be significantly higher next year, causing you to actually pay a significantly higher tax next year. So please be as sure as you can be of what your situation next year could be.
Maximize and/or Accelerate Your Deductions
The reverse of deferring taxable income is accelerating deductions to lower your tax bill. Mostly clients like having a lower tax sooner rather than later so they spend money on deductions as soon as they are able. This includes such items as:
- Paying 2016 Michigan / state, local and property taxes, due early next year, in December. Not everyone can do this, but some are able.
- Likewise, if you are behind on tax payments for earlier years and are able to pay them now rather than next year, pay them in December.
- Make your charitable gifts in December. Better yet, consider the following charitable giving technique. Donate appreciated stock or property to your charity rather than cash. If you’ve owned the appreciated asset for more than one year, you get twice the tax benefit from the donation because you can deduct the asset’s fair market value on the date of the gift and you avoid paying capital gains tax on the built-up appreciation.
- If you own a business and are planning on buying either expensable or depreciable equipment next year, go ahead and buy it in December.
A note of caution. Be careful; there are limits to what you can depreciate so please consult your business tax advisor. Also, at higher rates of adjusted gross income, the usability of deductions is phased out. So better to aim at reducing your adjusted gross income if possible.
The Standard Deduction for 2015 is $6,300 for a single individual and $12,600 for a married couple filing jointly.
In order to make use of itemized deductions (property taxes, state income taxes, casualty losses, medical expenses over 7.5% of AGI, etc.), they must aggregate more than the standard deduction. For many families, this is getting increasingly difficult.
Also, the IRS requires that you have a receipt to back up any contribution, regardless of the amount. (The old rule that you only had to have a receipt to back up contributions of $250 or more is no longer applicable.)
Retirement Plan Contributions
As you know, every person has limits on what they can contribute toward their retirement. And the amount they are able to contribute depends on the type of plan. For 401k’s and SEPs, the amount is $18,000. For Simple IRAs the amount is $12,500, and for IRAs and Roth IRAs, the amount is $5,500. Many client are not aware that, if they are over age 50, they can make additional contributions called “make-up” contributions. For IRAs, the make-up amount is $1,000. For, 401s the make-up contribution is $6,000. Here is a link to the IRS Announcement.
Most people don’t realize that they may postpone making their contributions to either type of plan until April 15 of next year, yet have them treated as having been made this year. This gives you additional time to pull together the funds.
There are other retirement funding options available such as deferred annuities, deferred gifts, and charitable lead trusts. But these are more complicated and should be used only in consultation with a specialist.
Take Required Minimum Distributions
Another opportunity is the timing of any Required Minimum Distributions. You should be aware that you must begin withdrawing funds from your retirement accounts in the year in which you turn 70 1/2. Generally speaking, most people use their life expectancy, or the joint lives of themselves and their spouse, to calculate the amount to withdraw.
If you turned 70 1/2 this year, you are able to postpone your first distribution until April 15 of next year. However, it would be TAXABLE next year. Postponement only makes sense really if there are unusual tax implications occurring in either the current year, or the next year, which make you eligible to pay lower taxes overall. The option is not available in later years.
Remember though that the penalty for failure to make a required distribution in a timely fashion is 50 percent of the amount that should have been withdrawn.
Exercising Stock Options and “Loss Harvesting”
Exercising or not exercising stock options gives one the opportunity to choose to increase taxable income if needed or defer it if beneficial. A stock option is the right to buy a company stock at the price stated in the option. Nonqualified stock options are less restrictive than qualified stock options. Nonqualified stock options are generally more beneficial to the company because it can deduct the expense sooner.
Qualified stock options are generally beneficial to the employee so long as the restrictions are met. When those restrictions are met, the difference between the price stated in the option (say $50) and the price it is exercised at (say $65) is capital gain taxed at a preferential rate (generally 15%). If the same option were a non-qualified stock option, the difference is taxable at ordinary income rates (as high as 39.6%). This may not affect many, but for those whom it does, it represents a significant year-end opportunity.
Time to get rid of the losers! Another year-end tax planning strategy is called “loss harvesting” – which involves selling investments such as stocks and mutual funds to realize losses. You can then use those losses to offset any taxable gains you have realized during the year – dollar for dollar. If your losses are more than your gains, you can use up to $3,000 of the excess loss to wipe out other income. If you have more than $3,000 in excess loss, it can be carried over to the next year. You can carry over losses indefinitely.
Potential Tax Changes for 2016
As this is an election year and the two parties have demonstrated little ability to work together on any significant legislation, there is little reason to believe there will be any meaningful tax changes in 2016. Rest assured that we will generate a newsletter should this unlikely event occur.
Please be reminded that you should consult with your tax advisor about your specific situation.
For the long term, Estate Planning & Elder Law Services offers a range of tax planning services in conjunction with estate planning, particularly to reduce your exposure to estate taxes. We welcome you to contact us for a complimentary consultation by calling (888) PLAN-050 or completing our online form.