To act or not to act? That is the question.
You still have time as year-end approaches to finalize your tax planning for 2015. With that in mind, this post separates areas where you may be able to act and provides more detail on the rules affecting how you act. If any of this is not clear, just ask questions, please.
- Look through the list below to see if there are any items in your 2015 and 2016 finances that you can change in any way – moving from one year to the other, or delaying further.
- Determine what impact each of these has and then the impact of all of them in concert:
- This includes the alternative minimum tax (“AMT”), which is the 28% flat rate as opposed to the marginal rate of up to 39.6%.
- If your deductions bring the regular tax down too low, the AMT kicks in, so that the deductions are wasted and need to be moved to another year, if possible, or income for that year increased to “pull you out of the AMT.” The AMT exemptions amounts for 2015 are $53,600 for individuals and $83,400 for married couples filing jointly.
- Be sure to prepare tax projections for both tax years to determine which changes have the best results so that the total tax paid in the two years is minimized.
What do you act on?
To get started, it is helpful to know the current tax rates. Here are the new rates for 2015: Federal Tax Rates for 2015. Also, note that the Standard Deductions rises to $6,300 for single taxpayers and married taxpayers filing separately, $12,600 for married couples filing jointly, and $9,250 for heads of household.
3.8% Medicare surtax
This affects all income for 2015 and beyond, but only to the extent of the lesser of:
- Net investment income, or
- The excess of modified adjusted gross income (“AGI”) over the threshold, which is $250,000 ($200,000 for single taxpayers).
Investment income includes interest, dividends, capital gains, annuities, royalties and passive rental income but excludes pensions and IRA distributions.
N.B. – the 3.8% surtax must be covered with your withholdings and estimated payments. See our post Update on the impact of the 3.8% Medicare surtax .
Wages – Can you defer or accelerate between years or even convert income into deferred income, such as stock options, or income to be received at retirement? Can you convert compensation into tax-free fringe benefits?
Stock options – can you exercise a non-qualified option (“NQ”), which is treated as ordinary income, or instead of as an ISO, which can be investment income? Disqualifying an ISO converts it into a NQ, so that you have control over the type and timing of the income.
Schedule C income and expenses – can you defer or accelerate income and deductions between years so that the net income falls in the best year?
Schedule A itemized deductions – like income, can you deductions for the maximum benefit, given the income-based deduction thresholds?
Medical – only the amount above 7.5% (10% above certain income levels) of qualified medical expenses, which include amounts paid for prescriptions, doctor co-pays, long-term care insurance premiums, and glasses, are allowed on Schedule A.
Miscellaneous – only the amount above 2% is allowed on Schedule A. Miscellaneous expenses include unreimbursed employee expenses, tax preparation fees and investment-related expenses.
Deductions – certain itemized deductions are phased out once your AGI exceeds $305,050 for married filing jointly ($254,200 for singles), so that your itemized deductions are reduced by 3%, on up to 80% of the deduction, for the excess of your AGI above $305,050 ($254,200 for single filers).
N.B. – many of the deductions affected by the phase-out are the ones not allowed in the AMT calculation. Also, investment interest expenses are not subject to reduction on Schedule A.
Investment income – can you shift interest, dividends, and capital gains? Can you use an installment sale to spread out a large gain or, if feasible, a like-kind exchange to defer the gain?
(An installment sale that spreads gain over several years; a like-kind exchanges involve investment property, which means you can swap, rent and later convert to residential.)
The tax rate on capital gains was as low as 0% in 2014, with a cap at 20% and those rates remained in place for 2015. The 20% rate applies in 2015 for AGI over:
- Married filing jointly – $464,850;
- Head of Household – $439,000;
- Single – $413,200;
- Married Filing Separately – $232,426; and
- Trusts and Estates – $12,300.
You net losses against gains. If you have a loss, with up to $3,000 of the loss is allowed to shelter other income, with any remaining losses carried to the next year.
Investment Loss – Take advantage of tax-saving losses by selling depreciated stocks or mutual funds that are in a taxable account, not your 401(k) or IRA. However, if your traditional IRA has declined in value, you may want to consider converting some or all of the funds in it to a Roth.
- Purchasing mutual funds late in the year can lead to dividend and capital gains distributions where the mutual fund price changes but your investment does not. This means that you have no economic gain for the distribution on which you pay taxes – you are effectively pre-paying taxes because you did not purchase after the declared distribution date.
- If you sell to recognize a loss, and want to hold the stock again, be aware of the wash sale rule which bars recognition of the loss if you re-purchase substantially the same security within 30 days – which applies to different accounts you own, including repurchasing in your IRA. An example of what works: a bond swap with the same issuer, where the maturity or interest rate is different, is a way to recognize a loss without being affected by the rule.
Investment income also includes passive income and losses (rental property, limited partnerships and LLCs).
If you can re-characterize any activities as material participation rather than passive by grouping together to meet the material participation rules, you have a one-time election to regroup.
N.B. – Gains include the sale of a primary residence (above the $250,000 per owner shelter).
Roth conversions – can you convert an IRA to a Roth IRA, so that future distributions are not subject to tax? Be sure to pay the tax with funds outside of the IRA so that the conversion has maximum benefit.
Health Insurance – It’s the time of year to choose your health insurance for next year and your decision could affect your 2015 tax filing:
- Choosing to opt out of buying health insurance could be a costly decision. The new penalty is $695 per adult and $347.50 per child, with a family maximum of $2,085. Those whose income is too low or for whom insurance is too costly may qualify for an exemption from this penalty;
- If you purchase insurance on an exchange, you may qualify for a tax subsidy if your income is between 100% and 400% of the federal poverty level; and
- The subsidy will be based on your expected 2016 income. However, if your income is higher than the estimated income, your credit may factor into your tax filing for that year.
Required Minimum Distribution (RMD) – If you are 70 ½ or older, you must take a withdrawal by the end of the year from your traditional IRA or face a significant penalty. To calculate your RMD, take your year-end IRA balances as of December 31, 2014, and divide each one by the factor for your age, which can be found in IRS Pub. 590-B. If you turned 70 ½ this year, you can delay your payout until April 1, 2016. If you opt to take your distribution 2016, you will be taxed on two IRA distributions in 2016.
Federal Estate Tax Exemption – the exclusion amount for estates of decedents who die in 2015 is $5,430,000, up from a total of $5,340,000 in 2014.
Gifting – can you shift assets by gifting within the $14,000 per year/per person annual gift tax exclusion, or even by filing a gift tax return to use some of your unified credit now, so that income is in the lower tax bracket of new owner?
If you’re looking to shift more than $14,000 per year per person, amounts directly paid to college tuition and medical services are exempt from gift-tax rules.
Inherited IRA – be sure to divide an inherited IRA among beneficiaries to get the maximum life expectancy for RMD calculations for each
If you made it this far, I hope you have a good idea of your 2015-2016 tax plan, or else a set of questions to ask so we can help devise one for you! Please Contact Us.