Tax Planning 2017

For those of you who read the title of this post and thought “Jay, it’s too early in the year to think about tax planning!”, my response is “some stores already have Christmas decorations out, and it’s not even Halloween yet…isn’t that too early?!”  As someone who plans out lunch and dinner while eating breakfast, I say it’s never too early to think about tax planning!

The reality is that you should’ve started thinking of 2017 tax planning at the same time that you filed your 2016 tax returns, in fact, there are instances when you can even plan for the following year, if there are circumstances that you know will be changing, such as a marriage.  I’m a big proponent in people knowing ahead of time what the tax consequences will be for certain things, rather than waiting until tax time (when it’s too late) and finding out that there’s a balance due of thousands of dollars.  So let’s take a look at a few things to consider, when planning out the rest of 2017.

Withholding and estimated taxes – did you have a large balance due or overpayment on your 2016 tax returns?  Did you sell a stock or mutual fund for a big gain?  Did you start a new business and are anticipating a big net income or net loss?  There are many other examples, but large balances due or large refunds are indications that you paid in too little or too much tax in the prior year.  If this is the case and you’d like to get closer to a break even this year, consider raising or lowering your withholding and/or estimated tax payments.  Similarly, large gains on securities sales or net income/loss from a new business can have effects on your taxable income, and could be reasons to increase or decrease your withholdings and/or estimates.  Think about your 2016 results and anything happening in 2017 that could have more than a minimal impact on your 2017 results, and adjust accordingly.

Alternative Minimum Tax – I could write an entire article just about Alternative Minimum Tax (AMT), but let me just say here that as taxable income rises, there’s a higher likelihood of winding up in the AMT, which could substantially increase your tax bill.  You can search for AMT worksheets to crunch your numbers to see if you’ll be there for 2017.

Marital Status – as I alluded to above, getting married (and on the flip side, getting divorced) will have an impact on your taxes.  Your tax filing status is determined by your marital status as of the last day of the tax year (Dec. 31), so if your marital status changed in 2017, think about how that will affect your taxes.  And if you plan to get married or divorced in 2018, you can start planning now for the changes next year.

Gifts – any taxpayer can make a gift of up to $14,000 per tax year to another taxpayer.  Property that is generating taxable income to you can incur less tax on that income when it’s gifted to somebody in a lower tax bracket, which is why parents will make gifts to their kids.  So consider making gifts to family members (or your favorite CPA, ha!)

Ordinary income vs capital gains – interest income (such as bank accounts, CDs, corporate bond funds) is taxed at your marginal income tax rate.  Based on current tax law, that rate can be as high as 39.6%.  If that same income was “qualified dividend” income, the tax rate on that income would be 15%, which is the same rate as long-term capital gains (for those in the 39.6% top ordinary tax bracket, the rate is 20%).  So for somebody in the top marginal tax bracket, converting ordinary interest income to qualified dividend income would halve the amount of tax charged (20% vs 39.6%).  Similarly, when considering selling appreciated securities, if the security is held a year or less (short-term), the tax will be at the marginal tax rate, while long-term gains (over a year) are taxed at the 15%/20% rate.  So if your holding period is nearing a year, think about holding it a few more days, to get the gain taxed at long-term rates.

These are just a few ideas to consider, when planning out the rest of the year’s taxes.  If you want to do some tax planning before the end of the year, but think it’s too complicated to do, remember to ask your favorite CPA (as in Jay the ___)  for help!

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Trumped on Taxes

One era ends and a new one begins, which is a happy or sad thing, depending on which side of the aisle you sit on.  Regardless of where you stand (or sit) on the prospect of Donald Trump becoming our next president on January 20th, one thing will be sure; he’s going to look to shake up the tax code.  Depending on how much he gets his way, your 2017 tax picture could look very different from your 2016 one.  Let’s take a quick look at some possibilities.

Tax Rates – whether it’s Mr Trump or Congress, the Republican majority will look to cut tax rates in some fashion.  Lower tax rates mean that any deductions you have will get less bang for the buck, in the form of income tax savings.  For example, if you’re in a 25% marginal tax bracket and have itemized deductions of $10,000, the deductions will save you $2,500 in federal tax (deduction amount times the tax rate).  If tax rates are reduced and you drop to a 20% marginal bracket (I’m just making up that rate), your same $10,000 of deductions will only save you $2,000 in tax.  The bottom line is that for those of you who claim itemized deductions for charity, state & local taxes, and mortgage interest, a reduction in tax rates means that you’ll save less in income tax.

Charitable contributions – because tax rates could go down (and your income tax savings for making charitable contributions could be reduced), you might want to consider accelerating any donations that you were going to put off to 2017, and make them before the end of 2016.  If you have any securities that have appreciated in value, making a donation of the appreciated securities is a great way to avoid the potential capital gain income on a sale, and get a deduction for the current value of the security.

State & local taxes – I’ve personally seen less people get a tax benefit for these, as more of my clients have wound up in the Alternative Minimum Tax (AMT).  In the AMT computation, state & local taxes are disregarded as a deduction.  If you’re not in the AMT, prepaying by December 31 any state estimated tax payment that you’d otherwise make by January 15 would save a few dollars in 2016, and with possible lower rates in 2017, you’d have lower income tax savings in 2017 anyway.

Capital gains – while Mr Trump’s plan would retain the current long-term capital gains rates of 0%, 15%, and 20%, the threshold for hitting the top rate would be reached a lot faster, which means that long-term gains would be taxed at 20% starting at about $225K of taxable income on a joint return (vs about $467K now) and $112K of taxable income on a single return (vs about $415K now).  This would seem to indicate that if you’re considering selling any investments at a long-term gain, and expect to have a pretty high taxable income, it would be better to sell before the end of 2016. But…the other consideration is the current 3.8% net investment income tax, which is a tax on interest and dividend income, and capital gains.  If adjusted gross income is above certain levels, this tax kicks in.  Mr Trump and Congress both want to eliminate the net investment income tax.  It then becomes an exercise of figuring out whether gains will net out a higher total of capital gain + net investment income taxes in 2016, or possibly only capital gain tax (potentially at a higher rate) in 2017.  You gotta admit, isn’t this fun stuff?!

These are just a few points to ponder, while you’re slugging it out and standing in line at the mall this holiday season.  As always, if you need some tax number crunching done, consult your favorite CPA!

Mistakes on Taxes? Avoid These

It’s tax season again, yee haw! Sure as the sun comes up in the morning, the IRS has its hand out from January to April 15th (and beyond) waiting for somewhere in the area of 150 million tax returns. In spite of ever more complicated tax laws, approximately one-third of those returns will be self-prepared. Based on their own research, my competitor (ha!), H&R Blockhead says that one of every five self-preparers forgo almost $500 in taxes (e.g. lower refunds or higher balances due) because of mistakes they’ve made on their own returns. These mistakes can lead to letters from IRS, possibly with penalties or other harsher actions resulting. As a licensed tax professional, my recommendation to all taxpayers is to avoid all preparers whose names start with either “H&R” or “Turbo”, and instead engage a qualified tax professional (preferably a CPA whose name starts with “Jay the”) who understands the tax laws, and stands a way better chance than you of preparing an error free return. But…I’m not naïve enough to think that people will actually listen to me (or read this), so for those of you who still insist on going it alone, and preparing your own tax returns, pay attention now, and don’t make these mistakes.

Claiming the wrong number of dependents-IRS has publications and pages and pages of information on who can and who can’t be claimed as a dependent on your tax return. Don’t think that just because somebody lives with you or is your kid that they can be claimed as a dependent.

Failing to itemize deductions-taxpayers automatically get a standard deduction, but don’t be so fast to leave it at that. Add up how much you paid in state/local tax, personal property tax, mortgage interest, charity, and other various items, and if that total exceeds the standard deduction, you can shave a few bucks off your tax bill by itemizing.

Overstating charitable contributions-yeah yeah, you put ten bucks in the Salvation Army kettle at Christmas time, or you put money in the basket when it’s passed around in church, but can you prove it? Like dependents, IRS has all sorts of information to read, that discusses the required substantiation for deducting charitable contributions. And they’ve been increasing their audits in this area, so make sure you’ve got the correct documentation, before you claim that deduction. Another mistake to avoid is forgetting about the United Way or CFC contributions that were deducted from your paycheck.

Deducting points on a refinance-while points paid on an original first mortgage are deductible when paid, you generally cannot do the same with points paid on a refinance. Instead, you must amortize that deduction over the life of that loan.

I could go on and on about mistakes you should avoid, but I think that’s enough free advice for one article. Remember rule number 1, which is to go to a qualified tax professional to have your tax return prepared. Rule number 1(a) is that the qualified tax professional should be me. Finally, rule number 2, if you’re gonna go it alone, make sure you review everything twice before you send the return out, and if you’re not sure about something, research and read!

Have you made any good (or bad) mistakes on tax returns, and are willing to tell about it? Leave a comment, and share it with others, so that they may learn.

The Supreme Court, the Defense Of Marriage Act, and Tax Planning

If you’ve either been living under a rock or on another planet in 2013, I want to let you know about a momentous event that happened about a half year ago. The U.S. Supreme Court held that Section 3 of the Defense of Marriage Act (DOMA), which required same-sex spouses to be treated as unmarried for purposes of federal law, was unconstitutional. Obviously there are many federal laws, and a lot that have been affected by this ruling, but I’ll try to lay out a few things to keep in mind, as they relate to tax laws and tax planning.

For Federal tax purposes, IRS will generally recognize as married, same-sex couples who were married in a state, the District of Columbia, a U.S. territory, or a foreign country that authorizes same-sex marriages. Note that the determining factor is where the couple marries, not where the couple is domiciled (generally, where they live). As an example, a same-sex couple lives in VA but gets married in DC. For federal tax purposes they will be considered married. On the flip side of this, IRS will not recognize as married, same-sex couples who have entered into a registered domestic partnership, civil union, or other similar formal relationship under state law “that is not denominated as a marriage under the laws of that state.”

O.K., you’re a same-sex couple, you’ve gotten married in a state that recognizes same-sex marriages, so for federal tax purposes, now what? Under this ruling, legally married same-sex couples will be treated as married for all Federal tax purposes, including income, gift, and estate taxes. Some of provisions that need to be considered are filing status, claiming personal and dependency exemptions, the standard deduction, contributing to an IRA, earned income tax credit, child tax credit, and many others.

I’m guessing that you’re now wondering when all of this goes into effect (did I guess correctly?). The answer is, it already did. IRS’s revenue ruling (2013-17) is generally effective on or after September 16, 2013. One thing that can be done immediately is to look back to any tax year for which the statute of limitations has not yet expired (generally three years) and determine whether amending tax returns will result in tax refunds. If it will, amended returns can be filed. Note that for 2012 or prior year “original” returns filed before 9/16/13, same-sex couples may choose (but are not required) to amend returns.

If a same-sex couple files an “original” 2012 or prior year return on or after 9/16/13, they must file the return as married filing jointly or as married filing separately. As with opposite sex couples, the date of the marriage will be the determining factor for what year married returns will start, and for which years single (or possibly head of household) would apply.

For the upcoming 2013 tax return filing season, legally married same-sex couples must file as married filing jointly or married filing separately. Single filing status does not apply, period.

Having said all of that, you now ask “what about the states”, right? The answer is, we’re not sure yet. Virginia recently issued a statement unequivocally saying that same-sex marriages are not recognized in the state. VA legally married same-sex couples (for Federal purposes) will have to file married returns for Federal purposes (joint or separate) and for VA purposes will have to file as single (or head of household, if applicable). This scenario will be the same for any state that doesn’t recognize same-sex marriages. Check your state’s laws to determine applicability.

I could go on for another 600 words, but I’ve barely scratched the surface of discussing planning points and opportunities. You should consult with your favorite tax professional (whose name hopefully starts with Jay and ends with Reiner) about details that you need to know as you move into the upcoming filing season and tax years beyond. Please send a link to this article to any friends, family, or associates who could benefit by it.

Home Sales and Taxes

With the housing market as hot as it’s been, you may be thinking of selling a home, and hopefully taking the profit and running. But will you owe any taxes to Uncle Sam? The short answer is, it depends (hey, nothing’s ever straightforward when it comes to taxes!) This article will discuss various aspects of home sales and taxes.

Principal Residence?

If the home being sold is your principal residence, up to $500K of gain on the sale can be excluded from tax on a married joint return ($250K for a single taxpayer). Note that this is gain on the sale, which is generally the difference between the selling price and the cost basis of the home. Also remember that this is for the place that you call home, normally your primary residence, and not a second or vacation home. The exclusion can be claimed if you’ve lived in this residence for at least two of the previous five years. If you don’t meet the two year requirement due to certain specific unforeseen circumstances, a reduced exclusion can be available.

Rental Property?
Do you live in a home that’s also partially rented out to somebody else? If you do, the two parts (residence and rental) need to be split into two transactions for tax purposes, and only the residence part is subject to the gain exclusion. Any gain on the rental portion will be 100% taxable.

3.8% Medicare Tax

For tax years starting in 2013, there’s a 3.8% Medicare tax on “net investment income”, and I’ll give you one guess what gets included in this computation. The good news is that if the principal residence exclusion amount wipes out your gain on sale, you won’t be subject to the 3.8% tax either.

Sale of Principal Residence at a Loss

Sorry, this one just isn’t deductible, period, end of story. The story has a different ending if it’s a property you rented out to others, but that’s beyond the immediate scope of this article.

Home Office Depreciation

If you took depreciation deductions on a home office, this will reduce the basis of your home, for purposes of computing the gain on sale. Not only that, but the amount of depreciation taken in previous tax years will be recaptured on sale as taxable income, and also be subject to the 3.8% Medicare tax.

Obviously there are lots of non-tax related things to think about when selling a home (moving, for one), but don’t lose sight of the tax laws surrounding the sale, because if you do, you may have a nasty surprise come tax time. My recommendation is to speak with your favorite CPA (hint hint) and do some pre-sale tax planning.

Please forward this article to anybody you know who is considering selling a home, and if you have any personal stories or comments about home sales and taxes, please leave a comment.

The Penalty of Marriage

It’s June, and what better time for love, weddings, and marriage penalties? Yes my friends, while you’re busy picking out flowers, caterers, and tacky bridesmaid dresses, start thinking about how much more tax you’re going to be paying, come tax time. That’s right, I said more tax, and if you’re in the majority of taxpayers, you’ll most probably wind up paying more tax as part of a married couple than you would as a single bachelor(ette). I wrote about this a couple of years ago, but a recent meeting with a new client reminded me of how often this subject has come up over the years, so I thought I’d revisit it.

You may or may not have heard of the term “marriage penalty”. What this refers to is combining two spouses’ incomes on one married tax return which will result in a higher tax than the same amount of income split between the two spouses on two single tax returns. In one of the more recent tax law changes within the last few years, Congress had attempted to eliminate the marriage penalty, but the problem is, they didn’t do it for all the tax brackets. For the lowest (10%) and next lowest (15%) tax brackets, the amount of joint income that falls into each bracket is exactly double the amount of single income that falls into each bracket. And that’s where marriage penalty relief ended. Taxable income for a single taxpayer in the next bracket (25%) falls between $36,250 and $87,850, while married joint taxpayers will find that bracket only covers income between $72,500 (double the single amount) and $146,400, (only 167% of the single amount). So if you have two taxpayers with taxable income of $87,850 each, they’ll both be in the 25% bracket, but add those up ($175,700), and on a joint return they’ll now be in the 28% bracket…penalty! For those in the uppermost tax bracket (39.6%), single taxpayers will hit that bracket with taxable income of $400K, while joint taxpayers will hit that bracket at $450K.

This may have you thinking “what about married filing separately?” Unfortunately, the answer is that the tax brackets are even less forgiving than the single ones, and you’ll be in the top tax bracket with only $225K of taxable income, compared to $400K single and $450K joint. There are reasons to file separately that are more legal and protective than tax saving (e.g. divorcing couples who want to keep their taxes/finances separate), and in my experience, in a majority of cases, filing jointly will be cheaper than filing separately, so for the happily married couple, filing jointly will probably be the best course of action.

There are limited ways to try to reduce the effect of the marriage penalty, but that wasn’t the goal of this article. The idea here is to make you aware that the marriage penalty is “out there”, so if you’re planning on tying the knot this year (or know somebody who is), when the dust has settled from the wedding, and the honeymoon is (literally) over, the next thing to think about is meeting with your friendly neighborhood CPA, and do some tax planning early, to help avoid a major tax headache next April 15th.

Summertime Child Care

No more pencils, no more books, no more teacher’s dirty looks…school’s out for summer. If you’re old enough to remember the Alice Cooper song, you can blame me when you’re still humming it six hours from now!

Now that another school year is coming to a close, how are you going to keep the kiddies occupied and out of trouble for the next few months? Chances are, you and your spouse will both be working during the lazy hazy crazy days of summer, and you’ll have to pay for child care, so why not have Uncle Sam pay for part of the cost? The federal Child and Dependent Care Tax Credit is applicable for summertime child care too, so take advantage of it, but first you need to know how it works. Here are some important points:

1-you have to pay for care so you (and your spouse if filing jointly) can work or actively look for work. The spouse can meet this test for any month that he/she is a full-time student or physically or mentally incapable of self-care.

2-you must have earned income, and if you’re filing jointly, your spouse must have earned income too. Earned income is generally wage and self-employment income.

3-the care must be for one or more qualifying people. In the case of this article, since I’m writing about children, they must be under age 13 and be claimed as a dependent.

4-the care can be provided at home, at a daycare facility, or even at a day camp. If it’s inside your home, then you also have to think about the household employer requirements.

5-the credit is a percentage of the qualified expenses that you for the qualifying person. This percentage starts at 35% and drops to a minimum of 20%, depending on income.

6-up to $3,000 of expenses for one person or $6,000 for two or more qualifying people can be used to compute the credit.

7-the cost of overnight camps or summer school tutoring doesn’t qualify, nor does anything paid to a spouse or other dependent. If either spouse receives dependent care benefits from an employer, special rules apply.

8-the credit is claimed on Form 2441, and basic information on the provider will need to be entered on this form, so make sure you have the provider’s name, address, and identifying number (social security or employer i.d. number). Keep good records to substantiate the credit claimed.

I’ve had many clients over the years who had unrealistic expectations of how much money they were going to save by claiming this credit. Realistically, if you have two or more eligible kids, $6,000 is the maximum amount of child care expenses you can use to compute the credit, and if your income is over $43,000, the percentage for the credit will be 20%, so the maximum credit you can get is $1,200, which isn’t a lot. Obviously it’s better than nothing, and it’s a credit so it will reduce your tax dollar for dollar, as opposed to a deduction which will only reduce your tax by whatever marginal tax rate you’re at. But with good record keeping you’ll save a few bucks, and will be able to afford to give each of your kids (and your spouse) their very own copy of Alice Cooper’s “School’s Out”.

Please forward this article to all parents who incur child care expenses, and have a good summer.

No more pencils, no more books…