Dear Clients and Colleagues:
Greetings from E.T. Kelly & Associates. We hope this letter finds you well as we enter the holiday season. In our profession, the season is coupled with year-end tax planning. The opportunity to take advantage of income timing exists particularly for taxpayers who are:
- In a different tax bracket in 2016 than in 2017;
- Subject to alternative minimum tax (AMT) in one year but not the other;
- Subject to the 3.8% net investment income (NII) tax in one year but not the other; or
- Subject to the 0.9% Medicare tax on earned income in one year but not the other.
President-elect Trump’s administration brings the likelihood of tax law change. During the campaign President-elect Trump outlined many tax proposals. Highlights include:
- Tax relief for middle class Americans – lowering individual rates for most taxpayers.
- Repeal of the alternative minimum tax (AMT).
- Repeal of the Affordable Care Act (ACA) which had created the 3.8% NII tax and the additional .9% Medicare tax.
- For businesses, doubling the Section 179 expensing election to $1 million and a reduction in the corporate tax rate to 15%.
If you are interested in reading about the full slate of proposed tax law changes, click HERE to read a letter on the topic prepared by one of our research services.
If these proposals become law, especially any reduction in income tax rates, and are made retroactive to January 1, 2017, your tax planning definitely needs to be reviewed. Our office will gladly work with you to maximize any potential tax savings.
For now, the “Protecting Americans from Tax Hikes Act of 2015” (PATH Act) can guide us in planning for 2016. This legislation made permanent the following tax breaks for individuals:
- The $250 above-the-line-deduction for K-12 teacher’s unreimbursed expenses.
- Tax-free IRA distributions for charitable purposes by those age 70-1/2 or older.
- The $2,500 American Opportunity Tax Credit for qualified education expenses related to the first four years of higher education.
For businesses, the PATH Act includes the following permanent tax breaks:
- $500,000 Section 179 expensing limit.
- The 15-year write-off for qualified leasehold improvement property, qualified restaurant property, and qualified retail improvement property as well as these properties’ eligibility for up to $250,000 Section 179 expensing.
- The research tax credit.
- The exclusion of 100% gain on certain small business stock.
Personal and business tax breaks with a limited life include:
- The exclusion for up-to-$2 million of mortgage debt forgiveness on a principal residence and the itemized deduction for mortgage insurance premiums (through 2016).
- The above-the-line-deduction for qualified higher education expenses (through 2016).
- For businesses, the 50% bonus first year depreciation for most new machinery, equipment and software (starts to phase out in 2018 and expires in 2019).
Higher-income-earners have unique concerns to address when mapping out year-end plans. They must be wary of the 3.8% surtax on certain unearned income and the additional 0.9% Medicare tax that applies to earned income in excess of $250,000 for married filing jointly and $200,000 for single filers, knowing the possibility exists for these taxes to be repealed in the future.
For Minnesota, tax law changes have been minimal. The state has yet to pass legislation to comply with the new PATH Act. In 2016, new Minnesota legislation consists of:
- Parents who experience the stillbirth of a child in Minnesota may be eligible for a refundable credit of $2,000
- Allowing a subtraction for certain military retirement pay (including pensions) when calculating Minnesota taxable income and Minnesota alternative minimum taxable income
A summary of 2016 federal income tax bracket changes and planning ideas follows.
Tax Rates – For 2016, the individual income tax brackets reflect a continuation of the same rates as in the past few years, with a slight increase in the thresholds for each tax bracket. President-elect Trump’s proposal consists of tax rate brackets: 12% (replaces current 10% and 15%), 25% (replaces 25% and 28%), and 33% (replaces 35% and 39.6%), creating potential tax savings for many of our clients. The 2016 individual tax rates and thresholds are as follows:
Tax Rate Income (Single Taxpayer) Income (Married Taxpayers)
10% Up to $9,275 Up to $18,550
15% $9,276 – $37,650 $18,551 – $75,300
25% $37,651 – $91,150 $75,301 – $151,900
28% $91,151 – $190,150 $151,901 – $231,450
33% $190,151 – $413,350 $231,451 – $413,350
35% $413,351 – $415,050 $413,351 – $466,950
39.6% $415,051 or more $466,951 or more
To accelerate deductions, these expenses are commonly prepaid as part of year-end tax planning:
- Charitable contributions including contributions of appreciated securities held more than one year. With a contribution of appreciated securities, the taxpayer receives the full value of the stock as a charitable deduction, but does not have to include the built-in gain in income.
- Prepayment of 4th quarter state and local income taxes (if not subject to AMT).
- To overcome certain AGI limitations on deductions, “bunch” deductions into one year.
Beware of the Alternative Minimum tax trap – After all the complexities of AMT, its net effect is to throw taxpayers into higher tax brackets than they would otherwise be subjected to based on their income and the standard brackets. If it’s possible you will be subject to the AMT in 2016, you should consider deferring certain tax payments that are not deductible for AMT purposes, such as state income taxes and real estate taxes, until 2017. Due to the complexity of AMT, the best way to determine if you might be subject to the AMT rules is to have a tax projection prepared. Very generally speaking, AMT becomes a concern for Minnesota residents as their income approaches $200,000 (single) or $250,000 (married filing joint).
Take Advantage of Long-Term Capital Gains – If you hold a capital asset for more than one year before selling it, your capital gain is long-term. For most taxpayers, long-term capital gain is taxed at rates no higher than 15%. But taxpayers in the 10% and 15% ordinary income tax brackets have a long term capital gain of 0%. Taxpayers whose income exceeds the thresholds set for the 39.6% ordinary tax rate are subject to a 20% rate on capital gain. Presumably, President-elect Trump’s new proposed income tax brackets would be realigned with the capital gains tax thresholds. Further complicating factors, anyone with modified AGI over $200,000 single or $250,000 married joint is also subject to the 3.8% tax on investment income. Remember that you can use capital losses to offset capital gains. If you lose more than you gain during the year, you can offset ordinary income by up to $3,000. Any remaining losses carry forward to next year.
Contribute to a Retirement Plan – You may be able to reduce your taxes by contributing to a retirement plan. If you are an employee, you generally must make the employee deferral portion of a retirement plan contribution prior to December 31. Traditional IRAs allow contributions as late as the due date for filing the 2016 tax return – April 17, 2017. Contributions to certain retirement plans available to businesses can be made as late as October 15, 2017, if the tax return is extended.
Review Estate and Gift Planning Strategies – As with other tax considerations, the estate and gift tax laws are also a target for reform in 2017. For 2016, taxpayers are permitted to make annual tax-free gifts of up to $14,000 per recipient ($28,000 if married and using a gift-splitting election, or if each spouse uses separate funds). By making these gifts annually, taxpayers can transfer significant wealth out of their estate without using any of their lifetime exclusion. Additional gifts can be made using the lifetime gift exclusion, which is $5.45 million ($10.9 million for married filing jointly), in 2016. The recent increases to the exclusion make it a good time to review any existing estate and gift plans to ensure they best meet your needs. For Minnesota residents, the estate tax exclusion is $1.6 million in 2016. Recent legislation increases this exclusion by $200,000 per year until the exemption reaches $2 million in 2018. Minnesota does not impose a gift tax.
Health Care Reform Tax Penalty – As part of ACA, taxpayers are required to carry health insurance. Administration of the various health care payments, penalties, and credits flows through the individual tax return. For 2016, if a taxpayer does not have qualifying coverage for himself/herself and any dependents, and does not qualify for an exemption, the taxpayer will be required to make an Individual Shared Responsibility payment (sometimes referred to as a penalty). This is due with the filing of the annual income tax return. The 2016 payment is the greater of:
- 2.5% of household income above the tax return-filing threshold, or
- A flat dollar amount, which is $695 per adult and $347.50 per child per year (pro-rated for any month with coverage or exemption), limited to an annual maximum of $2,085. The maximum payment cannot exceed the cost of the national average premium for the Marketplace’s Bronze-level health plan in 2016.
Health Care Reform Premium Tax Credit – A taxpayer or non-dependent child may be eligible for the Premium Tax Credit – which can lower out-of-pocket premiums – if they:
- Purchase insurance through the Marketplace and pay their share of the premiums,
- Are ineligible for employer or government-plan coverage,
- Are within specific low- or moderate-income limits (individuals with income below $47,520 and families of four more with income below $97,200), and
- Cannot be claimed as a dependent by another person.
- File a federal income tax return.
The information in this letter is a sampling of possible tax strategies. If there is one thing we can assure you based on our years of experience, it is that every taxpayer’s situation is different. A strategy that works well for one taxpayer may have very different results for another. If you would like to discuss planning ideas for your specific tax situation, we would be pleased to assist you. We thank you for your business and your support of our firm.
We wish you a happy holiday season!
Cory Kiner Patty Moskalik Nancy Marian Eileen Kelly
952-835-6891 952-548-9156 952-548-9154 952-835-1901