2016 End of Year Tax Planning
Hope everyone had a nice Thanksgiving! It’s been almost three months since my last post. Until now, there has been a lack of anything interesting to discuss. I’m sure most people would have been distracted by the Presidential election anyway. Regardless of what you thought of the results, we can expect some massive changes to the federal tax scheme in 2017. The President-Elect has already made numerous proposals to overhaul the personal tax regulations. Not all of them will make it through Congress, but any one of them successfully passing and implemented by the Internal Revenue Service as he has proposed them could result in a radically different method by which your taxable income is calculated.
For now, it’s important to take advantage of our current tax code before the champagne is poured at New Year’s. Some last-minute, friendly advice that could reduce your 2016 tax bill as well as help you save for retirement:
Pay your next property tax bill early.
There is a possibility that our President-Elect and the Congress will reduce or even eliminate the property tax deduction. The standard deduction could be increased an amount where itemizing deductions (which have always included deducting property taxes) is less beneficial than taking the standard deduction to all but the taxpayers in the most expensive of homes. Property taxes are typically billed on a quarterly basis and paid along with your mortgage interest. Contact your bank and local municipality and you may be able to arrange to make a property tax payment normally due in January or February 2017 in December of 2016. You will get the extra deduction in 2016, reducing your taxable income and tax liability when you file your 2016 return. If the laws regarding property tax change in 2017, you will have already received a tax benefit for the property taxes you would have paid anyway.
Other Itemized Deduction Considerations.
The President-Elect has indicated that allowable deductions for mortgage interest and charity will not be changed, but in addition to property taxes, other currently allowable deductions may be curtailed or even eliminated. State income taxes are deductible if you itemize deductions; if you usually owe on your state taxes, consider making an extra estimated payment in December to maximize the deduction for 2016, because you may not be able to deduct the full amount of state taxes owed on your 2017 return. Out-of-pocket medical expenses, un-reimbursed job expenses and tax preparation fees to the extent they exceed certain percentages of your income (10% for the first item and 2% for the latter two combined) are also common itemized deductions that may be eliminated under the new administration, so consider pre-paying these expenses in 2016 to take advantage of this deduction.
Dependent Care Flexible Spending Accounts.
For 2016, up to $ 5000 could be contributed on a pre-tax basis (saving you federal and possibly state taxes) to a savings account specifically designated to pay for child care and other babysitting expenses to allow parents to work or look for work. The money needs to be spent on day care expenses incurred through December 31, 2016; you may be able to ask your day care provider to bill you for January during December in order ensure all the funds are used and tax savings maximized. Otherwise the unused funds will be forfeited. The incoming administration has discussed reducing the maximum dependent care contribution to $ 2000 per year, although they may also implement an additional child care tax credit to make up for the lost tax savings. Contributing the full $ 5000 to a flexible spending account and using it before December 31 of this year ensures the maximum tax savings.
Maximize your Individual Retirement Account (IRA) or My Retirement Account (myRA).
The incoming administration has not commented on IRAs or the newly-created myRA. Regardless of what happens, I believe this it is important to put in the maximum amount of funds to your IRA or myRA. This allows you to save for retirement by generating income that grows on a tax-deferred basis while possibly also reducing your federal and state tax liability for 2016. Depending on your income level, you may qualify to contribute up to $ 5500 (or $ 6500 if you are over age 50) to a Roth IRA, Traditional IRA or myRA. Roth IRA contributions are made on a post-tax basis and have no effect on your taxable income but as the money is invested and grows, it grows completely tax-free and you will pay no income tax on it when you start making withdrawals in your retirement years (which can start as early as age 59 ½). Traditional IRA contributions are made on a pre-tax basis and reduce your taxable income. The money is invested and grows on a tax-deferred basis; withdrawals made in your retirement years are taxed. The myRA is available to households with less than $ 191,000 in annual income that have no access to any employer-sponsored 401(k) or other retirement plan and the money is invested in US savings bonds by the Department of the Treasury. Like a Roth IRA, contributions are made on an after-tax basis and have no effect on your taxable income but future earnings grow tax-free, allowing you to make withdrawals tax-free in your retirement years.
Max out the 401(k) account, or at least increase contributions in your December paychecks.
The maximum 401(k) contribution for 2016 was $ 18,000 and it is expected to remain the same for 2017. Money is contributed to a 401k on a pre-tax basis and reduces your taxable income while it is invested and grows on a tax-deferred basis until withdrawals are made in your retirement years. If you are paid every other week, to reach the maximum amount, you would need to have had $ 692.30 withheld from each paycheck, or $ 750 if you are paid twice a month. Anything less than that and you will miss out on federal (and possibly state) tax savings as well as less savings invested for your retirement. You cannot simply write checks on your own to contribute to a 401k like you can with an IRA but your employer should allow you to increase your pre-tax paycheck contributions at any time, up to the amount of your entire paycheck. Consider increasing your contributions during December to “catch up” for what you didn’t contribute earlier in the year. You can then change the regular contribution back to a smaller, more manageable amount the following January.
529 College Savings Plans.
Since contributing to 529 College Savings Plans can only reduce your state tax liability (but not in every state), the incoming administration has not made any comments on what is almost entirely a program administered by the states. 529 Plans allow you to put aside and invest funds for your children’s (or almost any other person you wish to help) future college education while also giving you a state tax deduction or credit. Some states do not give any tax benefit at all for contributing, or only allow a tax benefit on contributions made for your own children. Theoretically, you could contribute up to $ 14,000 per child per year in a 529 plan before potentially incurring federal gift tax liability, but most states set the maximum annual contribution at $ 10,000 per child, or offer no tax benefit for anything contributed over $ 10,000.
I would prefer not to have political discussions or commentary on my blog, but the paths of politics and taxation are always intersecting, and it is my job to report how this will affect you, or what you can do to take advantage of it. I hope you will find this advice helpful and perhaps addresses some concerns you might have in light of the uncertainty ahead. Enjoy the holiday season, and contact me anytime with your questions!
The Internal Revenue Service’s Share of the Sharing Economy
The “sharing” economy has brought me and my family some easy ways to save money and has also proven very convenient. I’ve used Uber and Lyft in neighborhoods where taxis weren’t readily available. I’ve used Zimride for longer drives, both to help defray out of town driving costs and a ride that is usually more desirable than taking a bus. AirBnB worked well for us when we wanted have a New Year’s Eve party in Manhattan near the ball drop without shelling out $500 or more for a hotel room. We didn’t need to worry about getting home among the heavily inebriated crowds after we’d toasted the new year with champagne with our friends. The Internet and smartphones have led to many other shared economy type services (I see advertisements for new ones almost every month, both online and in print) that allow individuals to make a few extra dollars by renting out things like bikes, cars or boats during hours they aren’t using them. This can be a godsend for those who can’t always pay the retail prices or in areas that are too small for any retail provider to have a convenient location.
The IRS Wants its Share Too
While the sharing economy has proven to be controversial and there have been buyers and sellers who have had some very bad experiences, it has become an integral part of our economic landscape and will probably continue to grow. The Internal Revenue Service has recognized this and has made it known that they want to be part of the sharing as well. They only want some of the money collected and won’t be giving us a ride or lending us their extra bedrooms. If you are collecting any money from the rental of anything – whether it’s extra seats in your car, spare bedrooms in your home, your bicycle or your boat – be prepared to report this extra income on your tax return, usually on a Schedule C for self-employment income.
When You Should Report Sharing Income
If the extra income you collect is minimal and you don’t receive it more than a few times a year at most, it will likely not affect your tax liability and you probably don’t need to report it. For example, if someone pays you $ 20 every few months to catch a ride in your car from New York City to Baltimore, the depreciation, wear-and-tear and fuel costs you could allocate to that one paid passenger probably exceed $ 20 anyway and there would be little or no profit to tax. But if you charge more, regularly have three passengers in your car almost every week on the same trip, the money collected and expenses associated with generating it over the course of a year need to be reported on a Schedule C. The net income you receive is subject to the 15.3% self-employment tax as well as regular income tax. Typically, self-employment income that amounts to less than $ 400 per year does not need to be reported. However, income from the sharing economy is an area that continues to emerge and the IRS is frequently issuing new guidance and regulation in this area, so check with your tax professional about how the rules may apply to your unique situation.
If you rent spare rooms in your home on a short-term basis, the Internal Revenue Service specifically provides an exemption for people who rent space for overnight guests in their home fewer than 15 nights a year – no need to report the extra income and you may not deduct any costs associated with it either. This exemption came about thanks to a Congressional representative from Georgia whose constituents collected a lot of extra money renting rooms in their homes to spectators of a major pro golf tournament every year. Residents of California, Florida and Louisiana have taken advantage of this exemption many times when the Super Bowl was held in places like Los Angeles, Tampa, Miami or New Orleans.
But if you receive money from overnight guests for 15 or more nights per year (no matter how many of your extra bedrooms are rented), you generally must report the income and related expenses on a Schedule C. Services for the tenants’ convenience, such as cleaning, changing linens and having clean cutlery and glassware for their use requires you to report the income and related expenses on a Schedule C. If you don’t provide these services and do little more than clean the common areas and/or collect trash, you may be able to consider it rental income and report it on a Schedule E instead. But verify this with your tax professional first. Income reported on a Schedule E is still subject to regular income tax but not the 15.3% self-employment tax. Expenses associated with the short-term rental to overnight guests in your home can include portions of your rent or mortgage interest, real estate taxes, maintenance costs, utilities, insurance and depreciation. You can only deduct these expenses on a pro-rated basis – for example, if the square footage of the bedrooms you rent out for 15 or more nights per year take up 15% of your home’s total space, 15% of these expenses are deductible.
The Future of the Sharing Economy
The sharing economy will probably undergo finer tuning and be subject to many more regulatory issues in the future. For example, states and cities have been demanding the payment of hotel occupancy taxes from short-term renters in some places. Also, the concept hasn’t always worked out for everything – the Federal Aviation Administration shut down a number of websites where people were trying to rent out empty seats on their private planes, claiming that you cannot offer airplane seats to the general public if you are not registered as a commercial airline. However, sharing as a concept has already been proven beneficial to both buyers and sellers and the Internal Revenue Service knows it won’t be going away. If you aren’t prepared to “share” with the IRS when you receive the extra income or when you file your return, be prepared to give a bigger share consisting of tax, under-reporting penalties and interest when you get audited.
When the IRS Says You Owe More
So you filed your annual return some time ago, but you receive a letter from the IRS stating you owe additional taxes. Not a happy thought! The IRS can adjust your federal return for a variety of reasons and assess additional taxes. Perhaps your employer made a mistake on your W-2 statement and issued a new one with different numbers. Maybe there was investment income you forgot to report. You may have computed your tax liability incorrectly when you prepared and filed your tax return. Or you faced a dreaded federal tax audit and the Internal Revenue Service deemed some of your itemized deductions as non-deductible or you did not have adequate proof (most likely the receipts) to show you spent the money for the deductions you claimed.
The IRS catches up with you sooner or later, adjusts your income and demands additional tax payments, interest and penalties. When you receive an IRS notice demanding additional tax, do not pay until you are sure your liability was computed correctly. The IRS may not be seeing the “whole picture.” Additional details provided by you or your tax professional may result in lower federal taxes owed. Once you have determined the correct amount of additional taxes owed, the IRS agrees with you, and you’ve paid the additional tax or worked out a payment plan for it, your work is not finished.
Uncle Sam’s counterpart at the state level will need to know about the changes to your federal return if it has an effect on your state tax liability, anywhere from 30 days to one year (depending on the state) after your federal return adjustments have been finalized. If the federal changes have no effect on your state tax return, you do not need to report the changes to the state. But if your total income or a deduction permitted at both the state and federal levels were changed by a federal audit or determination, you will need to prepare and file an amended state return to reflect these changes. Many people forget to do this and as a result, end up receiving a notice from the state automatically assessing additional taxes, interest and penalties. The interest accrues from the original filing deadline of the return, and can accrue over a period as long as five years. Even though most states cannot assess additional tax more than three years after a return has been filed, most states can assess additional taxes two years after the taxable income on your federal return has been changed and finalized by the IRS.
Of course, don’t forget that if you (or, on a rare occasion, the IRS), found an error on your federal return that overstated your federal tax liability and chose to file an amended return to get a refund, you can also file an amended state return to reflect the federal changes and get a state tax refund as well. The state tax refund will typically be considerably less than the federal refund and may not be worth the effort and/or tax professional’s fees. So decide if the additional refund from state taxes is worth the added costs of filing. The state, of course, will not have a problem keeping the extra money and you will not be obligated to file an amended return in that circumstance.
While simple changes do not always require a tax professional’s services, amended state tax returns can be tricky, cannot be filed electronically and will likely require copies of certain federal forms to properly complete the filings. Depending on how complicated the changes to your taxable income are, you may wish to have a tax professional prepare your amended state return filing.
Health Savings Accounts: The Ultimate Tax Shelter for your Retirement
When we hear the words “tax shelter”, many of us picture a real estate investment that purposely loses money or money filtered through a phony corporation that is nothing but a piece of paper on file in the Cayman Islands. Most of us don’t have the means or sophistication to take advantage of this dubious tax planning, nor would be able to afford a lawyer who could defend against it when the Internal Revenue Service wanted to know more about it. There is, however, an easy, perfectly legal way that most of us can shelter money from federal taxation to immediately use or allow to grow tax-free for the future.
If you or your family are under a High Deductible Health Plan, which, in addition to your share of the premium, requires you to cover at least $ 2600 in out of pocket health expenses (i.e. co-payments, extra charges for specialized surgical procedures), then you have the option of placing up to $ 6750 in a Health Savings Account (HSA) on a family insurance plan or $ 3350 for a single person plan. If you and/or your spouse are over the age of 55, you have the option of putting an additional $ 1000 in the HSA as well. Money contributed to the HSA is deducted from your income, regardless of whether you itemize deductions or not and escapes federal taxation (states vary on how they treat these contributions).
While many of us are inclined to only contribute the amounts we need for our un-reimbursed health expenses annually, that is not a strategy which takes full advantage of this benefit. Rather, contributing the maximum amount, whether the money is actually used for health-related expenses in a specific year is what achieves the maximum benefit. Not only will you receive the highest possible deduction on your current year taxes, the money will grow tax-free and will always be available to you for future un-reimbursed health expenses. Many HSA plans now give you the option to invest the funds more aggressively than a low-interest bearing account, although not as aggressively as the typical 401(k) plan or IRA. Your HSA is also portable; when you leave a particular employer, you may take it with you, either to your new employer’s HSA or invested through an independent HSA administrator (which you can find at www.hsafinder.com). When you retire, you will have built up a fund from money that was never taxed at the federal level (and possibly the state level) and grew tax-free throughout your life. You can it use for your health-related expenses, which are likely to be costly during your retirement years. That in turn leaves your 401(k) and IRA funds available for other retirement expenses.
An HSA that you contribute to over the years may not be the kind of glamourous tax shelter in the Cayman Islands to brag about, but if you contribute enough money to it over the years and have substantial funds in it before retiring, it will serve you well in your retirement years.