“LAST MINUTE” YEAR-END 2016 TAX-SAVING MOVES FOR BUSINESSES

As year-end approaches, you should consider whether you could benefit from the following “last minute” tax-saving moves, including adjustments to income to preserve favorable estimated tax rules for 2017, deferral of certain advance payments to next year, and fine-tuning bonuses to make the most of the Code Sec. 199 domestic production activities deduction.

Accelerating or deferring income can preserve estimated tax break. Corporations (other than certain “large” corporations) can avoid being penalized for underpaying estimated taxes if they pay installments based on 100% of the tax shown on the return for the preceding year. Otherwise, they must pay estimated taxes based on 100% of the current year’s tax. However, the 100%-of-last-year’s-tax safe harbor isn’t available unless the corporation filed a return for the preceding year that showed a liability for tax. A return showing a zero tax liability doesn’t satisfy this requirement. Only a return that shows a positive tax liability for the preceding year makes the safe harbor available.

A corporation (other than a “large” corporation; see below) that anticipates a small net operating loss (NOL) for 2016 (and substantial net income in 2017) may find it worthwhile to accelerate just enough of its 2017 income (or to defer just enough of its 2016 deductions) to create a small amount of net income for 2016. This will permit the corporation to base its 2017 estimated tax installments on the relatively small amount of income shown on its 2016 return, rather than having to pay estimated taxes based on 100% of its much larger 2017 taxable income. Also, by accelerating income from 2017 to 2016, the income may be taxed at a lower rate in 2016, e.g., at 15% instead of at 25% or 34%. However, where a 2016 NOL would result in a carryback that would eliminate tax in an earlier year, the value of the carryback should be compared to the cost of having to pay only a small amount of estimated tax for 2017.

Accrual-basis business can take a 2016 deduction for some bonuses not paid till 2017. An accrual-basis business can take a deduction for its current tax year for a bonus not actually paid to its employee until the following tax year if

  1. The employee doesn’t own more than 50% in value of the business,
  2. The bonus is properly accrued on its books for the current tax year, and
  3. The bonus is actually paid within the first 2 1/2 months of the following tax year (for a calendar year taxpayer, within the first 2 1/2 months of 2017).

The 2016 deduction won’t be allowed, however, if the bonus is paid by a personal service corporation to an employee-owner, by an S corporation to an employee-shareholder, or by a C corporation to a direct or indirect majority owner.

For employees on the cash basis, the bonus won’t be taxable income until the following year.

Accrual-basis taxpayers can defer inclusion of certain advance payments. Accrual-basis taxpayers generally may defer including in gross income advance payments for goods until the tax year in which they are properly accruable for tax purposes if the income inclusion for tax purposes isn’t later than it is under the taxpayer’s accounting method for financial reporting purposes.

An advance payment is also eligible for deferral—but only until the year following its receipt—if:

  1. Including the payment in income for the year of receipt is a permissible method of accounting for tax purposes;
  2. The taxpayer recognizes all or part of it in its financial statement for a later year; and
  3. The payment is for
    • Services
    • Goods (other than goods for which the deferral method discussed above is used)
    • The use of intellectual property (including by lease or license)
    • The occupancy or use of property ancillary to the provision of services
    • The sale, lease, or license of computer software
    • Guaranty or warranty contracts ancillary to the preceding items
    • Subscriptions in tangible or intangible format
    • Organization membership or
    • Any combination of the preceding items.

Example: An accrual-basis, calendar-year taxpayer received a payment on Nov. 1, 2016 for a contract under which it will repair a customer’s computer equipment for two years. In its financial statements, the taxpayer recognizes 25% of the payment in 2016, 50% in 2017, and 25% in 2018. For tax purposes, under the deferral method discussed above, the taxpayer can report 25% in 2016 and defer 75% to 2017.

The deferral method cannot be used for

  1. Rent
  2. Insurance premiums
  3. Payments on financial instruments (e.g., debt instruments, deposits, letters of credit, etc.)
  4. Payments for certain service warranty contracts
  5. Payments for warranty and guaranty contracts where a third party is the primary obligor
  6. Payments subject to certain foreign withholding rules and
  7. Payments in property to which Code Sec. 83 applies.

If an advance payment is only partially attributable to an eligible item, it may be allocated among its various parts, and the deferral rule may be used for the eligible part.

Taxpayers wishing to change to the above method may use automatic consent provisions (with certain modifications). Advance consent procedures apply in certain cases, e.g., where advance payments are allocated.

Businesses that qualify for the deferral should not let tax considerations keep them from accepting advance payments before the end of 2016.

Making the most of the domestic production activities deduction. Businesses can claim a domestic production activities deduction (DPAD) under Code Sec. 199 to offset income from domestic manufacturing and other domestic production activities.

The Code Sec. 199 deduction equals 9% of the smaller of—

  1. The taxpayer’s “qualified production activities income” or QPAI, for the tax year, or
  2. The taxpayer’s taxable income (modified adjusted gross income, for individual taxpayers), without regard to the Code Sec. 199 deduction, for the tax year.

However, the Code Sec. 199 deduction can’t exceed 50% of the W-2 wages of the employer for the tax year. And the otherwise allowable Code Sec. 199 deduction of a taxpayer with oil-related QPAI is subject to a special reduction.

Qualified production activities eligible for the deduction include items such as: the manufacture, production, growth or extraction of qualifying production property (i.e., tangible personal property such as clothing, goods, or food as well as computer software or music recordings) by a taxpayer either in whole or in significant part within the U.S.; construction or substantial renovation of real property in the U.S., including residential and commercial buildings and infrastructure such as roads, power lines, water systems, and communications facilities; and engineering and architectural services performed in the U.S. and relating to the construction of real property. (Code Sec. 199(c)(4))

Generally, wages are the sum of the aggregate amounts that must be included on the Forms W-2 of employees under Code Sec. 6051(a)(3) (i.e., wages subject to withholding) and Code Sec. 6051(a)(8) (elective deferrals). The wages must be allocable to the taxpayer’s domestic production activities, and they include tips and other compensation as well as elective deferrals to 401(k) and other plans.

It is important for businesses to calculate the tentative Code Sec. 199 deduction and the W-2 deduction cap before year-end. If the deduction cap will limit the otherwise available deduction—for example, in the case of a closely held business whose owners do not draw substantial salaries—the business may want to bonus out additional compensation to maximize the Code Sec. 199 deduction. Bear in mind that in some cases, an accrual-basis business can deduct a bonus that is declared before year-end but not paid until the following year (see discussion above).

Taxpayers also need to factor the Code Sec. 199 deduction into other year-end tax planning strategies. For example, when determining whether to defer or accelerate income, a taxpayer must determine the marginal tax rate for each year. Depending on the type of income or deduction that the taxpayer is dealing with when working on such strategies, the Code Sec. 199 deduction may have the effect of decreasing the taxpayer’s marginal rate.

 

Andy Farkas, CPA
Farkas Tax Advisors, Inc.
2173 Salk Ave., Ste 250
Carlsbad, CA 92008
(760) 237-4000 Office
(619) 204-6052 Cell
andy@farkascpa.com
www.farkascpa.com

Disclaimer: Any accounting, business or tax advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues, nor a substitute for a formal opinion, nor is it sufficient to avoid tax-related penalties. If desired, we would be pleased to perform the requisite research and provide you with a detailed written analysis. Such an engagement may be the subject of a separate engagement letter that would define the scope and limits of the desired consultation services.

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YEAR-END MOVES FOR THOSE WHO BELIEVE PRESIDENT-ELECT TRUMP WILL CUT THEIR TAXES NEXT YEAR

In his first televised interview, President-elect Trump declared that a “major tax bill lowering taxes in this country” would be one of his top three priorities. Those middle and upper income taxpayers who are betting he can deliver on this promise, and put his tax reduction plan in place for 2017, should revisit their year-end tax moves to make the most of what might be windfall savings next year.

Defer income to 2017. The Trump tax plan would feature three tax brackets instead of current law’s seven, and a top tax rate of 33% instead of current law’s 39.6%. The upshot of these and other tax-reduction changes, if retained in the final tax plan, would be reduced taxes for middle and upper income taxpayers, with the biggest tax savings realized by the wealthiest taxpayers.

The standard year-end tax-savings wisdom always has been to defer income, where possible, into the coming year. This standard approach would make even more sense for middle and upper income taxpayers if the Trump tax plan prevails over others in Congress, and goes into effect for tax year 2017.

Here are some of the ways to defer income until 2017:

  • An employee who believes a bonus may be coming his way may be able to request that his employer delay payment of any bonus until early in the following year. For example, if a bonus would normally be paid on Dec. 15, 2016, an employee may ask the employer before Dec. 15 to defer any bonus coming his way until Jan. 2, 2017. By deferring the bonus, the employee will succeed in having it taxed in 2017. But note that if an employee waits until a bonus is due and payable to request a deferral, the tax on the bonus will not be deferred. Also, if the deferral extends beyond 2-½ months after the close of the tax year, the bonus will be treated as non-qualified deferred compensation (currently includible in income to the extent not subject to a “substantial risk of forfeiture” if the arrangement fails to meet certain distribution, acceleration of benefit, and election requirements).
  • Income that a cash basis taxpayer earns by rendering services isn’t taxed until the client, patient etc., pays. If the taxpayer (e.g., consultant, business person, medical professional) holds off billing until next year—or until so late in the year that no payment can be received in 2016—he will succeed in deferring taxable income until next year.
  • Defer “first year” required minimum distributions (RMDs) from an IRA or 401(k) plan (or other employer-sponsored retirement plan). RMDs from IRAs must begin by April 1 of the year following the year a taxpayer reaches age 70-½. That start date also applies to company plans, but non-5% company owners who continue working may defer RMDs until April 1 following the year they retire. Although RMDs must begin no later than April 1 following the year in which the IRA owner attains age 70-½, the first distribution calendar year is the year in which the IRA owner attains age 70-½. Thus, if a taxpayer turns age 70-½ in 2016, he can delay the first required distribution to 2017, but if he does so, there will have to take a double distribution in 2017—the amount required for 2016 plus the amount required for 2017. Delaying 2016 distributions to 2017 thus will bunch income into 2017, but that would be beneficial if the taxpayer winds up in a substantially lower bracket that year.
  • Defer a traditional IRA-to-Roth IRA conversion until 2017. Such a conversion generally is subject to tax as if it were distributed from the traditional IRA or qualified plan and not recontributed to another IRA. Thus, a taxpayer who plans to make such a conversion should defer doing so if he believes the conversion will face a lower tax next year.

Defer property sales. The President-elect’s plan to repeal the Affordable Care Act (“Obamacare”) also would repeal the 3.8% surtax on investment income. This surtax applies to the lesser of

  1. Net investment income or
  2. The excess of modified adjusted gross income (MAGI) over the threshold amount ($250,000 for joint filers or surviving spouses, $125,000 for a married individual filing a separate return, and $200,000 for other taxpayers).

As a result, if the surtax is repealed for 2017, taxpayers within the reach of the surtax, and are contemplating the sale of property that would generate a large investment gain, would benefit by deferring the sale until next year (assuming of course that the sale price would stay more or less the same).

If the sale can’t be postponed, it may be possible to structure the deal as an installment sale. By making a sale this year with part or all of the proceeds payable next year or later, a non-dealer seller to whom the installment method applies becomes taxable in any year on only that proportion of his profit which the payments he receives that year bear to the total sale price. If the 3.8% surtax is repealed for tax years beginning after 2016, the profit on the post-2016 installment payments would escape the surtax. Note that the Trump tax plan would keep current law’s maximum tax rate of 20% of capital gains.

On the deduction side. Itemized deductions produce no tax savings for a year in which a taxpayer claims the standard deduction, and many more taxpayers would claim the standard deduction under President-elect Trump’s tax plan. It calls for a dramatically increased standard deduction: $30,000 for joint filers (up from $12,600 for 2016) and $15,000 for singles (up from $6,300). If the boosted standard deduction makes it into law for 2017, many taxpayers who itemize under current law and wouldn’t be able to under the Trump plan would be better off accelerating next year’s itemized deductions into this year, when they will generate a tax savings. And, even if the standard deduction proposal is watered down, itemized deductions still will be more valuable to a taxpayer this year than next if he expects to be in a lower marginal tax bracket in 2017.

For example, those whose medical expenses exceed the 10% of AGI floor (7.5% of AGI for those age 65 or older) could accelerate into this year discretionary or elective medical procedures or expenses, such as dental implants or expensive eyewear. Individuals could boost charitable contributions (e.g., making two years worth of contributions this year to a favorite cause), pay state income tax and local property tax a bit early (keeping in mind that such taxes are not deductible for alternative minimum tax purposes), or making a year-end mortgage payment.

 

Andy Farkas, CPA
Farkas Tax Advisors, Inc.
2173 Salk Ave., Ste 250
Carlsbad, CA 92008
(760) 237-4000 Office
(619) 204-6052 Cell
andy@farkascpa.com
www.farkascpa.com

Disclaimer: Any accounting, business or tax advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues, nor a substitute for a formal opinion, nor is it sufficient to avoid tax-related penalties. If desired, we would be pleased to perform the requisite research and provide you with a detailed written analysis. Such an engagement may be the subject of a separate engagement letter that would define the scope and limits of the desired consultation services.

YEAR-END PLANNING: REDUCING EXPOSURE TO THE 3.8% SURTAX ON UNEARNED INCOME

For high earning taxpayers, year-end tax planning for 2016 includes facing the complication of the 3.8% surtax on unearned income under Code Sec. 1411. This article takes a look at year-end moves that can be used to reduce or eliminate the impact of this surtax, including overall year-end strategies for coping with it and specific strategies for taxpayers with interests in passive activities.

General background. Certain unearned income of individuals, trusts, and estates is subject to a surtax (i.e., it’s payable on top of any other tax payable on that income). The surtax, also called the “unearned income Medicare contribution tax” or the “net investment income tax” (NIIT), for individuals is 3.8% of the lesser of:

  1. Net investment income (NII), or
  2. The excess of modified adjusted gross income (MAGI) over an unindexed threshold amount ($250,000 for joint filers or surviving spouses, $125,000 for a married individual filing a separate return, and $200,000 in any other case). (Code Sec. 1411(a)(1), Code Sec. 1411(b) )

MAGI is adjusted gross income (AGI) plus any amount excluded as foreign earned income under Code Sec. 911(a)(1) (net of the deductions and exclusions disallowed with respect to the foreign earned income). (Code Sec. 1411(d))

For an estate or trust, the surtax is 3.8% of the lesser of

  1. Undistributed NII or
  2. The excess of AGI (as defined in Code Sec. 67(e)) over the dollar amount at which the highest income tax bracket applicable to an estate or trust begins. (Code Sec. 1411(a)(2))

For 3.8% surtax purposes, NII is investment income (see below) less deductions properly allocable to such income. Examples of properly allocable deductions include investment interest expense, investment advisory and brokerage fees, expenses related to rental and royalty income, and state and local income taxes properly allocable to items included in NII.

Investment income is:

  • Gross income from interest, dividends, annuities, royalties, and rents, unless derived in the ordinary course of a trade or business to which the 3.8% surtax doesn’t apply,
  • Other gross income derived from a trade or business to which the 3.8% surtax contribution tax does apply, and
  • Net gain (to the extent taken into account in computing taxable income) attributable to the disposition of property other than property held in a trade or business to which the 3.8% surtax doesn’t apply. (Code Sec. 1411(c))

The 3.8% surtax applies to a trade or business only if it is a Code Sec. 469 passive activity of the taxpayer or a trade or business of trading in Code Sec. 475(e)(2) financial instruments or commodities. (Code Sec. 1411(c)(2)) Investment income doesn’t include amounts subject to self-employment tax (Code Sec. 1411(c)(6)), distributions from tax-favored retirement plans (e.g., qualified employer plans and IRAs) (Code Sec. 1411(c)(5)), or tax-exempt income (e.g. earned on state or local obligations).

Although NII doesn’t include income or net gain derived in the ordinary course of a trade or business (other than a passive activity or trading business), any item of gross income from the investment of working capital is treated as not derived in the ordinary course of a trade or business for the NIIT and any net gain attributable to the investment of working capital is treated as not derived in the ordinary course of a trade or business. So, that gross income and net gain is subject to the NIIT. (Code Sec. 1411(c)(3)

Gain or loss from a disposition of an interest in a partnership or S corporation is taken into account by the partner or shareholder as NII only to the extent of the net gain or loss that the transferor would take into account if the entity had sold all its property for fair market value immediately before the disposition. (Code Sec. 1411(c)(4))

Overview of year-end strategies. As year-end nears, a taxpayer’s approach to minimizing or eliminating the 3.8% surtax will depend on his estimated MAGI and NII for the year. Some taxpayers should consider ways to minimize (e.g., through deferral) additional NII for the balance of the year, others should try to see if they can reduce MAGI other than unearned income, and others will need to consider ways to minimize both NII and other types of MAGI.

Re-examine passive investment holdings. The 3.8% surtax applies to income from a passive investment activity, but not from income generated by an activity in which the taxpayer is a material participant. One subject a “passive” investor should explore with a tax adviser knowledgeable in the passive activity loss (PAL) area is whether it would be possible (and worthwhile) to increase participation in the activity before year-end so as to qualify as a material participant in the activity.

In general, under Reg. § 1.469-5T(a), a taxpayer establishes material participation by satisfying any one of seven tests, including: participation in the activity for more than 500 hours during the tax year; and participation in the activity for more than 100 hours during the tax year, where the individual’s participation in the activity for the tax year isn’t less than the participation in the activity of any other individual (including individuals who aren’t owners of interests in the activity) for the year. Special rules apply to real estate professionals.

Note: Becoming a material participant in an income-generating passive activity wouldn’t make sense if the taxpayer also owns another passive investment that generates losses that currently offset income from the profitable passive activity.

Taxpayers that own interests in a number of passive activities also should re-examine the way they group their activities. Under Reg. § 1.469-4(c)(1) and Reg. § 1.469-4(c)(2), a taxpayer may treat one or more trade or business activities or rental activities as a single activity (i.e., group them together) if, based on all the relevant facts and circumstances, the activities are an appropriate economic unit for measuring gain or loss for PAL purposes. A number of special “grouping” rules apply. For example, a rental activity can’t be grouped with a trade or business activity unless the activities being grouped together are an appropriate economic unit and a number of additional tests are met. And real property rentals and personal property rentals (other than personal property rentals provided in connection with the real property, or vice versa) can’t be grouped together.

Once the taxpayer has grouped activities, he can’t regroup them in later years, unless a one-time-only “fresh-start” regrouping is allowed under Reg. § 1.469-11(b). But if a material change occurs that makes the original grouping clearly inappropriate, he must regroup the activities. (Reg. § 1.469-4(e), Reg. § 1.469-4(f))

Use the installment method to spread out taxable gain on a sale. The entire profit from a sale ordinarily is taxable in the year of sale. But by making a sale this year with part or all of the proceeds payable next year or later, a non-dealer seller becomes taxable in any year on only that proportion of his profit which the payments he receives that year bear to the total sale price. This method, the installment method, can be a useful way to spread out gain and thereby avoid or minimize a taxpayer’s exposure to the 3.8% surtax.

Another advantage of installment reporting is that it can give the seller an important degree of hindsight in deciding whether to throw profit into 2016 or 2017. An individual who makes a qualifying sale in 2016 has until the due date of his 2017 return (including extensions) to decide whether to elect out of installment reporting and report his entire profit in 2016 or to defer that part of the gain attributable to payments to be received in later years. A problem here is that regardless of how the seller elects, the buyer will still be paying for the property in installments. If the installment method isn’t used, the seller will be paying taxes in the year of sale on income that won’t be received until a later year or years.

Use a like-kind exchange to defer gain recognition to a low-NII year. Under the like-kind exchange rules, if specific identification and replacement period requirements set forth in Code Sec. 1031 are met, gain or loss is not currently recognized on the exchange of property held for productive use in a trade or business or for investment for property of like-kind that will be held for productive use in a trade or business or for investment. Qualified intermediaries (QIs) and multiparty deferred exchanges may be used to structure like-kind exchanges, allowing greater flexibility in qualifying for income deferral.

A like-kind exchange may be appropriate for a taxpayer who wants to realize a gain on investment property this year, but defer gain recognition until a later year when his MAGI isn’t likely to exceed the applicable threshold. The taxpayer realizes the gain on the relinquished property this year, and recognizes the gain in a later year when he sells the like-kind property he receives in exchange for the relinquished property.

Adjust the timing of a home sale. Under Code Sec. 121, when a taxpayer sells a home he has owned and used as a principal residence for at least two of the five years before the sale, he may exclude up to $250,000 in capital gain if single, and $500,000 in capital gain if married. Gain on a sale in excess of the excluded amount will increase NII and net capital gain. And if taxpayers sell a second home (vacation home, rental property, etc.) at a profit, they pay taxes on the entire capital gain, and all of it will be NII potentially subject to the 3.8% surtax.

It should be noted that the non-excluded portion of a home sale gain also increases a taxpayer’s MAGI. Thus, the taxable portion of a home sale may cause a taxpayer to exceed the threshold amount, subject part or all of the taxable home sale gain to the 3.8% surtax, and expose other NII to the 3.8% surtax.

Note: A taxpayer who expects to realize a gain on a principal residence substantially in excess of the applicable threshold, and is planning to sell either this year or the next, should try to fine-tune the timing of the sale so as to minimize the gain’s exposure to the 3.8% surtax, and reduce his overall tax bill.

Recognize losses to offset earlier gains. As year-end approaches, one way to reduce NII is to recognize paper losses on stocks and use them to offset other gains taken earlier this year. What if the taxpayer owns stock showing a paper loss that nonetheless is an attractive investment worth holding onto for the long term? There is no way to precisely preserve a stock investment position while at the same time gaining the benefit of the tax loss, because the so-called “wash sale” rule precludes recognition of loss where substantially identical securities are bought and sold within a 61-day period (30 days before or 30 days after the date of sale). However, a taxpayer can substantially preserve an investment position while realizing a tax loss by using one of several techniques, such as buying more of the same stocks or bonds, then sell the original holding at least 31 days later, or selling the original holding and then buying the same securities at least 31 days later.

Use Roth IRAs instead of traditional IRAs. The 3.8% surtax makes Roth IRAs look like a more attractive alternative for higher-income individuals. Qualified distributions from Roth IRAs are tax-free and thus won’t be included in MAGI or in NII. By contrast, distributions from regular IRAs (except to the extent of after-tax contributions) will be included in MAGI, although they will be excluded from NII.

In general, a qualified distribution from a Roth IRA is one made:

  1. After the 5-year period beginning with the first tax year for which a contribution was made to a Roth IRA set up for the taxpayer’s benefit; and
  2. On or after he attains age 59 1/2; because of death or disability; or to buy, build, or rebuild the taxpayer’s first principal residence.

As a bonus, Roth IRA owners do not have to take required minimum distributions (RMDs) during their lifetimes. (Roth beneficiaries must, however, take required distributions from the account.)

Note: Higher-income employees should use designated Roth accounts if their retirement plans offer this option. A designated Roth is a separate account in a Code Sec. 401(k), Code Sec. 403(b), or Code Sec. 457 plan to which an employer allocates an employee’s designated Roth contributions and their gains and losses. Instead of making elective, pre-tax contributions to his regular account, the employee directs that part or all of the contribution be made to a nondeductible designated Roth account within the plan. When a designated Roth account is set up within a Code Sec. 401(k) plan, it’s called a Roth 401(k). Note that unlike regular Roths, where contributions can’t be made by higher-income individuals, there is no income limitation on annual contributions to a designated Roth. Workers of all income levels are eligible to contribute to such retirement accounts.

Time conversions to a Roth IRA. Taxpayers who are thinking of converting regular IRAs to Roth IRAs this year should do so with care, as the move will increase MAGI, and therefore potentially expose—or expose more of—their NII to the 3.8% surtax. Some suggestions:

  • If possible, time conversions so as to keep MAGI below the applicable threshold amount.
  • Where it isn’t possible, or isn’t desirable from a non-tax standpoint, to keep MAGI below the applicable threshold amount in the year of the conversion, and MAGI, without considering the conversion income, is lower than the MAGI threshold in 2016 and/or 2017, make the conversion in the year that has the lower MAGI.

Timing considerations for required minimum distributions. For the 3.8% surtax purposes, investment income doesn’t include distributions from tax-favored retirement plans, such as qualified employer plans and IRAs. (Code Sec. 1411(c)(5)) But MAGI does include taxable distributions from qualified employer plans and IRAs, including required minimum distributions (RMDs) from qualified plans and IRAs.

Taxpayers nearing their MAGI threshold, or who already exceed it because of other income, may have an opportunity to plan RMDs to avoid exposing their NII to the 3.8% surtax. For example, taxpayers who attain age 70 1/2 in 2016 may delay taking their first RMD (i.e., for 2016) until their required beginning date of Apr. 1, 2017. This would be advisable where taking the first distribution in 2016 will cause the distributee’s MAGI to exceed the threshold amount that triggers the 3.8% surtax on NII, but deferring the distribution until next year will not have the same effect because the distributee’s income from other sources will be much lower. However, when deciding if deferring the first RMD makes sense, note that doing so does not absolve the taxpayer from making an RMD for the second distribution year (i.e., for 2017).

Andy Farkas, CPA
Farkas Tax Advisors, Inc.
2173 Salk Ave., Ste 250
Carlsbad, CA 92008
(760) 237-4000 Office
(619) 204-6052 Cell
andy@farkascpa.com

Disclaimer: Any accounting, business or tax advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues, nor a substitute for a formal opinion, nor is it sufficient to avoid tax-related penalties. If desired, we would be pleased to perform the requisite research and provide you with a detailed written analysis. Such an engagement may be the subject of a separate engagement letter that would define the scope and limits of the desired consultation services.

THINGS TO COME? A LOOK AT TRUMP’S AND HOUSE REPUBLICANS’ TAX PROPOSALS

Beginning Jan. 20, 2017, the Republican Party will be in control of both houses of the U.S. Congress as well as the Presidency. On November 9, the day after the election, House Ways and Means Committee Chairman Kevin Brady (R-TX) and Senate Majority Leader Mitch McConnell (R-KY) indicated that they want to take up tax reform early in the next session of Congress. Here we present some of the recent tax proposals from both President-elect Donald Trump and House Republicans.

President-elect Trump’s proposals. As of Nov. 10, 2016, President-elect Trump’s Tax Plan website lists the following proposals:

For individual taxpayers:

    • Tax rates and breakpoints for Married-Joint filers would be:
      • Less than $75,000: 12%
      • More than $75,000 but less than $225,000: 25%
      • More than $225,000: 33%;

 

    • Brackets for single filers would be ½ of these amounts;
    • “Low-income Americans would have an effective income tax rate of 0”;
    • The existing capital gains rate structure (maximum rate of 20%) would be maintained, with tax brackets shown above;
    • Carried interest would be taxed as ordinary income;
    • The Affordable Care Act would be repealed; as part of this repeal, the 3.8% tax on investment income would be repealed;
    • The alternative minimum tax (AMT) would be repealed;
    • The standard deduction for joint filers would increase to $30,000, and the standard deduction for single filers would be $15,000;
    • Personal exemptions would be eliminated;
    • Head-of-household filing status would be eliminated;
    • Itemized deductions would be capped at $200,000 for Married-Joint filers and $100,000 for Single filers;
    • The estate tax would be repealed, but capital gains on property held until death and valued over $10 million would be subject to tax, with an exemption for small businesses and family farms. To prevent abuse, contributions of appreciated assets into a private charity established by the decedent or the decedent’s relatives would be disallowed;
    • The Trump website makes no mention of the gift tax.

 

    • There would be the following child care and elder care rules:
      • An above-the-line deduction for children under age 13, that would be capped at state average for age of child, and for eldercare for a dependent. The exclusion would not be available to taxpayers with total income over $500,000 for Married-Joint or $250,000 for Single;
      • Rebates for childcare expenses to certain low-income taxpayers through the Earned Income Tax Credit (EITC). The rebate would be equal to 7.65% of remaining eligible childcare expenses, subject to a cap. This rebate would be available to married joint filers earning $62,400 ($31,200 for single taxpayers) or less;
      • All taxpayers would be able to establish Dependent Care Savings Accounts (DCSAs) for the benefit of specific individuals, including unborn children. Total annual contributions to a DCSA would be limited to $2,000 per year from all sources. The government would provide a 50% match on parental contributions of up to $1,000 per year for these households.

 

For business taxpayers:

    • The business tax rate would decrease from 35% to 15%;
    • The corporate AMT would be eliminated;
    • There would be a deemed repatriation of corporate profits held offshore at a one-time tax rate of 10%;
    • “Most corporate tax expenditures”, except for the research and development credit, would be eliminated;
    • Firms engaged in manufacturing in the U.S. could elect to expense capital investment and lose the deductibility of corporate interest expense. An election once made could only be revoked within the first three years of election; and
    • The annual cap for the business tax credit for on-site childcare would be increased to $500,000 per year (up from $150,000), and the recapture period would be reduced to five years (down from ten years).

 

The House Republican’s “A Better Way” plan. On June 24, House Republicans released an installment of their “A Better Way” Our Vision for a Confident America” that contained a number of tax reform proposals. At that time, the Republicans announced that the document (“blueprint”) was meant to serve as the basis of tax reform legislation which will be “ready for legislative action in 2017”. It reflects several months of deliberation by the Tax Reform Tax Force, led by Chairman Brady.

Previously, on June 22, House Republicans had released another installment of their “A Better Way” Our Vision for a Confident America”; this installment contained a number of health care reform proposals.

On November 9, both Chairman Brady and Speaker of the House Paul Ryan (R-WI) mentioned the blueprint as being taken up by Congress, in concert with Mr. Trump, at the beginning of the next session of Congress.

Among its tax provisions regarding individuals, the blueprint would:

    • Reduce both the top rate (to 33%) and the number of brackets (to three);
    • Provide for reduced and progressive tax rates on capital gains, dividends and interest income;
    • Eliminate the AMT;
    • Consolidate a number of existing family tax benefits into a larger standard deduction and a larger child and dependent tax credit;
    • Continue the EITC, but look for ways to improve it;
    • Simplify tax benefits for higher education;
    • Eliminate all itemized deductions except the mortgage interest deduction and charitable contribution deduction;
    • Continue current tax incentives for retirement savings; and
    • Repeal the estate and generation-skipping transfer taxes.
    • The blueprint makes no mention of the gift tax.

 

Business tax provisions in the blueprint include:

    • Creating a new business rate for small businesses that are organized as sole proprietorships or pass-through entities instead of taxing them at individual rates;
    • Reducing the corporate tax rate to 20%;
    • Providing for immediate expensing of the cost of business investments;
    • Allowing interest expense to be deducted only against interest income, with any net interest expense carried forward and allowed as a deduction against net interest income in future years (with special rules that will apply for financial services companies);
    • Allowing net operating losses (NOLs) to be carried forward indefinitely and increased by an interest factor, and eliminating NOL carrybacks;
    • Retaining the research credit (but evaluating options to make it more effective);
    • Generally eliminating certain (but unspecified) special interest deductions and credits;
    • Shifting to a territorial tax system;
    • Moving “toward a consumption-based tax approach”;
    • Providing a 100% exemption for dividends from foreign subsidiaries; and
    • Generally simplifying international tax rules, including elimination of most of the subpart F rules.

 

The blueprint suggests a number of IRS reforms, including provisions to:

    • “Streamline” the agency and center it on three major units: one for families and individuals, one for business, and a new “small claims court” unit that would be independent of IRS and designed to allow routine disputes to be resolved more quickly;
    • Reform IRS leadership so that it is headed by an Administrator, appointed by the President with the consent and advice of the Senate for a single 3-year term;
    • Have a “Service First” mission; and
    • Commit to taxpayer assistance.

 

And the health care reform proposals would:

    • Repeal the Affordable Care Act;
    • Make the following changes to health savings accounts (HSAs): allow spouses to make catch-up contributions to the same HSA account; allow qualified medical expenses incurred before HSA-qualified coverage begins to be reimbursed from an HSA account as long as the account is established within 60 days; set the maximum contribution to an HSA at the maximum combined and allowed annual deductible and out-of-pocket expense limits; and expand accessibility for HSAs to certain groups (e.g., those who get services through the Indian Health Service and TRICARE).
    • Allow certain purchasing platforms, like private exchanges, to expand. The plan would encourage the use of direct or “defined contribution” methods, such as health reimbursement accounts (HRAs).
    • Encourage the portability of health insurance. Everyone would have access to financial support for an insurance plan chosen by the individual, which could be taken with them job-to-job, to non-work environments and into retirement years. For those who do not have access to job-based coverage, Medicare, or Medicaid, the proposal would provide an advanceable, refundable tax credit. The portable payment would be increased as the recipient aged.

 

Comparing the Trump and House proposals. Both the Trump and House Republicans proposals would repeal the Affordable Care Act, significantly lower tax rates on both individuals and businesses, eliminate the AMT, eliminate estate taxes, lessen the relevance of itemized deductions, eliminate some business credits and deductions, and tighten the rules on business interest deductions.

On the other hand, Trump puts great emphasis on new child and elder care tax breaks, and the House Republicans do not. And, the House Republicans consider many changes to existing tax rules that Trump doesn’t mention. And, while the House Republicans’ plan contains, and previous proposals by Trump contained, a special tax rate for businesses that operate as pass-through entities, the current Trump website has no such proposal.

Things to come? Given the newness of the election and its surprise results, we are probably pretty far from understanding the dynamics of the workings of the 115th Congress that will begin its work in January-including whether the Republicans will attempt to pass tax legislation in the Senate under the legislative process called “reconciliation” which only requires a simple majority, or will, instead, allow the Senate filibuster rules to apply to the tax legislation. Similarly, we are probably pretty far from understanding the push and pull between Congressional leaders and President-elect Trump. Thus, even given the large overlap between the proposal of the House Republicans and that of Mr. Trump, we probably have a long way to go in predicting a lot of the specifics of 2017 tax legislation. However, some significant 2017 tax legislation and some significant health care reform legislation seem quite likely.

 

Farkas Tax Advisors, Inc.
2173 Salk Ave., Suite 250
Carlsbad, CA 92008
info@farkascpa.com
Phone: (760) 237-4000
http://www.farkascpa.com

TAX TIPS FOR THE 2016 GRADUATE

TAX TIP #1
Avoid over-withholding in 2016 by increasing the “number of allowances” on Form W-4. Remember to change to the proper “number of allowances” at the beginning of 2017.

TAX TIP #2
Be prepared to file the 2016 Federal income tax return early to obtain a refund. The refund can be hastened by labeling the envelope containing the return “REFUND” and using the appropriate post office box number. Alternatively, electronic filing will also shorten the time between filing and receiving a refund. Use of the direct deposit option is also recommended.

TAX TIP #3
Determine and document the source and reason for all interest payments during
2016. Pay particular attention to loans used to pay qualified education expenses
since up to $2,500 of interest is deductible when computing Adjusted Gross Income.

TAX TIP #4
Prepare and maintain a record of the expenses involved in moving to the first place
of employment. These include: the actual moving expenses; travel and lodging
costs incurred en route to the place of employment.

TAX TIP #5
Familiarize yourself with the types of deductible expenses incurred as part of your
employment. Prepare and maintain a record of these expenses which can include
travel, meals, lodging, entertainment and educational costs. Also, if possible, insist
on specific item reimbursement instead of a general allowance system.

TAX TIP #6
Don’t attempt to itemize deductions unless you’ve incurred substantial
unreimbursed medical costs, state and local income taxes, home mortgage interest,
real estate and/or personal property taxes during 2016 and expect this total to
surpass the 2016 standard deduction amount for your filing status.

TAX TIP #7
Claim the American Opportunity Tax Credit or Lifetime Learning Credit for 2016 tuition and fee payments (including prepayments) made to any “eligible educational institution.” Alert your parent(s) to the eligibility requirements that may allow the reporting of the American Opportunity Credit on their 2016 tax return.

TAX TIP #8
Examine situations that would enable you to recognize income in 2016, instead of 2017. Where possible, shift that income into 2016.

TAX TIP #9
Protect the dependency exemption of your parent(s) by (a) documenting your support spending before and after you are employed and (b) spending less on your support from your funds than the amount spent by your parent(s) and others who provided resources for your support.

TAX TIP #10
When you are not reported as a dependent by your parent(s), document the relationship of educational expenses to (a) requirement established by state or employer or (b) maintenance and/or improvement of skills required in your current trade or business. Following an up to $4,000 Tuition and Fees Deduction, determine whether your tax liability is reduced more by treating the remaining eligible educational expenses as a miscellaneous itemized deduction or by using all of the educational expenses in computing the Lifetime Learning Credit.

TAX TIP #11
Do not waste precious time and space maintaining information about spending that
has no tax consequences. Furthermore, tax returns and the supporting data should
be kept for at least three years.

TAX TIP #12
Establish an IRA (Individual Retirement Account) or similar retirement arrangement — such as a 401(k) Plan – as soon as possible. Contribute the maximum amount to the IRA and allow it to grow until retirement.

I hope this information is helpful. If you would like more details about these or any other aspect of the tax law, please do not hesitate to call at (760) 237-4000 or e-mail at andy@farkascpa.com.