It’s Never Too Early for 2016 Tax Planning

Amy Woodward, CPA (Feb, 2016)

Now that we are almost into March, you have probably already filed or are getting ready to file your 2015 tax return.  Regardless of whether you are pulling together your 2015 tax forms or have just e-filed your return, the 2016 tax return is the last thing on your mind.  After all, you can worry about that next year, right?  It is never too early to start thinking about how to reduce next year’s tax liability and the earlier you start to plan for it, the more options you have available to take advantage of various credits and deductions.

This is particularly true since Congress passed a bill in December 2015 that permanently extended several key tax incentives.  In the past, Congress often waited until late in December to pass a bill that would extend expiring tax provisions for one year.  This was often too short a time frame for taxpayers to be able to take advantage of certain credits and deductions.  The permanent extensions now will allow taxpayers to plan ahead, not just for 2016, but for longer-term financial and business goals as well.

For individuals, the tax extenders made several popular tax deductions permanent.  Those who do not pay enough in state income taxes to take advantage of the itemized deduction on those taxes can take the permanent itemized deduction for state and local sales tax.  This is especially true for snowbirds in Florida and others who live in states with no income tax.  If you plan to make any large purchases in 2016, tracking the sales taxes paid on large items (cars, boats, etc.) can increase this deduction.  Another permanent extender is for Qualified Charitable Deductions from IRAs.  Those who are 70½ or older can make contributions to qualified charitable organizations from their IRAs of up to $100,000 and have them count towards Required Minimum Distributions (RMD).  While these distributions cannot be included as charitable contributions for itemized deductions, they can be used to reduce taxable income from RMDs.

In addition to the provisions of the recently passed tax extenders, there are a number of existing tax planning options available to individuals who plan ahead of time.  If you participate in a high deductible health plan, consider making your HSA contributions through payroll.  The HSA contribution limits for 2016 are $3,350 for self-only coverage and $6,750 for family plans, with a $1,000 catch-up contribution for those 55 and older.  An HSA contribution can be made directly into the HSA account by April 15, 2017 for the 2016 tax year, but making the contribution through payroll instead allows you to spread out the cash required for the contributions, while also saving you the Social Security and Medicare taxes you would otherwise pay on these amounts. Maxing out retirement contributions can also reduce your tax liability.  For W-2 employees, using payroll deductions to fund a 401(k) or other pension plan reduces the amount of taxable wages and self-employed individuals get a deduction on their tax return for any contributions to qualified retirement plans.  If you are looking to reduce your state tax bill, consider making 529 plan contributions during the year.  For New York, you can deduct up to $5,000 ($10,000 if filing jointly) of contributions to a New York 529 college savings plan.    

In addition to the tax extenders affecting individuals, Congress passed a number of provisions that benefit businesses as well.  Perhaps the most popular of these provisions relate to the Section 179 deduction and Bonus Depreciation.  In the past, businesses had a hard time planning for fixed asset purchases as a means to reduce their tax liability since these provisions would expire, only for Congress to retroactively extend them two or three weeks before the year ended.  This often did not leave enough time for a company to place an order for a large capital expenditure and place it in service prior to yearend.  If the asset was able to be placed in service in time, then the company would often fall under the mid-quarter convention, which states that if 40% or more of fixed assets are placed in service in the last quarter of the year, depreciation is taken from the mid-point of the quarter placed in service, rather than being able to take a half year of depreciation. 

With the tax extenders, businesses have a lot more certainty related to depreciation and expensing of fixed assets, and can plan their fixed asset purchases accordingly.  This is true not just for 2016, but for the next five years since the popular bonus depreciation deduction has been extended until 2019.  With this deduction, qualified assets (new tangible property with a recovery period of 20 years or less, including off-the-shelf software and qualified leasehold improvements), are eligible to expense 50% of the asset’s cost basis in the first year plus regular depreciation is taken on the remaining 50%.  While not a permanent provision, this extension will allow businesses to develop a 5-year plan for their largest fixed asset purchases.  Section 179 expense has been permanently increased from the $25,000 to $500,000 that can be written off in the year an asset is purchased, where qualifying section 179 property placed in service does not exceed $2,000,000.  The amount you can expensed is reduced dollar for dollar for the amount placed in service in excess of $2,000,000, so the 179 deduction is completely phased out when $2,500,000 is placed in service for the year.  Unlike bonus, this deduction can be used on both new and used purchases.  Beginning in 2016, these limits are adjusted for inflation each year.  While not part of the tax extenders, another planning tool related to fixed asset purchases is electing a new capitalization policy.  The IRS changed the de Minimis safe harbor election from $500 to $2,500.  This means that for companies that institute a capitalization policy effective January 1, 2016, all fixed asset purchases that fall below the $2,500 can be expensed as minor purchases. 

There are a number of credits that businesses can take advantage of which were included in the tax extender bill.  The Research and Development tax credit was permanently extended to incentivize companies to invest in developing or improving designs and processes.  For qualifying small businesses, this credit is additionally available against Alternative Minimum Tax (AMT).  The Work Opportunity Credit has been extended through 2019.  This credit applies when an employer hires members of specific target groups, including veterans and long-term unemployed individuals.  When such an employee is hired, documentation must be obtained that the individual qualifies within 28 days of starting work, so employers should be aware of this credit when they are bringing in new hires throughout the year.  The 5-year recognition period for built-in-gains (BIG) tax on S Corporations was made permanent as well.  This tax applies to S Corporations that held appreciated assets when they converted from a C Corporation, and then sold the assets within the recognition period.  The recognition period was previously 10 years.  This means that S Corporations who were hanging on to appreciated assets to avoid the BIG tax may be able to sell these assets sooner than anticipated without a large tax bill.

You may already plan on contacting your accountant in December for yearend tax planning, but planning now can help you to avoid any surprises down the line related to your 2016 tax return.  There are many more options available for tax planning when you start early and make tax planning part of your 2016 financial plans.  As always, please contact your Dermody, Burke & Brown advisor if you have any tax planning questions.

 

The information reflected in this article was current at the time of publication.  This information will not be modified or updated for any subsequent tax law changes, if any.

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