How to avoid a surprise tax burden for 2016
As you come to the end of 2016, ask yourself a few simple questions in regard to your tax position.
- What will I do if my return is prepared and there is a large balance due that I am not prepared to pay?
- What can I do now to estimate what my tax liability may be?
- Should I speak with an expert to explore strategies to reduce that tax burden?
If the answer to those questions is I don’t know, I’m not sure and yes I probably should then the following information should be considered.
1. Know the filing deadlines.
Some current filing deadlines have been changed for the 2016 year-end, make sure that you are aware of filing deadlines to avoid penalties.
- Individual Returns (Form 1040) Due 4/17/17 with extension available to 10/16/17.
- Partnership/LLC Returns (Form 1065) Due 3/15/17 with extension available to 9/15/17 (This is a change from 4/15 in previous years)
- Trust and Estate Returns (Form 1041) Due 4/17/17 with extension available to 10/2/17.
- Corporate Returns (Form 1120) Due 4/17/17 with extension available to 10/16/17 (This is a change from 3/15 in previous years)
- Corporate Returns (Form 1120S) Due 3/15/17 with extension available to 9/15/17
2. Understand your filing structure.
In order to understand what you tax burden will be it is important that you understand the tax structure of your current situation. If you are an employee of a business you are taxed on your salary which is reported to you on a W-2. A common misconception is that new business owners think about the money that they take as a “salary” or draw rather than the results of the business. Small business owners are taxed on the net income of the business rather than the money that they pay themselves.
- Sole Proprieter-Income is reported on Schedule C. Net income from the business is subject to both income tax and self-employment tax.
- Partnership/LLC business with active participation. Your share of net business income is reported on Form 1065 with K-1 flowing to schedule E page 2. Net income from the business is subject to both income tax and self-employment tax.
- Partnership/LLC business with passive participation or rental activity. Your share of net business income is reported on Form 1065 with K-1 flowing to schedule E page 2. Net income from the business is subject to income tax but not self-employment tax.
- S-Corporation. Your share of net business income is reported on Form 1120S with K-1 flowing to schedule E page 2. Net income from the business is subject to income tax but not self-employment tax. (In addition to distributions, S-Corporation owners pay themselves a salary and issue form W-2. Subject to income and self-employment tax)
3. Review whether you had any loss or other carryovers or if you made estimated tax installments.
4. Consider current tax breaks and planning strategies.
Think about the planning moves that will help to lower your tax bill for this year. There are a number of important tax breaks that will expire at the end of 2016. Some will likely be extended but not all, so it is important to review them to avoid missing a potential opportunity. The following list of actions may help you save tax dollars if you act before year-end.
Strategies for Individuals
- (Harvest Losses) Realize losses on stocks while preserving your investment position.
- Postpone income until 2017 and accelerate deductions in 2016. (this may enable you to claim larger deductions, credits and other breaks that are phased out with higher AGI levels).
- Consider converting traditional IRA to a Roth IRA, or recharacterizing an earlier conversion back to a traditional IRA.
- Consider possibility of deferring a bonus until early 2017.
- Pay additional state tax liability by 12/31/16 so that it is deductible if not in AMT.
- Bunch medical and miscellaneous deductions into a single year rather than spread over 2 years.
- Settle an insurance or damage claim in order to maximize your casualty loss deduction.
- Maximize eligible HSA contributions in December for all of 2016.
- If you are thinking about installing energy saving improvements to your home do it this year before the credits expire.
- Make gifts sheltered by the annual gift tax exclusion prior to the end of the year.
Strategies for Businesses
- Consider making expenditures that qualify for the business property expensing option or that qualify for first year bonus depreciation.
- Take advantage of the de minimis safe harbor election to expense the costs of lower-cost assets and materials and supplies.
- Consider accelerating income or deferring income depending on the tax bracket that you expect both this year and next.
- Consider ways to maximize the domestic production activities deduction.
- Consider deferring a debt-cancellation event until 2017.
- Consider disposing of a passive activity in 2016 if it will free up suspended losses.
- Determine if there are basis limitations that will preclude you from deducting losses.
5. Be aware of what is on the horizon.
Tax planning should take advantage of the existing tax law but must also look ahead to consider if the plan for the current year makes sense with future years. The following are some details pulled from the House Republican Tax Reform Plan to consider.
Changes to the Individual Income Tax
- Consolidates the current seven tax brackets into three, with rates of 12 percent, 25 percent, and 33 percent (Table 1).
|Table 1. Tax Brackets for Ordinary Income Under Current Law and the House Republican Tax Plan|
|Current Law||Proposal||Single Filers||Married Joint Filers||Head of Household Filers|
|10%||12%||$0 to $9,275||$0 to $18,550||$0 to $13,250|
|15%||12%||$9,275 to $37,650||$18,550 to $75,300||$13,250 to $50,400|
|25%||25%||$37,650 to $91,150||$75,300 to $151,900||$50,400 to $130,150|
|28%||25%||$91,150 to $190,150||$151,900 to $231,450||$130,150 to $210,800|
|33%||33%||$190,150 to $413,350||$231,450 to $413,350||$210,800 to $413,350|
|35%||33%||$413,350 to $415,050||$413,350 to $466,950||$413,350 to $441,000|
- Taxes capital gains and dividends as ordinary income and provides a 50 percent exclusion of capital gains, dividends, and interest income. This is equivalent to taxing capital gains, dividends, and interest income at half the rate of ordinary income, with three brackets of 6 percent, 12.5 percent, and 16.5 percent (Table 2).
|Table 2. Tax Brackets for Capital Gains and Dividends Under Current Law and the House Republican Tax Plan|
|Current Law||Proposal||Single Filers||Married Joint Filers||Head of Household Filers|
|0%||6%||$0 to $9,275||$0 to $18,550||$0 to $13,250|
|0%||6%||$9,275 to $37,650||$18,550 to $75,300||$13,250 to $50,400|
|15%||12.5%||$37,650 to $91,150||$75,300 to $151,900||$50,400 to $130,150|
|15%||12.5%||$91,150 to $190,150||$151,900 to $231,450||$130,150 to $210,800|
|15%||16.5%||$190,150 to $413,350||$231,450 to $413,350||$210,800 to $413,350|
|15%||16.5%||$413,350 to $415,050||$413,350 to $466,950||$413,350 to $441,000|
- Increases the standard deduction from $6,300 to $12,000 for singles, from $12,600 to $24,000 for married couples filing jointly, and from $9,300 to $18,000 for heads of household.
- Eliminates the personal exemption and creates a $500 non-refundable credit for dependents who are not children.
- Increases the Child Tax Credit to $1,500 per child, limits the refundability of the credit to $1,000, and raises the phaseout threshold for the Child Tax Credit for married households from $110,000 to $150,000.
- Eliminates all itemized deductions besides the mortgage interest deduction and the charitable contribution deduction.
- Eliminates the individual alternative minimum tax.
Changes to Business Income Taxes
- Reduces the corporate income tax rate from 35 percent to 20 percent.
- Eliminates the corporate alternative minimum tax.
- Taxes income derived from pass-through businesses at a maximum rate of 25 percent.
- Allows the cost of capital investment to be fully and immediately deductible.
- Eliminates the deductibility of net interest expenses on future loans.
- Restricts the deduction for net operating losses to 90 percent of net taxable income and allows net operating losses to be carried forward indefinitely, and increased by a factor reflecting inflation and the real return to capital. Does not allow net operating losses to be carried back.
- Eliminates the domestic production activities deduction (section 199) and all other business credits, except for the research and development credit.
- Creates a fully territorial tax system, exempting from U.S. tax 100 percent of dividends from foreign subsidiaries.
- Enacts a deemed repatriation of currently deferred foreign profits, at a tax rate of 8.75 percent for cash and cash-equivalent profits and 3.5 percent on other profits.
- Modifies all business income taxes to be border-adjustable, disallowing the deduction for purchases from nonresidents and exempting export profits and foreign-derived profits from taxation.
- Eliminates federal estate and gift taxes.