Saturday, September 3, 2016

Planning With Your Tax Return

This is a good time of the year to examine your 2015 tax return. It can help determine why you pay the taxes you do and what -- if any -- steps you can take now to minimize that number for 2016.  
Most of the action takes place on page one of your 1040. The key number is your Adjusted Gross Income (AGI)—line 37, at the bottom of the page. That number determines whether you’ll pay the Medicare surtax on unearned income ($250,000 for married filing jointly and $200,000 for singles -- not subject to inflation) and whether your itemized deductions and personal exemptions will be cut back ($311,300 for married filing jointly and $259,400 for singles -- adjusted annually for inflation). For anyone subject to that cut back, your AGI is key in determining your ultimate tax rate.  
Note that AGI is determined without regard to your itemized deductions or your exemptions. Those play an ever-decreasing role in determining your ultimate tax bill.  
Start with line 7, your W-2 income. The number is after your contributions to your 401(k) plan and Flexible Spending Account. The more you contribute to those plans, the more you reduce your taxable income. This year, you can contribute up to $18,000 to your 401(k) ($24,000 if you are at least age 50). You can contribute $2,550 to an FSA.  
Next is taxable interest, which should be zero. Put taxable fixed income in your retirement accounts, to shield the interest from tax. If you do hold fixed income in a taxable account, it should be tax-exempt.  
Most dividends are qualified. Those are taxed at 15 percent (20 percent if you’re in the highest tax bracket). Because of the favored tax rate, taxable investment accounts should be tilted toward stocks.
If you have recurring tax refunds (line 10), decrease your withholding and direct the increased funds into savings. There is no excuse for making interest-free loans to the government.
 If you are self-employed, you have significant control over your business income (line 12). That number is after expenses, so deduct what you are entitled to. Just be aware that showing multiple loss years can trigger an IRS inquiry into whether the business is real or merely a hobby.
Line 13 is capital gains and losses; ideally that number is a $3,000 loss. You can balance capital gains each year with capital losses. If you recognize more losses than gains, you can use up to $3,000 of those losses against ordinary income and carry the balance forward indefinitely. Another way to keep gains off line 13 is to make charitable gifts with significantly appreciated stock -- you avoid paying capital gains tax on the profits but get to deduct the entire value of your gift. If you do have net capital gains, those are taxed at a maximum rate of 15 percent (20 percent for those in the highest bracket).
You can also make charitable gifts with IRA distributions (line 15). For those at least aged 70-1/2, you can direct that up to $100,000 of required minimum distribution go directly to a qualified charity. This keeps the distribution off your tax return entirely.    
You may be able to control the items on line 17 -- income flowing through from real estate, partnerships, LLCs, trusts, S corporations, and the like. To the extent you manage any of those entities, you may be able depress taxable income.  
Most who receive Social Security benefits are taxed on 85 percent of them. That’s the case if your other income (including tax free interest and half of your Social Security benefits) exceeds $44,000 ($34,000 for singles).  
This gets you to “total income.”  There are few -- very few -- adjustments that can reduce total income to reach Adjusted Gross Income. Employees may be able to take advantage of Health Savings Accounts -- you can save and deduct as much as $6,750 in an HSA.  If you are self-employed, you can deduct half your payroll taxes plus your retirement savings.
That brings us to Adjusted Gross Income. The moral of all this? It is difficult to reduce your tax bill, but the biggest steps you can take are those on the front page of your tax return.