Sunday, October 23, 2016

How 529 Plans Can Help Reduce Taxes And Pay For College


Whatever the time of year, paying for college is usually on the minds of parents. For the middle class it is especially daunting. The wealthy usually have the means to afford the $50,000 to $60,000 annual cost at some private colleges. And, if a talented student is from an impoverished background, there are ways (grants, scholarships, need-based financial aid) to get some or even most of the tab covered. But it is the middle class who are squeezed with the high cost of college.

Against this backdrop, a working family often has to sacrifice to set aside funds for this potential future expense. With wage growth slowing over recent decades and health care costs rising at a rapid pace, it is getting harder for millions of Americans to save money for retirement or college. Fortunately, there is section 529 of the tax code which offers attractive tax advantages and other benefits.

Tax-Free Growth. The gains inside a 529 plan can be exempt from both federal and state income taxes provided they are used for a qualified higher education purpose. You must adhere to the rules and guidelines spelled out in the federal tax code, but for many, this is easily accomplished. Of course, as with any tax matter, you should consult with your tax advisor for final tax advice, but I find this portion of the tax code relatively easy to follow. Simply use the funds for college tuition, books, room and board and you should be in good shape.

From a state income tax perspective, currently 41 states tax earned income and 2 others tax dividends and interest.  So for the purposes of saving for college, 43 out of 50 states will join the federal government in taxing the gains on your investment accounts. 

Inside a 529 plan, however, all investment growth, whether it is from interest, dividends, or capital gains is tax exempt as long as the funds are used for qualified higher education expenses. Gains and dividends generated inside a 529 plan avoid federal dividend and capital gains taxes which can be as high as 28%. The interest earned inside this account can also avoid ordinary income taxes which can otherwise be as high as 39.6%. In addition, investment income in a 529 plan avoids the 3.8% investment tax high earners are subject to in the Affordable Care and Patient Protection Act. And, for states with income taxes, the 529 plan may help you avoid those as well.
State Income Tax Deduction. Many states offer a state income tax deduction for contributions into their state specific 529 plan. Each state has its own set of rules for the amount of your 529 plan contribution that they will allow you to deduct off your state income tax. Some states also let you ‘front-load” a large contribution and carry-forward any unused tax deductible portion into future years.  This part can get tricky so please review your states rules carefully – and talk your tax advisor about which plan is best for you. To benefit from a possible state income tax deduction, make sure you use a plan provider that your state partners with.

No Income Limits. There are no income limits or phase outs in order to be eligible to participate and benefit from the federal tax advantages. As a result, it is one of the very rare tax planning tools available for middle class and wealthy families. Please check with your own state’s rules as the contribution limits may vary and be sure to check with your tax advisor for specific advice.

Areas of Concern With 529 Plans
Penalties for non-education purposes. It is important to remember that investing should be guided by your unique situation including your current income and financial situation, your life and investment goals, risk tolerance, liquidity needs, and other factors. This is especially true with 529 plans as non-qualified distributions will be taxed and the gains that are withdrawn will also be hit with a 10% IRS penalty. It is heartbreaking to hear of stories where hardship hit and people needed to withdraw money for living expenses. Despite their hardship, these withdrawals can still incur a 10% penalty.  So be careful and only allocate money into a 529 plan that you can commit for higher education.

Costs. Some articles scare investors and write about the high costs of a 529 plan. I find this to be not always be accurate, but check it out for yourself. Investors have many competing plans to pick from so don’t automatically be discouraged when you read an article complaining about 529 plan costs.

Limits. There may be limits to how much you can contribute to a 529 plan when the balances get to a certain level and that limit varies by state. So once you start having a sizable amount in the plan you will want to keep an eye on the maximum limits (usually north of $200,000 per account).

Overall, the 529 plan may be a tax-smart way for parents (or any friend or relative) to save for a young person’s college. With good planning and regular contributions, when it comes time to start paying for college, hopefully the only tears will be for the joy of watching your child move forward with their life – and not because you had to take out a home equity line of credit to pay the tuition!

Saturday, October 22, 2016

Is there such a thing as too much tax planning?


I haven’t yet met the person who claims that they want to pay as much in income taxes as they possibly can. On the other hand, I’ve not yet met the person who didn’t want to pay as little as legally possible. But some carry the theme of paying as little as possible to a point where they risk future pain that may be greater than the pain of paying a little bit more income tax now.
Look at it this way. In my professional career, the top federal income tax rate has spanned from a low of 28 percent to a high of 70 percent. That actually makes today’s top tax bracket on the lower side of the midrange of taxes for the past 35 years. When it comes to long term tax planning, it is a coin toss decision regarding future tax rates. Therefore, all you can do at this point is to plan for the laws as they are now.
When it comes to paying as little as legally possible, you must take into account certain future occurrences that are most likely going to impact you in retirement. These are Social Security income and required minimum distributions from retirement accounts.
In essence of what we are trying to do is to plan your lifetime income tax bill as opposed to a single focus on any particular tax year. This process is most likely to occur for people in a transition year. Your transition may be a job change, retirement or starting a business.
In a job change year, it could cut either way. You may find yourself with unusually high income because of deferred compensation accounts, unused vacation or sick time, or other bonuses that vest upon your departure. In this case, it may be wise to think about additional retirement contributions or deductible payments like charitable contributions to keep your unusually high tax bracket in check.
The other side of the job change equation is you may find yourself out of work for a while with unusually lower than normal taxable income. In these cases, it may be wise to accelerate income and consider measures such as converting traditional retirement accounts to Roth accounts or to accelerate any capital gains in your portfolio or other investment assets.
This same possibility occurs for people that retire before age 70½ when required minimum distributions from retirement accounts must begin. If you find yourself in a tax bracket lower than what it will be upon receiving social security and retirement distributions, you may be wise to accelerate some income to use up the lower rates available now while preventing creeping up to a much higher bracket later when the income begins to flow again.
Don’t wing this. Get the help of a professional tax planner to be sure that all of your bases, such as the alternative minimum tax, are properly covered.

Friday, October 21, 2016

Reducing Your Income to Escape the Alternative Minimum Tax

If you got hit by the federal alternative minimum tax last year or think you might get hit this year, now is the time to think about your tax planning. There may still be some ways you can escape the AMT. Talk to your tax professional about the best strategy for you, but one way to avoid the AMT is to reduce your alternative minimum taxable income (AMTI) to the point where the AMT is less than the ordinary tax.

How it works

The AMT is an alternative method of calculating income tax that runs parallel to the regular tax system. Under the regular system, taxable income largely drives what tax bracket you fall into. I’ll call this “regular taxable income” (RTI). With the AMT, certain types of income, exemptions and itemized deductions also factor into your taxable income amount. You must calculate both your RTI and your AMTI to determine your tax liability under each system. Then you pay whichever is higher.
To find your AMTI, calculate your RTI and then add certain types of income that normally aren’t included. Examples include income from the exercise of incentive stock options, tax-exempt interest on industrial revenue bonds — a certain type of municipal bond — and depreciation. You also add back certain deductions such as property taxes, state income taxes, depreciation and interest on home equity loans. Finally, while deductions for medical expenses are still allowed, the threshold for claiming the deduction under AMT is higher than under RTI. So, under the AMT, fewer of your medical expenses will be deductible.
All of the above are examples of AMT preference items. The greater the number and amount of preference items you have relative to your income, the more likely you are to be hit by the AMT.

Escaping the AMT

Avoiding the AMT will involve either strategies that reduce both your RTI and your AMTI or strategies that reduce your AMTI relative to your RTI. Talk with your advisor about the following:
Retirement contributions: Maximize your contributions to qualified retirement plans such as your 401(k). The contributions reduce your adjusted gross income as well as your taxable income, regardless of whether you’re hit by the AMT. Reducing your AGI can be important, because as your AGI rises, your ability to use itemized deductions is slowly reduced. Qualified plan contributions also help you save for retirement.
Deferred compensation: If your company offers you access to a nonqualified deferred-compensation plan — essentially a promise by the employer to hold on to the assets until a future point in time — you may want to elect to defer income into the plan. By deferring compensation, you also defer taxation on the amount contributed to the plan, plus any growth, until you withdraw the money, typically when you leave your job or retire. The election to defer income normally doesn’t take effect until the next year, but it may still affect year-end planning for the current year. Work with your advisor to weigh the pros and cons of this income-reduction strategy.
Itemized deductions: The type, number and amount of deductions you take are key factors in determining whether you must pay the AMT or the regular income tax. Consider deferring certain itemized deductions if you fall under the AMT. For example, state income taxes can be an itemized deduction under ordinary tax but not under the AMT. If you’re making estimated tax payments, your fourth-quarter payment is due on or before Jan. 15. So if you review your tax situation in December and find that you’re going to fall under the AMT in the current year but possibly not in the following year, you would choose to defer that state tax payment until after Jan. 1, instead of making it this year.
Charitable contributions: If this year is an abnormally high income year, pushing you into the AMT, consider making a larger than normal donation. This is known as “bunching” several years’ worth of charitable contributions. You can give either directly to charities or through a donor-advised fund offered by a broker or a community foundation. Donations to these funds are deductible in the year of contribution, and once you’ve made the donation, the money may be distributed to charitable organizations over time according to your wishes.
Incentive stock options: With incentive stock options, you generally don’t have to pay ordinary income tax on the difference between the option strike price (the exercise price in your contract) and the stock price on the date of exercise. This is known as the bargain element. If you’ve exercised and held ISOs in the current year and expect to be subject to the AMT, consider selling some or all of the stock before the end of the year. If you sell the stock before you meet the qualifying holding periods — at least two years from grant date and at least one year from the date of exercise — the sale results in a disqualifying disposition. This makes the portion of the revenue attributable to the bargain element regular taxable income (RTI), not an AMT preference item.
If you’re going to do a disqualifying disposition to help reduce AMT, you must do it in the same year as the exercise. An exercise of an ISO could trigger both the AMT, in the year of exercise, and an ordinary income tax event, if you sell stock in the calendar year after the year of exercise but before you meet the qualifying holding periods.
If you find at the end of the current calendar year that you are subject to the AMT, and you’ve decided to continue holding the stock purchased through the exercise of an ISO, make sure you have enough money set aside (in particular, to pay your tax bill or meet other short-term obligations) without having to sell the stock as a disqualifying disposition.
Other strategies: You should also look for other ways to reduce your tax burden under the AMT and regular tax system. For instance, you can invest in tax-free municipal bonds (but avoiding industrial revenue bonds), rather than in taxable bonds, or you can enroll in your employer’s pretax medical-deduction plan to help reduce your salary.

Don’t delay

Meet with your tax professional and financial advisor to assess your level of AMT risk and find ways to avoid it or reduce the impact. Make an appointment for a year-end tax-planning meeting in November or early December. By then, you’ll have a pretty good idea of what your income, itemized deductions and exposure to preference items will look like for the year and what more you can do before the tax year ends.

Thursday, October 20, 2016

Year-End Tax Planning

Here are five money saving ideas for your consideration (Sorry I cannot give an in depth review of these ideas. You need to speak to your tax advisor or send me an email. If I can assist, I will be happy to do so.)

If your company offers a flexible spending account arrangement for out-of-pocket medical or child care expenses, or a health savings account for medical expenses, make sure you are maximizing the tax benefit.

If you own a partnership or S corporation that is expected to generate a loss this year, you may want to make a capital contribution (or in the case of an S corporation, a loan) before year end to ensure you have sufficient basis to claim the loss deduction.

By this time, you should be preparing an estimate of your tax refund or balance due for 2016. Consider increasing withholding (both Federal and State) from your paychecks now through the end of the year or deposit an additional amount before the end of the year. You just may save on penalties by doing this because the withholding is considered made as of the beginning of the year regardless of when the withholding is withheld.

If you have reached age 701/2, consider making charitable donations directly from your IRA. The donations are tax-free to you, which equates to a 100 percent write-off (up to $100,000 per individual IRA owner per year), without having to itemize deductions. Caution: to get this tax break, the funds must go directly form the IRA to the charity.

If you own any securities that are all but worthless with little or no hope of recovery, consider selling them before the end of the year to capitalize on the loss this year. The loss will be a write-off up to $3,000, $1,500 for married filing separately, or offset gains.

Wednesday, October 19, 2016

7 Tax Planning Tips for Millionaires


Taxes. It's perhaps the most dreaded five-letter word in the English language next to "audit," and the scourge of all working Americans.
Between 1955 and 2015, the U.S. tax code grew from just two documents totaling 1.4 million words into an impressive manifesto spanning over 10 million words. As the Tax Foundation pointed out last year, this 10 million-word figure doesn't even include the legal tax cases that allow Americans to make sense of the U.S. tax code.
Despite its complexity, tax time can also bring joy to many Americans. About 80% of all federal taxpayers receives refunds in a given year. This refund can help fund emergency accounts, kick-start a retirement fund, or be used to pay down debt.
But high-income earners, specifically millionaires, aren't typically so lucky. Millionaires almost always owe tax to the federal government, assuming their earned income stays consistent or grows from one year to the next. Millionaires can't do a whole lot to impact their earned income with regard to their federal taxes, but there are still a number of tax planning strategies that can be employed to improve their financial outlook each year.
Here are seven tax planning tips millionaires should take into considerati

1. Think long-term

One of the smartest tax moves millionaires can make is to think long-term to minimize what they'll owe come tax time.
For example, most interest and short-term stock gains are taxed at the ordinary income tax rate. Individuals earning in excess of $415,050, and couples with more than $466,950 in adjusted gross income are lumped into the highest ordinary income tax bracket, 39.6%. Thus, interest earned on a bank CD or the capital gain on a stock held for 365 days or less could be taxed quite heavily. Furthermore, individuals and couples earning more than $200,000 and $250,000, respectively, could be subject to the 3.8% net investment income tax (NIIT) and 0.9% Medicare surtax.
On the other hand, long-term capital gains taxes for the highest-income earners are just 20%, plus the aforementioned NIIT. Paying 20% on capital gains for investments held for 366 days or longer is a lot more favorable than 39.6%. Reasonably low long-term capital gains have allowed millionaires the ability to retain a sizable chunk of their wealth.

2. Contribute to tax-advantaged retirement vehicles

Secondly, millionaires should strongly consider maximizing their contributions to tax-advantaged retirement tools like employer-sponsored 401(k)s or Traditional IRAs.

Chances are that millionaires are going to be saving and investing regardless of whether they're using tax-advantaged retirement tools or not. However, utilizing a 401(k) and/or Traditional IRA can provide upfront tax benefits. According to the Tax Policy Center, the top 20% of income earners receive about 80% of the tax write-offs for retirement saving compared to just 7% for the bottom 60% of income earners.
Contributions to a 401(k) and Traditional IRA are made with before-tax dollars, meaning that you'll owe ordinary income tax when you begin making withdrawals during retirement (i.e., between age 59-1/2 and 70-1/2). However, contributions also reduce your tax liability since it's money that's taken out before taxes. Maxing out a 401(k) with an $18,000 contribution limit for those aged 49 and under, or $24,000 for those aged 50 and up, and/or a Traditional IRA with limits of $5,500 or $6,500 based on those same age ranges, could certainly lower your current-year liability. As an added bonus, as noted above, investment gains can grow on a tax-deferred basis for years, if not decades.

3. Use investment losses to your advantage

Another smart option for millionaires to consider is harvesting investment losses.
At some point, all investors will make bad trades and lose money. But for millionaires this bad choice can be quite helpful. Selling investments at a loss may not be what you had in mind when you originally purchased an asset, but tax-loss selling can help reduce your current-year capital gains tax liability, or possibly provide a carryover to future years if the loss is large enough. Selling a loser could be what pushes a high-income earner into a lower tax bracket, or for a millionaire it could help lower what you'll owe in federal taxes for the current or upcoming year.

4. Consider municipal bonds

The vast majority of interest income is taxed at the ordinary income tax rate, which isn't good news for millionaires looking for steady interest-based income. However, a solution exists: municipal bonds.
Municipal bonds are debt securities issued by a state, county, or city that are often used to fund large projects, such as building a new bridge or highway restoration. The beauty of municipal bonds is that they're exempt from federal taxation -- and, if you purchase a municipal bond from the same state you live in, there's a really good chance it'll be exempt from state taxation, too.
Municipal bonds are obviously subject to the risk of a city or state declaring bankruptcy, but history has shown this to be a rarity, making muni bonds a keen investment opportunity for risk-averse millionaires.

5. Give to charity

Millionaires also have access to considerably larger deductions than the lower- and middle-income classes when it comes to charitable contributions. The charitable tax deduction is based on an individual's or couple's peak ordinary income tax bracket. Thus, millionaires effectively receive a deduction of $0.396 for every $1 they donate to charity since the peak marginal tax rate is 39.6%. Comparatively, low- and middle-income Americans are liable to receive just $0.10, $0.15, or $0.25 on every $1 they donate.
One thing to keep in mind is that you'll want to ensure that your donation is both documented and headed to an eligible charity. If the charity isn't a federally recognized nonprofit organization, or you have no documentation to back up your donation, it won't help reduce your tax liability.

6. Buy health insurance

Health insurance may not be something that immediately springs to mind when you're thinking about tax planning, but being covered has two big benefits for millionaires.
To begin with, having health insurance is mandated in the United States via the Affordable Care Act's individual mandate. If you don't buy health insurance, you could face a penalty known as the Shared Responsibility Payment, or SRP. In 2016, the SRP is the greater of $695 or 2.5% of modified adjusted gross income (capped at the annual cost of a bronze plan in your state). In other words, having no health insurance will probably result in an SRP of $2,500 or higher for top-income earners.
Secondly, medical bills are the leading cause of bankruptcy in the United States. Having health insurance could provide the financial protection you need in case an unexpected and costly illness or accident arises.

7. Where you live matters

Finally, millionaires should take into consideration that where they decide to live could greatly impact their finances.
For instance, seven states have no state income tax. These include: Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming. Living in these could save millionaires a low-single digit percentage of their income that, over time, could be substantial.
Other factors millionaires should consider include local sales tax rates, property tax rates, whether or not an estate tax exists, and how each state handles the taxation of retirement income and Social Security benefits. These factors differ on a state-by-state basis, and taking the time to understand how one state differs from another should remove any state-based tax surprises.

Tuesday, October 18, 2016

Self-Filing, or Self-Defeating?- Do-it-yourself tax filers


Taxpayers can’t fill their own teeth or cut their own hair, yet in recent years at least some 30 million Americans filed their tax returns from home computers, an increasing trend.
Earlier this year a GoBankingRates survey revealed that 43 percent of Americans now file taxes “from the comfort of their home.”
“A ‘digital tax-prep tool’ is the most popular option among tax filers, with more than a third … of survey respondents saying this is the method they use,” surveyors reported. “Tax-filing software is a popular option most likely due to the lower costs associated with filing digitally, as well as the ease of using a program to automate calculations and file online.” Only 28.5 percent of respondents said an accountant files their taxes.

“There’s been a DIY trend in many industries because people are trying to conserve money,” admitted Enrolled Agent Jennifer Brown at Implex Tax & Accounting in Clearfield, Utah.
That supposed “ease of use” seems to motivate many self-filers. “Many people who self-file believe they can buy software and it will automatically prepare a correct return,” says G. Faith Owens, an EA at Grade A Business Services in Glendale, Ariz. “And it will if that person has a clear understanding of their own source documents, accounting and the question presented on the screen.”
“Have you ever sat down and seen how long it takes people to use software such as TurboTax?” said Michael Deininger of Deininger & Co. in Kenosha, Wis. “A return that I could have input, printed and e-filed in five minutes [can take] 90 minutes to complete on TurboTax, and then you can’t see the completed return until you e-file. I don’t see self-filing cutting into my business, but I charge a minimum of $250 a return so I can devote myself to my existing clients.”

‘Not even close’
“The main reason I am concerned about the increase in self-filing is that they are wrong wrong wrong!” said Terri Ryman, an EA at Southwest Tax & Accounting in Elkhart, Kansas. “I can’t imagine how much money the IRS is unable to collect because of the antics of self-filers. They post on the wrong forms and lines, don’t pay SE tax when required [and] take ridiculous deductions that are not even close to tax law.”
“I’m concerned for those who self-file in that the code is getting so complex that they’ll find themselves in situations of hearing from the IRS,” said Twila Midwood, an EA at Advanced Tax Centre, in Rockledge, Fla. “I am not concerned that it will cut into my practice. We may prepare fewer returns but may [also] find ourselves helping more taxpayers who’ve received correspondence from the IRS.”
Representation work is proving just one of the unintentional benefits for preparers from self-filing. “Although I’ve had folks do their own returns in the last five to 10 years,” Ryman said, “inevitably they end up coming to me with the mandatory IRS letter, not understanding what they did wrong. And once burned, they usually end up using our services from then on.”
EA John Dundon, of Taxpayer Advocacy Services in Englewood, Colorado, applauds and encourages DIY filers. “More people doing their own income tax preparation,” he said, “means more audit and appeal representation work in the future for me.”
Ryman noted that such added services as representation have reduced prep to only about 40 percent of her practice.

Show them the value
Brown sees a few varieties of DIY filers –- and noted some ways to turn them into paying clients.
“The ‘changers’ come in whenever they have a change, see how we handle it and then go back to self-preparing,” Brown said. “If we build a good relationship with these clients, at some point they’ll stop doing it themselves or they’ll refer others that don’t want to do [taxes] themselves.
“‘Fixers’ are the ones that have us fix what they’ve messed up,” Brown added. “They usually become great clients after their first IRS scare. The ‘not a chancers’ would never consider doing it themselves.”
Brown’s point? “There are a lot of different types of clients out there. If we show them value in what we do and educate them on why they need us, we will always have enough clients.”
Added Owens, “I spend more time now educating my clients about their own errors after the fact then preventing the errors up front. Often, untangling those errors will require more work than to have prepared the return correctly in the beginning, so those self-filers are actually adding to my billable hours and bottom line.”

Monday, October 17, 2016

South for the winter? Know where you 'reside'


With any luck, we here in Wisconsin will continue to enjoy a beautiful and temperate autumn. Yet, as those of us who stand ready to brave the harsh winter are checking the oil in our snowblowers, the snowbirds among us are servicing their cars and getting ready to “fly” south for the winter. Warmer climates beckon many Wisconsinites, and as they do, a number of considerations come to mind.

The first of these occurs to me as I just finished reading a New York State Tax Court case. The income tax authorities were making a claim that the other party in the case was still a New York resident. The other, a gentleman less than excited to find New York was not quite so willing to let him go, considered himself a Florida resident, at least for state income tax purposes.
The state of New York and the individual went round and round on all the facts and circumstances of his residency, but in the end, he lost the case and will pay taxes and penalties in the hundreds of thousands of dollars for failing to properly establish a Florida residence and abandon his New York tax domicile.

Your state of residence for purposes of income taxes (tax domicile) is a function of many things and not solely how much time you spend in one state or the other. The factors are many and vary from state to state.
Wisconsin uses its own set of factors for consideration, and the state to which you are traveling might also have a set of factors to be considered. Therein lies the rub. If you believe you are a resident of the state of Florida and no longer a resident of the state of Wisconsin, it is important not only that you comply with the rules in the state of Florida for establishing residence, but also understand what activities, if any, that you may still do in the state of Wisconsin part of the year that might cause the Wisconsin Department of Revenue to think you are a resident here.
In short, you need to understand two sets of rules.
An issue like this, falling between two states, also often falls between two offices: the attorney’s office and the accountant’s. It requires a coordination of the laws of both states applied to your facts, and coordination between your lawyer and your accountant with respect to being sure there is a clear understanding of domicile, full-year, part-year or not at all.
In addition to the tax domicile issues, estate planning issues exist. Your estate plan needs to be clearly coordinated with your state of residence. This might mean that if you use a Wisconsin power of attorney for health care and spend part of the year in Florida, you should also have a Florida version of that same document.
Wisconsin, as a marital property state, is different, from that perspective, from the laws of the state of Florida, or even Texas, New Mexico, Arizona, Nevada or any of the other common and popular “snowbird” states.
Integration of your estate plan and the laws of both states might be important for you. Your local counsel may need to work with other counsel licensed in those states to develop your plan and make it suitable for both.
In my case, a number of my partners are licensed in those states, so I frequently work with them on plans for individuals with ties to both.
So, before you slam the trunk lid shut, make sure you have copies of all your estate planning documents with you as you go, and consider having them checked over by counsel familiar with both Wisconsin and your destination state before the Wisconsin state line fades in your rear-view mirror.
If tax domicile is also at issue for you, the stakes are even higher.

Sunday, October 16, 2016

You Have Until Monday to Get These 2 Things Done

Oct. 17 isn't the first date that comes to mind as being an important deadline. But for many people, Monday is their last chance to do two things: Get their 2015 taxes filed, and undo a Roth IRA conversion from last year. Below, we'll look at why even those taxpayers who got their taxes done back in April should take a look and see if there's an opportunity to get some smart tax planning done in the next three days.

Back in April, millions of taxpayers asked for extensions to get more time to file their tax returns. The IRS has made filing for a tax extension extremely easy, with automatic extensions granted to anyone who made the appropriate request on IRS Form 4868 before this year's deadline of April 18. The extension gives you six extra months to file, and since Oct. 15 falls on a weekend this year, taxpayers get an additional two days, making Oct. 17 the final day.
Taxpayers in some states will have even more time to get their 2015 tax returns in. The IRS said earlier this week that victims of Hurricane Matthew in certain counties in North Carolina would qualify for tax relief, allowing both businesses and individual taxpayers to push back some of the deadlines that they'd otherwise have to meet over the next several months. The IRS notice specifically included the Oct. 17 individual tax filing deadline for those who received extensions as included in the tax relief, and it gives affected taxpayers until March 15, 2017 to get their returns filed.
As of this writing, only 17 counties in North Carolina were included in the relief area, and no other affected states were yet included. However, the IRS said that it expected to see areas in other states, such as South Carolina, Georgia, and Florida, to be included as well. Damage assessments by the Federal Emergency Management Agency help determine whether tax relief is granted, and the timing of FEMA's work will likely determine when taxpayers in other areas get their tax relief.

Undoing a Roth IRA conversion

The other tax planning opportunity that goes away on Monday is the ability to undo a 2015 Roth IRA conversion. The process of what's known as recharacterization allows you to arrange with your financial institution to take the money that you had converted into a Roth IRA and return it to its original source, typically a traditional IRA. By doing so, you can undo the tax consequences of the conversion, reducing your taxable income for the 2015 tax year by the amount that you converted. For all intents and purposes, recharacterizing your Roth conversion makes it as though the conversion never happened.
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The IRS gives you until the final filing deadline for the tax year in question to recharacterize a Roth, including extensions. That means this year's date is Oct. 17 for those who filed for an extension -- regardless of when they actually filed their 2015 tax return. Even if you got your 2015 return in on time back in April, as long as you filed for the extension, you gave yourself until Monday to do get your Roth do-over.
There are a couple of instances in which a Roth recharacterization makes a lot of sense. First, if the value of your converted Roth has gone down substantially since you converted, then undoing the conversion could help you cut your tax liability. By recharacterizing, waiting the required 30-day time period, and then doing another Roth conversion, you'll only pay taxes on the lower reduced value.
Also, many taxpayers find that they convert during a tax year in which they pay a high tax rate, only to see that rate drop the subsequent year. By recharacterizing a 2015 Roth conversion and then doing it in 2016 instead, you'll save on taxes if your marginal rate has gone down this year due to changes in your overall income.
Procrastinators like the fact that they can get half a year beyond mid-April to get their taxes done. However, for most taxpayers, Monday is the last chance to avoid late-filing penalties that can add 5% to your tax bill each and every month that they're late. Moreover, if you've used a Roth conversion, it's worth taking a closer look to see if a last-minute recharacterization could help produce some valuable tax savings.

Friday, October 14, 2016

Bonus Depreciation is Still a Valuable Tool for Year-End Tax Savings


Bonus depreciation – the ability to claim boosted first-year depreciation deductions for qualifying assets – has been a staple of year-end tax planning since it was introduced by the Job Creation and Worker Assistance Act of 2002. 
It has been overshadowed somewhat by the generous expensing allowance under Code Section 179 and the de minimis safe harbor in the capitalization regulations, but bonus depreciation under Section 168(k) is still an important year-end tax-saving tool for the many businesses that can’t write off all their machinery and equipment purchases by way of these other cost recovery breaks.
The 50 percent first-year bonus depreciation deduction is permitted without any proration based on the length of time that an asset is in service during the tax year. As a result, the 50 percent first-year bonus write-off for qualifying assets bought and placed in service in 2016 is available even if the assets are in service for only a few days in 2016.
Illustration: As year-end approaches, XYZ Inc., a calendar-year business, needs to buy $1,000,000 of five-year Modified Accelerated Cost Recovery System (MACRS) property. If it can move quickly to accelerate the purchase, and place the property in service before 2017, XYZ may claim a first-year depreciation allowance of $600,000 [($1,000,000 × .50 = $500,000 bonus depreciation) + ($1,000,000 - $500,000 × .20 first-year MACRS depreciation allowance = $100,000 regular first-year depreciation)]. This assumes that the half-year convention applies for 2016 (conventions are discussed below).

If bonus depreciation wasn’t available, XYZ’s regular first-year depreciation allowance using the half-year convention would be only $200,000 (20 percent of $1,000,000).
Accelerating a purchase into 2016 may not always be a good idea. For example, it may not produce good results for a taxpayer who has an about-to-expire net operating loss. On the other hand, a taxpayer for whom accelerating the purchase will produce a net operating loss for 2016 that can be carried back to 2014, and who had income taxed at the highest rate in that year, has a good reason to make the purchase in 2016.

How to qualify for bonus depreciation. In general, an asset acquired and placed in service in 2016 qualifies for the bonus depreciation allowance under Section 168(k) if:
1. It falls into one of the following categories:
  • Property to which the MACRS rules apply with a recovery period of 20 years or less;
  • Computer software other than computer software covered by the amortization of goodwill and other intangibles rules of Section 197;
  • Qualified improvement property (i.e., certain interior improvements to nonresidential buildings); or
  • Certain water utility property.
2. Its original use commences with the taxpayer. Original use is the first use to which the property is put, whether or not that use corresponds to the taxpayer’s use of the property. (Section 168(k)(2))
For eligible qualified property (generally, qualified property eligible for bonus depreciation), corporations can elect to forego bonus depreciation and accelerated depreciation in exchange for an increased alternative minimum tax credit limitation. (Section 168(k)(4))
Extra-generous luxury auto depreciation limits. Under Section 168(k)(2)(F)(i), the first-year depreciation deduction for new vehicles that qualify for bonus depreciation is $8,000 more than the first-year depreciation limit that would otherwise apply.
For new vehicles bought and placed in service in 2016, and that qualify for bonus first-year depreciation, the boosted first-year dollar limit is $11,160 for autos (not trucks or vans) and $11,560 for light trucks or vans (passenger autos built on a truck chassis, including minivans and sport-utility vehicles [SUVs] built on a truck chassis). The regular first-year luxury auto limits (e.g., for vehicles not eligible for bonus depreciation, or for which the taxpayer elects out of bonus depreciation) are $3,160 for autos and $3,560 for light trucks or vans.
Heavy SUVs – those that are built on a truck chassis and are rated at more than 6,000 pounds gross (loaded) vehicle weight – are exempt from the luxury-auto dollar caps because they fall outside of the definition of a passenger auto. Under Section 179(b)(5), not more than $25,000 of the cost of a heavy SUV may be expensed under Section 179.
The balance of the heavy SUV’s cost may be depreciated under the regular rules that apply to five-year MACRS property (e.g., a 20 percent first-year depreciation allowance if the half-year convention applies for the placed-in-service year). However, with the 50 percent first-year bonus depreciation available for qualified assets bought and placed in service in 2016 (in addition to the $25,000 expensing allowance and regular depreciation), taxpayers buying and placing in service new heavy SUVs in 2016 may be entitled to write off most of the cost of the vehicle in the first year.
Effect of half-year and midquarter conventions on year-end planning. The half-year convention generally applies in the computation of depreciation deductions for property (other than real property) first placed in service during the current tax year. Under this convention, a business asset placed in service at any time during the tax year is generally treated as having been placed in service in the middle of that year. (Section 168(d)(1))
However, the half-year convention only applies if property depreciable under Section 168 and placed in service during the last three months of the tax year (other than property expensed under Section 179, residential rental property, nonresidential realty, and certain other excluded categories) doesn’t exceed 40 percent of all of such property placed in service during the entire year. If it does, then a midquarter convention applies. (Section 168(d)(3)) Under that rule, personal property placed in service during any quarter of the tax year is treated as if it had been placed in service at the middle of the quarter in which it was placed in service.
Illustration: Ace Inc. buys one depreciable asset during 2016 – a $10,000 used machine that’s five-year property under MACRS. Assume Ace isn’t eligible for Section 179 expensing. If it places the asset in service during the first three quarters of its tax year, the first-year depreciation allowance is $2,000 (20 percent). If it places the asset in service during its fourth quarter, the write-off is slashed to $500 (5 percent midquarter table percentage for five-year property placed in service in the fourth quarter).
The availability of bonus first-year depreciation on most new machinery and equipment purchases (see discussion above) substantially diminishes the hazards of buying new assets in the last quarter. The 50 percent first-year bonus depreciation allowance is available even if the midquarter convention applies. In that case, the midquarter allowance is taken on the adjusted basis of the property after reduction for the bonus depreciation allowance.
Use of the bonus first-year depreciation allowance has no effect on the determination of whether or not the midquarter convention applies. The 40 percent test is computed with reference to the adjusted basis of nonrealty assets placed in service during the year, without reduction for the bonus depreciation allowance.
It may be possible in some cases to avoid application of the midquarter convention by electing to expense under Section 179 property placed in service during the last quarter. On the other hand, deliberately exceeding the 40 percent limit to trigger the midquarter convention may be a sound strategy where the taxpayer has placed a large amount of property in service during the first quarter of the year.
For instance, if a calendar-year taxpayer placed a large amount of five-year recovery property in service in March 2017, triggering the midquarter convention for 2017 will produce a 10 1/2-month regular first-year depreciation deduction for that property.