Thursday, February 9, 2017

How to Minimize Pricey Medicare Surcharges on your taxes

FROM THINKADVISOR.COM

Adjusted gross income (AGI) plays a powerful role in any client’s tax planning—deductions and credits phase out as income rises. Moderate- to high-income clients face the cost of Medicare surcharges that adds to the client’s Medicare bill. Moderate income clients can lose out on valuable tax benefits without planning to reduce AGI if possible.
AGI Reduction Strategies
Medicare income-based surcharges are determined based on a sliding scale that uses the recipient's modified AGI to determine liability for Medicare premium costs. Five tiers of income levels currently exist, and the amount of an individual's income-based surcharge is determined based upon the tier in which his or her income falls—beginning in 2018, a change in the rules will mean that more moderate income clients will find themselves in the tier that imposes the largest surcharge.
At the most basic level, clients should take advantage of tax-preferred retirement accounts in order to reduce AGI and avoid these surcharges—contributing to a 401(k) plan can reduce AGI by at least $18,000 in 2017 (clients age 50 and older can contribute an additional $6,000 in pre-tax funds to these accounts). 
Clients should also plan to maximize contributions to health savings accounts (HSAs), which can serve to reduce AGI by up to $6,750 per year for a client with family coverage in 2017.  The funds are withdrawn tax-free to cover medical expenses, but upon reaching age sixty-five, the client can withdraw the funds for any purpose without penalty (funds withdrawn for non-medical purposes will increase taxable income in a future year, however). 
Clients who have reached age 70 ½ can reduce AGI by up to $100,000 per year by using their IRA required minimum distribution (RMD) to contribute to charity. The donation must be transferred directly from the IRA to charity in order to qualify.
An Alternative Approach
For some clients, it may actually be better to increase AGI at some point before retirement in order to reduce taxable income (and take advantage of the benefits a lower income can provide) later in life.  This would subject the client to a larger tax bill in a short period of time in order to plan for tax-free income (and a reduced AGI) at a later time.
Frequently, this can be accomplished by converting retirement funds to a Roth account.  Other clients may choose to sell off assets in a single year, pay taxes on the gain and contribute the profits to a Roth that can be accessed tax-free in the future.  Because the new administration is proposing to reduce ordinary income tax rates for high-income clients, the next few years may be an ideal time to take advantage of this strategy. 
However, while compressing income into a short time span can be a valuable strategy, it is important to remember that Medicare uses a two-year look-back period to determine any income-based surcharges, so that a client’s 2015 AGI will be used in determining the client's liability for income-based surcharges today—meaning that as a client approaches Medicare eligibility, he or she will want to ensure that AGI is at its lowest at least two years ahead of time.
Conclusion
Planning to reduce AGI may seem basic, but it can provide substantial tax savings for clients whose high income could generate substantial costs—both in terms of Medicare premiums and phased out tax benefits.