2016 Individual Tax Planning: 10 Keys to Tax Savings!

John (Rusty) Davis, CPA

 1. ID Theft Safeguards in Tax Filings: Security is #1!

Before you do anything, get current on IRS security processes, and review all personal and business processes to ensure that your data is as secure as possible. More here:


2. Balance Tax Brackets for 2016 and 2017: Shift Between Years?

Taxable Income

Postpone income until 2017 and accelerate deductions into 2016 to lower your 2016 tax bill. This strategy may enable you to claim larger deductions, credits, and other tax breaks for 2016 that are phased out over varying levels of adjusted gross income (AGI). These include child tax credits, higher education tax credits, and deductions for student loan interest. Postponing income also is desirable for those taxpayers who anticipate being in a lower tax bracket next year due to changed financial circumstances. Note, however, that in some cases, it may pay to actually accelerate income into 2016. For example, this may be the case where a person’s marginal tax rate is much lower this year than it will be next year or where lower income in 2017 will result in a higher tax credit for an individual who plans to purchase health insurance on a health exchange and is eligible for a premium


Higher-income taxpayers are subject to the Pease limitation. The Pease limitation reduces itemized deductions by 3% of the amount that the taxpayer’s adjusted gross income (AGI) exceeds the thresholds below, but not by more than 80%. For 2016, the threshold amounts are:

  • $311,300 for MFJ and Surviving Spouses (SS);
  • $155,650 for MFS;
  • $285,350 for HOH; and
  • $259,400 for single taxpayers.
  • The personal exemption phase-out requires taxpayers to reduce the amount of their exemptions when their AGI exceeds the same threshold levels as the Pease limitation above. The total amount of exemptions that may be claimed by a taxpayer are reduced by 2% for each $2,500 (2% for each $1,250 for MFS), or portion thereof by which the taxpayer’s AGI exceeds the applicable threshold.

3. Contribute to IRAs and 401(k) Plans: Save for Retirement!

For 2016, you may contribute to the due date of your tax return, either a Roth IRA or Traditional IRA – To $5,500 for under 50, $6,500 for over 50, subject to limitations.

If you believe a Roth IRA is better than a traditional IRA, consider converting traditional-IRA money invested in beaten-down stocks (or mutual funds) into a Roth IRA if eligible to do so. Keep in mind, however, that such a conversion will increase your AGI for 2016.

If you converted assets in a traditional IRA to a Roth IRA earlier in the year and the assets in the Roth IRA account declined in value, you could wind up paying a higher tax than is necessary if you leave things as is. You can back out of the transaction by recharacterizing the conversion-that is, by transferring the converted amount (plus earnings, or minus losses) from the Roth IRA back to a traditional IRA via a trustee-to-trustee transfer. You can later reconvert to a Roth IRA.

Now is the time to maximize your elective deferral to your 401K Plan – To $18,000 for under 50, or to $24,000 for over 50.

4. Medical Expense Deductions for Seniors: Anticipate!

For 2016, the “floor” beneath medical expense deductions for taxpayers 65 or older is 7.5% of adjusted gross income (AGI). Unless Congress changes the rules, this floor will rise to 10% of AGI next year. Taxpayers age 65 or older who can claim itemized deductions this year, but won’t be able to next year because of the higher floor, should consider accelerating discretionary or elective medical procedures or expenses (e.g., dental implants or expensive eyewear).

5. RMD Timing: Know Your Options!

Take required minimum distributions (RMDs) from your IRA or 401(k) plan (or other employer-sponsored retirement plan). RMDs from IRAs must begin by April 1 of the year following the year you reach age 70-½. That start date also applies to company plans, but non-5% company owners who continue working may defer RMDs until April 1 following the year they retire. Failure to take a required withdrawal can result in a penalty of 50% of the amount of the RMD not withdrawn. Although RMDs must begin no later than April 1 following the year in which the IRA owner attains age 70 ½, the first distribution calendar year is the year in which the IRA owner attains age 70½. Thus, if you turn age 70-½ in 2016, you can delay the first required distribution to 2017, but if you do, you will have to take a double distribution in 2017-the amount required for 2016 plus the amount required for 2017. Think twice before delaying 2016 distributions to 2017, as bunching income into 2017 might push you into a higher tax bracket or have a detrimental impact on various income tax deductions that are reduced at higher income levels. However, it could be beneficial to take both distributions in 2017 if you will be in a substantially lower bracket that year.

Philanthropy Rewarded with RMD Incentive

Exclusion from gross income of qualified charitable distributions up to $100,000 from individual retirement plans for individuals aged 70&½ or older

6. Max Annual HSA AND FSA Plan Benefits: For 2016 & 2017!

Increase the amount you set aside for next year in your employer’s health flexible spending account (FSA) if you set aside too little for this year.

If you become eligible in December of 2016 to make health savings account (HSA) contributions, you can make a full year’s worth of deductible HSA contributions for 2016.

7. Investment Portfolio Planning: Optimize Capital Gain Rates!

Prior to 12/31/16, realize losses on stock while substantially preserving your investment position. There are several ways this can be done. For example, you can sell the original holding, then buy back the same securities at least 31 days later.

Also, be aware of preferential investment income rates, unchanged from 2015, with the following rates for long-term capital gains and qualified dividends:

  • 0% for taxpayers in the 10% and 15% income tax brackets
  • 15% for taxpayers in the 25%, 28%, 33%, and 35% income tax brackets
  • 20% for taxpayers in the 39.6% income tax bracket

Long-term capital gains rates apply to gains from the sale of investment assets held for longer than a year. Qualified dividends are those received from domestic corporations whose stock is held for more than 60 days.

Keep in mind the “wash sale rules” when reviewing year-end capital gains and dividends. Wash sales are sales of stock or securities in which losses are realized, but not recognized for tax purposes, because the seller acquires substantially identical stock or securities within 30 days before or after the sale. Non-recognition, however, applies only to losses; gains are recognized in full.

8. AMT, NIIT, and AMT: Acronyms to Know!

Alternative Minimum Tax (AMT)

The possibility of being subject to alternative minimum tax (AMT) should not be ignored, as doing so may negate certain year-end tax strategies. The AMT, as its name signifies, is an alternative tax calculation that makes certain adjustments to regular taxable income and subjects the resulting AMT income that is in excess of certain exemptions amounts to a rate of either 26% or 28%, depending on the AMT income level. You pay the higher of the regular tax calculated or the AMT. As mentioned, the presence of AMT for a year might mean that tax planning strategies generally designed to reduce regular tax purposes will not yield the expected results. The possibility of AMT is one reason why the most effective approach to making sound year-end tax planning decisions is often to model your expected tax situation for the current year as well as the following year, to achieve an overall lower tax result.

Net Investment Income Tax (NIIT)

The NIIT is a 3.8% Medicare surtax imposed on the lesser of an individual’s (a) net investment income (NII) or (b) the amount of modified adjusted gross income that exceeds the following thresholds:

  • $250,000 for MFJ
  • $125,000 for MFS
  • $200,000 for single taxpayers and HOH

The NIIT generally applies to passive income and is not imposed on income derived from a trade or business or from the sale of property used in a trade or business. NII includes the following:

  • Gross income from interest, dividends, annuities, royalties, and rents, provided this income is not derived in the ordinary course of an active trade or business;
  • Gross income from a trade or business that is a passive activity for the taxpayer;
  • Gross income from a trade or business of trading in financial instruments or commodities; or
  • Gain from the disposition of property not held in an active trade or business.

Keeping income below the thresholds, spreading income out over a number of years or offsetting the income with both above-the-line and itemized deductions are possible approaches to avoid the NIIT. Of course, every taxpayer’s situation is different and planning for the NIIT requires a specific strategy.

Additional Medicare Tax (AMT)

An additional 0.9% high income Medicare tax is imposed on wages and self-employment income that exceeds the same thresholds as the NIIT thresholds listed above. Although the thresholds are the same, this additional tax should not be confused with the 3.8% Medicare surtax on NII.

If federal income tax withholdings and estimated tax payments have not been made under a “safe harbor,” you can instruct your employer to withhold additional federal income taxes from your wages before year end to avoid an underpayment penalty related to this tax or the NIIT.

9. Child and Education Related Tax Benefits: Family Update!

Adoption Credit and Adoption Assistance Programs Most taxpayers can claim a credit for qualified expenses incurred in connection with the adoption of an eligible child. The credit for each adoption is limited to a maximum amount of $13,460 per child for 2016. Additionally, $13,460 received under an adoption assistance program may be excluded from gross income. Both the credit and gross income exclusion are phased out for higher income taxpayers. Different rules apply to domestic children, foreign children, and children with special needs.

Child and Dependent Care (CDC) Credit Taxpayers who incur expenses to care for children under age 13 (or for an incapacitated dependent or spouse) in order to work or look for work can claim a credit for those expenses. The credit is calculated as a percentage of the expenses incurred, up to a maximum of $3,000 for taxpayers with one qualifying child or dependent and $6,000 for taxpayers with two or more qualifying children or dependents.

Child Tax Credit (CTC) Taxpayers are allowed an income tax credit of $1,000 for each qualifying child under the age of 17 at the end of the calendar year. The child tax credit is refundable for some taxpayers, but begins to phase out for higher-income taxpayers at the thresholds below:

  • $110,000 for MFJ (complete phase-out at $130,000)
  • $75,000 for single taxpayers and HOH (complete phase-out at $95,000)
  • $55,000 for MFS (complete phase-out at $75,000)

American Opportunity Tax Credit (AOTC) The AOTC has now been made permanent beginning in 2016. The maximum credit that can be taken is $2,500 per eligible student for the first four years of higher education and up to $1,000 is refundable. The AOTC is phased out for single taxpayers with income ranging from $80,000 to $90,000, and for joint taxpayers with income ranging from $160,000 to $180,000.

Lifetime Learning Tax Credit The lifetime learning credit is a nonrefundable credit for qualified students and is available for all years of postsecondary education. The maximum credit of $2,000 is phased out for single taxpayers with income ranging from $55,000 to $65,000 and joint taxpayers with income ranging from $111,000 to $131,000. The lifetime learning credit and American Opportunity credit cannot be taken in the same tax year.

Coverdell Education Savings Accounts (ESAs) ESAs are trust or custodial accounts created exclusively to pay the qualified elementary, secondary and higher education expenses of a single named beneficiary. Annual contributions are limited to $2,000 per beneficiary, but this limit is phased out for higher-income contributors. Contributions may be made to an ESA up to the original due date of the return.

Qualified Tuition Programs (QTP) A Qualified Tuition Program is an education savings plan designed to help families set aside funds for future college costs. Contributions to a QTP are not deductible, however, the earnings in the plan grow tax free, provided they are used for qualified expenses (e.g. tuition, fees, room and board, books, supplies, computers and software) while enrolled at an eligible educational institution.

Educational Assistance Programs Employees are allowed to exclude up to $5,250 in annual educational assistance from gross income and wages provided under an employer’s nondiscriminatory “educational assistance plan.” Employer-provided educational benefits may also be excludable as a fringe benefit.

Scholarship Programs Any amount received as a qualified scholarship and used for qualified tuition and related expenses is excludable from income. The exclusion does not apply to any portion of the amount received which represents payment for teaching, research, or other services by the student required as a condition for receiving the qualified scholarship (with limited exceptions).

Student Loan Interest Deduction Taxpayers may deduct from gross income, subject to certain conditions, interest payments made on qualified education loans. The deduction is an above-the-line adjustment to income that can be claimed by all individuals, not just those who itemize. The maximum deduction of $2,500 is reduced when modified AGI exceeds $65,000 ($130,000 for joint returns) and is completely eliminated when modified AGI reaches $80,000 ($160,000 for joint returns).

10. Gift Planning: An Annual Decision!

 Make gifts sheltered by the annual gift tax exclusion before the end of the year and thereby save gift and estate taxes. The exclusion applies to gifts of up to $14,000 made in 2016 and 2017 to each of an unlimited number of individuals. You can’t carry over unused exclusions from one year to the next. The transfers also may save family income taxes where income-earning property is given to family members in lower income tax brackets who are not subject to the kiddie tax.

Key Figures

The maximum federal unified estate and gift tax rate is 40 percent with a $2,125,800 unified credit amount ($5,450,000 exemption amount) for gifts made and estates of decedents. The annual gift tax exclusion allows taxpayers to give up to $14,000 during 2016 to any individual ($28,000 for married individuals who split the gifts), gift-tax free and without counting the amount of the gift toward the lifetime $5,450,000 exemption, adjusted for inflation.

Exclusion for Educational and Medical Expenses

In addition to the $14,000 annual exclusion amount, expenditures may be made for certain educational and medical expenses with gift tax consequences. Any amount paid on behalf of an individual as tuition directly to certain educational organizations for the education or training of such individual is not treated as a transfer by gift for purposes of the gift tax. For medical expenses, the exclusion applies for certain medical expenses paid on behalf of an individual not reimbursed to the individual by insurance. The exclusion for educational and medical expenses is unlimited in amount, and can be made on behalf of anyone you choose, as long as the payments are made directly to the educational institution or health care provider.