Year End Tax Strategies To Consider Deploying

By: Randall A. Denha, J.D., LL.M.

The presidential election of 2016 seemed like an eternity, but it has finally come to pass and we now have elected President-elect, Donald Trump.  From real estate mogul to Celebrity Apprentice to White House, there doesn’t appear to be much he can’t do.  That said, and in keeping with his many promises to the American people, President-elect Trump and Congress may tell the tax code, “You’re fired!”  What this means to you is that deferring income into next year, if you can, might be wise. Next year, the rates should be lower. Under current law, we pay tax on ordinary federal income tax at graduated rates stretching from 10% to 39.6%.

1. Utilize strategies to reduce or avoid taxable income. Contributing to a retirement plan or IRA, funding a flexible spending account (FSA), or deferring compensation income can reduce adjusted gross income (AGI) and prevent a taxpayer from reaching key income thresholds that may result in a higher tax bill. Maximizing use of tax deductions such as charitable contributions or mortgage interest can offset income as well. Conversely, be mindful of transactions, such as the sale of a highly appreciated asset, which may increase your overall income above thresholds for the 3.8% surtax, the income phase-out of itemized deductions, or the new highest marginal tax rates.

Trump proposes cutting the tax brackets to three: 12%, 25%, and 33%. He would eliminate Obamacare’s 3.8% net investment income tax, too. As a result, the top rate would be 33%, with the top rate on capital gains and dividends a firm 20%. There are some drawbacks, though, that may alter your usual tax planning. For example, Trump’s tax plans call for slashing itemized deductions. Under Trump’s plan, personal exemptions are eliminated. High earners already do not deduct personal exemptions due to the phase out, so this should have little impact. More consequential, though, is that itemized deductions would be capped at $200,000 for married couples. Paying state taxes before year-end means you can deduct them now. And the same for charitable contributions.

2. Consider Roth IRA/401(k) contributions or conversions. A thoughtful strategy utilizing Roth accounts can be an effective way to hedge against the direction of future tax rates in light of the longer-term federal budget deficit challenge. Younger investors or taxpayers in lower tax brackets should consider using Roth accounts to create a source of tax-free income in retirement. It is virtually impossible to predict tax rates in the future or to have a good idea of what your personal tax circumstances will look like years from now. Like all income from retirement accounts, Roth income is not subject to the new 3.8% surtax and is also not included in the calculation for the $200,000 income threshold ($250,000 for couples) to determine if the new surtax applies.

3. Be mindful of irrevocable trusts and taxes. Because of the low income threshold ($12,400 for 2016), which will subject income retained within an irrevocable trust to the highest marginal tax rates and the 3.8% Medicare surtax, trustees may want to reconsider investment choices inside of the trust (municipal bonds, life insurance, etc.). Or, maybe trustees should consider (if possible) distributing more income out of the trust to beneficiaries who may be in lower income tax brackets.

4. Review estate planning documents and strategies. The permanency of the historically high $5,000,000 exemption (indexed for inflation and currently $5,450,000 and in 2017 to $5,490,000) amount may have unintended consequences for some individuals and families with wealth under that threshold. They may think that they do not have to plan for their estate. However, the taxes are just one facet of estate planning. It is still critical to plan for an orderly transfer of assets or for unforeseen circumstances such as incapacitation. Strategies to consider include proper beneficiary designations on retirement accounts and insurance contracts, wills, powers of attorney, health-care directives, and revocable trusts.

5. Evaluate whether to transfer wealth during lifetime or at death. The unified lifetime exemption amount ($5,450,000 for 2016 and $5,490,000 in 2017) for gifts and estates provides flexibility for taxpayers to decide whether to transfer wealth while living or at death. Lifetime gifting shelters appreciation of assets post-gift from potential estate taxes, helps heirs now, and utilizes certain valuation discounts available through strategies such as family limited partnerships. Transferring assets at death allows individuals to maintain full control of property while living and benefit from step-up in cost basis at death.

6. Evaluate whether a Credit Shelter Trust (CST) makes sense. A properly designed CST will shelter appreciation of assets from the estate tax after the death of the first spouse. However, since the portability provision allowing a surviving spouse to utilize the unused exemption amount of a deceased spouse is permanent, is trust planning actually necessary? There are some benefits for still utilizing a credit shelter trust including protection of assets from potential creditors, spendthrift protection for trust beneficiaries, planning for state death taxes, and preserving the Generation Skipping exemption, which is not portable. However, costs and effort are required to establish the trust while the portability provision does not involve any special planning. Additionally, assets transferred to a trust at the death of the first spouse do not receive a “step-up” in cost basis at the death of the second spouse.

7. Real Estate Transactions. If you are selling real estate or other non-publicly traded property at a gain, you would normally structure the terms of the arrangement so that most of the payments would be due next year. You can use the installment sale method to report the income. This would allow you to recognize only a portion of the taxable gain in the current year to the extent of the payments you received, thereby allowing you to defer much of that tax to future years.

8. Capital Gains Planning. The following ideas can lower your taxes this year:

• If you have unrealized net short-term capital gains, you can sell the positions and realize the gains in the current year if you expect next year’s tax rate to be higher (time will tell with a Trump Presidency.) This may be a good strategy if the gain will be taxed at the AMT rate of 28% this year but at 39.6% next year (exclusive of the additional Medicare Contribution Tax). Only consider this strategy if you do not otherwise intend to hold the position for more than 12 months, making it eligible for the long-term capital gain rate of 20%, exclusive of the additional Medicare Contribution Tax. However, you may be able to apply the netting rule which may result in the offsetting of long-term losses to short-term gains, resulting in a tax savings of 39.6% rather than 20%.
• Review your portfolio to determine if you have any securities that you may be able to claim as worthless, thereby giving you a capital loss before the end of the year. A similar rule applies to bad debts.
• Consider a bond swap to realize losses in your bond portfolio. This swap allows you to purchase similar bonds and avoid the wash sale rule while maintaining your overall bond positions.
• Similarly, you may consider selling securities this year to realize long-term capital gains that may be taxed at the more favorable rate this year, and then buying them back to effectively gain a step-up in basis. Since the sales are at a gain, the wash sale rules do not apply.

9. 1031 Planning. If selling real or personal property and acquiring other “like kind” property, consider taking advantage of a like-kind exchange under Section 1031. If you are able to take advantage of Section 1031, gain is deferred until the ultimate taxable sale of the replacement property that is received in the exchange.  For senior taxpayers, a series of ongoing exchanges has resulted in the term “swap ‘til you drop.” Under this strategy, a taxpayer engages in consecutive exchanges to defer taxes on sales. Upon the death of the taxpayer, the potential income tax on the cumulative gain is eliminated through the estate step-up in basis (unless the estate basis step-up is repealed).  State income tax rules need to be considered as well for conformity or lack of conformity with the federal rules on Section 1031. If selling real or personal property, by taking steps to structure as a Section 1031 tax-free exchange, even if the exchange fails and replacement property is not acquired, it may be possible to defer the gain and tax into the next tax year. This may be possible if the property to be disposed of under the first step of a like-kind exchange is sold during the last half of the taxpayer’s tax year (so that fewer than 180 days remain in the tax year).

10. Using Non-cash assets for charitable deductions. As you’re putting together your holiday shopping list, be sure to include charitable gifts that could help reduce your tax bill. In addition to the usual dollar donations or household goods and clothing, consider some less traditional ways to give to charities. Many groups will accept vehicles, with some even making arrangements to pick up the vehicles. Donate stock or mutual funds that you’ve held for more than a year but that no longer fit your investment goals. When you contribute appreciated securities that you’ve held for more than one year to a qualified charitable organization, you may deduct the full fair market value of the donated securities and thereby avoid the capital gains taxes that would otherwise be due if sold and then net proceeds donated.  The charity gets the asset to hold or sell, and your portfolio rebalancing nets you a deduction for the asset’s value at the time of gifting.

A little bit more about charitable gifting. Generally, you can deduct the full amount of your charitable contributions on your tax return, up to the stated limit of 50% of your adjusted gross income (AGI), while gifts of property are limited to 30% of AGI. Any excess may be carried over for up to five years. In other words, a client may benefit in 2016 from a donation made in prior years. If you’re giving a monetary donation, you can deduct the amount of your cash or check or credit card charge.

For donations of property, the deductible amount is generally equal to the property’s fair market value (FMV) if you’ve owned it longer than a year, even if the property has substantially appreciated in value. Otherwise, the deduction is limited to your cost of the property. However, the tax law imposes strict record keeping rules in this area. Notably, to deduct a charitable contribution of $250 or more, a taxpayer must obtain a written acknowledgment from the charity, including the amount of the donation, a description of any non-cash property that was contributed and the value of any goods or services provided.