Editor's Note: In-depth coverage of this issue can be found at Tax Facts Online, the premier reference on the taxation of insurance, employee benefits and investments.
While it is always important for clients to take stock of their financial health as we ring in the new year, planning ahead for the 2017 tax year can prove more valuable than ever, as the new presidential administration has promised several changes that could dramatically impact a client’s tax planning.
This article will highlight four tax planning strategies that clients may be overlooking as the New Year — and new presidency— dawns. Planning to take advantage of income tax strategies as well as tax savings that can be realized using health savings vehicles and retirement accounts can all prove critical to a client’s ability to maximize their tax savings.
No. 4: The value of income tax deferral
It can always be valuable for a client to defer income — and the corresponding tax liability — to a future year.
But President-elect Donald Trump’s promise to lower tax rates in future years could make this strategy incredibly valuable. While the highest income tax rate is currently 39.6 percent, the Trump administration has promised to reduce that rate to 33 percent in future years, meaning that higher income clients can realize significant tax savings by reducing 2016 taxable income.
Some clients may be able to choose to receive bonuses in future years, while others can reduce their taxable income by contributing to a tax-preferred retirement account by the income tax filing deadline. For example, clients have until April 17, 2017, to contribute up to $5,500 to an IRA ($6,500 if the client is 50 or older) and have their taxable income reduced for the 2016 tax year. As a result, most clients should make sure that they are maximizing contributions to retirement accounts for the 2016 tax year even if this means that they will have less to contribute in 2017.
Despite this, some taxpayers will need to examine the new proposed tax structure to determine whether they could actually end up paying a higher tax rate in 2017. For example, single taxpayers who earn between $127,500 and $200,500, among others, could be subject to a higher tax rate under the new administration’s proposal. Clients such as these should consider taking the opposite approach in order to plan to reduce income for 2017 and take advantage of (potentially) lower 2016 tax rates.
Some taxpayers may wish to strategically sell investments now to take advantage of the current 15 percent long-term capital gains tax rate. (Photo: iStock)
No. 3: Capital gains planning
Clients should also note that many will become subject to higher long-term capital gains tax rates if the new administration’s tax proposal is adopted in its entirety. The proposed 20 percent rate would begin to apply to single taxpayers who earn over $127,500, and married taxpayers would become subject to the rate once income hits $255,000. These taxpayers may wish to strategically sell investments that would result in long-term capital gains before the new proposal becomes effective in order to take advantage of the 15 percent long-term capital gains tax rate that currently applies for some taxpayers.
However, the new administration proposes to cut the rates on short-term capital gains (or gains on investments that have been held for less than a year) for many clients, as those rates are tied to ordinary income tax rates. A client who would see a reduction in his or her ordinary income tax rates under the Trump proposal may wish to wait until those new rates become a reality in order to sell investments that would result in short-term capital gains in order to take advantage of potentially lower rates.
(Related: 6 Tax-Law Time Bombs Affecting IRAs)
2: Track all charitable giving
Currently, clients who give to charity are entitled to take a deduction for charitable contributions against their tax liability as an itemized deduction. While the value of itemized deductions is currently phased out for higher income taxpayers, the new administration has proposed implementing a much more restrictive cap on itemized deductions.
After the new proposal becomes effective, single taxpayers could be limited to $100,000 in itemized deductions. (The cap is proposed to be $200,000 for married taxpayers filing joint returns). As a result, clients who wish to take advantage of the current structure for charitable contributions deductions should plan to donate as soon as possible.
Many clients may have access to health flexible spending accounts (FSAs) that contain grace period or carryover provisions. (Photo: iStock)
No. 1: Maximize health savings accounts
Health savings and flexible spending accounts (FSAs) contain grace period or carryover provisions that allow clients to spend FSA funds that otherwise would have expired at the end of 2016. Health FSAs may be subject to this rule, known as the use-it-or-lose-it rule, which means that all 2016 contributions must be used by the end of the plan year unless the FSA offers either of the carryover or grace period options. The carryover provision allows a taxpayer to carry up to $500 in unused funds into 2017, while the grace period option gives taxpayers an extra 2 1/2 months after year-end to use the funds. (FSAs may contain one of these provisions, but not both).
Clients should check their plan to determine whether it contains one of these provisions in order to maximize the savings generated by these tax-preferred accounts early in 2017.
One final reality check
It is important for clients to realize that the changes to the tax code that have been proposed by the new administration are not yet a reality. Even so, it is critical to plan for these changes now in order to ensure that clients aren’t taken off guard if some or all of these new rules do become effective.
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