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To Minimize Clients’ Tax Exposure, Focus on These 10 Key Areas

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Although clients (and even some advisors) tend to think exclusively about taxes in the few months leading up to April 15, tax planning—and minimizing clients’ tax exposure—should be on your radar throughout the year. But what areas should you focus on as you look for ways to reduce your clients’ tax bill? Here are my top 10.

1) Net Investment Income Tax

The 3.8-percent net investment income tax is applied to the lesser of net investment income or the excess of modified adjusted gross income (MAGI) over the applicable threshold:

  • $200,000 for single filers
  • $250,000 for married taxpayers filing jointly
  • $125,000 for married taxpayers filing separately

Let’s look at an example to see how this tax works:  

Will and Jean earned $175,000 in wages and $100,000 in investment income. Their total wages and investment earnings (MAGI) equal $275,000. As the 3.8-percent net investment income tax is applied to the lesser of net investment income ($100,000) or the excess of MAGI over the applicable threshold ($275,000 – $250,000 = $25,000), only $25,000 of their income will be subject to this tax.

Tip: Be sure you know what actually is considered net investment income; taxable interest, capital gains, dividends, nonqualified annuity distributions, royalties, and rental income are all considered net investment income. It also includes business income if the taxpayer is a passive participant and rental income not earned by a real estate professional.

2) Medicare Contribution Tax

This tax increases the employee share of the Medicare tax by an additional 0.9 percent of covered wages in excess of $200,000 for single filers, $250,000 for married taxpayers filing jointly, and $125,000 for married taxpayers filing separately. It is also applied to self-employment income in excess of these same threshold amounts.

Tip: Consider the Medicare tax when reviewing your client’s current withholdings or estimated payment amounts.

3) Alternative Minimum Tax (AMT)

Now “permanently” patched, the AMT can be a liability for many high-net-worth clients.

Tip: Determine if there’s a benefit in shifting AMT-triggering items from an AMT year to a different year in which the client is not expected to be subject to AMT liability.

4) Pease Limitation Phaseout

The American Taxpayer Relief Act restored the Pease limitation phaseout for itemized deductions. The threshold amounts for adjusted gross income are $259,400 for single taxpayers and $311,300 for married taxpayers filing jointly. Your clients’ allowable itemized deductions can be reduced by 3 percent of the amount exceeding these thresholds, although this reduction will be capped at 80 percent.

Tip: When considering the Pease limitation phaseout as part of your clients’ tax planning strategies, keep in mind the most common federal itemized deductions:

  • Mortgage interest
  • State income tax and property tax
  • Charitable donations
  • Medical expenses (10-percent floor)
  • Miscellaneous itemized deductions (2-percent floor)
  • Unreimbursed business expenses
  • Home office deductions
  • Investment management fees

5) Individual Income and Capital Gain Tax Rates

Individual income tax rates are 10, 15, 25, 33, 35, and 39.6 percent, and the top rate for capital gains is 20 percent. But how can you look for ways to avoid spikes in income and determine the best method to spread the recognition of income over future years?

Tip: Help your clients with a marginal tax rate analysis. This involves understanding the difference between your client’s marginal tax rate and his or her effective tax rate. That is, if you know the rate at which your client’s next dollar of income will be taxed, you may be able to identify a strategy that will prevent him or her from being pushed into a higher tax bracket unnecessarily. If a higher tax bracket does seem likely, certain strategies, such as deferring income and accelerating deductions, may allow your client to lower his or her federal income tax burden.

6) Tax Loss Harvesting

This traditional tax planning strategy can be used to offset current gains or to accumulate losses to offset future gains (which may potentially be taxed at a higher rate). Here, evaluate whether the investment qualifies for long- or short-term capital gain, and be sure to offset short-term gains with short-term losses and long-term gains with long-term losses.

Tip: Keep the wash sale rule in mind, as this prohibits a tax-deductible loss on a security if your client repurchases the same or substantially identical assets within 30 days of the sale.

7) Estate and Gift Taxes

In 2016, individual taxpayers can give up to $14,000 ($28,000 per married couple) to any individual gift tax-free. For taxpayers making noncharitable gifts, there is no limit to the number of individuals who can benefit from a gift under this annual exclusion. In addition, the federal estate tax exemption has increased to $5,450,000 for 2016.

Tip: State gift and estate tax laws may vary from the federal provisions and are playing a more important role in gift and estate tax planning. Be sure you understand how the state provisions may affect your clients’ planning—and consult with a qualified tax advisor for guidance.

8) Charitable Giving From IRAs

The Protecting Americans from Tax Hikes (PATH) Act of 2015 made permanent a taxpayer’s ability to make qualified charitable distributions from IRAs. This means that clients age 70½ or older may make tax-free distributions directly from an IRA or Roth IRA to a qualified charity, up to a maximum of $100,000 per person.

Tip: Excluding the IRA distribution from income will lower AGI and can help high-income clients eliminate or minimize the 3.8-percent net investment income tax and the phaseout of itemized deductions.

9) Convert Traditional IRAs to Roth IRAs

Roth IRA balances are not subject to required minimum distributions while the original owner is alive.

Tip: Converting a traditional IRA to a Roth IRA makes sense in years where income may be lower and if your client anticipates a higher tax rate in later years.

10) Life Events

It’s important to keep aware of various events that affect not only your clients’ personal lives but also their tax returns. These may include:

  • Birth of a child
  • Change in marital or filing status
  • Change in dependent status
  • Support payments, such as alimony or child support
  • Employment changes
  • Retirement
  • Bankruptcy
  • Inheritances
  • Changes to medical expenses

Tip: Any changes in personal circumstances should be reviewed on an ongoing basis to determine the impact on your client’s tax return.

Staying Focused Throughout the Year

To help your clients stay ahead of the game, encourage them to conduct an annual review of their personal and business taxes with you and their tax advisor. By using these tips to help minimize taxes early—and keeping abreast of the latest in tax reform—your clients will see benefits throughout the tax year and avoid unnecessary scrambling at year’s end.

For more on how you can improve your clients’ overall financial well-being and manage their tax liabilities, download our step-by-step guide: Uncover Value-Added Planning Through Your Client’s Tax Returns.

This post originally appeared on Commonwealth Independent Advisor, a blog authored by subject-matter experts at Commonwealth Financial Network®, the nation’s largest privately held independent broker/dealer–RIA.

This material has been provided for general informational purposes only and does not constitute either tax or legal advice. Although we go to great lengths to make sure our information is accurate and useful, we recommend you consult a tax preparer, professional tax advisor, or lawyer.


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