Planning Ahead for Your 2015 US Tax Return
As the end of 2015 is fast approaching and we make plans for the upcoming festive season, this is also the time to consider what opportunities exist to optimise your US tax position (or your client’s if you are an advisor) for the 2015 tax year by implementing some effective year-end planning.
The starting point is to understand both your current circumstances and any potential changes in the upcoming 2016 year that may affect your tax position (e.g., marriage, birth, sale of property). Below, we review some fundamental planning techniques and related potential pitfalls that when correctly implemented will optimise your overall US tax position for 2015 and 2016.
Accelerating or deferring income or expenses
Consider the potential benefits of deferring income receipts. For example, employees might choose to defer receipt of any 2015 year-end bonus to 2016 or those who are self-employed might be able to delay collection of payment for services and business debts until early 2016. The deferral of this income from 2015 to 2016 will postpone payment of any related tax liability from the current tax year to the next. Additionally, if there is a chance that your 2016 taxable income is likely to be lower than that of 2015 then any income deferred to the 2016 year may be taxed at lower rate.
Conversely, consider opportunities to accelerate deductions or tax credits of the 2016 year into the 2015 year. For instance, if you generally itemize deductions, making payments of mortgage interest, medical expenses, state and local taxes or other Schedule A deductible items before the end of 2015 (rather than during early 2016) will increase 2015 deductible expenses and therefor reduce your taxable income for the year. Also, if you think you may be claiming the standard deduction in one year and itemizing deductions in the other then deferring or accelerating your Schedule A deductible items may enable you to take the benefit of deductions that might otherwise be lost in a year in which you claim the standard deduction.
Alternatively, if your circumstances are such that you think your 2016 tax rate will be higher than that of 2015 (i.e., as a result of increased salary or intended sale of an asset that will result in a large gain) then consider accelerating income into 2015 and deferring payment of Schedule A deductible items in 2016 to take advantage of these deductions and reduce the amount liable to the higher tax rate in 2016.
Health Savings Account
Consider making a contribution to a Health Savings Account (HSA) before the end of 2015 as the tax benefits for contributions to a HSA are now available to US expatriates. A HSA is a trust account into which tax-deductible contributions can be made by qualified taxpayers who have high deductible medical insurance plans. This deduction is separate from the general Schedule A deductions available for medical insurance premiums and additional unreimbursed medical expenses (which can be restricted depending on the level of your adjusted gross income). This deduction is claimed as part of your above the line deductions in calculating adjusted gross income. The 2015 deductible contribution limits are $3,350 (single, plus $1,000 if age 55) or $6,650 (family, plus $1,000 if age 55).
Other benefits of making a contribution to an HSA account are:
- Income earned on the HSA is tax-free
- The account can then be used to pay “qualified medical expenses” not covered by the medical insurance for an “eligible individual”.
- If the funds are not used in a year they are simply rolled over year on year.
- Finally, when you reach age 65, the HSA can be used like a retirement plan meaning amounts are only taxable when withdrawn, however, the bonus is the account is not subject to a withdrawal penalty. Alternatively, the account can be saved to be used for future medical expenses.
Accelerate Payment of Tax
If for foreign tax credit purposes you are on the “paid basis” then consider increasing the foreign tax credit available to reduce your 2015 tax liability by making a payment towards your foreign income tax liability before the end of the 2015 year. Also, consider making early payment of any real estate taxes and state income taxes that are due in early 2016 prior to the end of 2015 in order to increase your Schedule A deduction.
You may further reduce your 2015 taxable income by making deductible contributions to a traditional IRA and pre-tax contributions to a self-employed pension (SEP IRA). For 2015 you may contribute up to a maximum of $5,500 ($6,500 if you are age 50 or older) to a Traditional IRA plan (deductible or non-deductible) or Roth IRA before April 15, 2016. If you have a SEP plan you may contribute up to $53,000. Prior to making any year-end contributions to your retirement plan you should check your contribution limits for 2015 to avoid excess contributions, which would result in adverse tax consequences.
If you reached age 70½ during 2015 and have a qualified retirement account (IRA accounts, 401ks, 457 plans or other tax-deferred retirement savings plans like a TSA, SEP or SIMPLE) then the IRS requires that you start taking withdrawals from such retirement plans. The Required Minimum Distributions (RMD) is the minimum amount you must withdrawal from your account each year. The first RMD for those reaching 70½ years during 2015 must be taken by April 1, 2016. Any amount withdrawn will form part of your taxable income (except those amounts previously taxed (i.e., your basis) or that can be withdrawn tax-free (i.e., qualified distributions from designated Roth accounts). Depending on your taxable income level it would be prudent to compare the potential tax advantage of timing the first RMD to occur prior to the end of 2015 or alternatively deferring it until April 1st 2016 at the latest. Note: deferring the 2015 RMD until April 1st 2016 will result in two RMDs for the 2016 year.
Potential Pitfalls to Year-End Tax Planning
Alternative Minimum Tax (AMT)
The above suggested consideration regarding acceleration or deferral of income and/or expenses should be made with caution if you are likely to be subject to Alternative Minimum Tax (AMT). AMT is a tax levied in addition and separate to regular federal tax that may nullify the benefits of year-end planning strategies or, in some cases, result in negative tax consequences. This is because the itemized deductions available to reduce the taxable income on which the regular federal tax liability is calculated are disallowed in calculating AMT. Therefore the prepayment of 2016 state and local taxes will not be effective in reducing your overall 2015 tax liability and in fact may increase your overall 2016 liability.
Phase Out of Exemptions and Limitations on Deductions
The benefits of accelerating or deferring income and/or expenses may also be adversely affected by the level of your adjusted gross income (AGI). Personal and dependency exemptions are phased out (or gradually reduced) and itemized deductions limited once your AGI reaches a certain threshold. So depending on the level of your AGI the intended benefits of accelerating or deferring income and/or expenses may be reduced or nullified. For 2015 the phase out of exemptions and limitation of itemized deductions begins when AGI reaches $258,250/$309,900/$154,950/$284,050 (if you file as single/married filing jointly/married filing separately/head of household) and these deductions are phased out entirely when AGI reaches $380,750/$432,400/$216,200/$406,550 (if you file as single/married filing jointly/married filing separately/head of household).
Annual Gift Tax Exclusion
Utilising the annual gift tax exclusion is a tax efficient way of giving to others. For 2015 Individuals may make gifts of up to $14,000 per donee without paying any federal gift tax. As this exclusion amount applies per donee (other than a US citizen spouse) this means that, for example, you can gift the maximum amount of $14,000 to each sibling, child, grandchild, or other third party person prior to the end of 2015 with no gift tax consequences. Furthermore, the annual exclusion amount is doubled to $28,000 for joint gifts made by US citizen spouses. Utilising this annual gift tax exclusion year on year is an efficient way of reducing the assets and therefore taking them out of the estate tax net. Note that if the 2015 annual gift tax exclusion is not utilised it cannot be carried forward to future years.
Any individual gifts made to an individual in excess of the annual gift exclusion must be reported on a gift tax return. However, the gift amount in excess of the annual exclusion can be offset by the lifetime gift tax exemption to reduce the taxable gift. For 2015 the lifetime gift exemption is $5.43 million, however, it is important to note that any part of the lifetime gift exemption utilised against 2015 gifts reduces the amount of the exemption available to reduce your estate tax.
In addition, there is an unlimited marital deduction for any gifts made between US spouses. This means that any assets gifted by a US person to their US spouse is free of gift tax. However, if a gift is made by a US person to a spouse that is not a US person then the unlimited marital exemption is not available but replaced by an annual exclusion which is $147,000 for the 2015 year.
Other Year-End Planning Tips
- Hold on to appreciated assets for 12 months or more prior to sale to take advantage of the lower capital gains tax rate on long term capital gains disposals.
- Sell loss-producing assets to set against any capital gains arising during 2015. Be sure to avoid the “wash sale” rules. These rules apply if you purchase the same or similar assets which were sold at a loss within 30 days before or after the sale.
- Consider making charitable donations that also qualify for tax relief in your country of residence. Caution must be taken here as to qualify as a deduction for US tax purposes the donation must be made to charitable entities registered with the IRS as US qualified charitable organizations.
- Avoid or limit penalties/interest by making estimated tax payment. Note that if your 2015 tax return is not filed with the IRS within 60 days of due date of the return (including extensions for time to file) the penalty for failure to file a tax return is the lesser of $135 or 100% of the tax due.
Making sure you’re organised by having your receipts and tax documents ready will minimize stress and anxiety come February, when the tax filing season opens. Documents to look out for include:
- Receipts for medical expenses (not reimbursed by insurance) and US qualified charitable donations
- Forms 1099 from your brokerage accounts, detailing any gains and losses
- Support for mortgage interest payments or US real estate tax receipts
- Your calendar year payslips
- Interest income generated by non-US accounts
The year-end planning suggestions outlined here are complex and the related benefits are dependent on personal circumstances so please seek advice from one of our Enrolled Agents or CPAs to discuss the available options that may help reduce your US tax liability depending on your personal circumstances.
If you are living outside of the US, you should also take advice on any non-US tax implications, such as exchange rate gains or losses, relating to any of the above as well as general non-US financial advice. Our non-US resident clients should also be aware that planning based on your resident jurisdiction alone is not always beneficial. In many cases any taxes saved in the resident jurisdiction are just an additional tax owed on the US return. Careful planning is required to avoid this trap.