As this year’s Thanksgiving festivities approach, we at US Tax & Financial Services are looking forward to enjoying the relative respite that the holiday season brings. As always, the final months of the year also provide an opportunity to focus on year-end tax planning opportunities available to optimise US tax for 2016.

The starting point of any effective year-end tax planning is to understand both current circumstances and subsequent year issues that may affect a tax position.  This article reviews some fundamental planning techniques and related potential pitfalls regarding the 2016 and 2017 tax years.

Basic Considerations:

Accelerating or deferring income or expenses:

Consider the potential benefits of deferring income receipts. For example, employees might choose to defer receipt of any 2016 year-end bonus to 2017 or those who are self-employed might be able to delay collection for payment for services and business debts until early 2017. The deferral of this income from 2016 to 2017 will postpone payment of any related tax liability from the current tax year to the next. Additionally, if there is a chance that circumstances could change, such that 2017 taxable income is likely to be lower than that of 2016, then any income deferred to the 2017 year may be taxed at lower rate.

Conversely, consider opportunities to accelerate deductions or tax credits of the 2017 year into the 2016 year. For instance, for itemized deductions, making payment of mortgage interest, medical expenses, state and local taxes or other Schedule A deductible items before the end of 2016 (rather than during early 2017) will increase 2016 deductible expenses and, therefore, reduce taxable income for the year. Also, if claiming the standard deduction in one year and itemizing deductions in the other then deferring or accelerating Schedule A deductible items may enable the benefit of deductions that might otherwise be lost in a year in which the standard deduction is claimed.

Alternatively, if circumstances are such that that the 2017 tax rate will be higher than that of 2016 (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 2016 and deferring payment of Schedule A deductible items to 2017, when these deductions would offset income subject to tax at higher rates than in 2016.

Health Savings Account:

Consider a contribution to a Health Savings Account (HSA) before the end of 2016 as the income tax deduction for contributions to an HSA Plan are also 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 expense deductions available for medical costs which are subject to restrictions based on the level of adjusted gross income. The 2016 HSA deductible contribution limits are $3,350 (single, plus $1,000 if age 55) or $6,750 (family, plus $1,000 if age 55).

Accelerate Payment of Tax:

If the “paid basis” is utilized for foreign tax credit purposes consider increasing the foreign tax credit available to reduce 2016 tax liability by making a payment towards foreign income tax liability before the end of the 2016 year. In addition, making early payment of any real estate taxes and state income taxes that are due in early 2017 prior to the end of 2016 will increase available Schedule A deductions.

Retirement Planning:

2016 taxable income may be further reduced by making a contribution to a traditional IRA or a SEP IRA (self-employed pension).

For 2016 a contribution of up to a maximum of $5,500 ($6,500 if age 50 or older) to a traditional IRA plan or $53,000 to a SEP IRA.  Depending on the circumstances, the traditional IRA contribution may be a deductible or non-deductible.  A tax advisor can confirm availability of an IRA or SEP IRA contribution and the amount that can be contributed.  It should be noted that there are potential penalties if the allowable contribution limits to an IRA plan are exceeded and the contribution is not withdrawn within prescribed time limit.

Contributions to IRS plans for 2016 can be made up to April 15, 2017.

For those reaching age 70½ during 2016 who have a qualified retirement account (IRA accounts, 401ks, 457 plans or other tax-deferred retirement savings plans like a TSA, SEP or SIMPLE) the IRS requires that you start taking withdrawals from such retirement plans. The Required Minimum Distributions (RMD) is the minimum amount that must be withdrawn from the account each year. The first RMD for those reaching 70½ years during 2016 must be taken by April 1, 2017. Any amount withdrawn will form part of the taxable income (except those amounts previously taxed) or that can be withdrawn tax-free (i.e. qualified distributions from designated Roth accounts). Depending on the situation, it may be prudent to compare the potential tax advantage of timing the first RMD to occur prior to the end of 2016 or alternatively deferring it to 2017 (by April 1^st at the latest).

Potential Pitfalls to Year-End Tax Planning

Alternative Minimum Tax (AMT)

The consideration regarding acceleration or deferral of income and/or expenses outlined above should be made with caution if subjected 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.

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 adjusted gross income (AGI). Personal and dependency exemptions are phased out (gradually reduced) and itemized deductions limited once AGI reaches a certain threshold. So depending on the level of AGI the intended benefits of accelerating or deferring income and/or expenses may be reduced or nullified. For 2016 the phase out of exemptions and limitation of itemized deductions begins when AGI reaches $259,400-Single, $311,300-Married, $155,650-Married Separate, $285,350-Head of Household and these deductions are phased out entirely when AGI reaches $381,900, $433,800, $216,900, $407,850.

Gifting

Annual Gift Tax Exclusion

The annual gift tax exclusion is a tax efficient way of giving to others. For 2016, individuals may make gifts of up to $14,000 per donee without paying any federal gift tax. Furthermore, the annual exclusion amount is doubled to $28,000 per donee for joint gifts made by US citizen spouses. Utilizing this annual gift tax exclusion year on year is an efficient way of reducing gross estate for estate tax purposes. Note: There is no carryover of unused gift exclusion.

Gifts made to individual donees exceeding the annual exclusion amounts must be reported by the donor on a gift tax return. The gift amount in excess of the annual exclusion can be offset by the lifetime gift tax exemption to reduce/eliminate any potential gift tax. For 2016 the lifetime gift exemption is $5.45 million, however, it is important to note that any part of the lifetime gift exemption utilized against 2016 gifts reduces the amount of the exemption available to reduce estate tax.

It should be noted that there is an unlimited marital deduction for any gifts made between US citizen 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 citizen to a non-resident alien spouse then the unlimited marital exemption is not available and is instead replaced by an annual exclusion which is $148,000 for the 2016 year.  Any gift over this amount to a non-resident spouse is required to be reported on a gift tax return by the US spouse.

Other Year-End Planning Considerations:

Hold on to appreciated assets for 12 months or more prior to sale to take advantage of the lower long-term capital gains tax rate.

Sell loss-producing assets to set against any capital gains arising during 2016. Be sure to avoid the “wash sale” rules. These rules apply if a purchase is made of 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 the 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 organization.

Avoid or limit penalties/interest by making estimated tax payments. Note: If 2016 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.

2016 Report of Foreign Bank & Financial Accounts (FBAR):

As most US taxpayers are aware if an individual has a financial interest in or signature authority over a foreign financial account (i.e. a bank account, a brokerage account, mutual funds, trusts, or other types of foreign financial account) and the aggregate value of all such accounts exceeds $10,000 at any time during a calendar year, the Bank Secrecy Act requires the reporting of any such account(s) to the Department of Treasury by electronically filing a Financial Crimes Enforcement Network (FinCEN) Form 114, Report of Foreign Bank and Financial Accounts (FBAR).

For the 2016 and later tax years, the enactment of Surface Transportation and Veterans Health Care Choice Improvement Act of 2015 modified the FBAR filing deadline date from 30 June following the end of the tax year to 15 April following the end of the tax year.  However, the FBAR deadline is extended based on the extended due date of your tax return.  Therefore, those resident outside of the US on 15 April 2017 have until 15 June 2017 to file the 2016 FBAR.  The deadline to file the FBAR will extend to October 15^th if an extension to file your tax return is submitted.

As always, those who must file FBARs must be mindful of the potential penalties for non-compliance (i.e. up to $10,000 per account for a non-willful violation, and up to the higher of $100,000 per account or 50% of the balance of the account for a willful (or intentional) violation).

The year-end planning suggestions outlined above are complex and the related benefits are dependent on personal circumstances so advice should be taken by of one of our Enrolled Agents or CPAs to discuss the available options that may help reduce US tax liability depending on personal circumstances.  

Individuals living outside of the US 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. However, non-US resident individuals should also be aware that tax planning considering 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.

Contact us if you wish to discuss your specific situation.