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Also see: In-Depth Article: CPA Year-End Tax Planning for Businesses 2015.

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In-Depth Article: CPA Year-End Tax Planning for INDIVIDUALS 2015.

(Parker Tax Publishing November 8, 2015)

Parker's annual series on year-end tax planning recaps 2015's major changes affecting individual taxpayers, and strategies clients can use to minimize their 2015 tax bill.

Introduction

Just as the daylight hours are getting shorter, so is the time for practitioners to fine tune any last-minute strategies to lower their clients' 2015 tax bill. While year-end legislation extending certain expired tax benefits may still come to pass and be of benefit to individual taxpayers, there are other options practitioners should explore for potentially lowering a client's taxes. Often, the correct steps to take will depend on whether the client's income is predicted to go up or down next year.

CLIENT LETTERS for both individuals and businesses are available online now:

Practice Aid: Keep your clients informed. Use Parker Tax 2015 CPA Client Letters as templates or just sign your name at the bottom. Take a look at our CPA Client Letter: Year-End Tax Planning for 2015 for INDIVIDUALS. and CPA Client Letter: Year-End Tax Planning for 2015 for BUSINESSES.

It's important that practitioners meet with clients before the end of the year to nail down any actions that may be appropriate with respect to their 2015 tax return. The following is a recap of changes affecting individual taxpayers in 2015, and a discussion of some tax strategies that practitioners may want to consider.

Income Subject to Top Tax Rate

For 2015, the top tax rate of 39.6% will apply to incomes over $413,201 (single), $464,851 (married filing jointly and surviving spouse), $232,426 (married filing separately), and $439,000 (heads of households). However, high-income taxpayers are also subject to the 3.8 percent net investment income tax and/or the 0.9 percent Medicare surtax. If clients are subject to one or both of these additional taxes, there are certain actions practitioners should discuss that can mitigate the damage of these additional taxes.

Retirement Plans Considerations

Fully funding a company 401(k) with pre-tax dollars will reduce current year taxes, as well as increase retirement nest eggs. For 2015, the maximum 401(k) contribution taxpayers can make with pre-tax earnings is $18,000. For taxpayers 50 or older, that amount increases to $24,000.

For taxpayers with a SIMPLE 401(k), the maximum pre-tax contribution for 2015 is $12,500. That amount increases to $15,500 for taxpayers age 50 or older.

If certain requirements are met, contributions to an individual retirement account (IRA) may be deductible. For taxpayers under 50, the maximum contribution amount for 2015 is $5,500. For taxpayers 50 or older but less than age 70 1/2, the maximum contribution amount is $6,500. Contributions exceeding the maximum amount are subject to a 6 percent excise tax. Even if a client is not eligible to deduct contributions, contributing after-tax money to an IRA may be advantageous because it will allow the client to later convert that traditional IRA to a Roth IRA. Qualified withdrawals from a Roth IRA, including earnings, are free of tax, while earnings on a traditional IRA are taxable when withdrawn.

If a client already has a traditional IRA, practitioners should evaluate whether it is appropriate to convert it to a Roth IRA this year. The client will have to pay tax on the amount converted as ordinary income, but subsequent earnings will be free of tax. And if the client has a traditional 401(k), 403(b), or 457 plan that includes after-tax contributions, a new rule allows him or her to generally rollover these after-tax amounts to a Roth IRA with no tax consequences. A rollover of a SIMPLE 401(k) into a Roth IRA may also be available. As with all tax rules, there are qualifications that apply to these rollovers that practitioners should discuss before their clients take any actions.

Additionally, the Treasury Department has introduced a starter retirement account known as "myRA," into which taxpayers may deposit tax refunds. The program allows individuals to establish a Roth IRA with a Treasury Department designated custodian. Taxpayers can continue to participate in the program until the account balance reaches $15,000 or until he or she has participated in the program for 30 years, whichever occurs first. At any time, individuals can transfer the balance to a commercial financial services provider to take advantage of a broader array of retirement products available in the marketplace. Because the accounts offered through the program are Roth IRAs, they have the same tax treatment and follow the same rules as Roth IRAs.

Finally, self-directed IRAs allow an IRA owner to have more control over the type of investments that will be held in the IRA. However, the large amount of money held in self-directed IRAs makes them attractive targets for fraud promoters. Thus, self-directed IRA can be costly if not properly managed. In addition, because of the types of investments taxpayers with self-directed IRAs are able to make, taxpayers have a greater risk of running afoul of the prohibited transaction rules. The prohibited transaction rules impose an excise tax on certain transactions - such as sales of property, the lending of money or extension of credit, or the furnishing of goods, services, or facilities - between an IRA and a disqualified person. If a client has a self-directed IRA, practitioners need to review the specifics of the arrangement.

Net Investment Income Tax Considerations

A 3.8 percent tax applies to certain net investment income of individuals with income above a threshold amount. The threshold amounts are $250,000 (married filing jointly and qualifying widow(er) with dependent child), $200,000 (single and head of household), and $125,000 (married filing separately). In general, investment income includes, but is not limited to: interest, dividends, capital gains, rental and royalty income, non-qualified annuities, and income from businesses involved in trading of financial instruments or commodities. Thus, while the top tax rate for qualified dividend income is generally 20%, the top rate on such income increases to 23.8% for a taxpayer subject to the net investment income tax.

One way around the increased tax rate on dividend income is to invest instead in tax-exempt state and municipal bonds. The bonds generate tax-exempt income which isn't subject to the net investment income tax and is not included in determining if taxpayers meet the threshold amount for being subject to the net investment income tax. Note, however, that such income may be subject to state taxes and the alternative minimum tax. Additionally, taxpayers selling an appreciated asset, the gain from which will exceed the threshold amount for being subject to the net investment income tax, should consider selling the asset on an installment basis.

The net investment income tax also applies to income from trades or businesses that are passive activities. An activity is not generally considered passive if the taxpayer materially participates in the activity. If a client is engaged in an activity which may be considered passive and thus has the potential to trigger the net investment income tax, practitioners should evaluate the factors for determining material participation to see if they can help the client escape this tax. Finally, since net capital losses can be used against capital gains, taxpayers may want to consider getting rid of some losing stocks. Additional Medicare Taxes

An additional Medicare tax of 0.9 percent is imposed on wages and self-employment income in excess of a threshold amount. The threshold amount is $250,000 in the case of a joint return or surviving spouse, $125,000 in the case of a married individual filing a separate return, and $200,000 in any other case. Employers are required to withhold the extra .9 percent once an individual's wages pass $200,000. No deduction is allowed for the additional tax. However, married taxpayers may be due a credit if, for example, they use the married filing jointly status, one spouse had wages over $200,000, but joint wages are less than $250,000. On the flip side, married taxpayers may owe the additional .9 percent if they file jointly and each made under $200,000 of wages but together made over $250,000 in wages.

AMT Considerations

Because many deductions taken for regular tax purposes are not allowed for alternative minimum tax (AMT) purposes, clients may be subject to the AMT if he or she has excessive deductions. Deductions which typically throw taxpayers into an AMT situation include high state and local taxes, interest on home equity loans, a high number of dependent deductions, and a large amount of miscellaneous itemized deductions. For 2015, the AMT rate is 26% on alternative minimum taxable income (AMTI) up to $185,400 ($92,700 for married filing separately) and 28% on AMTI over that amount. Taxpayers are allowed an AMT exemption depending on filing status, but the exemption is phased out for taxpayer's above a certain income level.

If it looks like a client may be subject to the AMT this year, practitioners should discuss what actions can be taken to reduce his or her exposure. Since the calculation of the AMT begins with adjusted gross income, lowering a clients adjusted gross income by maximizing contributions to a tax-deferred retirement plan (e.g., 401(k)) or tax-deferred health savings account may be appropriate. Additionally, if a client uses his or her home for business, related expenses (e.g., a portion of the property taxes, mortgage interest, etc.) allocable to Schedule C will also reduce adjusted gross income.

American Opportunity Credit

If a client, his or her spouse, or a dependent incurred qualified education expenses to attend an accredited postsecondary institution (e.g., a college or university), he or she may be eligible for the American Opportunity Credit. The maximum annual credit is $2,500 per eligible student. Expenses which qualify for the credit include tuition and fees required for the enrollment or attendance at an eligible educational institution. For taxpayers with modified adjusted gross income in excess of $80,000 ($160,000 for joint filers), the amount of the credit is phased out. The credit is not available for married taxpayers filing separately.

Obamacare Considerations

Under Obamacare, there is a penalty, known as the "shared responsibility payment," for not having health insurance coverage. Clients who did not have health insurance for two or more months in 2015 may be liable for this penalty. However, clients may be eligible for an exemption from the penalty depending on their income. The penalty is 2 percent of the client's 2015 income or $325 per adult, whichever is higher, and $162.50 per uninsured dependent under 18, up to $975 total per family.

Extension of the Health Coverage Tax Credit

Taxpayers who receive benefits under certain trade adjustment assistance (TAA) programs or benefits from the Pension Benefit Guaranty Corporation (PBGC) generally are allowed a credit for a percent of amounts paid for qualified health insurance coverage. This Health Coverage Tax Credit (HCTC) was set to expire at the end of 2013 but was extended and modified by the Trade Preferences Extension Act of 2015. The HCTC can now be claimed for coverage through 2019.

Compliance Tip: Unfortunately, taxpayers who wish to claim the credit for 2014 must wait for IRS guidance. The credit cannot be claimed using an old or altered Form 8885 because, while the new law is similar to the version that expired in 2013, it includes modifications that affect how the credit is administered.

Child Tax Credit

The Trade Preferences Extension Act also added a provision which limits the refundable portion of the child tax credit for taxpayers who elect to exclude foreign earned income from tax.

Tax Extenders Legislation

Additional tax benefits may be available if Congress passes Tax Extender legislation introduced in the Senate in August. That legislation would retroactively extend many tax breaks that expired in 2014. If it passes, the bill will extend the following tax breaks through 2016:

the deduction by elementary and secondary school teachers of up to $250 of qualified expenses they paid during the year ($500 on a joint return if both spouses were eligible educators) and expand the deduction to include expenses in connection with the professional development activities of an educator;

the exclusion from income of imputed income from the discharge of acquisition indebtedness for a principal residence;

the equalization of the tax exclusion for employer-paid mass transit and parking benefits and expands such exclusion to include bike sharing programs;

the tax deduction for mortgage insurance premiums;

the tax deduction for state and local general sales taxes in lieu of state and local income taxes;

the tax deduction for contributions of property made for conservation purposes;

the deduction from gross income for qualified tuition and related expenses; and

the tax-free distributions from IRAs for charitable purposes.

Other Steps to Consider Before the End of the Year

The following are some of the additional actions practitioners should review before year end to see if they make sense for clients. The focus should not be entirely on tax savings. These strategies should be adopted only if they make sense in the context of the client's total financial picture.

Accelerating Income into 2015

Depending on the client's projected income for 2016, it may make sense to accelerate income into 2015 if the client expects 2016 income to be significantly higher. Options for accelerating income include:

(1) harvesting gains from the client's investment portfolio, keeping in mind the 3.8 investment income tax;

(2) as previously mentioned, converting a retirement account into a Roth IRA and recognizing the conversion income this year;

(3) taking IRA distributions this year rather than next year;

(4) for self-employed clients with receivables on hand, trying to get clients or customers to pay before year end; and

(6) settling lawsuits or insurance claims that will generate income this year.

Deferring Income into 2016

There are also scenarios (for example, if the client thinks that his or her income will decrease substantially next year) in which it might make sense to defer income into 2016 or later years. Some options for deferring income include:

(1) if a client is due a year-end bonus, having the employer to pay the bonus in January 2016;

(2) if a client is considering selling assets that will generate a gain, postponing the sale until 2016;

(3) delaying the exercise of any stock options;

(4) if a client is selling property, considering an installment sale; and

(5) parking investments in deferred annuities.

Deferring Deductions into 2016

If a client anticipates a substantial increase in taxable income, practitioners may want to explore pushing deductions into 2016 by looking at the following:

(1) postponing year-end charitable contributions, property tax payments, and medical and dental expense payments, to the extent deductions are available for such payments, until next year; and

(2) postponing the sale of any loss-generating property.

Accelerating Deductions into 2015

If a client expects his or her income to decrease next year, accelerating deductions into the current year can offset the higher income this year. Some options include:

(1) prepaying property taxes in December;

(2) making January mortgage payment in December;

(3) if a client owes state income taxes, making up any shortfall in December rather than waiting until the return is due;

(4) since medical expenses are deductible only to the extent they exceed 10 percent (7.5 percent for individuals age 65 before the end of the year) of adjusted gross income (AGI), bunching large medical bills not covered by insurance into one year to help overcome this threshold;

(5) making any large charitable contributions in 2015, rather than 2016;

(6) selling some or all loss stocks; and

(7) if a client qualifies for a health savings account, setting one up and making the maximum contribution allowable.

Life Events

Certain life events can also affect a client's tax situation. If the client got married or divorced, had a birth or death in the family, lost or changed jobs, retired during the year, should discuss the tax implications of these events.

Miscellaneous Items

Finally, these are some additional miscellaneous items to consider:

(1) Encourage clients that have a health flexible spending account with a balance to spend it before year end (unless their employer allows them to go until March 16, 2016, in which case they'll have until then). Clients may want to check with their employer to see if they give the optional grace period to March 15.

(2) If a client owns a vacation home that he or she rented out, practitioners should look at the number of days it was used for business versus pleasure to see if there are ways to maximize tax savings with respect to that property. For example, if the client spent less than 14 days at the home, it may make sense to spend a few more days and have the house qualify as a second residence, with the interest being deductible. For a rental home, rental expenses, including interest, are limited to rental income.

(3) Practitioners should also consider if there is any income that can be shifted to a child so that the income is paid at the child's rate.

(4) If a client has any foreign assets, there are reporting and filing requirements with respect to those assets. Noncompliance carries stiff penalties.

(Staff Editor Parker Tax Publishing)

Also see: CPA Client Letter: Year-End Tax Planning for 2015 for INDIVIDUALS.

Also see: CPA Client Letter: Year-End Tax Planning for 2015 for BUSINESSES.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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