Time is Running Out to Implement Year-End Strategies

Dec 21st 2015
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Nowadays, financial planning throughout the year – with an eye particularly on taxes – isn't just for the wealthy. Advance planning is also rewarding for most middle-income individuals.

Spend a few hours plotting how to choose and implement your year-end strategies, and you may be pleasantly surprised to discover how many IRS-blessed opportunities there are to save on your taxes for this year and even gain a head start on next year. The main thing is to act before Dec. 31 while there's still time to take advantage of tax angles that can generate a dramatic savings if you understand how to get the full benefit of what the law allows.

Once we are beyond Dec. 31, it's generally too late to do anything but file Form 1040 on the basis of what took place during the preceding year. There are a few exceptions – for instance, deductible contribu­tions to traditional IRAs and other retirement plans that reduce taxes for the prior year.

The key to successful planning. You need to know and keep reminding yourself of two numbers: One is your top tax bracket (the highest rate at which you pay taxes) for ordinary income from such sources as salaries, interest, and pensions. The other is your top tax rate for long-term capital gains and dividends.

Tax brackets for individuals. For 2015, there are seven brackets – 10, 15, 25, 28, 33, 35, and a top bracket of 39.6 percent (introduced in 2013).

Actually, the official rates are less than the true top rates for millions of upper-middle and high-income individuals who owe the Medicare surtax on investment income or the surtax on earnings, or who are subject to phase-outs for dependency exemptions and most itemized deductions because their adjusted gross incomes exceed specified amounts that are adjusted each year to reflect inflation.

Rates for long-term capital gains and dividends. The taxes on ordinary income from sources like salaries and interest don't apply to long-term capital gains and dividends. For 2015, there are three tiers of rates for capital gains and dividends. The rate continues to be zero percent for individuals in the two lowest brackets of 10 and 15 percent, meaning taxable income below $74,900 for married couples filing jointly, $37,450 for single individuals and married couples filing separately, and $50,200 for heads of households.

The 15 percent rate remains for those in the next income tier. That means income between $74,900 and $464,850 for joint filers, $37,450 and $413,200 for single filers, $50,200 and $439,000 for heads of households, and $37,450 and $232,425 for married couples filing separately.

There's an increase from 15 to 20 percent in the top rate for those in the tax bracket of 39.6 percent. That means income above $464,850 for joint filers, $413,200 for single filers, $439,000 for heads of households, and $232,425 for married couples filing separately.

The top rate continues to be 28 percent for long-term gains from sales of so-called collectibles and 25 percent for gains from sales of real estate attributable to depreciation.

Why your tax bracket matters. There could be a double whammy when the receipt of additional income moves you into a higher bracket. Suppose some or all of what you receive from salaries and other kinds of ordinary income gets taxed at a higher rate – 25 percent, instead of 15 percent. If that happens, you lose out on the zero percent rate for dividends and long-term capital gains, a break that's available only if you're in a bracket of 10 percent or 15 percent.

Ditto when additional ordinary income gets taxed at 39.6 percent. The rate for dividends and long-term gains goes from 15 percent to 20 percent.

Parents, grandparents, and other wannabe benefactors in the upper-income tax brackets should think about shifting investment income from themselves to children, grandchildren, and other family members in the bottom two brackets by making gifts to them of stocks, mutual-fund shares, and other kinds of income-producing property that have appreciated in value over the years.

Beware the alternative minimum tax. The preferential rates for dividends and long-term capital gains also apply for calculating the alternative minimum tax (AMT) on these two sources of income. The AMT is a highly complex levy originally structured to ensure the payment of at least something by even the wealthiest individuals able to avail themselves of the most sophisticated tax breaks.

To make payment of some taxes more likely, the AMT counts more items as reportable income and allows fewer write-offs than under the regular method used to calculate liability. AMT disallowances include exemptions for dependents, the standard deduction, and such itemized deductions as state and local income, property and sales taxes and most miscellaneous expenses, a broad-ranging category that includes things like dues for professional associations, and payments to investment advisors and return preparers. The AMT also prohibits deductions for interest on home-equity loans obtained for reasons other than to acquire, construct, or substantially improve first or second homes.

Related articles:

Year-End Tactics to Reduce the 3.8% Surtax on Unearned Income
The ABCs of the Alternative Minimum Tax: Strategies for Your Clients

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