It's that time of year when many of your clients want to discuss tax strategies. But as an advisor, finding ways to help minimize your clients' tax exposure doesn't happen just once a year. With that in mind, you can use the tips below to help reduce your clients' tax bill and—perhaps more important—improve their overall financial outlook.
Evaluate Net Investment Income
For those clients with an adjusted gross income above certain thresholds, the 3.8-percent net investment income tax will come into play. It 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
Here's an example that illustrates how the net investment income 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. Since the 3.8-percent net investment income tax applies 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.
Tax Tip: Be sure to educate your clients regarding what falls under the umbrella of net investment income. It includes, but is not limited to, taxable interest, capital gains, dividends, nonqualified annuity distributions, royalties and rental income, and business income if the taxpayer is a passive participant.
Review Current and Estimated Medicare Contributions
The Medicare contribution 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.
Tax Tip: When reviewing your client's current withholdings or estimated payment amounts, don't overlook the Medicare tax.
Calculate Alternative Minimum Tax (AMT) Liability
The AMT was designed to set a limit on certain tax benefits that can reduce a taxpayer's regular tax amount. Although it has been "permanently" patched (i.e., the income threshold amounts are permanently adjusted for inflation), the AMT can be a liability for many of your high-net-worth clients. The 2017 AMT threshold amounts are as follows:
- $54,300 for single filers
- $84,500 for married taxpayers filing jointly
- $42,250 for married taxpayers filing separately
- $24,100 for trusts and estates
Tax Tip: Here, one strategy is to determine if there could be a benefit in shifting AMT-triggering items from an AMT year to a different year in which your client is not expected to be subject to AMT liability.
Use the Pease Limitation Phaseout
The American Taxpayer Relief Act of 2012 restored the Pease limitation phaseout for itemized deductions. The 2017 Pease threshold amounts for adjusted gross income are $261,500 for single taxpayers and $313,800 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.
Tax Tip: If you do use 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
Perform a Marginal Tax Rate Analysis
Individual income tax rates are 10, 15, 25, 28, 33, 35, and 39.6 percent, and the top rate for long-term capital gains is 20 percent. Fortunately, there are ways to avoid spikes in income and spread the recognition of income over future years.
Tax Tip: One such method is the marginal tax rate analysis. This analysis involves finding the difference between your client's marginal tax rate and his or her effective tax rate. 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, deferring income and accelerating deductions, for example, may allow your client to lower his or her federal income tax burden.
Offset Gains with Tax Loss Harvesting
Tax loss harvesting, a traditional tax planning strategy, can be used to offset current gains or to accumulate losses to offset future gains (which may be taxed at a higher rate). Here, it's important to first evaluate whether the investment qualifies for long- or short-term capital gain and then offset short-term gains with short-term losses and long-term gains with long-term losses.
Tax Tip: When using this strategy, keep the wash sale rule in mind, which prohibits a tax-deductible loss on a security if your client repurchases the same or substantially identical assets within 30 days of the sale.
Tie in Gift and Estate Planning
In 2017, the federal gift tax annual exclusion allows individual taxpayers to 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 the annual exclusion. In addition, the federal estate tax exemption has increased to $5,490,000 in 2017.
Tax Tip: State gift and estate tax laws may differ from the federal provisions and play an important role in gift and estate tax planning for many taxpayers. Be sure to investigate how the state provisions may affect your clients' planning—and consult with a qualified tax advisor for guidance.
Plan Charitable Giving Using IRAs
Thanks to the Protecting Americans from Tax Hikes (PATH) Act of 2015, taxpayers can make qualified charitable distributions from IRAs. This means that those clients who are 70½ or older may make tax-free distributions directly from an IRA or Roth IRA to a qualified charity. The maximum donation is limited to $100,000 per person.
Tax Tip: Excluding the IRA distribution from income will lower adjustable gross income, plus help high-income clients eliminate or minimize the 3.8-percent net investment income tax and the phaseout of itemized deductions.
Convert Traditional IRAs to Roth IRAs
While the original owner is alive, Roth IRA balances are not subject to required minimum distributions.
Tax Tip: In years where income may be lower or if your client anticipates a higher tax rate in later years, converting a traditional IRA to a Roth IRA makes sense.
It’s important to keep abreast of the events that affect not only your clients’ personal lives but also their tax returns. For example:
- Birth of a child
- Change in marital or filing status
- Change in dependent status
- Support payments, such as alimony or child support
- Employment changes
- Changes to medical expenses
Tax Tip: Be sure to review changes in personal circumstances on an ongoing basis to determine the potential impact on your client's tax return.
Stay Ahead of the Game
To help your clients prepare for tax season and beyond, it's important to stay ahead of the game. 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.
What strategies do you use to minimize clients' tax exposure? Have do you keep track of changes in your clients’ lives? Share your thoughts below!
Editor's Note: This post was originally published in February 2016, but we've updated it to bring you more relevant and timely information.
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.