Your 2016 taxes may increase because the amount allowed for exemptions is reduced as AGI increases above certain amounts, depending on filing status. You may also have to pay an additional Medicare tax of .9% on wages and an additional 3.8% tax on net investment income (investment income less related expenses) for taxpayers with MAGI (adjusted gross income plus non taxable foreign income). The threshold amount depends on your filing status. If you expect your income to be in these ranges, increase your withholding or 4th quarter estimated tax payment—due by January 15—to avoid the underpayment penalty.
The penalty is charged if taxes paid-in are less than 90% of current year or 100% of the prior year (110% if AGI was more than $150,000). To avoid a penalty for 2016, increase your withholding for November and December Any tax withheld at any point during the year is treated as if paid evenly over the year. You can also increase your fourth quarter estimated tax payment due January 15.
The two biggest ways to lower your 2016 taxes are to increase your deductions before the end of the year or decrease your income subject to tax. The following are ways to minimize your 2016 taxes.
(1) Make additional charitable contributions of cash or property-particularly unwanted household items and clothing. An excellent way to increase non-cash contributions is to make gifts of appreciated property, particularly securities. By doing this, you receive a donation for the fair value on the date of the gift. The big advantage of doing this instead of selling it and make a cash donation is not having to pay tax on the gain. If you do this, discuss with your broker which securities would be best to donate. Your broker will take care of transferring the securities to your designated charity.
(2) Make a contribution to your traditional IRA or SEP (you have until April 15, 2017 to make a contribution for the 2016 tax year).
(3) Pay health insurance premiums and other medical expenses in 2016 instead of next year. The 2016 threshold for medical expenses is 10% of AG I (7.5% for taxpayers 65 or over).
(4) Make the January payments for your mortgage, mortgage insurance, and 2017 property taxes in December. If you pay these by escrow, have the mortgage holder to take them out in December.
(5) Make a contribution to your “cafeteria plan” or Health Savings Account (HSA) [flexible spending arrangement] before the end of 2016. Contributions for 2016 for individuals are limited to $3,350 ($6,650 for employees with a family) to pay medical or dependent care expenses. For taxpayers 55 or older, an additional $1,000 may be contributed. Over-the-counter medications,, unless prescribed by a doctor, can not be paid with HSA contributions. Your contributions reduce your W-2 and self employment income and federal income and social security or self employment tax) taxes withheld. A HSA allows you to pay medical expenses with pre-tax dollars instead of after-tax dollars [medical expense are reduced by 10% (7.5% if 65 or over)] of AGI). Be sure to use all your contributions before December 31 because any remaining amount in your account at the end of 2016 will be forfeited to your employer but taxpayers can carry over unused amounts up to $500 to future years if your employer allows. If you don’t expect to use the full amount in your HSA, check with your employer to see if they will approve a carryover. You may also take a deduction for a HSA contribution from after-tax income which is deductible FOR AGI.
(6) Sell securities with an unrealized loss to offset already realized capital gains. You can deduct capital losses in excess of capital gains up to $3,000 against other income. Any unused capital losses can be carried forward indefinitely to reduce capital gains and other income in future years. Wait until 2017 to sell securities with realized gains unless you already have large realized losses this year.
(7) Increase contributions to your tax deferred 401(k), 403(b), 457 government plan, or SEP plans before the end of the year, Contributions reduce salaries or self-employment income which reduces the income and self-employment tax (for a SEP contribution).
(8) Have your bonus or pay raise or expected self employment income deferred to 2017 unless you expect to be in a higher tax bracket.
(9) Pay dependent care expenses in 2016 to increase your allowable dependent care credit. Credits reduce your tax, whereas deductions reduce income subject to tax.
(10) Pay 2017 student loan interest in 2016 which is a deduction FOR AGI. But to deduct it, you must be the person responsible for the loan.
(11) You may exclude from income canceled debt from a qualified principal residence.
(12) Pay 2017 college tuition and fees for yourself, your spouse, and dependents in 2016. Unless you or your spouse’s education expenses are business related (these are a miscellaneous itemized deduction), they are deductible FOR AGI. In lieu of a deduction you may be eligible for a credit which may reduce your taxes more than a deduction. Forty percent of The American Opportunity Credit is refundable. For more information, see the author’s article “Tax Credits for Education Expenses”.
(14) If you received a large refund last year and expect to have about the same income this year, income tax withheld. The IRS has a withholding calculator on its web page (IRS.gov).
(15) When you are 70 ½, you are required to take a minimum distribution every year from your traditional IRA or tax deferred retirement plan, unless you are still working. The amount required to be withdrawn is the balance in all IRAs at the end of the previous tax year multiplied by a IRS mortality factor. Your retirement plan or IRA administrator can tell you how much it is. In the year you are 70 1/2, you have until April 15 of the following tax year to take it. In future years, it must be taken by December 31. If you do not take the required minimum distribution, you will have to pay a penalty of 50% of the difference between the required minimum distribution and the amount taken.
(16) If you are taking a minimum distribution from your traditional IRA, you are allowed to designate all or part of it to be donated to charity. This reduces the amount you are taxed on but you cannot also take a deduction for the charitable contribution. The contribution must be made directly by the plan administrator to the designated charity on your behalf. If you receive the distribution, it will be taxable and any contribution must be taken as an itemized deduction. A donation from the minimum distribution is very beneficial for taxpayers who take the standard deduction. Check with your IRA administrator regarding this.
(17) Make energy-related expenditures in 2016 to increase the allowable energy credit. The total credit for tax years 2006-2016 is limited to $500. But if you have not used the full $500 in prior years, you can use the balance in 2016. The items must be installed in your primary residence in the U.S., meet government energy-efficient ratings, and have an expected life span of at least five years. To substantiate the credit you must have the Manufacturers Certification Statement with a receipt. You can obtain information on energy items and ratings at energystar.gov. Qualifying items are:
- Insulation or insulating materials-10% of cost.
- Exterior windows or skylights-10% of cost, up to $200.
- Exterior doors-10% of cost, up to $200.
- Metal roof with pigmented coating or asphalt roof with cooling granules-10% of cost.
- Advanced main air circulating fan-up to $50.
- Natural gas, propane, or oil furnace or hot water boiler-up to $150. The item must have an “energy factor” of at least .92 or a thermal efficient rating of at least 90%.
- Electric heat pump water heater-up to $300.
- Electric heat pump, natural gas, propane, or oil water heater and central air system up to $300.
- Biomass stove-up to $300. It must have a thermal efficient rating of at least 75%.
(18) Taxpayers who, live in a state without an income tax can instead deduct sales tax. Also, the sales tax deduction can be taken if it exceeds the state income tax paid during the year. The IRS publishes tables to compute the sales tax based on AGI. Tax return preparation software will automatically compute it. In addition to the standard amount, you can deduct amounts paid on large purchases (e.g., a car, boat, appliances, furniture).
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