Tax planning should be continuous. However, many people procrastinate, waiting until near the end of the year to determine what might be done to reduce or defer taxes. Tax planning is dependent upon individual circumstances, and the considerations discussed below are not universally applicable. That said, these topics are worth discussing with your CPA so that you might take advantage of these tax strategies while pursuing your non-tax objectives.
Income planning is a major area of concern in tax planning.
Some people can defer income, which can reduce this year’s tax burden. Contributing to a retirement plan is one such opportunity. You may find it difficult to forgo part of your paycheck, but doing so builds a financial base for your future, and reduces the taxes you will pay this year.
Likewise, an installment sale may allow you to reduce this year’s tax burden. You can spread the gain from your sale across multiple years and avoid a lump sum that would cause an anomalous spike in your tax bracket. However, this tax advantage may not be feasible if you need the proceeds immediately.
You should still take care to plan the timing of the sale. If you sell this year, gain will be reported by April 2018. However, you can wait until 2019 if the sale occurs next January or later.
Another consideration for your income tax plan is what deductions you will take.
The standard deduction is $6,350 for an individual, and $12,700 for a married couple filing jointly.
You should discuss with your CPA what expenses you have that count as itemized deductions to determine if itemizing deductions would provide you more than the standard deduction.
You may be able to “bunch” expenses in one year to increase the amount by which your itemized deductions exceed the standard deduction.
This strategy could produce some years with large itemized deductions and some years in which you take the standard deduction. Bunching is the type of technique that shows tax planning is a continuous effort. Whether this technique will benefit you depends on your individual circumstance.
Your health needs might become part of your deduction strategy. Qualifying medical expenses in excess of 10% of your adjusted gross income (AGI) may be taken as an itemized deduction.
Bunching procedures would increase the tax benefit. However, there is greater advantage to those able to utilize a flex spending account (FSA), health reimbursement account (HRA), or health savings account (HSA).
These plans allow pre-tax dollars to be used for medical costs and, thus, are more tax efficient than itemized deduction.
Be sure to use your FSA benefit each year because you lose it if you do not use it. If your employer does not offer an FSA or HRA, you should consider what benefits you might realize by finding an HSA provider.
Whichever strategy you pursue, be sure not to allow tax consequences to determine when to have a necessary procedure. Your health comes first. But if timing of a procedure is flexible, you should consider the tax efficiency of your schedule.
Charitable giving is another avenue to coordinate your tax and non-tax goals. You may deduct up to half of your AGI for amounts contributed to charity, though a 30% or 20% may apply depending on the type of organization or donation. (Further limitations may apply depending on your AGI, i.e. if above $261,500 for an individual, $313,800 for a married couple.)
Donations must be made to qualified organizations, and you must have records to substantiate your deduction.
The organization must give you a written statement if you make a payment that is partly a donation and partly a payment for goods and/or services. Further, to claim a single donation of $250 or more, you need an acknowledgement from the organization.
When considering your charitable contributions, you should determine what you intend to give to charity and then figure when you might receive the greatest impact from making the donation.
Pending tax reform should be considered when crafting your tax plan. The president’s proposal for tax reform includes eliminating itemized deductions. Whether this will occur is uncertain, like all legislative action.
However, it might be best to bunch your itemized deduction this year considering the president’s declared intentions. You might also defer income to 2018 because the president said he intends to reduce tax rates.
Ask your CPA how you should prepare in the face of this pending change.
Estate planning is an important part of your overall tax and non-tax planning.
An estate plan involves non-tax matters such as appointment of an Attorney-in-Fact by executing a power of attorney or providing end-of life health care instruction in an advance healthcare directive, also called a living-will.
Estate planning may also involve tax concerns, particularly for those with an estate of $2,000,000 or more in Washington or $1,000,000 or more in Oregon.
Washington, Oregon (as well as many other states) and the Federal government tax the transfer of wealth upon a person’s death. In Washington, the first $2,129,000 per person is exempt from the tax.
For Oregon residents—or those dying with property in Oregon—the first $1,000,000 is exempt. One may pass $5,490,000 without any federal estate tax.
Each year the Washington and federal amounts are adjusted for inflation. The effect of these taxes may be mitigated, particularly for married couples.
Married couples should take care so that their estate plan avoids subjecting their separate estates to multiple rounds of taxation.
In Washington, each spouse’s half of their community property estate is individually subject to transfer tax. The estate of the first spouse to pass will be subject to the transfer tax twice if it is directed to the estate of the survivor.
This can be avoided with some simple trust planning. A trust can provide a lifetime benefit to the spouse and be distributed to your children after the survivor passes.
You may need a spousal trust if your estate will exceed your tax credit.
Spousal trusts are subject to special rules so that the survivor’s interest is considered qualified terminable interest property (QTIP). QTIP trusts defer the transfer tax upon the interest received by the surviving spouse until that spouse passes, avoiding any estate tax when the first spouse passes.
After considering how your estate will pass to your spouse, you should also consider how you intend to pass wealth to your children.
You may consider a lifetime gifting plan, especially if you are near the Federal estate tax threshold.
The Federal government recognized this estate tax loophole and enacted the gift tax, which shares the transfer tax credit that allows an estate to transfer $5,490,000 of wealth tax free. (Washington does not have a gift tax, but gift tax paid within three years of your death is included in your gross estate.) The gift tax rules, however, provide some planning opportunities.
The annual gift tax exclusion allows you to give away $14,000 ($15,000 beginning in 2018) without being subject to transfer tax or having to file a gift tax return.
This amount is known as the gift tax annual exclusion, which reduces the amount considered to be gifted when determining your gift tax liability. If you are married, you and your spouse can each give $14,000 per person, meaning you and your spouse can give each of your children $28,000 a year, or $56,000 to each child and his or her spouse.
This strategy can be used to reduce the value of estates that may be close to the threshold requiring payment of estate tax.
More complicated gifting strategies exist for those well above the taxable threshold. One such strategy, the grantor retained annuity trust (GRAT), may allow for another tax-free transfer option. In this strategy, you establish a trust that pays you an annuity.
The GRAT then expires at the end of a period you determine. Any remaining trust property can then be transferred to your children as remainder beneficiaries.
The remainder interest is valued when the trust is created and considered gifted at that time. However, the GRAT rules assume the trust property will increase in value based on a rate set by the Federal government.
You will transfer additional wealth not subject to the estate tax if your assets grow faster than the Federal rate projects them to. This is one of many advanced strategies for those interested in gifting as part of their estate plan.
Plan for change
You will need to adjust your estate and tax plans as your goals and circumstances change.
What was right for you this year may not be right for you next year, particularly as the tax codes are reformed or revised. Be sure to learn different options from your CPA so that you are aware of opportunities that may present themselves in the future. You never know exactly what is in store, but a well-crafted plan will be ready to adapt as your story develops.
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