By Kira Bravo
For the Bellingham Business Journal
With the end of the 2015 year, many folks may be wondering if there is anything further they can do to manage their upcoming tax bill. Even though many year-end planning techniques are no longer an option, there are still several effective strategies worth considering.
Contribute to retirement accounts
Contributions to both traditional IRAs and Roth IRAs are still permitted up until April 18, 2016. Currently, income limitations are in place that prevent higher income taxpayers from contributing directly to a Roth IRA. Income thresholds also limit tax deductible contributions to a traditional IRA. The solution: make a “backdoor” Roth IRA contribution.
A backdoor Roth IRA contribution allows a taxpayer who is over the income threshold to make a non-deductible contribution to a traditional IRA and immediately convert the money to a Roth IRA. If this is done following certain conditions, there will be no tax impact on the conversion and the money can now grow tax-free in the Roth IRA account. When the money is distributed upon retirement, the distributions are tax-free.
Additionally, a Self-Employed Plan (SEP) can yield a significant tax deduction. Currently, self-employed individuals can make a tax-deductible contribution to a SEP of up to $53,000, depending on the amount of self-employed income you have. Even better, you have until the due date of your return (including extensions) to make the contribution. This means that if you extend your tax return, you have until October 17, 2016 to actually contribute the funds to the SEP.
Evaluate participation in business & real estate activities
The net investment income tax of 3.8% applies to passive income. To the extent that you materially participate in certain activities you may be able to reduce your tax liability. One way this can be accomplished is by grouping similar activities together. Work with your tax advisor to decide whether this strategy makes sense for your situation.
Distribute trust income
If you are the trustee or beneficiary of a trust, you may consider whether it is better for trust income to be taxed within the trust or on the beneficiary’s individual return. The income tax brackets for trusts are much smaller than those for individuals, so that higher tax brackets are reached more quickly. For example, the highest tax bracket of 39.6 percent for trusts applies when income reaches $12,300 or more, whereas the highest tax bracket of 39.6 percent for individuals applies when income reaches $464,851 for married filing jointly taxpayers. To further exacerbate this problem, the net investment income tax of 3.8 percent also applies to trusts in the highest tax bracket, meaning that the total tax rate could be as much as 43.4 percent.
Trusts with taxable income may want to consider making distributions to beneficiaries who are in lower tax brackets. Under the “65 Day Rule” a trustee can elect to make a distribution within 65 days of the end of the preceding tax year, so that a distribution made in early 2016 applies to the 2015 tax year. This effectively transfers the income and related tax liability to the beneficiary. Conversely, if you have a beneficiary who is in the highest individual tax bracket, you may choose to leave at least some income within the trust to take advantage of an additional set of tax brackets where some of the income will be taxed at lower rates.
Make a last minute estimated tax payment
If you discover that you may owe a significant bill with your return, you could consider making a fourth quarter estimated tax payment by January 15th. While you would still likely be underpaid during the first three quarters of 2015, making the payment could eliminate interest and penalties for the fourth quarter. Additionally, if your income increased significantly after August 31, 2015, your tax preparer may be able to reduce underpayment penalties by annualizing your estimated tax liability. This is done using Form 2210 filed with your return.
Gather documentation early
Good documentation can save you time and money when it comes to filing your return. Many deductions are missed or disallowed due to the lack of proper documentation.
Even though 2015 is over, there are still several strategies you can use to reduce your tax bill. You should consult a tax professional to determine whether it makes sense to implement any of these strategies so that you achieve results that will fit with your overall financial goals.
Kira Bravo is a CPA and has practiced public accounting for over a decade. She works extensively with individual clients, as well as closely held businesses. Her specialties include income tax planning and compliance, estate, trust and gift taxation. She can be reached at 360-733-1010 or Kirab@metcalfhodges.com.