2016 Year-End Tax Planning: Four Simple Strategies to Reduce or Defer Income Tax and Transfer Wealth

By Joseph Dionisio, CFP® Senior Financial Planner, First Republic Investment Management
November 9, 2016

Year-end tax planning should start early in the year. Many people, however, wait until late in the year when they have more certainty around their tax situation. Below are simple strategies you can implement with ease before year-end to reduce or defer your income tax and transfer wealth.

Strategy One: Accelerate deductions and defer income. In the past, when there was uncertainty around whether tax rates would increase, it made sense to accelerate income in the current year and defer deductions to the following year to take advantage of lower tax rates in the event that rates would rise. Now that there is “temporary permanency”1 — a term that simply means that tax laws are never permanent and future legislation may increase or lower rates — with tax rates, the opposite strategy makes sense. Why pay tax now when you can pay it later? If you are a salaried employee, deferring income may be more of a challenge, so be sure to check with your employer to see if you can defer a year-end bonus or commission to January.

You may also choose to bunch expenses that are subject to a floor, such as healthcare expenses, unreimbursed work-related expenses, investment expenses and tax preparation fees. Prepaying tax- deductible expenses in December, such as charitable contributions you expect to make early in the year or state income taxes that will be due when you file in April will reduce your taxable income. Note, however, that some itemized deductions are reduced by three percent up to a maximum of 80 percent for taxpayers whose incomes are above certain thresholds.

Strategy Two: Review your portfolio. To avoid letting the tax tail wag the dog, make sure your portfolio is managed tax efficiently. Increased tax rates on ordinary income, qualified dividends, long-term capital gains, and the 3.8 percent surtax on net investment income can reduce your investment return substantially. Review your asset positioning and make sure taxable accounts hold tax-efficient assets and tax-inefficient assets are held in tax-deferred accounts.

If your asset allocation is not in sync with your investment policy statement, sell some winners and losers to offset the gain. You can deduct up to $3,000 of capital losses against ordinary income and carry forward excess capital losses to future years.

Strategy Three: Take advantage of gift tax exclusions. The annual gift tax exclusion is one of the most significant ways you may be able to reduce your federal gift tax liability. Currently, individuals can gift up to $14,000 each year to an unlimited number of donees (that is, people or organizations you elect to give to) and pay no gift tax. In this way, parents may give up to $28,000 to each child, grandchild and anyone else they want to share their wealth with. The annual gift tax exclusion is important because it allows you not only to distribute your property gift-tax free, but also potentially put your taxable estate into a lower tax bracket by removing assets from your estate.

Strategy Four: Keep an eye on proposed IRC Section 2704 regulations. If finalized, proposed IRC Section 2704 regulations will have significant impact on the transfer tax consequences associated with transfers of interest in controlled family entities to family members. From a valuation perspective, taxpayers and appraisers currently incorporate restrictions as defined by IRC Section 2704 through the application of discounts for lack of control and lack of marketability which, in aggregate, range from 15 to 40 percent. By refining the definition of applicable restrictions, the proposed regulations significantly limit the ability of the taxpayer and their estates to apply these discounts when estimating the fair market value of interest in certain family-owned entities that are transferred to family members.

1The current tax law contains no sunset provision that provides for a repeal of a section of the law after a specific date is reached unless further legislative action is taken. Thus current tax rates in effect are permanent.

The strategies mentioned in this document will often have tax and legal consequences; therefore, it is important to bear in mind that First Republic does not provide tax or legal advice. This information is provided to you as-is, does not constitute legal advice, and is governed by our Terms and Conditions of Use; we are not acting as your attorney. We make no claims, promises or guarantees about the accuracy, completeness, or adequacy of the information contained here. Clients’ tax and legal affairs are their own responsibility. Clients should consult their own attorneys or other tax advisors in order to understand the tax and legal consequences of any strategies mentioned in this document.

©First Republic Investment Management 2016