AGI

Article Dean Dorton

There were some changes made to the child tax credit rules in the new tax bill. The amount of the credit was increased, the adjusted gross income phase-outs were increased, a new non-child dependent tax credit was added, and limits were added to the refundable portion of the tax credit. The changes are summarized in the below table.

Old Law New Law
Qualifying Child Tax Credit $1,000 per child UNDER age 17 $2,000 per child UNDER age 17
Qualifying Dependent Tax Credit N/A A $500 nonrefundable tax credit is added for qualifying dependents other than qualifying children
AGI Phase-Outs The child tax credit is reduced $50 for each $1,000 of modified gross income (AGI) over $75,000 for single individuals or heads of households, $110,000 for married individuals filing jointly, and $55,000 for married individuals filing separately. The child tax credit is reduced by $50 for each $1,000 of modified gross income (AGI) in excess of $400,000 for married individuals filing jointly, and $200,000 for all other taxpayers. The phase-outs are not indexed for inflation.
Refundable Credit If the child tax credit exceeds the taxpayer’s tax liability, the taxpayer is eligible for a refundable credit (also known as the “additional child tax credit”) equal to 15% of earned income in excess of $3,000 (the “earned income” formula).

The maximum refundable tax credit cannot exceed $1,000.

 Same as the old law, except the additional child tax credit is equal to 15% of earned income in excess of $2,500 instead of $3,000.

The maximum refundable tax credit cannot exceed $1,400. This amount will be indexed for inflation in increments of $100.
Alternative Formula Families with three or more children may determine the additional tax credit using the alternative formula if it results in a larger credit under the earned income formula. Under this formula, the additional child tax credit equals the amount by which the taxpayer’s Social Security taxes exceeds the taxpayer’s earned income credit. Same as old law
Social Security Numbers No credit will be allowed unless the taxpayer includes the name and Social Security number of the qualifying child on the taxpayer’s tax return. The Social Security number must be issued on or before the filing due date (including extensions) of the taxpayer’s return. There is still a Social Security number requirement for the qualifying child tax credit, but there is not a Social Security number requirement for the $500 non-child dependent tax credit. If a qualifying child does not have a Social Security number, they are still eligible for the $500 non-child dependent credit.

Article Dean Dorton

Many tax breaks are reduced or eliminated for higher-income taxpayers. Two of particular note are the itemized deduction reduction and the personal exemption phaseout.

Income thresholds

If your adjusted gross income (AGI) exceeds the applicable threshold, most of your itemized deductions will be reduced by 3% of the AGI amount that exceeds the threshold (not to exceed 80% of otherwise allowable deductions). For 2016, the thresholds are $259,400 (single), $285,350 (head of household), $311,300 (married filing jointly) and $155,650 (married filing separately). The limitation doesn’t apply to deductions for medical expenses, investment interest, or casualty, theft or wagering losses.

Exceeding the applicable AGI threshold also could cause your personal exemptions to be reduced or even eliminated. The personal exemption phaseout reduces exemptions by 2% for each $2,500 (or portion thereof) by which a taxpayer’s AGI exceeds the applicable threshold (2% for each $1,250 for married taxpayers filing separately).

The limits in action

These AGI-based limits can be very costly to high-income taxpayers. Consider this example:

Steve and Mary are married and have four dependent children. In 2016, they expect to have an AGI of $1 million and will be in the top tax bracket (39.6%). Without the AGI-based exemption phaseout, their $24,300 of personal exemptions ($4,050 × 6) would save them $9,623 in taxes ($24,300 × 39.6%). But because their personal exemptions are completely phased out, they’ll lose that tax benefit.

The AGI-based itemized deduction reduction can also be expensive. Steve and Mary could lose the benefit of as much as $20,661 [3% × ($1 million − $311,300)] of their itemized deductions that are subject to the reduction — at a tax cost as high as $8,182 ($20,661 × 39.6%).

These two AGI-based provisions combined could increase the couple’s tax by $17,805!

Year-end tips

If your AGI is close to the applicable threshold, AGI-reduction strategies — such as contributing to a retirement plan or Health Savings Account — may allow you to stay under it. If that’s not possible, consider the reduced tax benefit of the affected deductions before implementing strategies to accelerate deductible expenses into 2016. If you expect to be under the threshold in 2017, you may be better off deferring certain deductible expenses to next year.

For more details on these and other income-based limits, help assessing whether you’re likely to be affected by them or more tips for reducing their impact, please contact us.

Article Dean Dorton

In addition to income tax, you must pay Social Security and Medicare taxes on earned income, such as salary and self-employment income. The 12.4% Social Security tax applies only up to the Social Security wage base of $118,500 for 2016. All earned income is subject to the 2.9% Medicare tax.

The taxes are split equally between the employee and the employer. But if you’re self-employed, you pay both the employee and employer portions of these taxes on your self-employment income.

Additional 0.9% Medicare tax

Another employment tax that higher-income taxpayers must be aware of is the additional 0.9% Medicare tax. It applies to FICA wages and net self-employment income exceeding $200,000 per year ($250,000 for married filing jointly and $125,000 for married filing separately).

If your wages or self-employment income varies significantly from year to year or you’re close to the threshold for triggering the additional Medicare tax, income timing strategies may help you avoid or minimize it. For example, as a self-employed taxpayer, you may have flexibility on when you purchase new equipment or invoice customers. If your self-employment income is from a part-time activity and you’re also an employee elsewhere, perhaps you can time with your employer when you receive a bonus.

Something else to consider in this situation is the withholding rules. Employers must withhold the additional Medicare tax beginning in the pay period when wages exceed $200,000 for the calendar year — without regard to an employee’s filing status or income from other sources. So your employer might not withhold the tax even though you are liable for it due to your self-employment income.

If you do owe the tax but your employer isn’t withholding it, consider filing a W-4 form to request additional income tax withholding, which can be used to cover the shortfall and avoid interest and penalties. Or you can make estimated tax payments.

Deductions for the self-employed

For the self-employed, the employer portion of employment taxes (6.2% for Social Security tax and 1.45% for Medicare tax) is deductible above the line. (No portion of the additional Medicare tax is deductible, because there’s no employer portion of that tax.)

As a self-employed taxpayer, you may benefit from other above-the-line deductions as well. You can deduct 100% of health insurance costs for yourself, your spouse and your dependents, up to your net self-employment income. You also can deduct contributions to a retirement plan and, if you’re eligible, an HSA for yourself. Above-the-line deductions are particularly valuable because they reduce your adjusted gross income (AGI) and modified AGI (MAGI), which are the triggers for certain additional taxes and the phaseouts of many tax breaks.

For more information on the ins and outs of employment taxes and tax breaks for the self-employed, please contact us.

Article Dean Dorton

Many expenses that may qualify as miscellaneous itemized deductions are deductible only to the extent they exceed, in aggregate, 2% of your adjusted gross income (AGI). Bunching these expenses into a single year may allow you to exceed this “floor.” So now is a good time to add up your potential deductions to date to see if bunching is a smart strategy for you this year.

Should you bunch into 2016?

If your miscellaneous itemized deductions are getting close to — or they already exceed — the 2% floor, consider incurring and paying additional expenses by Dec. 31, such as:

  • Deductible investment expenses, including advisory fees, custodial fees and publications
  • Professional fees, such as tax planning and preparation, accounting, and certain legal fees
  • Unreimbursed employee business expenses, including vehicle costs, travel, and allowable meals and entertainment.

But beware …

These expenses aren’t deductible for alternative minimum tax (AMT) purposes. So don’t bunch them into 2016 if you might be subject to the AMT this year.

Also, if your AGI exceeds the applicable threshold, certain deductions — including miscellaneous itemized deductions — are reduced by 3% of the AGI amount that exceeds the threshold (not to exceed 80% of otherwise allowable deductions). For 2016, the thresholds are $259,400 (single), $285,350 (head of household), $311,300 (married filing jointly) and $155,650 (married filing separately).

If you’d like more information on miscellaneous itemized deductions, the AMT or the itemized deduction limit, let us know.

Article Dean Dorton

Today it’s becoming more common to work from home. But just because you have a home office space doesn’t mean you can deduct expenses associated with it.

Eligibility Requirements

If you’re an employee, your use of your home office must be for your employer’s convenience, not just your own. If you’re self-employed, generally your home office must be your principal place of business, though there are exceptions.

Whether you’re an employee or self-employed, the space must be used regularly (not just occasionally) and exclusively for business purposes. If, for example, your home office is also a guest bedroom or your children do their homework there, you can’t deduct the expenses associated with that space.

A Valuable Break

If you are eligible, the home office deduction can be a valuable tax break. You may be able to deduct a portion of your mortgage interest, property taxes, insurance, utilities, and certain other expenses, as well as the depreciation allocable to the office space.

Or you can take the simpler “safe harbor” deduction in lieu of calculating, allocating, and substantiating actual expenses. The safe harbor deduction is capped at $1,500 per year, based on $5 per square foot up to a maximum of 300 square feet.

More Considerations

For employees, home office expenses are a miscellaneous itemized deduction. This means you’ll enjoy a tax benefit only if these expenses, plus your other miscellaneous itemized expenses, exceed 2% of your adjusted gross income (AGI).

If, however, you’re self-employed, you can deduct eligible home office expenses against your self-employment income.

Finally, be aware that we’ve covered only a few of the rules and limits here. If you think you may be eligible for the home office deduction, contact us for more information.