If your income is abnormally low this year or your investment portfolio has taken a downturn in value, you might consider some of the following actions:
- Make Gifts – When values are low and expected to rise, the stage is set for making a gift. Under current law, the gift is valued at its fair market value at the date of the gift. If the value of a planned gift is depressed but the value is beginning to recover (rise), this might be the time to make the gift and minimize the gift tax ramifications while reducing your estate for any future estate tax.
If you are helping a loved one weather economic hard times, you can give him or her appreciated property, which the recipient can immediately sell for cash. The result is a transfer of the gain to the person you are helping, who probably will be taxed at a lower tax rate than you are, or possibly will pay no tax at all depending on their circumstances for the year.
For 2016 and 2017, you can gift up to $14,000 of value ($28,000 if married and both spouses make a gift) to as many individuals as you would like without affecting your lifetime gift tax exclusion, paying any gift tax, or even having to file a gift tax return. The gift limit is periodically inflation adjusted so call this office for amounts applicable to years other than 2016 and 2017.
- Traditional IRA to Roth IRA Conversions – When one converts a conventional IRA to a Roth IRA, the conversion is taxed at the individual’s marginal tax rate, as if the individual withdrew the funds without being subject to any penalties. Thus, if your taxable income is negative, your marginal tax rate is very low or you have tax credits that are not being fully utilized, it might be appropriate to convert some or all of your traditional IRA funds into a Roth IRA at no or a very small cost. The benefit is not immediate, but in the future at retirement time, the Roth IRA withdrawals, unlike traditional IRA withdrawals, will be tax-free.
- Use Up Capital Loss Carryovers – If you are one of the lucky investors who has benefited from the recent market upswing and would like to reduce your position in a security or realign your portfolio, and you have unused capital loss carryovers, you might consider selling some of your existing holdings with gains. By utilizing the unused capital loss carryovers to offset those gains, you may pay little or no tax on the profits.
- Relinquish Dependency Rights – If you are the custodial parent of a child, have the right to claim the child as a dependent, but have no need for the tax benefits associated with the dependency this year, you might consider relinquishing the exemption to the child’s other parent. Form 8332 is used for this purpose, but be careful to complete it correctly lest you release the exemption for more tax years than intended.
- Exercise Options – Employee stock options, when exercised, produce either ordinary income (non-qualified options) or alternative minimum tax preference income (qualified options) equal to the difference between the exercise price and the market value of the shares at the time of exercise (purchase). Employees who have stock options with a non-publicly-traded company, where the stock’s value is low but is expected to climb in the near future, should consider exercising their options while the stock value is low. In doing so, the employees will be able to acquire the stock at a preferential price and hold it for future appreciation with a minimum, or perhaps zero, current tax bite.
- Deduct IRA Losses – A traditional IRA account often contains only contributions that were previously deducted, so if the account’s value declines, no additional loss deduction can be claimed. However, if you have made nondeductible contributions to a traditional IRA and the value of all of your IRA accounts combined is less than the sum of your nondeductible contributions, you can take a loss — but to do so, you must take withdrawals from (close out) all of your IRA accounts. The result is a miscellaneous itemized deduction equal to the total of the nondeductible contributions less the sum of the withdrawn amounts. However, this loss is beneficial only if your deductions are itemized, and the loss, along with your other miscellaneous deductions, exceeds 2% of your income (AGI) for the year.
- Cash in Savings Bonds – Two options are available for tax reporting of interest income from certain U.S. savings bonds, such as EE Bonds and I Bonds: include the increase in redemption value each year as interest, or postpone reporting any of the interest until the return for the earlier of the year the bonds mature or are cashed in. Typically, most people choose the latter method. If you are holding savings bonds that are approaching their maturity and your taxable income for the year will be negative or lower than it normally is, and you haven’t previously reported the interest, you may want to cash in some or all of these bonds to take advantage of your lower tax bracket. If you don’t want to cash in the bonds, you can make an election to switch to the annual interest reporting method, but if you do so, on the return for the year of the change, you will have to include all of the interest accrued to date for all Series E, EE or I savings bonds that you hold, and then report the annual interest in each succeeding year for those and any bonds of these series that you may acquire in the future.
- Variable Annuity Losses – Variable annuities typically invest in a variety of stock funds, money market accounts, etc. Since purchase, the annuity may have declined in value, making it worth less today than its original cost. If the annuity is sold, the loss can be taken as a miscellaneous itemized deduction.
The foregoing are examples of some of the many tax strategies that can be employed during depressed economic times or years of low income to provide both current and future tax benefits. Please give this office a call if you would like to review your specific circumstances for any year-end or long-range strategies that might apply to you.