Are you able to deduct medical expenses on your tax return?
For many people, the cost of medical care keeps going up. So if possible, you should find ways to claim tax breaks related to health care. Unfortunately, it can be difficult because there’s a threshold for deducting itemized medical expenses that can be tough to meet.
To make matters worse, the threshold for senior taxpayers is going up beginning January 1, 2017.
Before 2013, you could claim an itemized deduction for unreimbursed medical expenses paid for you, your spouse and your dependents, to the extent those expenses exceeded 7.5% of your adjusted gross income (AGI). AGI includes all of your taxable income items, reduced by certain write-offs, including those for deductible IRA contributions, alimony payments and student loan interest.
As part of the Affordable Care Act, a higher deduction threshold of 10% of AGI now applies to most taxpayers. However, if either you or your spouse were at least 65 as of December 31, 2016, the 10%-of-AGI deduction threshold won’t affect you for the 2016 tax year (the tax return you’ll file in 2017). For 2016, the 7.5%-of-AGI deduction threshold still applies for qualifying seniors.
However, this exemption is temporary. Beginning January 1, 2017, the 10% threshold will apply to all taxpayers, including those over 65.
Consider “bunching” expenses in alternating years
If you aren’t eligible for a deduction, you might be able to qualify if you concentrate medical expenses in alternating years. That way, you may qualify to claim an itemized medical expense deduction every other year — instead of losing the opportunity to claim any deduction for health care costs. Of course, this might only work if you have flexibility about when medical expenses are incurred.
Qualified medical expenses involve the costs of diagnosis, cure, mitigation, treatment, or prevention of disease, and the costs for treatments affecting any part or function of the body. This includes payments to physicians, dentists and other medical practitioners, as well as equipment, supplies, diagnostic devices, prescription drugs and other health care expenses.
Contact your tax advisor if you have questions about what expenses are eligible and whether you can qualify for a deduction.
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How entity type affects tax planning for owner-employees
Come tax time, owner-employees face a variety of distinctive tax planning challenges, depending on whether their business is structured as a partnership, limited liability company (LLC) or corporation. Whether you’re thinking about your 2016 filing or planning for 2017, it’s important to be aware of the challenges that apply to your particular situation.
Partnerships and LLCs
If you’re a partner in a partnership or a member of an LLC that has elected to be disregarded or treated as a partnership, the entity’s income flows through to you (as does its deductions). And this income likely will be subject to self-employment taxes — even if the income isn’t actually distributed to you. This means your employment tax liability typically doubles, because you must pay both the employee and employer portions of these taxes.
The employer portion of self-employment taxes paid (6.2% for Social Security tax and 1.45% for Medicare tax) is deductible above the line. Above-the-line deductions are particularly valuable because they reduce your adjusted gross income and modified adjusted gross income, which are the triggers for certain additional taxes and phaseouts of many tax breaks.
But flow-through income may not be subject to self-employment taxes if you’re a limited partner or the LLC member equivalent. And be aware that flow-through income might be subject to the additional 0.9% Medicare tax on earned income or the 3.8% net investment income tax (NIIT), depending on the situation.
S and C corporations
For S corporations, even though the entity’s income flows through to you for income tax purposes, only income you receive as salary is subject to employment taxes and, if applicable, the 0.9% Medicare tax. Keeping your salary relatively — but not unreasonably — low and increasing your distributions of company income (which generally isn’t taxed at the corporate level or subject to employment taxes) can reduce these taxes. The 3.8% NIIT may also apply.
In the case of C corporations, the entity’s income is taxed at the corporate level and only income you receive as salary is subject to employment taxes, and, if applicable, the 0.9% Medicare tax. Nevertheless, if the overall tax paid by both the corporation and you would be less, you may prefer to take more income as salary (which is deductible at the corporate level) as opposed to dividends (which aren’t deductible at the corporate level, are taxed at the shareholder level and could be subject to the 3.8% NIIT).
Whether your entity is an S or a C corporation, tread carefully, however. The IRS remains on the lookout for misclassification of corporate payments to shareholder-employees. The penalties and additional tax liability can be costly.
As you can see, tax planning is extra important for owner-employees. Plus, tax law changes proposed by the President-elect and the Republican majority in Congress could affect tax treatment of your income in 2017. Please contact your tax advisor for help identifying the ideal strategies for your situation.
Few changes to retirement plan contribution limits for 2017
Retirement plan contribution limits are indexed for inflation, but with inflation remaining low, most of the limits remain unchanged for 2017. The only limit that has increased from the 2016 level is for contributions to defined contribution plans, which has gone up by $1,000.
|Type of Limit||2017 Limit|
|Elective deferrals to 401(k), 403(b), 457(b)(2) and 457(c)(1) plans||$18,000|
|Contributions to defined contribution plans||$54,000|
|Contributions to SIMPLEs||$12,500|
|Contributions to IRAs||$ 5,500|
|Catch-up contributions to 401(k), 403(b), 457(b)(2) and 457(c)(1) plans||$ 6,000|
|Catch-up contributions to SIMPLEs||$ 3,000|
|Catch-up contributions to IRAs||$ 1,000|
Nevertheless, if you’re not already maxing out your contributions, you still have an opportunity to save more in 2017. And if you turn age 50 in 2017, you can begin to take advantage of catch-up contributions.
However, keep in mind that additional factors may affect how much you’re allowed to contribute (or how much your employer can contribute on your behalf). For example, income-based limits may reduce or eliminate your ability to make Roth IRA contributions or to make deductible traditional IRA contributions. If you have questions about how much you can contribute to tax-advantaged retirement plans in 2017, check with your tax advisor.
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Want to save for education? Make 2016 ESA contributions by December 31
There are many ways to save for a child’s or grandchild’s education. But one has annual contribution limits, and if you don’t make a 2016 contribution by December 31, the opportunity will be lost forever. We’re talking about Coverdell Education Savings Accounts (ESAs).
How ESAs work
With an ESA, you contribute money now that the beneficiary can use later to pay qualified education expenses:
- Although contributions aren’t deductible, plan assets can grow tax-deferred, and distributions used for qualified education expenses are tax-free.
- You can contribute until the child reaches age 18 (except beneficiaries with special needs).
- You remain in control of the account — even after the child is of legal age.
- You can make rollovers to another qualifying family member.
Not just for college
One major advantage of ESAs over another popular education saving tool, the Section 529 plan, is that tax-free ESA distributions aren’t limited to college expenses; they also can fund elementary and secondary school costs. That means you can use ESA funds to pay for such qualified expenses as tutoring and private school tuition.
Another advantage is that you have more investment options. So ESAs are beneficial if you’d like to have direct control over how and where your contributions are invested.
Annual contribution limits
The annual contribution limit is $2,000 per beneficiary. However, the ability to contribute is phased out based on income.
The limit begins to phase out at a modified adjusted gross income (MAGI) of $190,000 for married filing jointly and $95,000 for other filers. No contribution can be made when MAGI hits $220,000 and $110,000, respectively.
Maximizing ESA savings
Because the annual contribution limit is low, if you want to maximize your ESA savings, it’s important to contribute every year in which you’re eligible. The contribution limit doesn’t carry over from year to year. In other words, if you don’t make a $2,000 contribution in 2016, you can’t add that $2,000 to the 2017 limit and make a $4,000 contribution next year.
However, because the contribution limit applies on a per beneficiary basis, before contributing make sure no one else has contributed to an ESA on behalf of the same beneficiary. If someone else has, you’ll need to reduce your contribution accordingly.
Would you like more information about ESAs or other tax-advantaged ways to fund your child’s — or grandchild’s — education expenses? Contact your tax advisor.
Take stock of your inventory accounting method’s impact on your tax bill
If your business involves the production, purchase or sale of merchandise, your inventory accounting method can significantly affect your tax liability. In some cases, using the last-in, first-out (LIFO) inventory accounting method, rather than first-in, first-out (FIFO), can reduce taxable income, giving cash flow a boost. Tax savings, however, aren’t the only factor to consider.
FIFO vs. LIFO
FIFO assumes that merchandise is sold in the order it was acquired or produced. Thus, the cost of goods sold is based on older — and often lower — prices. The LIFO method operates under the opposite assumption: It allocates the most recent costs to the cost of sales.
If your inventory costs generally rise over time, LIFO offers a definite tax advantage. By allocating the most recent — and, therefore, higher — costs first, it maximizes your cost of goods sold, which minimizes your taxable income. But LIFO involves more sophisticated record keeping and more complex calculations, so it’s more time-consuming and expensive than FIFO.
LIFO can create a problem if your inventory levels begin to decline. As higher inventory costs are used up, you’ll need to start dipping into lower-cost “layers” of inventory, triggering taxes on “phantom income” that the LIFO method previously has allowed you to defer. If you use LIFO and this phantom income becomes significant, consider switching to FIFO. It will allow you to spread out the tax on phantom income.
If you currently use FIFO and are contemplating a switch to LIFO, beware of the IRS’s LIFO conformity rule. It generally requires you to use the same inventory accounting method for tax and financial statement purposes. Switching to LIFO may reduce your tax bill, but it will also depress your earnings and reduce the value of inventories on your balance sheet, which may place you at a disadvantage in comparison to competitors that don’t use LIFO. There are various issues to address and forms to complete, so be fully informed and consult your tax advisor before making a switch.
The method you use to account for inventory can have a big impact on your tax bill and financial statements. These are only a few of the factors to consider when choosing an inventory accounting method. Contact your tax advisor for help assessing which method will provide the best fit with your current financial situation.