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Year-Round Tax Planning for Families: Strategies for Special Needs Care

Learn effective tax planning strategies for families, including those caring for individuals with special needs. Understand income tax rates, definitions of rich income earners, and new due dates for 2016 tax returns.

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Year-Round Tax Planning for Families: Strategies for Special Needs Care

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  1. FPA Northeastern New York ChapterOctober 20, 2016Year-Round Tax Planning for Families (including Families Caring for Those with Special Needs)Presented by:Thomas M. Brinker, Jr., LL.M., CPAProfessor of AccountingArcadia University

  2. 2010-12 & 2013-16 Income Tax Rates • Individual Income: 2010-12: 10%, 15%, 25%, 28%, 33%, and 35% 2013-16: 10%, 15%, 25%, 28%, 33%, 35%, and 39.6% • Long-term Capital Gains and Qualifying Dividends: 2010-12: 0% and 15% and 2013-16: 0%, 15% and 20%* • The American Taxpayer Relief Act imposes a 39.6% rate on Taxable Income exceeding: Single: $413,200; MFJ: $464,850; HH: $439,000 for 2015 Single: $415,050; MFJ: $466,950; HH: $441,000 for 2016 As of 2013, the maximum tax rate on long-term capital gains & qualifying dividends for TPs in the 39.6% bracket is 23.8% (with the 3.8 % Medicare surtax on net investment income).

  3. Definitions of “Rich” Income Earners • Super Rich: $415,050 Single and $466,950 MFJ TIs ...Highest brackets (39.6% Ordinary Income and 20% for LTCG/Qualifying Dividends) • Medium Rich: $259,400 Single and $311,300 MFJ AGIs …Phase-out begins of personal exemptions and itemized deductions • Poor Rich: $200,000 Single and $250,000 MFJ AGIs …additional 3.8% Medicare Surtax on NII • Social Security Wage Base remains at $118,500

  4. Surge of Identity Theft and Tax Fraud! • Expect refunds to be slower by IRS and states • 2016 Form W-2s & 1099s will be required to be filed by employer by January 31, 2017 • ID theft reduced by filing earlier • Social media creates enormous risk with too much “kiss and tell” about name, place of employment, spouse, kids, etc. – Easy picking for organized crime and other criminals! • Phishing scams up 40% during first half of 2015!

  5. New Due Dates for 2016 Tax Returns • Extended Due Dates based on calendar year taxpayer: These dates apply for taxable years beginning after December 31, 2015 (2016 Filing Season). • Form 1040: April 15 / October 15 with extension (no change) • Forms 1065 and 1120S: March 15 / September 15 with extension (was April 15th for partnerships and no change for S corporations) • Form 1041: April 15 / September 30 with extension (was September 15th with extension) • Form 1120: April 15 / September 15 with extension (was March 15th for corporation) A 6 month extension applies to non-June 30 and December 31st year-ends with original due date on the 15th of the fourth month.

  6. Protecting Americans from Tax Hikes (PATH) Act of 2015: Individual Extenders - Tuition Deduction (Extended through 12/31/16) • American Opportunity Tax Credit (Made permanent) …Beginning for 2016, EIN of educational institution must be reported • Deduction for sales tax (in lieu of income tax) (Made permanent) • Deduction for mortgage insurance premium as mortgage interest (Extended through 12/31/16) • $250 teacher deduction for supplies (Made permanent) (For 2016 and later, indexed for inflation and expanded to include professional development expenses, such as curriculum related coursework)

  7. Protecting Americans from Tax Hikes (PATH) Act of 2015: Individual Extenders • IRA transfers of up to $100,000 (applies to each spouse - $200,000 if MFJ) to charity for 70 ½ or older (Made permanent) (Ensure receipts are properly worded) • Exclusion for personal residence cancellation of debt up to $2 million ($1 million if MFS). Exclusion reduces home’s basis, but not below zero. (Extended through 12/31/16) • $500 credit for nonbusiness energy property (Extended through 12/31/16) (Energy Star requirements updated) • Enhanced child tax credit (Made permanent) • Enhanced earned income tax credit (Made permanent)

  8. 2013 Health Care Reform Changes • .9% Medicare Tax on Compensation and/or Self Employment Income in excess of $200,000 for individuals, and $250,000 for married couples filing jointly. • 3.8% Medicare Tax on Investment Income; applies to the lesser of: net investment income, or the excess of modified adjusted gross income (AGI) over the threshold amount ($200,000 for single individuals or heads of households; $250,000 for married couples filing jointly; and $125,000 for married couples filing separately). • Higher Threshold for Medical Expense Deductions • $2,500 Cap on Health Care FSA Contributions Initially ($2,550 Cap as of 2015 and projected at $2,600 for 2017)

  9. Health Care Alert: the Combined Impact of a Broader Medicare Tax Base! Example: Cliff and Julia are married and have a modified AGI of $650,000, including $500,000 in wages, investment income of $50,000, and the sale of their principal residence for a $600,000 gain (only $100,000 is taxable due to the Sec. 121 exclusion). Result - An additional tax of $7,950: (i) the “Additional Medicare Tax on Wage Earners” of .9% of $250,000 or $2,250, plus (ii) the “Unearned Income Medicare Contributions Tax” of 3.8% of $150,000 or $5,700.

  10. Tax Formula for Individuals Income (broadly conceived) - Exclusions = Gross Income - Deductions for AGI = AGI - the larger of: (a) itemized deductions or (b) the standard deduction - personal & dependency exemptions = Taxable Income Tax on Taxable Income less Credits and Prepayments = Taxes payable or refund due

  11. Itemized Deductions • Personal itemized deductions are deductible on Form 1040, Schedule A, only if • they exceed the standard deduction or, • the taxpayer is not eligible for the standard deduction • Itemized deductions are taken FROM AGI

  12. Exemption Standard Deduction Amounts Amount Year MFJ HH S MFS $4,050 2016 $12,600 $9,300 $6,300 $6,300 4,000 2015 12,600 9,250 6,300 6,300 *With the JGTRRA of 2003, MFJ has been 2X Single S/D Exemption vs. Standard Deductions Exemption Basic support should not be taxed Standard Deduction To simplify tax administration

  13. Additional Standard Deductionsfor Elderly or Blind Elderly or Blind Married Unmarried 2016 1,250 1,550 2015 1,250 1,550

  14. Filing Status Marriage Penalty Relief? • JGTRRA of 2003 originally provided relief for 2003 and 2004 ONLY!* • Increased Basic Standard To 2X Basic Standard Deduction for Singles • Increased Size of 15% Tax Bracket for MFJs to 2X the width of the 15% Tax Bracket for “Single” Filer • * The American Taxpayer Relief Act permanently extended the JGTRRA of 2003’s “doubling of the Standard Deduction” and 15% Tax Bracket.

  15. Filing Status Marriage Penalty Relief? • Example: John and Mary, a power couple earning $450,000 each and having individual Taxable Incomes of $443,700 in 2016 (AGI less Standard Deduction – no exemption in 2016) are contemplating marriage. • Single v. MFJ in 2016: Single: $131,875.15 each ($263,750.30 combined) or MFJ: $297,076.70 for a marriage penalty of $33,326.40! • For 2015…the marriage penalty was $33,177.80! • This excludes any Medicare surtaxes…both on earned income and investment income (with AGIs over $200,000 S v. $250,000 MFJ)!

  16. Filing Status Marriage Penalty Relief? • Inequities also occur with many of the credit, exemption and itemized deduction AGI phase-outs! • Exclusion of U.S. Savings Bond for Higher Education ($77,550 S v. $116,300 MFJ) • Traditional and Roth IRA Contributions (depends…) • Earned Income, Adoption, and Child Credits ($75,000 S v. $110,000 MFJ for Child Tax Credit) • SS Benefit Inclusion & AMT Exemptions ($53,900/$119,700 S v. $83,800/$159,700 MFJ for the AMT) • Exemptions & Itemized Deductions ($259,400 S v. $311,300 MFJ)

  17. Filing Status Marriage Penalty Relief - IRAs? • The maximum contribution to either a Roth IRA or a Traditional IRA remains unchanged at $5,500. People 50 and over can contribute an additional $1,000 for a total of $6,500. • Roth IRAs…For single filers in 2016, the income threshold for phase-out starts at $117,000 and ends at $132,000. In that range, your contribution is limited, eventually reaching zero. For married filers in 2016, the income threshold starts at $184,000 and ends at $194,000. The income thresholds are $1,000 higher than in 2015.

  18. Filing Status Marriage Penalty Relief - IRAs? • - • If a TP is covered by a retirement plan at work, the traditional IRA phase-out varies disproportionately between Single and Married Filing Jointly. A single individual’s phase-out range is MAGI of $61,000 to $71,000; whereas, married couples where both spouses are participating in employer-sponsored retirement plans have a phase-out range of between $98,000 and $118,000 of MAGI (no $1,000 increase over prior year). • There is NO phase-out for a traditional IRA for any filing status, including married filing jointly as long as neither spouse is covered by a retirement plan at work. However, if one spouse is a nonparticipant in an employer-sponsored plan, the phase-out range is $184,000 to $194,000 of MAGI. The income threshold is $1,000 higher than in 2015.

  19. Regarding Disabilities, are Autism Rates Stabilizing?Currently 1 in 68 as reported by CDC! • Is the prevalence of autism increasing or just our recognition of it?  Autism is now 1 in 68, according to the CDC on both March 28, 2014 and March 31, 2016(Boys are 4.5 times more likely to be identified with an ASD than girls with a rate of 1 in 42 among boys and 1 in 189 among girls). The study’s conclusion is that the increase can be accounted for by increased diagnoses (or misdiagnosis) of children with a previously unrecognized Autism Spectrum Disorder. • Whatever the cause behind the increase, we need to identify potential tax benefits and financing concerns, including deductions or credits for exemptions, medical expenses, special instruction, impairment-related work expenses, child and dependent care, adoption costs, penalty waiver rules,…

  20. Medical Expenses Who may deduct medical expenses? • A TP may deduct eligible medical expenses paid for him/herself, spouse, and dependents • Eligible expenses deductible only to extent they exceed 10% of AGI • …limit was 7.5% of AGI prior to 2013. However, 7.5% still applies to individuals age 65 or older and spouses thru 2016

  21. Eligible Medical Expenses Medical expenses include any amount paid for: • Diagnosis, cure, mitigation, treatment or prevention of disease, or for the purpose of affecting any structure or function of the body, and • Transportation primarily for and essential to above medical care Often overlooked medical expense deductions… • Capital Expenditures for Medical Care • Special Schools and Institutions • Medical Conferences and Seminars No deductions for: • Illegal operations or treatment; Cosmetic surgery except reconstructive surgery for deformities, and disfigurements arising from trauma or disease; Trips to improve general health, and nonprescribed medicines/drugs, vitamins, and health foods.

  22. Capital Costs/Home Improvements Incurred for Medical Reasons • Permanent improvements in TP’s residence or office are deductible as a medical expense if recommended or prescribed by a physician for medical reasons Deduction is limited to excess of cost over increase in the home or building’s FMV as a result of improvement. EXAMPLE A physician recommends daily swimming for an individual suffering from arthritis. A therapeutic swimming pool costing $40,000 is installed. The FMV of the home rises by $5,000. $35,000 may be deducted as a medical expense (plus ongoing pool maintenance).

  23. Capital Costs/Home Improvements Incurred for Medical Reasons • Expenditures to remove structural barriers in the home of an individual with physical limitations are deductible in FULL as a medical expense. • Costs of Operating/Maintaining are deductible as long as the medical reason for the capital expenditure exists. EXAMPLES Costs of constructing entrance ramps, widening doorways and halls, lowering kitchen cabinets, and adding railings. (Note: Expenditure is deductible in full since the increase in the home’s fair market value is deemed to be zero.)

  24. Capital Costs/Home Improvements Incurred for Medical Reasons: Example In 2015, Theresa was injured in an extreme sport accident. Theresa sustained a chronic disabling leg injury, which requires her to spend most of her time in a wheelchair. Her physician recommends that she install an elevator in her home to alleviate the pressure on her knees from walking up and down stairs. During the year, Theresa made the following expenditures: Wheelchair: $2,500; Elevator: $17,000; Operational and maintenance costs incurred with the elevator: $2,800; and entrance ramp and door modifications: $7,500. According to appraisers, the home increased in value as a result of the elevator by $5,000. QUESTION What is Theresa’s medical expense deduction associated with her capital expenditures in 2015? Answer: $24,800

  25. Capital Costs/Home Improvements Incurred for Medical Reasons: Another Example In 2015, Jane, a single mother with AGI of $100,000, fully supported her 20 year old daughter living with her. Her daughter has no income for the year, and was properly claimed as Jane’s dependent. During the year, Jane installed a central air conditioner at a cost of $15,000, which her Dr. said was required in caring for the daughter’s asthma. After installation, Jane’s home increased in value by $5,000. In addition, Jane incurred the following medical expenses in 2015: prescribed drugs: $500; physician expenses: $1,000; and unreimbursed health insurance premiums: $3,000. QUESTIONS What is Jane’s current medical expense deduction? What if the air conditioning system increases the monthly utility bill by $150? Answers: $4,500 and $6,300

  26. Medical Expenses and Retirement Plan/IRA Distribution Exception • Although a 10% penalty exists as a disincentive for early retirement and pre-retirement withdrawals (i.e., prior to age 59 ½), the penalty does NOT apply to distribution amounts that are less than or equal to an individual’s allowable medical expense deduction in excess of 10% of AGI (regardless of whether the individual actually itemizes deductions) if the distributions are used to pay for the medical care during the year (Section 72(t)(2)(B)).

  27. Medical Expenses and Retirement Plan/IRA Distribution Exception • The penalty waiver only applies to that component of the distribution which is included in gross income. The income tax still applies to the taxable distribution. • Tax law does not require that individuals first deplete the 10% penalty exception for medical care by using the non-taxable component of a distribution (i.e., non-taxable return of investment).* *Argyle v. Commissioner, T.C. Memo, 2009-218

  28. Medical Expenses and Retirement Plan/IRA Distribution Exception • In addition, the penalty exception for itemized medical deductions will apply even if the taxpayer is receiving substantially equal periodic payments (i.e., annuity per Section 72(t)(2)(A)(iv)). • However, with regard to an IRA distribution, Section 72(t)(2)(E) and (F) applies the medical expense exception before other exceptions (notably first-time home buyer and education exceptions).

  29. Medical Expense/Retirement Plan/IRA Distribution Exception: Non-Itemizer --- Mr. and Mrs. Peter (both age 50) have an AGI of $35,000 for the year 2015. The Peter’s incur (and actually pay) $10,000 in qualifying medical expenses on behalf of their child with special needs during the year. Their allowable medical deduction will be $6,500 for 2015 ($10,000 less 10% of their AGI of $35,000 or $3,500). QUESTIONS Will the penalty waiver apply to a $6,000 retirement plan distribution? How about $8,500?

  30. Medical Expense/Retirement Plan/IRA Distribution Exception: Non-Itemizer • For the Peter family, a $6,000 taxable distribution from a retirement plan would NOT be subject to penalty in 2015. • If the taxable distribution was $8,500, only $6,500 would escape the 10% penalty. The balance of the distribution, $2,000 will be subject to a 10% penalty of $200 in 2015.

  31. Medical Expense/Retirement Plan/IRA Distribution Exception: Itemizer – Sch. A --- Mr. and Mrs. Peter (both age 50) have an AGI of $95,000 for the year 2015. The Peter’s incur (and actually pay) $25,000 in qualifying medical expenses on behalf of their child with special needs during the year. Their allowable medical deduction will be $15,500 for 2015 ($25,000 less 10% of their AGI of $95,000 or $9,500). QUESTIONS Will the penalty waiver apply to a $15,000 retirement plan distribution? How about $20,000?

  32. Medical Expense/Retirement Plan/IRA Distribution Exception: Itemizer – Sch. A • A $15,000 taxable distribution from a retirement plan would NOT be subject to penalty. • However, if the taxable distribution was $20,000, only $15,500 would escape the 10% penalty. The balance of the distribution, $4,500 will be subject to a 10% penalty of $450. • NOTE: To the extent the distribution is included in gross income, AGI increases, reducing the medical expense deduction!

  33. Another Itemized Deduction: Qualified Residence Interest • Interest on qualified loans secured by a primary or secondary residence is deductible Two types of qualified loans: • Acquisition Debt: debt incurred to purchase, construct, or substantially improve a residence • Home Equity Debt: debt secured by a primary or secondary residence that does not exceed FMV— acquisition debt. The loan proceeds may be used for any purpose (i.e., medical expenses). • “Residence” includes vacation homes, condos, mobile homes, boats, or RVs with basic living accommodations.

  34. Limitations on Qualified Residence Interest Deductions • Deductible interest on aggregate acquisition debt is limited to $1,000,000 of debt ($500,000 if MFS) • Deductible interest on home equity loans is limited to $100,000 of debt ($50,000 if MFS) • IRS announced its acquiescence in Voss (9th Circuit Court of Appeals) where two unmarried individuals co-owned two properties and were permitted to claim interest on a per TP, per residence basis, effectively doubling the limitations! • Acquisition debt is increased only if capital improvements are made (i.e., capital improvements for medical purposes) • Home equity debt may be increased at any time

  35. Qualified Residence Interest DeductionsExample • John & Mary make a $150,000 down payment and take out a $500,000 mortgage to purchase a residence worth $650,000. Several years later, John & Mary’s home is now worth $800,000 and their acquisition debt remaining is $400,000. They borrow $200,000 to provide for the ongoing medical care of their 15 year old son with special needs, and use their residence to secure this note. • They may deduct interest on: $400,000 of remaining acquisition debt and $100,000 of home equity debt.

  36. Itemized DeductionsNo Deduction Cut-Back for 2010-12! • 3% cut-back rule • Taxpayers must reduce itemized deductions other than medical expenses, gambling losses, investment interest, and casualty & theft losses by 3% of their AGI • 2015 threshold: $309,900 ($154,950 if MFS) • 2016 threshold: $311,300 ($155,650 if MFS) • The threshold is indexed for inflation • The reduction may not exceed 80% of deductions subject to cut-back

  37. MFJ have the following deductions: Medical expenses of $16,000 (after 10% AGI ) State income taxes of $22,000 Mortgage interest of $30,000 Charitable contributions of $7,000 AGI is $406,300 Threshold for 2016 is $311,300 AGI exceeds threshold by $95,000 Itemized deductions are reduced by $2,850 Itemized deductions reduced to $72,150. Example: Deduction Cutback

  38. …Individual AMT Considerations • Adjustments for Individuals only! • Itemized Deductions: • no deduction for taxes (including sales taxes) • no misc. itemized deductions • medical expenses must exceed 10% of AGI (N/A unless age 65 or older in 2013-2016) • no home equity interest expense • No Standard Deduction • No Personal or Dependency Exemptions

  39. AMT: Home Equity Interest ExpenseExample • John & Mary (from the prior example) paid $19,000 in mortgage interest expense and $11,000 in interest expense on their home equity indebtedness in 2015. Although $24,500 is deductible for regular tax purposes (only half of the home equity indebtedness is deductible), only $19,000 is permitted as a deduction for the AMT, requiring an AMT add-back of $5,500. • The add-back of home equity interest expense, when combined with all of the other tax-preference items may create an unexpected tax…the AMT!

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