Taxpayers can take advantage of two types of deductions. So-called “above-the-line” deductions reduce both your adjusted gross income (AGI) and your modified adjusted gross income (MAGI), while “itemized” deductions (i.e., below-the-line deductions) do not reduce either AGI or MAGI.
Deductions that reduce your AGI (or MAGI) are particularly favorable because they not only reduce your taxable income, they also may free up other deductions and tax credits that phase out as your AGI (or MAGI) increases (e.g., itemized deductions, personal exemptions, certain IRA contributions, certain education expense deductions and credits, adoption credit, etc.).
In addition, “above-the-line” deductions could serve to reduce your MAGI below the income thresholds for the 3.8% Net Investment Income Tax.
“Above-the-line” deductions “Above-the-line” deductions include the following:
- Allowable deductions for IRA or Health Savings Account (HSA) contributions;
- Health insurance premiums for self-employed individuals;
- Qualified student loan interest;
- Alimony payments;
- Moving expenses; and
- Business expenses for a self-employed individual.
Unreimbursed “employee” business expenses are classified as “miscellaneous itemized deductions” and trigger two potential limitations:
- Aggregate “miscellaneous itemized deductions” are allowed only to the extent they exceed 2% of your AGI, and
- Any excess is included in “itemized deductions,” which are reduced once your AGI exceeds certain thresholds (e.g., for 2016, $311,300 for joint returns; $259,400 if single).
However, if you arrange for your employer to reimburse you for your “qualified” employee business expenses under an “accountable reimbursement plan,” the reimbursement is excluded from your income, which is generally the equivalent of an “above-the-line” deduction.
Accelerating “above-the-line” deductions As a cash method taxpayer, you can generally accelerate a 2017 deduction into 2016 by “paying” for the deductible item in 2016. “Payment” typically occurs in 2016 if a check is delivered to the post office, if your electronic payment is debited to your account, or if an item is charged on a third-party credit card (e.g., Visa, MasterCard, Discover, American Express) in 2016.
Note that if you post-date the check to 2017 or if your check is rejected, no payment has been made in 2016. Also know that prepayments of expenses applicable to periods beyond 12 months after the payment are not deductible in 2016, according to the IRS.
Accelerating “itemized” deductions into 2016 Although itemized deductions (i.e., below-the-line deductions) do not reduce your AGI or MAGI, they still may provide valuable tax savings.
Itemized deductions generally include:
- Charitable contributions;
- State and local income taxes (or, alternatively state and local sales taxes);
- Property taxes;
- Medical expenses;
- Unreimbursed employee travel expenses;
- Home mortgage interest; and
- Gambling losses (to the extent of gambling income).
However, if your itemized deductions fail to exceed your standard deduction in most years, you are not receiving maximum benefit for your itemized deductions. You could possibly reduce your taxes over the long term by bunching the payment of your itemized deductions in alternate tax years. This may produce tax savings by allowing you to itemize deductions in the years when your expenses are bunched, and use the standard deduction in other years.
The easiest deductions to shift from 2017 to 2016 are charitable contributions, state and local taxes, and your January 2017 home mortgage interest payment.
For 2016, the standard deduction is $12,600 on a joint return and $6,300 for single individuals. If you are blind or age 65, you get an additional standard deduction of $1,250 if you’re married ($1,550 if single).
Be aware, though, that certain itemized deductions are not allowed in computing your alternative minimum tax (AMT), such as state and local taxes (including state income taxes) and unreimbursed employee business expenses. Before you accelerate 2017 itemized deductions into 2016, to be safe, we should calculate your taxes with and without accelerating the deduction so we can determine the AMT impact of this strategy.
Medical expenses for seniors Generally, you are allowed an itemized deduction for un-reimbursed medical expenses (including un-reimbursed health insurance premiums) only to the extent your aggregate medical expenses exceed 10% of adjusted gross income (AGI). However, if either you or your spouse is at least age 65 before the close of the year, your threshold is 7.5% of AGI instead of 10% (whether you file a joint return or separate returns).
After 2016, however, the threshold for those at least age 65 increases from 7.5% to 10% of AGI. If you or your spouse are age 65 or older and anticipate more than negligible medical expenses in the near future, consider accelerating as many elective medical expenses (i.e., braces, new eye glasses, etc.) into 2016 as possible – if this will allow you to exceed the 7.5% threshold. Waiting until 2017 will require your medical expenses to exceed the 10% threshold.
Charitable contributions If you are planning to contribute to a charity before the end of this year and you want a charitable deduction for 2016, please note that a charitable contribution deduction is allowed for 2016 if the check is mailed on or before December 31, 2016, or the contribution is made by a credit card charge in 2016.
If you merely give a note or a pledge to a charity, no deduction is allowed until you pay the note or pledge.
Document your giving
The IRS regulations provide that you may not take a deduction for a charitable contribution unless you strictly comply with the rigid documentation requirements imposed by the Internal Revenue Code. Over the last several years (including 2016), there have been a series of court cases disallowing charitable contribution deductions because the taxpayer failed to satisfy one or more of the strict documentation requirements. The IRS and the courts have been particularly harsh with respect to taxpayers that fail the mandatory documentation requirements for contributions of “$250 or more.”
Under this requirement, if you contribute $250 or more (whether by cash, check, charge card, or in property) to a charity, you are allowed a deduction only if you receive a “qualifying written receipt” from the charity by the time you file your return (a cancelled check is not enough) and the return is timely filed. The qualifying written receipt must contain the following information:
- The amount of cash and a description (but not value) of any property other than cash you contributed to the charity;
- A statement as to whether the charity provided you with any goods or services in return for your contribution; and
- A description and good faith estimate of the value of any goods or services, if any, the charity provided to you (or, if applicable, a statement that the goods and services consisted solely of intangible religious benefits).
In addition, for all noncash contributions, the receipt must contain:
- The date of the charitable contribution;
- The location of the contribution; and
- A description of the property contributed.
Even for contributions of less than $250 each, you need certain documentation:
- For cash contributions, you need a written receipt from the charity.
- For contributions made by check, debit card, or credit card, you need either a written receipt from the charity, a cancelled check, a bank statement, or a credit card statement.
Maximizing your home mortgage interest deduction. If you are looking to maximize your 2016 itemized deductions, you can increase your home mortgage interest deduction by paying your January, 2017 mortgage payment on or before December 31, 2016.
Typically, the January mortgage payment includes interest that was accrued in December and, therefore, is deductible if paid in December. If you plan to take advantage of this, make sure that you send in your January 2017 mortgage payment early enough in December for your lender to actually receive it before year-end. That way, your lender should reflect that last payment on your 2016 Form 1098, and we can avoid a matching problem on your 2016 return.
Source: Don Farmer, CPA
