Various factors influence the amount of income tax you will pay for the 2016 tax year.  Many taxpayers wait until late in the year or even after the end of the year before thinking about the tax ramifications of their actions in a given tax year.  If you have not already considered these issues, you still have time to make informed decisions and tax-wise planning for the 2016 tax year.  The following opportunities apply to employees and may merit your consideration.

Health flexible spending accounts. You can reduce your taxes by placing funds in your employer’s flexible spending accounts (health FSA). For 2016, you can contribute up to $2,550 in pre-tax dollars to a health FSA. This permits you to use the FSA to pay for medical expenses that might not be deductible, especially if you don’t itemize your deductions.  If you do itemize, you still may not be able to deduct some health care costs because the tax regulations limit the amount you can deduct, based on adjusted gross income. Those limitations don’t apply to the tax-free funds you place in the FSA. In addition, you won’t have to pay PICA taxes on the earnings that you contribute to a health FSA.  If you contribute the maximum $2,550 to a FSA, you’ll save $195 in ICA taxes, in addition to the state and local income taxes you would have paid on the $2,250. Here are some other points to keep in mind:

  • Use it or Lose it – You must use all FSA funds by the last day of the health care plan year, usually December 31.  Some plans allow for a grace period through March 15th of the next year. Health care FSAs may also be able to carry forward up to $500 for use in the next year and add it to the $2,550 limit.
  • Excluded Drugs – New this year – you cannot receive reimbursements for aspirin, antacids and other over-the-counter items unless your healthcare provider gives you a prescription for them. Check your plan for a list of qualified items and any needed documentation to claim them.
  • High Deductible Health Plans – if you or your spouse participate in an HDHP, participating in a health FSA may interfere with contributing to a health savings account (HSA).  You may be able to contribute to a limited purpose FSA to cover specific expenses like vision or dental.  Check the details of your plan if this interests you.
  • How Much to Contribute – It helps to track your medical expenses and to review the details before the end of the year. If you anticipate significant expenses such as elective surgery or a lot of dental work in the coming year, try to estimate how much to set aside to cover this.  Having actual health expense history helps make an informed decision.
  • Dependent Care FSAs – If your employer allows it, you may benefit from setting aside some funds to cover dependent care, also pre-tax.  A married couple can set aside up to $5,000 to cover dependent care. The tax savings from doing this could save you more than if you claimed a dependent care credit on your taxes.  It also saves on FICA taxes.  If this applies to you, consider comparing the resulting tax benefits both ways before making a decision.

Health savings accounts.  You may benefit from a health savings account if you qualify for it. A health savings account (HSA) can benefit an eligible individual covered under a “high deductible health plan” or “HDHP.” You can use HSA to pay for qualified medical expenses. The rules for 2016 define an “eligible individual” who is covered under an HDHP:

  •  (1) that has an annual deductible which is not less than-
    • $1,300 for self-only coverage, and
    • $2,600 for family coverage, and
  •  (2) for which the sum of the annual deductible and the other annual out-of-pocket (OOP) expenses required to be paid under the plan (other than premiums) for covered benefits does not exceed-
    • $6,550 for self-only coverage, and
    • $13,100 for family coverage.
In 2016, you can contribute up to $3,350 for an individual with self-only coverage under an HDHP and $6,750 for an individual with family coverage under an HDHP.
Qualified transportation/parking benefits. If you receive transportation or parking benefits, you may be able to exclude them from income, too. Examples include mass transit passes, parking, vanpooling and bicycle commuting reimbursements. Employers may pay for these tax-free through reimbursement or a salary reduction arrangement with the employee. This can total up to $130 per month for a commuter highway vehicle or any transit pass.  Parking exclusion amounts can total up to $255 per month. If you bicycle, you can exclude up to $20 per month for a bicycle commuting reimbursement.
Adjustments to state or federal withholding. You can ask your employer to increase withholding of federal or state and local taxes, by amending your tax withholding forms and federal Form W-4 well before the end of the year. You can also pay estimated tax payments for federal, state and local taxes. Increasing withholding and paying estimated tax can prevent the additional cost of late payment or underpayment penalties.
401(k) and Roth IRA Contributions. For 2016, you can contribute up to $18,000 for pre-tax and Roth 401(k) accounts. If you are age 50 or older by year-end you can also contribute an additional $6,000, for a total limit of $24,000 in 2016. Employers who make matching contributions can help further escalate total retirement savings. Get to know the details about the opportunities your employer offers. You can also contribute to a Roth IRA whether or not you participate in an employer plan. Up to age 50, you can contribute as much at $5,500 in 2016. The earnings result from these savings will not be taxable if you start to withdraw after age 59 1/2.  Individuals over 50 before year-end can contribute $6,500.  Higher income individuals may not be able to contribute as much if their income exceeds $117,000 for single people and $184,000 for married-filing jointly. Individuals with incomes over $132,000 for single and $194,000 for married-filing jointly do not qualify for Roth IRAs.
Convert your traditional IRA to a Roth IRA.  You can take funds from a traditional IRA and convert them to a Roth IRA.  The IRS treats this as a distribution; the move will generate some taxable income. The same follows for making an in-plan conversion to a Roth in your employer plan.  You will pay some tax now, but growth in value from this point forward follows the Roth IRA rules.
Borrow from your 401(k) instead of taking a distribution.  If you need money and you’re under age 59 ½, taking funds out of your 401(k) results in taxable income and a 10% premature distribution tax. Some 401(k) accounts permit taking out a loan against the value of your plan. The plan and the IRS limit the amount you can borrow, but you’ll generally have five years or even longer to repay the loan. The interest that you pay will go back into your account. Some life insurance plans have this feature, too.

Business Vehicle Deductions. If your business uses a qualifying SUV or Truck greater than 6000 pounds in gross weight, you may be able to claim a deduction.  Here’s how the IRS describes the rules for such a deduction.

  • Passenger automobiles: Four-wheeled vehicles having an unloaded gross weight of 6,000 pounds or less, manufactured primarily for use on public roads are subject to depreciation limitations.
  • Trucks or Vans: The 6,000-pound weight limit is based on “gross weight” (including passengers and cargo) rather than unloaded weight. Many full-sized pickups and large vans may not be subject to those depreciation limitations because their gross weight exceeds 6,000 pounds.
  • Light trucks and vans specially modified for business use – Example include ambulances, hearses, taxicabs, and specially modified vans.  The nature of the business use or modification makes these vehicles unlikely for personal use and, therefore, not subject to the depreciation limitations. IRS regulations consider passenger automobiles generally as five-year (MACRS) property for purposes of computing depreciation expense.
  • Get help from TD&T – If you are considering an investment in a vehicle for your business, we can assist you with these calculations.
Lease or Buy – How Does this Affect Taxes?

You can deduct the percentage of lease payments that correspond to an auto’s business-use in any tax year, in addition to the business-use percentage of other out-of-pocket operating costs. Leasing a luxury auto, however, will not avoid the depreciation limits. You must include an amount in income to offset a portion of the lease expense in order to achieve parity with luxury autos that are owned and depreciated rather than leased.

  • The amount included in income depends on the auto’s Fair Market Value (FMV) on the first day of the lease term. The IRS helpfully provides a table to determine the amount to include as income.  For autos leaded in 2015, you will find this table in IRS Revenue Procedure 2015-19.
  • FMV is the amount it would take to buy the vehicle in an arm’s length transaction. TD&T can assist you with finding and calculating the vehicle Fair Market Value (FMV) for purposes of valuing the employee’s use of the employer’s auto.
Example:  Lease income inclusion amount.
On January 12, 2013, Ted leased a car for three years for use in his business. The car had a $36,250 FMV on the first day of the lease term and is used 75% for business. The lease inclusion amount for 2013 was $8 (table amount of $11, prorated for 75% business use and 354/365 days of the year). For 2014 (the second year of the lease  ), the income inclusion amount was $19 (table amount of $25 × 75% business use). For 2015 (the third year of the lease), the income inclusion amount is $27 (table amount of $36 × 75% business use). The income inclusion for 2016 is based on the table amount for the preceding year (2015) because 2016 is the last year of the lease. Thus, the 2016 income inclusion will be $1 (table amount of $36 × 75% business use × 11/365 days).
  • The total gross income inclusion of $55 for the entire three-year lease period appears minimal compared to the depreciation limits on passenger cars. However, the lease inclusion amount represents a permanent difference (calculated to represent the time value of the extra lease deduction), while the depreciation limitations represent a timing difference that the taxpayer eventually recovers through depreciation deductions or upon the car’s disposition.Self-employed taxpayers report the income inclusion amount by reducing the amount of lease deduction claimed on either Schedule C or F.
  • A taxpayer may use the standard mileage rate method with respect to an automobile that is leased, instead of deducting actual costs (including lease payments). This use of the standard mileage rate allows the taxpayer to avoid the lease income inclusion requirement.
  • Auto leases often require a cash down payment at signing. These payments must be amortized over the entire lease period and are not currently deductible (See IRS Pub. 463). However, the portion of the down payment allocable to a refundable security deposit is not deductible or amortizable.
  • You may also have additional payments when the lease is terminated.
  • For example, you may have to pay a penalty for an early termination of the lease. In this case, you can generally deduct lease termination payments. Also, you may have additional charges for exceeding the allowed mileage at the end of the lease. These charges are fully deductible as a business expense if you used the auto 100% for business; otherwise, they are prorated.
  • A lessee of an automobile is generally not entitled to expense the cost of the automobile under IRC Sec. 179 unless the rare exception exists that requires the lessee to purchase the vehicle at the end of the lease term. The mere option to purchase does not satisfy this requirement
When evaluating the decision to lease vs. buy, the professionals at TD&T can assist you with this task to optimize the use of your business dollars.