Advice sought for one-time high-income tax return planning

[FEDUKE404]

Like many (most) of the folks here, I generally try to avoid giving tax-planning advice except in the most general of terms. I figure CFPs and similar are best suited (and liable) for such advice.

However, for 2015 I have two separate clients who have encountered a significant bounce in their incomes, both due to long-term capital gain events. One had a stock sale with a profit of ~$175k and the other has a pending land sale (personal residence) with taxable profit of ~$400k. The "stock" person has other total income in the range of the stock sale, and the "residence" person has other total income in the range of half of the land sale.

For general planning purposes, I have used the 2014 income tax returns and then "added" the new items. As can be expected, all kinds of unpleasant things happen.

Personal exemptions get reduced/eliminated. (For "residence" person, it is likely four personal exemptions will yield zero taxable income reduction.)
Otherwise allowable itemized deductions get pared.
Form 8960 comes into play.
Form 8959 is a strong possibility for "residence" person who is still employed at a good salary level. (The "stock" person is retired.)
AMT is an issue for "residence" person only. The "stock" person will get assaulted (MFJ) with higher Medicare B premiums starting in 2017.
While there is a bit of uncertainty as to whether the land sale will occur late in 2015 or (slight chance) early in 2016, there is *NO* possibility of an installment sale (it's a commercial buyer).

Both persons will be making some investment decisions, primarily seeking to find some 2015 stock losses to reduce the overall Sch D gain. That would also help with Form 8960 issues. Other than Sch D variances, there is little either party can do to modify their overall incomes.

The MAIN issue I would like to hear some input on is how to handle potential Schedule A issues. Neither individual has a mortgage. Property taxes and contributions are not significant, and in the past they have often barely broken the standard deduction floor except for "stock" (non-AMT) person who does have sizable medical expenses. . .which are to get whacked in addition to what is noted above!

The only things that are really on the table, as for Schedule A, are doubling up on contributions, perhaps prepay some property tax, and consider calculating/paying the expected state income tax balance due by 12/31/2015. **BUT** with AMT on the horizon, and the fact that virtually any "increased" deductions would be summarily limited due to high income, it almost seems possible that NOT bumping up the 2015 deductions (and having a greater 2015 taxable income) could perhaps be preferable as, for 2016, it is likely both clients would face NO limitations on their Schedule A itemized deductions. Somewhat in the range of "more bang for the (deduction) buck."

Am I not seeing the forest for the trees here, to the extent that doing whatever is possible to increase 2015 itemized deductions may very well NOT be the proper path to follow?

Thanks for any input on this topic you might have to offer. To encounter two such high-income tax returns in the same year is a bit unusual for me.

FE

[TAXNJ]

Only you

"I can't see the forest through the trees, except the trees are people " quote Sloane Crosley.

Only you know your limitations. You are correct that many of us may experience this type of client that is not the norm.

Many would do the "What If" scanerios based on clients history is a good starting point (however, a deduction for future years personal Real Estate taxes in current year may be an issue - need to review that).

With high income clients, think it is always wise to work with a "Tax" Attorney for areas you may not be familiar and if need be, also a CFP. This scenario may provide a better basis for decision making.

With your expertise and knowledge along with the others mentioned, may help with your decision. But only you know if that works.

Best of luck in your journey of becoming a high income taxpayer yourself and remember us.

Let us know

[Kram BergGold]

Multiple What Ifs

You seem to have a handle on this.
You just need to do multiple what Ifs for 2015 and 16 playing with charity and then advise cleints which is the best year to make the contributions.

[BOB W]

Like many (most) of the folks here, I generally try to avoid giving tax-planning advice except in the most general of terms. I figure CFPs and similar are best suited (and liable) for such advice.

However, for 2015 I have two separate clients who have encountered a significant bounce in their incomes, both due to long-term capital gain events. One had a stock sale with a profit of ~$175k and the other has a pending land sale (personal residence) with taxable profit of ~$400k. The "stock" person has other total income in the range of the stock sale, and the "residence" person has other total income in the range of half of the land sale.

For general planning purposes, I have used the 2014 income tax returns and then "added" the new items. As can be expected, all kinds of unpleasant things happen.

Personal exemptions get reduced/eliminated. (For "residence" person, it is likely four personal exemptions will yield zero taxable income reduction.)
Otherwise allowable itemized deductions get pared.
Form 8960 comes into play.
Form 8959 is a strong possibility for "residence" person who is still employed at a good salary level. (The "stock" person is retired.)
AMT is an issue for "residence" person only. The "stock" person will get assaulted (MFJ) with higher Medicare B premiums starting in 2017.
While there is a bit of uncertainty as to whether the land sale will occur late in 2015 or (slight chance) early in 2016, there is *NO* possibility of an installment sale (it's a commercial buyer).

Both persons will be making some investment decisions, primarily seeking to find some 2015 stock losses to reduce the overall Sch D gain. That would also help with Form 8960 issues. Other than Sch D variances, there is little either party can do to modify their overall incomes.

The MAIN issue I would like to hear some input on is how to handle potential Schedule A issues. Neither individual has a mortgage. Property taxes and contributions are not significant, and in the past they have often barely broken the standard deduction floor except for "stock" (non-AMT) person who does have sizable medical expenses. . .which are to get whacked in addition to what is noted above!

The only things that are really on the table, as for Schedule A, are doubling up on contributions, perhaps prepay some property tax, and consider calculating/paying the expected state income tax balance due by 12/31/2015. **BUT** with AMT on the horizon, and the fact that virtually any "increased" deductions would be summarily limited due to high income, it almost seems possible that NOT bumping up the 2015 deductions (and having a greater 2015 taxable income) could perhaps be preferable as, for 2016, it is likely both clients would face NO limitations on their Schedule A itemized deductions. Somewhat in the range of "more bang for the (deduction) buck."

Am I not seeing the forest for the trees here, to the extent that doing whatever is possible to increase 2015 itemized deductions may very well NOT be the proper path to follow?

Thanks for any input on this topic you might have to offer. To encounter two such high-income tax returns in the same year is a bit unusual for me.

FE

Can you be clearer on the residential property, personal residence (primary residence) or investment property? Is the $400,000 after any excludable issues? Single or Married?

I know the income issues was not on your list but I was just curious............................

[FEDUKE404]

Initial responses

Thanks TAXNJ and Kram BergGold -

Interestingly enough, both of these clients are pretty much "normal" in the nature of their tax returns other than during 2015 each will experience a one-time significant bump in income.

On the income side, other than finding some Sch D losses as an offset, there is very little either can do to move the "income" side of the balance. A fair amount of the tax pain is inflicted via the ACA/Medicare surcharge (Form 8960) based mostly on "investment" income.

On the deduction side, there is not much there either. Get a mortgage when both have none? Not wise. Consider being very benevolent in charitable contributions? Consider prepaying (expected) state income taxes before 12/31/2015? Perhaps, but an extra $2k donation or extra $5k income tax payment shown on line 19 or line 9 of Schedule A shrinks considerably by the time you have the final (limited) number on line 29 of Schedule A. Aside from that consideration, for the person facing AMT to a certain extent they may have to think in reverse, i.e. income "good" and deductions "bad." That further muddies the waters.

For TAXNJ, I have in the past had clients (myself included) prepay the upcoming year ( = expected ) real property taxes prior to 12/31. When the actual bill shows up around July, the county folks apply the prepayment. At least, according to them, it is a fairly common practice and is the flip side of paying the current property taxes a bit "late" (such as on Jan 2nd) to double-up on deductible taxes. Late-payment penalties often do not begin until around the 2nd week in January. IIRC, there is a gray zone associated with such, but prepayments of the type described should (did?) fit within the rules.

I do feel, as a "tax person," some need to clarify what may be possible with the scenarios listed above. Conventional wisdom, for the most part, says to increase deductions as best you can during a high-income tax year. In most cases, decreasing taxable income is a worthy goal! However, the issue that is at hand here is that certain "deductions" could potentially be better used in a "normal" year (such as 2016) versus the 2015 "unusual" year. It would help if there were significant tax law differences between 2015 and 2016, but that appears unlikely, making such considerations essentially moot. In all likelihood, both clients will be settled in at the 33% federal tax marginal rate regardless.

These are not "rich folks." Comfortable, but far from rich. They likely have little need for off-the-wall tax gimmicks (said in a nice way). For 2016 and beyond, their taxes should be quite normal once again. It also helps that both clients have a good understanding of the underlying issues at hand, and the fact there are several approaches to be evaluated. Because of the number of variables involved, many of the traditional "what-ifs" scenarios become extremely complicated in nature. . .way too many variables can come into play!

At this stage, and the purpose for my original post, is that I'm leaning heavily toward *NOT* creating more deductions for 2015 (such can be limited and/or counterproductive) and focusing on having less income show up on the return (again, not much wiggle room there except for Sch D). With the understanding the same deductions can (likely) do more good in 2016 when the clients will have moderately (but not ridiculously) high income once again

Thanks for the continuing input. I value all opinions here!

FE

[FEDUKE404]

Clarification of home being sold

Can you be clearer on the residential property, personal residence (primary residence) or investment property? Is the $400,000 after any excludable issues? Single or Married?

I know the income issues was not on your list but I was just curious............................

Residential property is sale of personal (qualifying primary) residence and adjoining (~4 acres) land. Several families who used to live "in the sticks" are being bought out, as a group, by a commercial developer. The $400k amount previously mentioned is AFTER consideration of sale/cost basis issues and AFTER removal of the $500k qualifying MFJ homeowner gift. Stated differently, the bottom line number on Sch D will be the $400k taxable gain (although they will be "clearing" somewhere in the range of $900k+ on the sale). All of the nearby existing homes that are part of the sale will likely be bulldozed the morning after the sale is finalized. Interestingly enough, wife had in recent years known such a sale was likely sometime in the reasonably near future. Comment?: "Not until they meet MY price!!" [Hint - same included several zeros.] Obviously they, and the other homeowners, have reached "an understanding" with the buyer.

Aside: Their intention is to buy/build? a new home later this year, and they are adamant they do NOT want a mortgage on their new home. Certainly their choice!

Both clients are MFJ. Home sale folks have two dependents (college age). Stock sale folks' dependents flew away long ago.

FE

[kathyc2]

I agree that once you hit AMT, there is little if any benefit to shift some A expenses to high income year. Of course you always want to run the numbers to verify. Couple of things you probably already thought of is having the working couple max out 401K for 2015, and possibly having retired couple do direct charitable contributions from IRA and hope it gets extended again.

I have quite a few clients that see little benefit of itemizing. When I explain the concept of doubling charitable, RE tax, etc to one year and itemizing and then taking the std deduction next year, they generally say that's a great idea, but I don't think any have actually followed through. You can lead a horse to water....

[FEDUKE404]

AMT and selective itemizing

I agree that once you hit AMT, there is little if any benefit to shift some A expenses to high income year. Of course you always want to run the numbers to verify. Couple of things you probably already thought of is having the working couple max out 401K for 2015, and possibly having retired couple do direct charitable contributions from IRA and hope it gets extended again.

I have quite a few clients that see little benefit of itemizing. When I explain the concept of doubling charitable, RE tax, etc to one year and itemizing and then taking the std deduction next year, they generally say that's a great idea, but I don't think any have actually followed through. You can lead a horse to water....

The "land" couple has been maxing out their 401(k)s for some time. Cannot go Traditional IRA, but they've been funding Roth IRAs when allowable. Forget about that one for 2015! The "stock" couple is retired, but H has small Sch C and has also been tossing funds into a Roth IRA in years when they do not hit the dollar limitations. (In recent years the allowable amount HAS been limited.) All four adults have been effectively locked out of any Traditional IRAs for many years. Husband of "stock" couple has some Traditional IRA funds lying around from long ago, but no recent drains from that account have occurred. One end run that had been used in the past is that "stock" couple has significant (recurring) medical bills, and in a couple of instances their taxable income has been so low that they can withdraw Traditional IRA funds and their tax liability is completely unchanged. (They also have some Form 1116 current/prior tax credits gathering considerable dust. . .) We've had a couple of "December decisions" made as related to that option.

FE

[TAXNJ]

After

Think you are at a point to go over the "what ifs" with the clients for them to decide.

"After the fact" planning is always tough. Similar to ciients whose spouse or both died without proper tax planning (or even a will) which is a topic many do not discuss, plan or think it's not going to happen to them. Then there are some that are smart and do the proper planning. Or a client who just won the lottery. As you know, it's just the nature of the business.

Once the clients make their decision on the "what ifs" you presented, then it sounds like you have a good opportunity to work estate planning recommendations with other Professionals and your clients.

[kathyc2]

The "land" couple has been maxing out their 401(k)s for some time. Cannot go Traditional IRA, but they've been funding Roth IRAs when allowable. Forget about that one for 2015! The "stock" couple is retired, but H has small Sch C and has also been tossing funds into a Roth IRA in years when they do not hit the dollar limitations. (In recent years the allowable amount HAS been limited.) All four adults have been effectively locked out of any Traditional IRAs for many years. Husband of "stock" couple has some Traditional IRA funds lying around from long ago, but no recent drains from that account have occurred. One end run that had been used in the past is that "stock" couple has significant (recurring) medical bills, and in a couple of instances their taxable income has been so low that they can withdraw Traditional IRA funds and their tax liability is completely unchanged. (They also have some Form 1116 current/prior tax credits gathering considerable dust. . .) We've had a couple of "December decisions" made as related to that option.

FE

I'm confused as to why retired stock couple is locked out of Traditional IRA's unless due to being over 70 1/2. If that's the case, couldn't he still do a SIMPLE? Can they set up some deferred payment plans for medical expenses to shift them to 2016?

[Roland Slugg]

One had a stock sale with a profit of ~$175k.

It's too bad those clients already sold that stock. A pre-sale gift might have been smart.

That opportunity may exist, however, for the "residence" clients. If they would be willing to do so, they could make a gift of an undivided interest in their home to their two children, who you indicated are "college age." Use your tax prep software's planning screen to see how much that $400k gain would need to be reduced in order to achieve the optimal result. It probably won't need to be eliminated completely. Then figure out what percentage of the home would need to be gifted, before its sale, in order to result in the targeted taxable gain, and then gift each child 50% of that amount. If giving away, say, a 34% undivided interest in the home will reduce the gain taxable to the parents to a manageable $100k, then each child would need to be gifted a 17% interest in the home. (The gifts would not have to be equal. To give away 34% the gifts could be, say, 20% and 14%.)

Depending on the ages of the children the "kiddie tax" may apply, but there would still be a significant savings. The parents' itemized deductions would be saved, and the NIIT would be reduced or eliminated. The children's higher income would probably mean the parents would lose the exemption deductions for them, but if so, then the children could claim them on each of their own returns.

In order for this to work the parents would have to be willing to part with the portion of the house, and the resulting sale proceeds, gifted to their children. To soften the financial blow they could then require the children to fund the remaining years of their college educations. In the long run the parents might not be out any more $$$ than they would have if they had done no planning. College is expensive, and although you didn't say the children were actually going to college, I inferred that from your wording.

You indicated that an installment sale is out of the question. I would not be so fast to assume that. The buyer is going to a lot of work to buy several contiguous parcels for a new development, and I'm sure he would be willing to consider a two-payment purchase ... especially if the first is paid late in 2015, and the second is payable early in 2016. That would probably be a very easy demand for the buyer to accommodate.

If these were my clients, I would advise them to try both ... the two-payment installment sale and the gifting. In fact if the installment sale is arranged, the portion of the house gifted to the two children could be less.

Regarding the "what-iffing" you and others have mentioned regarding itemized deductions, it's a no-brainer. If no planning will result in the loss of most of the taxpayers' itemized deductions, then delaying paying them until next year has got to be a good idea. You don't need to do any what-iffing to understand that. If the AMT then nails them in 2016, well, that's the way it goes. Just remember that the AMT only adds a small percentage to a taxpayer's tax bill in most cases, so even when it applies, it doesn't mean tax planning was done incorrectly.

[TAXNJ]

R. Sluugg's suggestions

R. Sluugg's suggestions offer some more "what ifs" that would be worth exploring.

As far as the gift suggestion, not knowing the age of the children or the family unit, would the children (and if spouses involved) be willing to sell once given an interest in the house, and at the price offered the parents or would they have a different price in mind? As you know, if it's a gift, no strings can be attached.

But it's another strategy to explore.