Grossbach Zaino & Associates, CPA's, PC


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A Student Loan Tax Break

If you are paying interest on one or more student loans, you may be able to deduct up to $2,500 of the interest annually. The deduction is “above the line,” so you don’t need to itemize to claim it.

 

General Rules

 

To qualify, the debt must have been incurred by you, your spouse, or your dependent (as of the time the debt was incurred) for the sole purpose of paying tuition, room and board, and related expenses for post-high-school education. Certain post-graduate and vocational programs also qualify. The student must be a degree candidate carrying at least half the normal full-time course load.

 

The person claiming the deduction must be legally obligated to make the interest payments and not be another taxpayer’s dependent. Married couples must file jointly to claim the deduction. For 2016, the deduction is phased out if a couple’s adjusted gross income is between $130,000 and $160,000 ($65,000 and $80,000 for single filers).

 

Home Equity Loans

 

Taxpayers who choose to use a home equity loan for higher education expenses also may be able to deduct the interest on their loans. Generally, interest on a home equity loan may qualify for an itemized deduction if the underlying debt doesn’t exceed $100,000 ($50,000 for a married taxpayer filing separately) and all mortgages on the home do not exceed the home’s fair market value.


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Was That Stock Sale a Wash?

Unfortunately, not every purchase of securities ultimately makes a profit for the investor. However, tax law allows investors to use any capital losses realized when securities are sold to offset capital gains on other transactions. Moreover, excess capital losses may be used to offset an additional $3,000 of ordinary income ($1,500 if married filing separately) annually, and any additional capital losses may be carried forward to later tax years (subject to the same restrictions).

 

There is an exception though. You cannot deduct losses from sales or trades of securities in a wash sale. Generally, a wash sale occurs when you sell securities at a loss and purchase substantially identical securities within 30 days before or after the sale date.


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Will Taxes Be Part of Your Home Sale?

You’ve sold your home and made a nice profit on the sale. So you may be wondering if Uncle Sam is entitled to a cut. Although gain on a home sale is potentially taxable, you may qualify for a federal income-tax exclusion.

 

The Rules in General

 

If you’re a single taxpayer, you may qualify to exclude gain of up to $250,000 if you owned the home and used it as your principal residence for at least two of the five years before the sale. Married couples who file jointly may exclude up to $500,000 of gain as long as one spouse owned the home — and both spouses used the home as a principal residence — for two of the last five years.

 

The Frequency Factor

 

The exclusion is generally available to sellers only once during a two-year period. A married couple is entitled to the $500,000 exclusion only if neither partner used the exclusion within the two-year period that ended on the sale date.

 

Reduced But Available

 

Even if you don’t meet the criteria described above, you may still qualify for a reduced exclusion (of less than $250,000 or $500,000) if the primary reason for the home sale was a change in the location of your employment, a health condition, or certain other “unforeseen” circumstances. The affected individual can be you, your spouse, a co-owner of the residence, or a person sharing your household. You may also qualify for the reduced exclusion if you sell your home to care for a sick family member.

 

Additional restrictions on gain exclusion may apply if you’ve rented out your home, maintained a home office, or turned a second home into a principal residence.


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Back to the Drawing Board

It’s April. Your tax return has been filed. So what’s next? If you’re hoping to pay less tax in the future, your best move may be to go back to the drawing board. Using your 2015 return and what you tell us about your current financial picture as a guide, we can help you identify potential tax-reducing strategies for 2016 and beyond. Here are a few ideas to get you started.

 

Save for Retirement

Making pretax contributions to a 401(k) or 403(b) plan sponsored by your employer reduces the amount of your taxable wages — and the amount of income tax withheld from your paycheck. Your deferrals, along with earnings from investing the deferrals, are not taxable until the money is distributed to you.

 

As a 401(k), 403(b), or 457 plan participant, you may also have an opportunity to make after-tax “Roth” contributions. Making Roth contributions won’t save you taxes upfront. The advantage comes later, after a five-year period passes, beginning with the year you made your first Roth contribution. At that point, any Roth money distributed from the plan is tax free, provided you are at least age 59½ or the distribution is made on account of your disability or death. So, qualifying earnings on your Roth contributions are never taxed.

 

Think Capital Gains and Dividends

Turning to non-retirement account investments, two types of earnings receive favorable tax treatment: long-term capital gains and qualifying dividends. For 2016, the tax rate on both is capped at 20% (15% or 0% for those in a tax bracket below 39.6%). Because your regular tax bracket could be as high as 39.6%, there may be a substantial tax incentive to earn capital gains and dividends instead of fully taxed short-term gains and interest income. Of course, tax considerations are only one factor to consider in managing your investments.

 

Find Above-the-Line Deductions

On the expense side of the equation, certain expenses, often referred to as “above-the-line” expenses, are deductible in arriving at your adjusted gross income rather than as itemized deductions. Some examples include: alimony paid, student loan interest, moving expenses, and self-employed health insurance. Limits apply. An above-the-line deduction not only lowers your taxable income, it can help you qualify for various other tax breaks.

 

A review of your 2016 tax situation may reveal additional opportunities to save taxes. When you’re ready to think taxes, think of us. We’ll be glad to help.


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Capitalizing on a Tax Holiday

Net long-term capital gain is generally taxed at a relatively low 15% or 20% rate in 2016. But low-bracket taxpayers enjoy an even better deal: Their net capital gain is tax free (i.e., the tax rate on the gain is 0%) to the extent it would have been taxed at the 10% or 15% rate if it had been ordinary income instead of capital gain.

 

Are tax-free capital gains out of your reach if your marginal tax rate is higher than 15%? Maybe not. Here are a couple of family gifting strategies that could save you tax.

 

Gift to parent. If you’re helping your folks financially, a gift of appreciated stock might be a tax-smart way to do it. As long as your parents’ taxable income stays below $75,300* in 2016, they can sell the stock and a 0% rate would apply to the capital gain.

 

Gift to child/grandchild. Until children reach age 19 (24 if they’re full-time students), the 0% rate generally would apply to only a limited amount of capital gain because of the “kiddie tax” rules.** But these rules aren’t an issue for older children (or for children ages 18-23 who have earned income exceeding one half of their support).

 

You can make tax-free gifts of up to $14,000 (per recipient) in 2016 without using up any of your $5.45 million estate- and gift-tax exemption amount.

 

 

* Substitute $37,650 for $75,300 if your parent is a single taxpayer. These figures represent the top of the 15% bracket for single and married-joint taxpayers, respectively.

 

** Under the kiddie tax rules, children pay tax at their parents’ highest rate on unearned income over $2,100 (in 2016).


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Investor Tax Tips

Income taxes probably aren’t your main consideration when you’re choosing investments. But when you’re investing outside of a retirement or other tax-deferred account, taxes are one of many factors to consider. Here are some points to keep in mind.

 

Mutual Funds

 

Mutual funds distribute the capital gains that are earned on investment transactions to their shareholders, typically during the last quarter of the year. Gains are accounted for in the fund’s share price before the distribution, so buying shares just before a fund goes ex-dividend means you’re essentially paying for the distribution you’re about to receive. You then have to report the “gain” on your tax return. So it’s wise to check on a fund’s distribution date before making a purchase.

 

Another thing to watch for, particularly in actively managed mutual funds, is high turnover rates. Trades generate transaction costs and commissions and, in some cases, result in short-term gains (which are taxed as regular income at rates as high as 39.6% in 2016, plus the 3.8% investment income surtax if applicable). So high turnover rates could signal higher costs and higher taxes.

 

Selecting tax-managed mutual funds may help you in your battle to reduce the impact of income taxes. The managers of these funds use strategies (such as low turnover and tax loss “harvesting”) to help lower taxes.

 

ETFs

 

Exchange traded funds (ETFs), like mutual funds, typically make distributions of interest and/or dividend income, which will be taxable if shares are held in a taxable account. Capital gains distributions, though less frequent, are also taxable. (Capital gains could result if an ETF sells securities to match the index it tracks.)

 

Given the increased tax rates imposed on the capital gains and other investment income of higher income taxpayers that started in 2013, it is more important than ever to make tax-smart investment decisions.


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Reflections on a Tax Refund

It’s hard not to like a tax refund. And many taxpayers receive them — over 116 million federal income-tax refunds were issued to individual taxpayers in 2014, according to IRS data.

 

If you expect to receive a refund this year, here is some food for thought.

 

Plan for Your 2016 Taxes

The reason you are receiving a refund is that you paid too much tax, either through wage withholding or by making payments of estimated tax. Instead of giving the IRS what amounts to an interest-free loan, you could have invested your money or used it for other things during the year.

 

For 2016, it might make sense to have your employer withhold less tax from your wages or to reduce your quarterly estimated tax payments. But don’t pay too little. Then, you would have a large tax bill to pay when you file your 2016 taxes — and you could be subject to an underpayment penalty.

 

Make Hay This Year

Now let’s look at this year’s refund for tax year 2015. What are you planning to do with it? Something impulsive, like take a vacation or make a purchase you wouldn’t otherwise make? If your finances are in good shape, then go for it. If not, you might want to consider the following possibilities.

 

Debt reduction. If you routinely carry credit card balances, use your refund to make a dent in your debt. With the average interest rate on credit cards around 18%, any reduction will help improve your financial situation.

 

Retirement savings. Unless you already have a healthy nest egg, investing your tax refund in a tax-advantaged retirement account is a step toward a more secure future.

 

College savings. Both Coverdell education savings accounts (ESAs) and Section 529 college savings plans provide tax benefits — two good ways to use your refund to save taxes and help with future expenses.

 

Emergency fund. If the money you have socked away for emergencies is running low, your tax refund could replenish it. If you don’t have an emergency fund, consider using your tax refund to start one. Aim for having enough liquid savings to cover between three and six months’ worth of expenses.