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What to Expect in 2016 Cost-of-living Adjustments

The IRS’ cost of living adjustments for 2016 have been released. Many amounts have remained flat since last year so inflation remains low. Those that did increase did so only modestly. Nonetheless, it’s helpful to know the 2016 amounts as you evaluate which 2015 year-end tax planning strategies to implement.

 

Changes in Individual Income Tax Brackets

Tax-bracket thresholds increase for each filing status but, because they’re based on percentages, they increase more significantly for the higher brackets. For example, the top of the 10% bracket increases by $50 to $100, depending on filing status, but the top of the 35% bracket increases by $1,050 to $2,100, again depending on filing status.

The personal and dependency exemption increases by only $50, to $4,050 for 2016. The exemption is subject to a phase-out, which reduces exemptions by 2% for each $2,500 (or portion thereof) by which a taxpayer’s Adjusted Gross Income (AGI) exceeds the applicable threshold (2% of each $1,250 for separate filers).

For 2016, the phase-out starting points increase by $700 to $1,400, to AGI of $259,400 (singles), $285,350 (heads of households), $311,300 (joint filers), and $155,650 (separate filers). The exemption phases out completely at $381,900 (singles), $407,850 (heads of households), $433,800 (joint filers), and $216,900 (separate filers).

Your AGI also may affect some of your itemized deductions. An AGI-based limit reduces certain otherwise allowable deductions by 3% of the amount by which a taxpayer’s AGI exceeds the applicable threshold (not to exceed 80% of otherwise allowable deductions). For 2016, the thresholds are $311,300 (up from $309,900) for joint filers, $285,350 (up from $284,050) for heads of households, $259,400 (up from $258,250) for singles, and $155,650 (up from $154,950) for separate filers.

 

Alternative Minimum Tax Considerations

The Alternative Minimum Tax (AMT) is a separate tax system that limits some deductions, doesn’t permit others, and treats certain income items differently. If your AMT liability is greater than your regular tax liability, you must pay the AMT.

Like the regular tax brackets, the AMT brackets are annually indexed for inflation. For 2016, the threshold for the 28% bracket increased by $900 for all filing statuses except married filing separately, which increased by half that amount.

 

The AMT exemptions and exemption phase-outs are also indexed. The exemption amounts for 2016 are $53,900 for singles and heads of households and $83,800 for joint filers, increasing by $300 and $400, respectively, over 2015 amounts. The inflation-adjusted phase-out ranges for 2016 are $119,700–$335,300 (singles and heads of households) and $159,700–$494,900 (joint filers). (Amounts for separate filers are half of those for joint filers.)

 

Breaks for Education and Child-related Expenses

The maximum benefits of various education and child-related breaks generally remain the same for 2016. But most of these breaks are also limited based on the taxpayer’s Modified Adjusted Gross Income (MAGI). Taxpayers whose MAGIs are within the applicable phase-out range are eligible for a partial break — breaks are eliminated for those whose MAGIs exceed the top of the range.

The MAGI phase-out ranges generally remain the same or increase modestly for 2016, depending on the break. For example:

The American Opportunity credit.

The MAGI phase-out ranges for this education credit (maximum $2,500 per eligible student) remain the same for 2016: $160,000–$180,000 for joint filers and $80,000–$90,000 for other filers.

The Lifetime Learning credit.

For 2016, the MAGI phase-out range for this education credit (maximum $2,000 per tax return) increases only for joint filers, to $111,000–$131,000 (up $1,000). The phase-out range remains at $55,000–$65,000 for other filers.

The Adoption credit.

The MAGI phase-out ranges for this credit also increase for 2016 — by $910, to $201,920–$241,920 for joint, head-of-household, and single filers. The maximum credit increases by $60, to $13,460 for 2016.

(Note: Married couples filing separately generally aren’t eligible for these credits.)

These are only some of the education and child-related breaks that may benefit you. Keep in mind that if your MAGI is too high for you to qualify for a break for your child’s education, your child might be eligible.

 

Effect on Retirement Plans

Retirement plan-related limits remain unchanged for 2016:

 

Type of limitation

2015 limit

2016 limit

Elective deferrals to 401(k), 403(b), 457(b)(2) and 457(c)(1) plans

$18,000

$18,000

Annual benefit for defined benefit plans

$210,000

$210,000

Contributions to defined contribution plans

$53,000

$53,000

Contributions to SIMPLEs

$12,500

$12,500

Contributions to IRAs

$5,500

$5,500

Catch-up contributions to 401(k), 403(b), 457(b)(2) and 457(c)(1) plans

$6,000

$6,000

Catch-up contributions to SIMPLEs

$3,000

$3,000

Catch-up contributions to IRAs

$1,000

$1,000

Compensation for benefit purposes for qualified plans and SEPs

$265,000

$265,000

Minimum compensation for SEP coverage

$600

$600

Highly compensated employee threshold

$120,000

$120,000

 

Your MAGI may reduce or even eliminate your ability to take advantage of IRAs. Most IRA-related MAGI phase-out range limits remained unchanged in 2016, including:

Traditional IRAs.

MAGI phase-out ranges apply to the deductibility of contributions if the taxpayer (or his or her spouse) participates in an employer-sponsored retirement plan:

  • For married taxpayers filing jointly, the phase-out range is specific to each spouse based on whether he or she is a participant in an employer-sponsored plan, as follows:
    • For a spouse who participates, the 2016 phase-out range limits remain the same as for 2015: $98,000–$118,000.
    • For a spouse who doesn’t participate, the 2016 phase-out range limits increase by $1,000, to $184,000–$194,000.
  • For single and head-of-household taxpayers participating in an employer-sponsored plan, the 2016 phase-out range limits remain the same as for 2015: $61,000–$71,000

Taxpayers with MAGIs within the applicable range can deduct a partial contribution; those with MAGIs exceeding the applicable range can’t deduct any IRA contribution.

But a taxpayer whose deduction is reduced or eliminated can make non-deductible, traditional IRA contributions. The $5,500 contribution limit (plus $1,000 catch-up, if applicable and reduced by any Roth IRA contributions) still applies. Non-deductible, traditional IRA contributions may be beneficial if your MAGI is also too high for you to contribute (or fully contribute) to a Roth IRA.

Roth IRAs.

Whether you participate in an employer-sponsored plan doesn’t affect your ability to contribute to a Roth IRA, but MAGI limits may reduce or eliminate your ability to contribute, as follows:

  • For married taxpayers filing jointly, the 2016 phase-out range limits increase by $1,000, to $184,000–$194,000.
  • For single and head-of-household taxpayers, the 2016 phase-out range limits also increase by $1,000, to $117,000–$132,000.

You can make a partial contribution if your MAGI falls within the applicable range, but no contribution if it exceeds the top of the range.

(Note: Married taxpayers filing separately are subject to much lower phase-out ranges for both traditional and Roth IRAs.)

 

Implications for Gift and Estate Taxes

The unified gift and estate tax exemption and the generation-skipping transfer (GST) tax exemption are both adjusted annually for inflation. For 2016, the amount is $5.45 million (up from $5.43 million for 2015).

The annual gift tax exclusion remains at $14,000 for 2015. It’s adjusted only in $1,000 increments, so it typically increases only every few years. It increased to $14,000 in 2013, so it might go up again for 2017.

If you’re unsure how this year’s cost of living adjustments may affect your year-end tax planning or retirement planning, please contact us. We’d be happy to help you tweak your plans based on next year’s adjustment amounts. 

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