Tax concerns are a big issue for clients of financial advisors. Typically, there is a direct relationship between clients' overall wealth and the complexity of clients' financial plans. Here are five major tax concerns advisors can bring up with their clients as they prepare to file taxes.
1. Personal Exemptions and Exemptions for Dependents
Personal exemptions are $4,050 per person for the 2016 tax year. Generally, taxpayers can take exemptions for dependents who are qualifying children or relatives. Once a taxpayer's adjusted gross income (AGI) exceeds a certain level, these exemptions begin to phase out or become eliminated. For 2016, the dollar threshold is $259,4000 for a single person and $311,300 for married individuals filing jointly. Depending on the number of exemptions, this threshold can cause a suboptimal tax situation. Clients should discuss and plan their personal income with a financial advisor to ensure that they can take exemptions if their income is near the threshold.
2. Itemized Deductions
Taxpayers may lose benefits from itemizing deductions. Approximately four-fifths of the benefit from deducting real estate taxes, state income taxes, state sales taxes, mortgage interest and charitable contributions can vanish once the filer's AGI exceeds the threshold for personal exemptions. For 2016, this limitation kicks in at $259,400 or more for individuals, or $311,300 for married couples filing jointly.
Taken in conjunction with the personal exemptions, this can lead to the loss of many thousands, or tens of thousands, of deductible dollars. This is why it is critical to hire a financial advisor to establish a solid and beneficial tax plan for every tax year.
3. Extra Taxes for High Earners
A taxpayer may need to pay extra taxes if he or she is a high net worth individual or a higher earner. If taxable compensation, including self-employment income, exceeds $200,000 for an individual, or $250,000 for a married couple filing jointly, Medicare assesses a 0.9% tax on earned income. If a person is hovering near the $200,000 mark in income, it may be wise to stay just below it. For example, if a person makes $200,001, he or she would owe $1,800 for this Medicare tax, but if that person made $199,999, he or she would not. Two dollars in less income saves $1,800 in taxes. Also, depending on income thresholds, the government may assess an additional 3.8% Medicare tax on net investment income.
4. Estate Taxes
Estate taxes become a major concern for clients who have accumulated wealth. Most people want to pass on their wealth to their heirs after they die. An individual is only allowed to pass on so much money before the federal government begins applying an estate tax. The federal estate tax for 2016 is as high as 40%, and the estate exemption amount for 2016 is $5.45 million.
For example, assume that a client dies and has an estate of $7 million. Of this, $5.45 million passes tax-free to his or her heirs, while the remaining $1.55 million is taxed at 40%. The resulting after-tax amount that would pass to heirs is $6.38 million; $620,000 would go to estate taxes.
In addition, some tax payers will need to consider estate taxes at the state level. There are various legal methods of protecting an estate and passing as much money to heirs as possible. An estate attorney can work with clients to develop estate plans that meet their needs.
5. Gift Taxes
A person may give assets as gifts up to a certain limit without being taxed. In 2016, the annual gift limit is $14,000, with a lifetime exemption of $5.45 million. Depending on a client's individual wealth and financial plan, he or she may need expert planning to make gifts over the course of many years to avoid paying unnecessary taxes. For example, if a gift is given that has a value below $14,000, it is simply ignored. If it exceeds $14,000, it is counted toward the $5.45 million lifetime exemption. After passing the $5.45 million limit, all gifts are taxed at individual rates of up to 40%. (For related reading, see: Tax Planning 2016.)