Year-End Tools and Techniques to Reduce Your 2016 Tax Bill

cut-taxesBy Carole C. Foos, CPA and David B. Mandell, JD, MBA

As we approach the 4th quarter of the year, most attorneys now have a fairly good idea of what their taxable income will be for 2016. You may be wondering “is there anything I can do now to save taxes on April 15th?” The answer is very likely “yes.” In fact, the 4th quarter of the year ending and the 1st quarter of the new year are the best times for focusing on tax reduction.

This short article will lay out a few ideas that could save you tens of thousands of dollars on your 2016 income tax bill, depending on your facts and circumstances, as well as explaining some capital gains and planning concepts.

Techniques to Reduce 2016 Income Taxes

1. Maximize the Tax Benefits of Your Qualified Retirement Plan (QRP)

Nearly 95 percent of attorneys have some type of QRP in place. These include 401(k)s, profit-sharing plans, money purchase plans, defined benefit plans, or even SEP or SIMPLE IRAs, for these purposes.

However, most of these plans are not maximized for deductions for the business/practice owners. The Pension Protection Act improved the QRP options for practice owners. In other words, many owners may be using an “outdated” plan and forgoing further contributions and deductions permitted under the most recent rule changes. By maximizing your QRP under the new rules, you could increase your deductions significantly for 2016 and reduce your taxes on April 15, 2017.

2. Implement a Non-Qualified Plan

Unfortunately, the vast majority of attorneys begin and end their retirement planning with QRPs. Most have not analyzed, let alone implemented, any other type of benefit plan. Have you explored non-qualified plans in the last two years? The unfortunate truth for many is that they are unaware of plans that enjoy favorable short-term and long-term tax treatment. If you have not yet analyzed all options, we highly encourage you to do so. A number of these plans can help you reduce your taxable income for years as part of a tax diversification plan.

3. Consider a Captive Insurance Company (CIC)

CICs are used by many of the Fortune 1000 for a host of strategic reasons. For a law practice, a CIC can be equally beneficial, especially for the practice owners. Here, you actually create your own properly licensed insurance company to insure all types of risks of the practice – often those that have little coverage today. These can be economic risks (that revenues drop), business risks (that electronic records are destroyed), litigation risks (coverage for defense of harassment claims or wrongful termination), and even real estate. If created and maintained properly, the CIC can enjoy tremendous income tax benefits that can translate into hundreds of thousands of dollars of tax savings annually.

4. Pre-Pay 2017 Expenses in 2016

As the year winds down, we typically counsel cash basis clients to prepay for some of the following year’s expenses in the present year. As long as the economic benefit from the prepayment lasts 12 months or less, this can be done. Since 2017 highest marginal tax rates will likely be the same as those in 2016, this makes sense because of the benefit of the early deduction.

Techniques to Reduce Taxes on Investments

Planning for the 3.8 Percent Medicare Surtax

Beginning in 2013, the tax law imposed 3.8 percent surtax on certain passive investment income of individuals, trusts and estates. For individuals, the amount subject to the tax is the lesser of (1) net investment income (NII) or (2) the excess of a taxpayer’s modified adjusted gross income (MAGI) over an applicable threshold amount.

Net investment income includes dividends, rents, interest, passive activity income, capital gains, annuities and royalties. Specifically excluded from the definition of net investment income are self-employment income, income from an active trade or business, gain on the sale of an active interest in a partnership or S corporation, IRA or qualified plan distributions and income from charitable remainder trusts. MAGI is generally the amount you report on the last line of page 1, Form 1040 adjusted by the above non-includible items.

The applicable threshold amounts are shown below.

  • Married taxpayers filing jointly $250,000
  • Married taxpayers filing separately $125,000
  • All other individual taxpayers $200,000

A simple example will illustrate how the tax is calculated:

Al and Barb, married taxpayers filing jointly, have $300,000 of salary income and $100,000 of NII. The amount subject to the surtax is the lesser of (1) NII ($100,000) or (2) the excess of their MAGI ($400,000) over the threshold amount ($400,000 -$250,000 = $150,000). Because NII is the smaller amount, it is the base on which the tax is calculated. Thus, the amount subject to the tax is $100,000 and the surtax payable is $3,800 (.038 x $100,000).

Fortunately, there are a number of effective strategies that can be used to reduce MAGI and or NII and reduce the base on which the surtax is paid. These include (1) Roth IRA conversions, (2) tax exempt bonds, (3) tax-deferred annuities, (4) life insurance, (5) oil and gas investments, (6) timing estate and trust distributions, (7) charitable remainder trusts, (8) installment sales and maximizing above-the-line deductions. We would be happy to explain how these strategies might save you large amounts of surtax.

2. Use Charitable Giving for Capital Gains Tax Planning

There are many ways you can make tax beneficial charitable gifts while benefiting your family as well. Charitable Remainder Trusts (CRTs), Charitable Lead Trusts (CLTs), Private Foundations – these can all be used, within the IRS rules, to benefit charitable causes, reduce taxes and retain some benefits for families. If you have considered any of these tools in the past, implementing them in a year of high income might be a good idea.

This article gives you a few ideas for potential tax savings for 2016 income and beyond. The key is to take the time to evaluate which of these concepts, or others not mentioned in this short article, may work for you. In 2016, all attorneys need to be as financially efficient as possible.

SPECIAL OFFERS:  To receive a free hardcopy of Fortune Building for Business Owners and Entrepreneurs, please call 877-656-4362. Visit and enter promotional code NTL01 for a free ebook download of Fortune Building for your Kindle or iPad.

David B. Mandell, JD, MBA, is an attorney, consultant, and author of ten books for attorneys, physicians and business owners including Fortune Building for Business Owners and Entrepreneurs. He is a principal of the financial consulting firm OJM Group, where Carole C. Foos, CPA is a principal and lead tax consultant. They can be reached at 877-656-4362 or mand[email protected] Disclosure:

OJM Group, LLC. (“OJM”) is an SEC registered investment adviser with its principal place of business in the State of Ohio.

Six Steps for Lawyers to Reduce Taxes on Investments

unpleasant tax business surprise

By Carole C. Foos, CPA, and Andrew Taylor, CFP

Lawyers in the highest income tax brackets may have been presented with an unpleasant surprise in the last two years when they learn of their investment tax liability. A prolonged period of strong domestic stock performance, combined with the implementation of The American Taxpayer Relief Act of 2012 may have resulted in significantly higher taxes for you.

The top ordinary income tax rates increased by 24%, while the top capital gains rate was increased by more than 58%. Writing a large check to the Internal Revenue Service serves as a harsh reminder that tax planning requires attention throughout the year, and is not a technique you can properly manage one week out of the year.

Recent market volatility has resulted in domestic stocks experiencing a sell off of substance for the first time in four years. While most investors are understandably frustrated with their losses, savvy advisors are using the correction as an opportunity to re-position portfolios while reducing their clients’ tax bill at the same time.

An era of higher taxes

Proper tax planning becomes more critical as we move into an era of higher taxes. Five years of a rising stock market resulted in many traditional investment vehicles holding large amounts of unrealized gains that can become realized gains if you are not careful. In this article, we will provide you with six suggestions that could save you thousands of dollars in investment taxes over the next several years.

1. Account Registration Matters: If you are reading this article you likely have a reasonable amount of investment experience and have become familiar with the benefits of security diversification in your portfolio. However, a common mistake investors make is failure to implement a tax diversification strategy. Brokerage accounts, Roth IRAs, and qualified plans are subject to various forms of taxation. It is important to utilize the tax advantages of these tools to ensure they work for you in the most productive manner possible. A properly integrated approach is critical during your accumulation phase. Further, it is just as important when you enter the distribution period of your investment life cycle. Master Limited Partnerships offer a potentially advantageous income stream for a brokerage account, while it is generally preferable for qualified accounts to own high yield bonds and corporate debt, as they are taxed at ordinary income rates. There are countless additional examples we could discuss, but the lesson is it is important to review the pieces of your plan with an advisor who will consider both tax diversification and security diversification as they relate to your specific circumstances.

2. Consider Owning Municipal Bonds in Taxable Accounts: Most municipal bonds are exempt from federal taxation. Certain issues may also be exempt from state and local taxes. If you are in the highest federal tax bracket, you may be paying tax on investment income at a rate of 43.4%. Under these circumstances, a municipal bond yielding 3% will provide a superior after tax return in comparison to a corporate bond yielding 5% in an individual or joint registration, a pass through LLC, or in many trust accounts. Therefore, it is important in many circumstances, to make certain your long-term plan utilizes the advantages of owning certain municipal bonds in taxable accounts.

angry businessman surprise3. Be Cognizant of Holding Periods: Long term capital gains rates are much more favorable than short term rates. Holding a security for a period of 12 months presents an opportunity to save nearly 20% on the taxation of your appreciated position. For example, an initial investment of $50,000 which grows to $100,000, represents a $50,000 unrealized gain. If an investor in the highest tax bracket simply delays liquidation of the position (assuming the security price does not change) the tax savings in this scenario would be $9,800. Although an awareness of the holding period of a security would appear to be a basic principal of investing, many mutual funds and managed accounts are not designed for tax sensitivity. High income investors should be aware that the average client of most advisors is not in the highest federal tax bracket. Therefore, it is generally advantageous to seek the advice of a financial professional with experience executing an appropriate exit strategy that is aware of holding periods.

4. Proactively Realize Losses to Offset Gains: As mentioned in the opening paragraph of the article, 2015 has presented investors with an opportunity to realize losses in domestic stocks for the first time in four years. Clients with a diversified portfolio, likely had this opportunity in prior years. One benefit of diversifying across asset classes is that, if the portfolio is structured properly, the securities typically will not move in tandem. This divergence of returns among asset classes not only reduces portfolio volatility, it creates a tax planning opportunity. Domestic equities experienced tremendous appreciation over a five year period through 2014; however international stocks, commodities, and multiple fixed income investments experienced down years. Astute advisors were presented with the opportunity to save clients thousands of dollars in taxes by performing strategic tax swaps prior to yearend. It is important to understand the rules relating to wash sales when executing such tactics. The laws are confusing, and if a mistake is made your loss could be disallowed. Make certain your advisor is well versed in utilizing tax offsets.

5. Think Twice About Gifting Cash: This is not to discourage your charitable intentions. Quite the opposite is true. However, a successful investor can occasionally find themselves in a precarious position. You may have allocated 5% of your portfolio to a growth stock with significant upside. Several years have passed, the security has experienced explosive growth, and it now represents 15% of your investable assets. Suddenly your portfolio has a concentrated position with significant gains, and the level of risk is no longer consistent with your long term objectives. The sound practice of rebalancing your portfolio then becomes very costly, because liquidation of the stock could create a taxable event that may negatively impact your net return.

By planning ahead of time, you may be able to gift a portion of the appreciated security to a charitable organization able to accept this type of donation. The value of your gift can be replaced with the cash you originally intended to donate to the charitable organization and, in this scenario; your cash will create a new cost basis. The charity has the ability to liquidate the stock without paying tax, and you have removed a future tax liability from your portfolio. Implementing the aforementioned gifting strategy offers the potential to save thousands of dollars in taxes over the life of your portfolio.

6. Understand your Mutual Fund’s Tax Cost Ratio: The technical detail behind a mutual fund’s tax cost ratio is beyond the scope of this article. Our intent today is to simply bring this topic to your attention. Tax cost ratio represents the percentage of an investor’s assets that are lost to taxes. Mutual funds avoid double taxation, provided they pay at least 90% of net investment income and realized capital gains to shareholders at the end of the calendar year. But, all mutual funds are not created equally, and proper research will allow you to identify funds that are tax efficient.

A well-managed mutual fund will add diversification to a portfolio while creating the opportunity to outperform asset classes with inefficient markets. You do need to be aware of funds with excessive turnover. An understanding of when a fund pays its capital gains distributions is a critical component of successful investing. A poorly timed fund purchase can result in acquiring another investor’s tax liability. It is not unusual for an investor to experience a negative return in a calendar year, yet find himself on the receiving end of a capital gains distribution. Understanding the tax cost ratios of the funds that make up portions of your investment plan will enable you to take advantage of the many benefits of owning mutual funds.

The above steps are by no means the only tax strategies experienced advisors can execute on behalf of their clients. This article highlights several strategies you should discuss with your advisor to determine if implementation is appropriate for your unique portfolio and overall financial situation. Successful investing requires discipline that extends beyond proper security selection. While gross returns are important and should not be ignored, the percentage return you see on your statements does not tell the full story.

In today’s tax environment, successful investors must choose an advisor who will help them look beyond portfolio earnings and focus on strategic after-tax asset growth.

SPECIAL OFFERS:  To receive a free hardcopy of Fortune Building for Business Owners and Entrepreneurs please call 877-656-4362. Visit and enter promotional code NTL27 for a free ebook download of Fortune Building for your Kindle or iPad.

Carole FoosCarole Foos is a Principal of OJM Group, and aCertified Public Accountant (CPA) offering tax analysis and tax planning services to OJM Group clients. Carole has over 20 years of experience in public accounting in the field of taxation. She was formerly a manager in the tax department of a Big 4 firm and spent several years in public accounting at local firms. She has been a tax consultant to both individuals and businesses providing compliance and planning services over the course of her career. In addition to her work for OJM, Carole maintains a tax practice in Cincinnati. She is a co-author of the books For Doctors Only: A Guide To Working Less and Building More, For Doctors Only: Highlights Edition and Fortune Building for Business Owners and Entrepreneurs, along with state specific editions in the For Doctors series.

andrew taylorAndrew Taylor is a Wealth Advisor with 19 years of experience working with affluent individual investors. His career in the financial industry has focused on providing customized investment management, and comprehensive wealth planning in a tax efficient manner for his clients. Prior to joining OJM Group, Andrew spent 13 years at Charles Schwab & Co. managing and growing a substantial practice in the greater Cincinnati area, and working with local attorneys and CPAs to implement integrated wealth planning for his clients. Andrew’s experience includes time as a Retirement Consultant at Fidelity Investments, where he provided strategic planning solutions for individuals experiencing a career transition.

They can be reached at 877-656-4362 or [email protected].