For federal employees, many of whom are currently enjoying their summer vacations, now is a good time to perform a 2017 mid-year tax checkup and to consider tax saving moves that will hopefully reduce their 2017 federal and state tax bills when they file their 2017 tax returns next spring. This column presents 10 tax saving moves employees should consider taking action at this time. Personal and financial events such as getting married, having a child, sending a child off to college, or retiring happen throughout the year and can have a big impact on one’s annual tax bill.
The following is a list of the most important 10 mid-year tax saving moves for employees to consider:
1. A step increase or a job promotion may necessitate changes in tax withholding.
When an employee receives a step increase or a job promotion, the amount of federal and state income taxes withheld from the employee’s paycheck should increase proportionally. But if the employee is working another job outside Federal service, or has significant investment income or self-employment income, the increased income could push the employee into a higher marginal tax bracket that may not be accounted for by the amount of federal and state income tax withholdings on file with the employee’s payroll office. If the employee is not contributing the maximum possible to the Thrift Savings Plan (TSP), then contributing more to the traditional TSP will reduce one’s 2017 taxable salary resulting in lowering at least the employee’s 2017 federal income tax liability.
2. Strategies to avoid paying the Medicare surtaxes.
Those employees who are relatively high income earners should check to see if they are on track to surpass the net investment income tax (NIIT) threshold. The NIIT, often called the Medicare surtax, is a 3.8 percent additional tax paid on the lesser of net investment income or the excess of modified adjusted gross income (MAGI) above $200,000 for individuals, $250,000 for married couples filing jointly, and $125,000 for spouses filing separately. In addition, individuals with wages or salary above these thresholds will owe another 0.9 percent in the Medicare (Part A) hospital insurance tax on top of the normal 1.45 percent that is deducted from their paycheck. Any employee who may exceed the Medicare surtax threshold for 2017 should consider strategies to defer earned income or to shift some of their income-generating investments to tax-advantaged retirement accounts. These strategies are important and generally recommended for individuals at almost every income level, but their tax-saving impact is even greater for those who are subject to the Medicare surtax.
3. Employees rolling over qualified retirement money into the TSP should request a direct (“trustee-to-trustee”) transfer.
Those employees new to federal service and existing employees with TSP accounts who plan to rollover traditional IRA or money from a former employer’s 401(k) or similar retirement should be careful on how to rollover the money into their TSP accounts. Using TSP Form TSP-60 (Rollover of Money into the TSP), they should request a direct transfer of the funds into their TSP account. If instead a rollover is requested, then 20 percent in Federal income taxes will be withheld. The TSP account owner may owe tax on the withdrawal plus a 10 percent penalty if all of the money (including the 20 percent of Federal income taxes withheld) is not deposited into the TSP within 60 days of receipt of the funds. A direct (“trustee-to-trustee”) transfer avoids that possibility.
4. Is there a newborn child or a child no longer living at home?
Now is the time to plan ahead for the impact of claiming one more, or one less, tax dependent on one’s 2017 Federal income tax return. In particular, if a child was born to an employee during 2017, then the employee should consider adding one withholding exemption on his or her W4 in order to have less Federal income tax withheld. There is also the child tax credit ($1,000) for having a child younger than age 17 living at home. If an employee has a child who is a full-time college student, then the employee can generally continue to claim him or her as a tax dependent and take the dependent exemption ($4,050 in 2017) until the student becomes age 25. If a child is no longer living at home and can no longer be claimed as a tax dependent, then the parent should decrease the number of tax withholdings in order to increase the amount of taxes (Federal and state if applicable) withheld.
5. Federal employees with children attending undergraduate college or university should see whether they qualify for the American Opportunity Tax Credit (AOTC).
Those employees with children attending a university or college in the fall as an undergraduate may be eligible for a tax credit based on the tuition and fees paid in order for the child to attend school. The AOTC can be as much as $2,500 per undergraduate every year for four years.
There is another education tax credit called the Lifetime learning tax credit. Tax credits reduce one’s tax liability “dollar-for-dollar” and call for less federal income tax withholding. A critical planning point for parents is that the same qualified college expenses paid for by using tax-free withdrawals from a 529 college savings plan cannot also be used as the basis for the AOTC or another college expense-related tax credit.
6. Is an employee’s marital status changing?
Whether an employee is getting married or divorced, the tax consequences can be significant. In case of a marriage, an employee may be able to save on taxes by filing jointly. Getting divorced on the other hand may increase one’s tax liability as a single individual. Revisiting one’s W-4 or meeting with a tax professional may be necessary so as to avoid a big tax surprise next spring. Also, keep in mind that alimony paid is a deduction from income while alimony received is considered income.
7. Is the employee contributing as much as he or she can to the TSP?
Contributing to the traditional TSP is one of the most effective ways of lowering one’s 2017 taxable salary and income. For 2017, all employees can contribute a maximum $18,000 to the TSP. The $18,000 does not include a FERS-covered employee’s agency matching and one percent of gross pay automatic contribution. Those employees age 50 and older during 2017 – that is, employees born before Jan. 1, 1968 – can make “catch-up” contributions of as much as $6,000 for a maximum contribution of $24,000 during 2017.
8. Is an employee’s taxable investments doing well?
Now is the time for the employee to think about strategies that may help reduce the employee’s 2017 tax liability if an employee has investments held outside of the TSP and an IRA in non-retirement accounts. If these investments are doing well and the employee has realized capital gains, then “tax-loss harvesting” – the timing of the sale of “losing” investments and generating capital losses to cancel out some of the tax liability from any realized gains – can be an effective strategy to save on 2017 taxes.
9. Is the employee using his or her care flexible spending accounts (FSAs) for health care and dependent care?
By using pre-taxed salary set aside to the health care FSA to pay for out-of-pocket medical, dental and vision expenses on a before-taxed basis, the employee will save in taxes overall. The same thing is true when an employee uses the dependent care FSA to pay for out-of-pocket day care expenses for dependents including children under the age of 13. But employees who have set aside part of their salary to fund their HCFSA cannot carry over more than $500 of unused funds into 2018. They cannot carry over any of their unused DCFSA funds into 2018. This means employees participating in the HCFSA and DCFSA for 2017 should be actively spending their HCFSA and DCFSA funds from now through the end of 2017. More information about the HCFSA and DCFSA may be found at www.fsafeds.com.
If instead of contributing to an HCFSA an employee is contributing to a Health Savings Account (HSA), then the employee can contribute a maximum $3,400 ($4,400 if the employee is over age 54) if the employee has a self only health insurance policy and $6,750 ($7,750 if the employee is over age 54) if the employee has a self plus one or self and family health insurance. Note the following with respect to the HSAs that are associated with the Federal Employees Health Benefits program: (1) The $3,400 and $6,750 contribution limit includes both the employee’s contribution and the employee’s agency contribution to the HSA account; and (2) An employee’s HSA contribution is an “adjustment to income” (line 25 of Form 1040 for 2016) with no annual income limitations for contributions and the employee has until April 17, 2018 (2017 tax filing deadline) to make his or her 2017 HSA contribution.
10. Those employees who plan to retire or reaching age 70.5 during 2017 need to think about a smart retirement income plan.
The retirement accounts – this includes traditional and Roth IRAs, the TSP and any other qualified retirement plans an employee may have participated in – one taps into first and how much one withdraws can have a major impact on one’s federal and state and local income taxes as well as how long one’s retirement savings will last. Those employees who become age 70.5 during 2017 – that is, those employees born between July 1, 1946 and June 30, 1947 – are reminded to start taking a required minimum distribution (RMD) from their traditional IRAs and qualified retirement accounts such as 401(k) and 403(b) retirement plans that they previously participated in. If the employee continues in Federal service, then the employee is not required to take a RMD from the TSP. The IRS penalty for not taking a RMD from a particular retirement account is 50 percent of the shortfall. While the deadline to take the first RMD is Apr. 1, 2018, the employee is encouraged to take his or his first RMD by Dec. 31, 2017 so as to avoid having to take two RMDs during 2018; namely the one for 2017 due Apr. 1, 2018 and the other RMD for 2018 due by Dec. 31, 2018.