Federal Employees News Digest
Informed Investor: Now is the time for mid-year tax moves
- By Edward A. Zurndorfer
- Aug 22, 2016
Many employees are enjoying their summer vacations before their children return to school in the fall. Saving on their 2016 taxes is the last thing they want to think about. But by making some simple tax moves over the next few weeks, they can reduce their 2016 tax liabilities. This column presents some tax-saving suggestions for 2016.
During 2016, all federal employees can contribute via payroll deduction a maximum $18,000 ($24,000 if they are over age 49 as of Dec. 31, 2016) to the Thrift Savings Plan. There are two types of TSP accounts. The first, the traditional TSP, allows employees to contribute a portion of their gross (before-tax) salary, resulting in federal and with most states, state income tax savings. The second kind, the Roth TSP, allows employees to contribute a portion of their after-tax salary to the TSP. Contributing to the traditional TSP is one of the most effective ways to lower an employee’s current-year taxable income.
Any employee who requests a transfer of money from a qualified retirement plan such as a 401(k) plan to the traditional TSP should use caution. Form TSP-60 is used to request a transfer. In the case of a qualified retirement plan, if the employee requests a rollover in which the retirement funds are paid directly to the employee, 20 percent in federal income taxes will be withheld by the qualified plan administrator. If the TSP participant does not deposit the full amount of the requested rollover (including the 20 percent withheld income taxes) into the TSP within 60 days, then the employee will owe federal and state income tax on the withdrawal, plus a 10 percent early withdrawal penalty if the participant is under age 59.5. The employee should therefore request a direct transfer in which no federal income taxes are withheld.
Was there a newborn or an adopted child added to the employee’s home during 2016? Now is the time to adjust one’s tax withholding for the impact of claiming another dependent. One should increase one’s number of exemptions if one had a newborn or adopted a child during 2016. Note that one dependent exemption is $4,050 in 2016. This means every dependent legitimately claimed during 2016 results in a decrease of $4,050 of taxable income.
Employees who have children attending college in 2016 should not forget about college cost-related tax credits and deductions. College tuition costs are rising at double-digit rates, and many employees with children attending colleges and universities this fall are perhaps having a difficult time making those tuition payments. There are some tax breaks available to these parents, if they qualify. The American Opportunity Tax Credit can be worth up to $2,500 per undergraduate per year. Different college-related credits and deductions have different rules, so it is important for parents to check which credits and deductions are best for them.
If an employee is getting married or getting divorced, the tax consequences can be significant. In the case of marriage, the employee may be able to save on taxes by filing jointly. In that case, the employee should reevaluate his or her federal (on Form W-4) and state withholding rates.
On the other hand, getting divorced may increase an employee’s tax liability as a single taxpayer. Once again, revisiting one’s W-4 is in order. Divorced employees who pay alimony are allowed to deduct alimony payments as an adjustment to their income. Employees who receive alimony must include the alimony as income. Employees who live in states with state and local taxes also should consider making changes to their state income withholding for the rest of 2016.
How have one’s taxable investments performed during 2016? Those employees who invest outside the TSP in nonretirement brokerage accounts should start thinking about strategies—such as “tax loss harvesting”—that may help reduce their 2016 tax liabilities. Tax loss harvesting is the timing of the sale of losing investments to cancel out some of the tax liability from any realized gains on investments, and can be an effective tax-saving strategy. Any sale of capital assets such as stocks, bonds, mutual funds or ETFs that have decreased in value must be performed before Jan. 1, 2017, in order to claim capital losses for 2016.
Employees reaching age 70.5 during 2016—that is, employees born between July 1, 1945, and June 30, 1946—will need to take their first minimum required distribution (MRD) payment. These distributions are taken from employees’ traditional IRAs and other qualified retirement plans, such as 401(k) and 403(b) retirement plans, which employees may have participated in prior to entering federal service. These employees have until April 1, 2017, to take their first MRD, but in future years the annual distribution must occur by Dec. 31. MRDs must be done in order to avoid a steep IRS penalty. If employees remain in federal service throughout 2016, they will not have to take a 2016 MRD payment from their TSP account.