Taxes

Chapter 14: Section 1

The final day to file 2016 income tax returns is Tuesday, April 18, 2017.

Recent Income Tax Provisions Affecting Taxpayers

The American Taxpayer Relief Act of 2012 (ATRA), signed into law on Jan. 2, 2013, simplified tax planning for most Americans, including federal employees, starting in the year 2013. Since ATRA”s passage, there has been little additional change beyond extending to married same-sex couples the same treatment as common-in-law married couples under the tax code.

The 39.6% bracket applies to taxable income above $470,701 for married couples filing joint returns in 2017 (up from $466,950 in 2016), $418,401 for single household filers in
2017 (up from $415,050 in 2016) and $444,550 for head of household filers in 2017 (up from $441,000 in 2016). For married couples filing separate, the taxable income thresholds are half of the married filing joint thresholds.

Employment Taxes. During 2016, the Social Security (FICA) tax was equal to 6.2 per- cent of the first $118,500 of an employee’s taxable wages. That threshold increased to $127,200 for 2017. FERS and CSRS Offset employees pay FICA taxes on their taxable wages with the federal government matching the FICA tax at 6.2%.

Dividends and Capital Gains Tax Rates. The regular (ordinary) and minimum (prefer- ential) tax rates for capital gains and qualified dividend income in effect for 2016 are shown in the following table. Capital gains are reported on IRS Form 8949.

Permanent Alternative Minimum Tax (AMT) Relief. ATRA’s passage resulted in a permanent patch to the AMT. The exemptions were raised to $83,800 for married couples filing jointly in 2016 (an increase from $83,400 in 2015) and $53,900 for single filers in 2016 (an increase from $53,600 in 2015). The exemptions are indexed to the rate of inflation and will be raised accordingly in the future. This automatic increase is important because in the past the AMT exemption was not indexed to inflation. Without this “patch”, an increasing number of individuals, particularly middle-income taxpayers, would have been affected by the AMT.

Health Care Reform Impact on Taxes

The tax impact of the Affordable Care Act (ACA) of 2010 includes Medicare tax surcharges, higher limits on medical expense deductions, changes to flexible savings account contributions and carryovers, and a penalty for not complying with the medical insurance mandate.

(1) Additional hospital insurance (Medicare Part A) surtax on high income individuals. The employee portion of the hospital insurance tax part of FICA, normally 1.45% of covered wages, is increased by 0.9% on wages that exceed a threshold amount. The additional tax is imposed on the combined wages of both the individual and the individual’s spouse, in the case of a joint return. The threshold amount is $250,000 in the case of a joint return or surviving spouse, $125,000 in the case of a married individual filing a separate return, and $200,000 in the case of an individual filing as head of household.

(2) Medicare surtax on investment income. Internal Revenue Code Section 1411 imposes a tax on individuals equal to 3.8% of the lesser of the individual’s net investment income for the year or the amount the individual’s modified adjusted gross income (AGI) exceeds a threshold amount. For estates and trusts, the tax equals 3.8 percent of the lesser of undistributed net investment income or AGI over the dollar amount at which the highest trust and estate tax bracket begins. For married individuals filing a joint return and surviving spouses, the threshold amount is $250,000; for married individuals filing separately, it is $125,000; and for other individuals it is $200,000.

Net investment income means investment income reduced by deductions properly allocable to that income. Investment income includes income from interest, dividends, non-qualified annuities, passive income from partnerships, royalties, rents, and net gain from disposition of property, other than such income derived in the ordinary course of a trade or business. However, income from a trade or business that is a passive activity and from a trade or business of trading in financial instruments or commodities is included in investment income.

(3) New limitations on deductibility of out-of-pocket medical expenses. Uninsured medical expenses must exceed 10 percent of an individual’s adjusted gross income (AGI) before they can be claimed as an itemized deduction on Schedule A. This is an increase from the 7.5 percent AGI floor that existed in 2012. Individuals age 65 and older continue to qualify for the lower 7.5 percent AGI floor through the year 2017.

(4) Limitations on contributions to health care flexible spending accounts (HCFSA). HCFSA contributions are now limited to $2,600 annually per person. The federal flexible spending accounts program, FSAFEDS, allows a carryover of unused balances of up to $500 from one plan year to the next, effective with the 2015 plan year. With that change, FSAFEDS ended the grace period of two-and-half months (until March 15).

(5) As of Jan. 1, 2014, failure of an individual to maintain essential health coverage will result in a penalty. For 2015, the penalty is the greater of 2 percent of household income above the gross income threshold for filing a tax return or $325 per adult ($162.50 per child) limited to a family maximum of $975. Employees who are enrolled in the Federal Employees Health Benefits (FEHB) program or the military health care program TRICARE have essential health care coverage.
Other tax code changes effective Jan. 1, 2015:

Phase-out of the personal exemption. The repeal of the phase-out for personal exemptions ended on Dec. 31, 2012. The phase out became effective Jan. 1, 2013 but at higher levels than in the past. The personal exemption for tax year 2016 increased to $4,050, up from the 2015 personal exemption of $4,000. However, the exemption is subject to a phase-out that begins with single filers adjusted gross incomes of $259,400 (increased from $258,250 during 2015), head of household filers with adjusted gross incomes of $285,350 (increased from $284,050 during 2015) and married couples fil- ing jointly with adjusted gross incomes of $311,300 (increased from $309,900 during 2015. Married individuals filing separate returns using half of the married filing joint return adjusted gross income amount. The total amount of exemptions that can be claimed by an individual is reduced by 2 percent for each $2,500 or portion thereof by which AGI exceeds the threshold level.

•The personal exemption phases out starting at an adjusted gross income (AGI) level of $381,900 for single filers, AGI level of $407,850 for head of household filers, and at an AGI level of $433,800 for married filing joint returns ($216,900 for married filing separate returns) during 2016.

Itemized deduction phase-outs. The phase-out of itemized deductions (the “Pease” limitation) for individuals with AGI above a certain amount was reinstated by the ATRA. It applies to married filing jointly individuals with 2016 AGI of $311,300 single indi- viduals with 2016 AGI of $259,400, head of household individuals with a 2016 AGI of $285,350, and married filing separate filers with a 2016 AGI of $155,650.

Child Tax Credit. ATRA extended permanently the $1,000 child tax credit. As of 2016, the value used to determine the amount of credit that may be refundable is
$3,000 (the credit amount was not changed).

Child and Dependent Care Tax Credit. ATRA extended permanently Bush-era enhancements to the child and dependent care credit. The 35 percent credit rate was made permanent along with the $3,000 cap on expenses for one qualifying individual and the $6,000 cap on expenses for two or more qualifying individuals.

Education Incentives. ATRA made permanent or extends a number of enhancements to tax incentives designed to promote education. These enhancements include: (1) the above-the-line deduction for qualified tuition and related expenses; (2) the student loan interest deduction; and (3) Coverdale Education Savings Accounts.

Energy Incentives. ATRA extended through Dec. 31, 2013 the Internal Revenue Code Section 25C credit to individuals who make energy efficiency improvements to their existing residences. The lifetime credit is $500 ($200 for windows and skylights). The Tax Extender Bill of 2014 did not extend this credit to 2015.

Estate/Gift Tax. The estate and gift tax exclusion amount was increased to $5.45 million indexed for inflation (it was $5.43 million in 2015), but the top tax rate increased from 35 percent to 40 percent effective Jan. 1, 2013. The estate tax “portability” election, under which, if an election is made, the surviving spouse’s exemption amount is increased by the deceased spouse’s unused exemption amount, was made permanent by the act. During 2015, the gift tax exclusion was $14,000 per donor and was unchanged for 2016.

Professional Tax Preparers. The IRS now requires that professional tax preparers register with the IRS and obtain a Preparer Tax Identification Number (PTIN). Starting in 2012, preparers who file 10 or more tax returns (forms 1040 or 1041) must submit them to the IRS electronically.

Levy on Thrift Savings Plan (TSP) Accounts. P.L. 112-267 clarifies that IRS can levy on TSP accounts in order to collect unpaid taxes. Previously there was uncertainty on that point and the TSP did not honor such levies.

Child Tax Credit. ATRA extended permanently the $1,000 child tax credit. For 2016, the value used to determine the amount of credit that may be refundable is $3,000 (the credit amount has not changed).

Child and Dependent Care Tax Credit. ATRA extended permanently Bush-era enhancements to the child and dependent care credit. The 35 percent credit rate was made permanent along with the $3,000 cap on expenses for one qualifying individual and the $6,000 cap on expenses for two or more qualifying individuals.

Education Incentives. ATRA made permanent or extends a number of enhancements to tax incentives designed to promote education. These enhancements include: (1) the above-the-line deduction for qualified tuition and related expenses; (2) the student loan interest deduction; and (3) Coverdale Education Savings Accounts.

Energy Incentives. ATRA extended through Dec. 31, 2013 the Internal Revenue Code Section 25C credit to individuals who make energy efficiency improvements to their existing residences. The lifetime credit is $500 ($200 for windows and skylights). The Tax Extender Bill of 2014 did not extend this credit to 2014.

Estate/Gift Tax. The estate and gift tax exclusion amount is increased to $5.43 million indexed for inflation (it was $5.34 million in 2014), but the top tax rate increased from 35% to 40% effective Jan. 1, 2013. The estate tax “portability” election, under which, if an election is made, the surviving spouse’s exemption amount is increased by the deceased spouse’s unused exemption amount, was made permanent by the act. During 2014, the gift tax exclusion was $14,000 per donor and will continue to be $14,000 per donor during 2015.

Professional Tax Preparers. The IRS now requires that professional tax preparers register with the IRS and obtain a Preparer Tax Identification Number (PTIN). Starting in 2012, reparers who file 10 or more tax returns (forms 1040 or 1041) must submit them to the IRS electronically.

Levy on Thrift Savings Plan (TSP) Accounts. P.L. 112-267 clarifies that IRS can levy on TSP accounts in order to collect unpaid taxes. Previously there was uncertainty on that point and the TSP did not honor such levies.

New Legislation Passed in December 2015

In late 2015, Congress passed the Protecting Americans from Tax Hikes (PATH) Act of 2015. This legislation retroactively reinstated the “tax extenders” that were renewed for and then expired at the end of 2014. But unlike past “tax extenders” legislation, this time many of the provisions were permanently renewed. Among the key tax extenders made permanent through the PATH Act affecting federal employees:

State and local sales tax deduction. Each year, individuals may claim an itemized deduction for either the payment of state income taxes in the calendar year, or payment of state sales taxes instead. In general, federal employees will claim whichever amount is higher — state income taxes paid, or state sales taxes paid to produce the largest deduction on Schedule A. The state income tax deduction is typically higher in any states that have an income tax, and the state sales tax deduction is usually only claimed by those individuals who live in states with no income tax (Florida, Texas, Nevada, South Dakota, Alaska, Washington and Wyoming).

Enhanced American Opportunity Tax Credit Made Permanent. In 2009 under the American Recovery and Reinvestment Act, the Hope Scholarship Credit was changed to become the American Opportunity Tax Credit, expanding the credit to $2,500 per year, allowing it for up to four years of post-secondary education, and raising the adjusted gross income (AGI) phaseouts to $160,000 for married couples (and $80,000 for individuals). The American Opportunity Tax Credit was scheduled to lapse (and revert back to the old Hope Scholarship Credit) at the end of 2017. The PATH Act makes the American Opportunity Tax Credit permanent.

Deductibility of mortgage insurance premiums as qualified residence interest extended through 2016. For those individuals who pay mortgage insurance premiums — that is, private mortgage insurance or PMI on a primary residence that had a less than 20 percent downpayment — current law has permitted those individuals to deduct the mortgage insurance as though it was interest on mortgage debt. This is the case provided the mortgage was taken out after 2006 and was acquisition debt for the primary residence. The PATH Act extends the mortgage insurance premium deduction for qualifying mortgage insurance premiums through the end of 2016.

Above-the-line education deduction for qualified tuition and fees extended through 2016. This law allows individuals with children in college to claim as an alternative to the American Opportunity Tax Credit or the Lifetime Learning Credit an above-the-line (adjustment to income) deduction of up to $4,000 of tuition and related fees for an eligible student (in general, the individual, the individual’s spouse, or dependents) to attend an institution of higher learning. The PATH Act extends the above-the-line tuition and fees education deduction through the end of 2016.

Deductibility of mortgage insurance premiums as qualified residence interest extended through 2016. For those individuals who pay mortgage insurance premiums—that is, private mortgage insurance or PMI on a primary residence that had a less than 20 percent downpayment —current law has permitted those individuals to deduct the mortgage insurance as though it was interest on mortgage debt. This is the case pro- vided the mortgage was taken out after 2006 and was acquisition debt for the primary residence. The PATH Act extended the mortgage insurance premium deduction for qualifying mortgage insurance premiums through the end of 2016.

Above-the-line education deduction for qualified tuition and fees extended through 2016. This law allows individuals with children in college to claim as an alter- native to the American Opportunity Tax Credit or the Lifetime Learning Credit an above-the-line (adjustment to income) deduction of up to $4,000 of tuition and related fees for an eligible student (in general, the individual, the individual’s spouse, or dependents) to attend an institution of higher learning. The PATH Act extended the above- the-line tuition and fees education deduction through the end of 2016.

New Legislation Passed During 2016

A number of recently-passed laws will affect individual tax return filings this filing season. The 2017 filing season begins officially Jan. 23, 2017. This section reviews these new laws and what they mean to federal employees as they prepare their 2016 federal income tax returns.

Trade Facilitation and Trade Enforcement Act of 2015. One of the revenue raisers in the Trade Facilitation and Trade Enforcement Act of 2015 increased the minimum penalty for failing to file an individual tax return in a timely fashion from $135 to $205. The higher failure-to-file penalty was effective for tax returns filed after calendar year 2015. This means that the penalty already applied during the 2016 tax filing season for 2015 tax returns. The penalty is equal to five percent of the additional taxes owed amount for every month, or a fraction thereof, up to a maximum of 25 percent. Before this act was passed, the minimum penalty for failing-to-file a tax return within 60 days of the due date including extensions was the lesser of $135 or 100 percent of the tax due on the tax return. The new law increases the minimum failure-to-file penalty to the lesser of $205 or 100 percent of tax owed. The only “saving grace” is that the penalty may be reduced or waived if the individual taxpayer can show that the failure-to-file is due to a reasonable cause.

Some IRS refunds to be delayed until Feb. 15, 2017. Effective Jan. 1, 2017, the Protecting Americans from Tax Hikes (PATH) act of 2015 requires the IRS to hold refunds on tax returns claiming the Earned Income Tax Credit (EITC) or the Additional Child Tax Credit (ACTC) until Feb. 15, 2017. Under the change, the IRS must hold the entire refund and the portion not associated with the EITC and ACTC until at least February 15th. This change helps ensure that individuals get the refund they are owed by giving the IRS more time to help detect and prevent fraud.

Payroll changes. The PATH Act also changed the filing deadlines for W2s and 1099- MISCs. Starting with 2016 forms, all W-2’s given to employees and 1099-MISC’s given to independent contractor and a copy of the W-2 and 1099-MISC, together with a Form W-3 and Form 1096, respectively, filed with the Social Security Administration, must be delivered by Jan. 31, 2017. While employees should receive their W-2s from their agencies by Jan. 31, 2017, there may be some employees who employed household employees such as babysitters, nannies or caretakers during 2016. If they employed such individuals and paid their household employees more than $1,000, they are considered a household employer and they must furnish their household employee a W2 reporting the total wages paid and payroll taxes withheld. Next week’s column will discuss the “Nanny tax”.

Employees who need an extension to file Form W-2 with the Social Security Administration may request one 30 day extension by submitting Form 8809, Application for Extension of Time to File Information Returns. A detailed explanation of why additional time is needed to file the W-2 and W-3 forms and signed under penalties of perjury is required. The IRS will only grant the extension in extraordinary circumstances.

FBAR filing deadline changes. Any employee who has a financial interest in or a signature authority over a foreign financial account - this includes a bank account, brokerage account, mutual fund or trust exceeding certain thresholds - may have to report these accounts to the US Department of Treasury. The report is done by electronically filing a Financial Crimes Enforcement Network (FinCen) 114, Report of Foreign Bank and Financial Accounts or FBAR. The filing rules and in particular the filing deadlines for the FBAR have been changed, effective with the 2017 filing season.

Any US individual is required to file an FBAR if: (1) the person had a financial interest in, or signature authority over, at least one financial account located outside of the US; and (2) the aggregate value of all foreign financial accounts exceeded $10,000 at any time during the calendar year being reported. For this year, that means if such an account exceeds $10,000 on any day during 2016, an FBAR must be filed. A “US per- son” includes a citizen or resident of the US, a trust formed under the laws of the US, or an estate formed under the laws of the US.

Recently passed legislation changes the FBAR due date to April 15, beginning with the 2016 calendar year which is due this year on April 17, 2017, with no extensions permitted. The FBAR must be filed electronically through FinCen’s BSA E-Filing System. Information may be obtained at  https://www.efilefbar.com. The FBAR is not filed with a federal tax return. Those individuals who are required to file a FBAR and who do not file a FBAR are subject to a civil penalty not to exceed $10,000 per violation for non- willful violations.

Free E-Newsletter

FederalDAILY

I agree to this site's Privacy Policy.

Stay Connected

Latest Forum Posts

Ask the Expert

Have a question regarding your federal employee benefits or retirement?

Submit a question