Income Tax Changes 2016 - 2017

In this article, we'll continue the approach taken in the past, explaining the significant income tax changes in 2016. That discussion will include changes to Social Security and Medicare, federal income tax standard deductions and exemptions, mileage deduction rates, earned income credits, Hope and Lifetime Learning tax credits, in addition to changes to retirement accounts such as the 401(k), 403(b), IRAs, and Roth plans.

Federal Income Tax Filing Deadline

The filing deadline for the year 2016 is Tuesday April 17, 2017.  Information appearing in this article applies to changes effective in 2016, which then become part of a taxpayer's return in 2017.

Income Tax Rates

The American Taxpayer Relief Act of 2012, or ATRA, added a seventh federal income tax bracket (39.6%) in 2013, while the remaining six rates were unchanged.  In 2016, taxable incomes above the following thresholds now fall into the 39.6% bracket:  Married Filing Separately ($233,475), Unmarried Individuals ($415,050), Head of Household ($441,000), and Married Filing Joint Returns ($466,950).

Capital Gains Tax

ATRA also made several important changes to the treatment of capital gains, and eliminated sunset provisions, adding stability and permanence to these rules:

  • Income Thresholds:  individuals in the 10% and 15% tax brackets will pay 0% on eligible dividends and most capital gains.
  • Qualified Dividends:  income received will be taxed at the same rate as long-term capital gains.
  • Tax Rate:  individuals in the 25%, 33%, and 35% federal income tax brackets will pay 15% on capital gains, while taxpayers in the 39.6% bracket will pay 20%.

Unmarried individuals (Single) with income over $200,000 and Married couples filing jointly with income over $250,000 will also pay a 3.8% Medicare surcharge tax on investment income; thereby increasing the effective rate on capital gains to 23.8% (20% + 3.8%).

Social Security and Medicare

As was the case in the past, all wages earned in a given year are taxed at the 1.45% rate for Medicare.  In 2016, wages paid in excess of $200,000 for Unmarried filers and in excess of $250,000 for Married filers will be subject to an extra 0.9% tax.

Social Security tax remains at 6.20%, while the wage limit, or Social Security maximum, also remains at $118,500.  The Cost of Living Adjustment (COLA) was 0.0% in 2016, maintaining the SSI limit at $2,663 per month.

Unified Credits, Gift Tax and Estate Tax

ATRA also increased the estate and gift tax rate from 35 to 40%.  The gift tax and estate tax exclusion continue to be indexed for inflation and remain at $14,000 (the same as 2015 and 2014) and increase to $5.45 million respectively in 2016.

Standard Deductions

According to the IRS, approximately two out of every three taxpayers claim the standard deduction on their income tax returns.  In 2016, there was virtually no change to the standard deductions from their 2015 levels, including:

  • Single (Unmarried Individuals):  $6,300 (no change)
  • Married Filing Separately:  $6,300 (no change)
  • Head of Household:  $9,300 (an increase of $50)
  • Married Taxpayers Filing Jointly and Qualifying Widow(er)s:  $12,600 (no change)

Exemption Values

The amount deducted for each exemption claimed on a federal income tax return in 2016 is $4,050, which is an increase of $50 from the 2015 amount.

Mileage Deduction Rates

Studies funded by the IRS continue to reflect the price of gasoline.  The standard mileage deductions (or reimbursement rates) appear in the following table:

Mileage Deduction Rates 2016

Category Rate (January to December)
Business Miles 54.05 cents per mile
Charitable Services 14.0 cents per mile
Medical Travel 19.0 cents per mile

Increase to Earned Income Credit

The earned income credit applies to working taxpayers that have income falling below certain thresholds.  The qualification threshold depends on the number of persons in each family.  The thresholds in 2016 to qualify for this credit include:

  • No Children:  earnings must be less than $14,880, or $20,430 if Married Filing Jointly.
  • One Child:  earnings must be less than $39,296, or $44,846 if Married Filing Jointly.
  • Two Children:  earnings must be less than $44,648, or $50,198 if Married Filing Jointly.
  • Three or More Children:  earnings must be less than $47,955, or $53,505 if Married Filing Jointly.

The tax credits themselves also increased in 2016, with the maximum received as indicated below:

  • No Children:  $506
  • One Child:  $3,373
  • Two Children:  $5,572
  • Three or More Children:  $6,269

Coverdell ESA, Lifetime Learning and Hope Scholarship Credits

ATRA also eliminated the sunset provision for Coverdell Education Savings Accounts.  Taxpayers with modified adjusted gross income less than $110,000 ($220,000 if filing a joint return), may be eligible to contribute to a Coverdell ESA.  There are no limits on the number of separate Coverdell accounts that can be established for a beneficiary, but the total of all contributions to a single beneficiary cannot exceed $2,000 each tax year.

The maximum Hope Scholarship Credit, available for the first two years of post-secondary education, remains at $2,500 in 2016.  This includes 100% of qualifying tuition and related expenses not in excess of $2,000, plus 25% of those expenses that do not exceed $4,000.

The maximum Lifetime Learning Credit is $2,000 in 2016.  The credit applies to 20% of the first $10,000 of a taxpayer's out-of-pocket expenses for all students attending an institution of higher education.  A taxpayer cannot claim the Hope Credit and the Lifetime Learning Credit in the same tax year for the same student.

In 2016, the taxpayer's modified adjusted gross income is used to determine the reduction in the amount of the Hope Scholarship and Lifetime Learning Credits.  Reductions start for taxpayers with an AGI in excess of $80,000, or $160,000 for those filing joint returns for the Hope Credit.  The income threshold for the Lifetime Learning Credit increases to $55,000 or $111,000 for those filing joint returns in 2016.

Contributions to Retirement Accounts

The contribution limits for 401(k) as well as 403(b) plans remains unchanged at $18,000 in 2016.  Catch up contributions also remain at $6,000.  The contribution limit for SIMPLE retirement plans remains at $12,500, as does the catch up contribution limit of $2,500.

In 2016, the contribution limits for Traditional IRAs and Roth IRAs is $5,500, with a catch-up contribution of $1,000 for anyone age 50 or older by the end of the calendar year.  The income limits for individuals willing to fund Traditional IRAs as well as Roth IRA plans increased modestly again in 2016.  The income phase-out threshold for Roth IRAs now starts at $184,000 for those filing joint returns, which is an increase of $1,000.  The phase-out threshold for taxpayers filing their returns as Head of Household or Single is now $117,000, which is a $1,000 increase over last year's value.

The income phase-out limits that apply to Traditional IRAs remain the same for those individuals covered by a retirement plan at work.  The 2016 income phase-out limits start at $98,000 for joint filers (no increase from 2015), and $61,000 for those with a filing status of Single or Head of Household (no increase from 2015).

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