2017 Year-End Tax Planning
InsightsSPECIAL EDITION - 2017 YEAR-END TAX PLANNING
With the Senate passing the tax bill just after midnight last night and the House expected to take another vote later today it is virtually certain that the Tax Cuts and Jobs Act of 2017 will become law. Over the course of the next several months we intend to delve into some of the details of the new provisions in the law but with so little time left before year-end this Communiqué will focus on a summary of new or changed provisions that apply to individuals and most importantly, some year-end planning strategies that each of us should consider. It has been our experience that if a document is over two pages most readers will quit reading so rather than review the new law and then explain year-end planning opportunities, we are doing this backwards – first, the year-end planning recommendations and then, the explanation of the pending new law provisions!Unfortunately, the new law is complicated and takes more than two pages, but we did get the year-end planning strategies in the first two pages.
End of Year Planning …..
Historically, year-end tax planning advice often included the recommendation to defer income into the next year and to accelerate deductions into the current year. Perhaps more than ever this is true for 2017-2018. With tax rates going down and certain deductions going away it makes sense to look at ways to postpone income to the extent possible until 2018 and to take deductions, especially those that will disappear next year, in 2017.
Deferral of Income
If you have the ability to defer a year-end bonus or delay taking a capital gain into 2018 consider doing so. You will not only defer the payment of tax until April 2019 but also move the income to a year where your tax rates will almost surely be lower.
Accelerate the Payment of Deductible Expenses
State and local taxes – Since beginning in 2018 state and local taxes will be limited to no more than $10,000 per year moving tax payments from 2018 to 2017 can save you money.
Planning tip -> If your combined deduction for taxes typically exceed $10,000 (see line 9 of last year’s Schedule A) consider the following:
- If you expect to have a balance due on your 2017 state income tax pay that amount on or before December 31, 2017 either by adjusting your withholding or by making a 4th Quarter Estimated Tax Payment by December 31, 2017.Caution: prepaying more than you expect to owe for 2017 will not be advantageous since any overpayment of state income tax will be taxable income to you in 2018. Furthermore, any advance payment of 2018 state or local income tax is specifically barred by the new law.
- Making a prepayment of your expected 2018 real estate tax. The rules for doing this vary by taxing authority so make sure you check with the local Department of Revenue to see if they allow prepayments and, if so, exactly how the prepayment should be made. In order to take the deduction in 2017 the payment must typically be dated and postmarked on or before December 31, 2017.
Expenses that will no longer be deductible next year – Since miscellaneous itemized deductions have been totally eliminated for 2018 prepayment of next year’s miscellaneous deductions into 2017 affords you one last chance to take these deductions and reduce your tax liability.
Planning tip -> If your total miscellaneous itemized deductions are greater than or almost equal to the 2% of AGI limitation (see lines 24 and 26 of your last Schedule A) consider prepaying before year-end as many “itemized deductions” as you can. This would include an estimate of your tax preparation fee for 2018, safe deposit box rental fees and a portion of next year’s investment management fees. Doing so will ensure that you receive a tax deduction that would otherwise be lost after this year under the new law.
2018 Standard Deduction of $24,000 exceeds your expected itemized deductions for next year – if you will be one of the expected 90% of taxpayers that no longer itemizes beginning in 2018 consider accelerating all deductions into 2017.
Planning tip -> If you expect your 2018 deductions to be less than or near the standard deduction amount ($12,000 for a single taxpayer and $24,000 for a married couple) consider what is known as “bunching of deductions.” In essence, you “bunch” your deductions as much as possible into alternating years.This can be done in multiple ways:
- Consider (this year) paying your real estate tax early and by making next years’ charitable contributions in December of the current year. Next year you have no taxes to pay and minimal charitable contributions so you will take the standard deduction. The end result is that in alternating years your itemized deductions will be higher than the standard deduction and in the off years the standard deduction will be higher.
- Another very easy way to “lump” charitable contributions is to create a donor advised account (we can assist you in doing this at Charles Schwab). You can then make a large contribution of appreciated securities or cash to the donor advised account, take the full deduction in the year you make the transfer to the donor account and then use that account to make your usual contributions for the next couple of years before replenishing it.
Caution: Please keep in mind that increasing itemized deductions such as taxes and / or charitable contributions may trigger alternative minimum tax which would offset any tax benefit. We therefore recommend that you consult with your tax advisor before taking any significant action.
Major Provisions of the Tax Cuts and Jobs Act of 2017
7 Tax Brackets still remain…..
Although President Trump had proposed collapsing the existing 7 bracket structure down to 3, the new law will continue to use a 7 bracket structure but the good news is that these brackets will lower taxes for most taxpayers. Brackets are wider so more income is taxed in the lower rate brackets and the rates themselves have been reduced by a few points.
Repeal of Phase-Out of Itemized Deductions
For higher income taxpayers, itemized deductions were reduced by up to 3% once income crossed certain thresholds ($261,500 of adjusted gross income for individuals and $313,800 for married couples). Since the phase-out of deductions reduced high income taxpayers total itemized deductions (and therefore increased taxable income) this rule effectively increased the marginal rate. The new law repeals this phase-out which effectively provides a further reduction in marginal tax rates for upper-income individuals and couples.
Expanded and Larger (Really?) Standard Deduction
By now most of us have read about the new much higher standard deductions. Effective in 2018, the standard deduction for single taxpayers increases from $6,350 to $12,000 and for married couples the standard deduction increases from $12,700 to $24,000. But wait…. although these appear to be significant increases in the standard deduction the deduction for “personal exemptions” is repealed. Under old law, in addition to the standard deduction individuals also received a personal exemption of $4,050 (a married couple would be able to deduct a combined exemption of $8,100 and a family of 4 could deduct a whopping $16,200). So for the single taxpayer the new standard deduction of $12,000 is only $1,600 more than the former standard deduction + the personal exemption and for a married couple the difference is a net higher deduction of $3,200. However, for a young married couple with two children the math isn’t so appealing – they lose the old standard deduction of $12,700 and 4 personal exemptions of $4,050 each and get in exchange a combined larger standard deduction of $24,000 – a reduction of $4,900!
Expanded Child Tax Credit
What the family of four might lose in the combination of the standard deduction and personal exemptions noted above is likely to be more than offset by the new expanded Child Tax Credit which has increased from $1,000 to $2,000 per child. And, the old phase-out rules are dramatically increased so for many young couples, the loss in deductions will be more than compensated for by the significantly increased Child Tax Credit which is a dollar-for-dollar reduction in tax liability.
Changes in Rules for Itemizing Deductions
According to government reports, about 30% of tax filers are currently itemizing deductions (as opposed to taking the standard deduction). This will change dramatically in 2018 with new rules limiting deductions for state and local taxes and the elimination of almost all miscellaneous itemized deductions.
Deduction for State and Local Taxes – The Tax Cuts and Jobs Act of 2017 creates new limitations for deducting state and local taxes. The new rules are one of the more controversial aspects of the proposed law particularly for residents of high tax states such as California and New York.The new rules will limit the combined total for all property (real estate and personal property) and income taxes (state and local) to no more than $10,000 per year.
Mortgage Interest Deduction – The new cap for deducting mortgage interest, effective for new mortgages taken out after December 15, 2017, limits the interest deduction to that portion of the interest that is attributable to the first $750,000 of home mortgage for a primary residence. Any existing mortgages retain the deductibility of interest on the first $1 million of debt principal. Special rules apply to future refinancing. Beginning next year, interest incurred for debt attributable to a second home is no longer deductible. 2017 is also the last year that interest on home equity or HELOC loans will be deductible unless the proceeds of the home equity indebtedness can be traced to the acquisition or improvement of a primary residence.
Miscellaneous Itemized Deductions Repealed – Miscellaneous itemized deductions that have historically been subject to a 2% of AGI floor have been repealed entirely. This applies to tax preparer fees (or tax prep software for do-it yourselfers), unreimbursed employee business expenses, home office expenses, safe deposit box fees and investment advisory fees.
Section 529 Plans for Education Expenses – Section 529 plan distributions can now be used tax-free for private elementary and secondary school expenses (up to $10,000 per student per year) and includes both public, private and religious schools.
Alternative Minimum Tax – The alternative minimum tax (more commonly referred to as “AMT”) was dramatically altered by the new Act. The computation of AMT will be no easier to explain but the good news is that it will apply to far fewer individuals beginning in 2018. This is due to the elimination of many of the deductions that were considered tax preference items and substantially higher thresholds for the applicability of the AMT.
Other Changes – The new law also includes several other provisions impacting taxpayers. The much debated (and publicized) Obama Care Individual Mandate for health insurance is repealed effective 2019.Alimony payments will no longer be deductible by payors and no longer reportable by recipients. Moving expense deductions are no longer deductible and payments of moving expense reimbursements by employers are no longer tax-free. Beginning in 2018 there are increased depreciation limits for the business use of cars that might even make buying a new business car more appealing that leasing from a tax savings standpoint. And, the new law makes entertainment deductions even more limiting beginning in 2018.
The Tax Cuts and Jobs Act of 2017 is obviously far from tax simplification. If you have specific questions about your situation and year-end maneuvering to minimize your tax liability, please contact us – preferably sooner rather than later. We will do our best to give you some guidance.
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