The end of the year is traditionally a good time to tackle tax planning. You have an idea of what your total income will be, so you can make decisions with an eye on tax efficiencies. This year, the back-and-forth on tax reform has narrowed the window of opportunity a bit. Now that comprehensive tax reform has passed the House and Senate and will soon be signed by the President, there are some actions that you can take before 2017 wraps up to save tax dollars. Below are several strategies you may want to consider.
1. Prepay state and local income and property tax in 2017.
(IF you’re not subject to AMT)
Because these deductions are limited in 2018 ($10,000 cap), it’s best to accelerate payment if you can. However, if you expect to pay Alternative Minimum Tax (AMT) in 2017, you will lose the benefit of the deduction for state and local taxes and accelerated payments will not provide a benefit. When it comes to prepaying state and local income taxes keep in mind that you can only deduct amounts related to 2017 tax liabilities. The limitation on prepayment of taxes does not apply to property taxes. You’ll need to check with your tax assessor to confirm that they will accept and apply a prepayment of 2018 property taxes.
2. Consider the timing of other itemized deductions besides state and local taxes.
Under current law you have the option to itemize your deductions (mortgage interest, real estate taxes, charitable donations, etc.) or take the standard deduction – whichever is greater. In 2017 the standard deduction for single filers is $6,350 and $12,700 for married filers. Under the new bill, these amounts would increase to $12,000 and $24,000, respectively. The increase to the standard deduction, and the limitation/elimination of some itemized deductions, will significantly decrease the number of taxpayers who itemize their deductions.
If you think your 2018 itemized deductions will not exceed the new standard deduction, consider paying those items early.
3. Business Owners: Consider placing qualified business property into service in 2017 vs. 2018.
As a business owner, you can fully take advantage of the new 100% expensing of qualified business property (“modified bonus depreciation”) in 2018 through 2022. However, you may realize an even greater benefit for a deduction in 2017, since the tax rates under current law are generally higher than the new tax rates which will apply beginning in 2018.
As a result of tax reform, the tax rates will generally decrease for taxpayers and a 20% deduction will be allowed against “Qualified Business Income.” The 100% expensing of qualified business property provision is one of the few that was made retroactive (applies to property placed into service after September 27, 2017) and applies to both new and used qualified business property.
Other Implications to Note
- Tax Lot Identification
- Earlier versions of the proposed bill included a requirement to use First-in First-out accounting when selecting tax lots of securities that were sold. This would require you to sell your oldest tax lots (most likely to have higher built in gains) first. Luckily this provision was removed from the final version of the bill.
- $10,000 State & Local Tax Deduction Cap
- Individuals and married couples filing jointly are subject to the same $10,000 deduction limit on state and local taxes. Often limits for joint filers are double those of individual filers. So, this is a bit of a “marriage penalty.” This is a combined limit covering all state and local taxes (income, property, sales, etc.).
- Expanded Medical Deduction for 2017 & 2018
- Under current law medical expenses are allowed as an itemized deduction to the extent they exceed 10% of AGI. Under the new law, the threshold goes down to 7.5% of AGI. This change is effective for the 2017 tax year but reverts back to the 10% threshold in 2019.
- Miscellaneous Itemized Deductions
- Many fees—including those for unreimbursed business expenses, safety deposit boxes, professional dues and financial advice— were previously deductible to the extent they exceeded 2% of AGI. The new law eliminates these deductions.
- Mortgage Interest Changes
- Before, you could deduct mortgage interest on up to $1 million plus $100,000 of home equity loans on your primary residence. The new bill eliminates the home equity piece completely and decreases the $1 million mortgage limit to $750,000. However, it is not limited to debt on your primary residence. If you enter a contract to buy a new house from December 15th forward, these new rules apply to you. Loans taken before the cutoff are not subject to the new limits.
- Alternative Minimum Tax Changes
- The bill does not eliminate the Alternative Minimum Tax but the related exemptions and phase-outs were increased. Individuals would have an exemption of $70,300 that is phased out beginning at $500,000 of income (AMTI). For married couples filing jointly the exemption is $109,400 and the phase-out begins at $1,000,000 of income (AMTI). The higher exemptions/phase-outs, the limitation on deducting state/local taxes and the elimination of miscellaneous itemized deductions should significantly reduce the number of individual taxpayers paying AMT in the future.
- Roth Conversions
- The bill eliminates your ability to recharacterize or undo a Roth conversion. Recharacterization provides a significant benefit if the value of a Roth IRA declines substantially post conversion. The loss of the ability to recharacterize limits your ability to optimize Roth conversion strategies. That being said, Roth conversions remain a valuable wealth-building tool.
- Business Implications
- Under the proposed law, choosing an entity (e.g., C corp, pass-through, etc.) for your business would become more nuanced than it is today. Pass-through entities have been the dominant choice for some time but that could change going forward. We’ll address these considerations in further detail in the coming months.
- Increased Estate/Gift Tax & Generation Skipping Tax Exemptions
- While the estate and generation skipping taxes are not repealed under the law, the exemption amounts have doubled to $10 million per taxpayer adjusted for inflation ($11.2 million in 2018). For those taxpayers who have used their existing exemptions this presents an additional planning opportunity.
- Sunset Provisions
- Other than corporate tax reform, the repeal of the individual mandate, and a few other administrative changes, the rest of the tax bill expires or “sunsets” at the end of 2025. At that point individual taxes will revert back to current law. This is similar to President Bush’s tax cuts in 2001 and 2003. Those cuts eventually became “permanent.” Whether or not the sunset occurs in 2025 or the law is made permanent is anyone’s guess at this point. However, it ensures that tax reform will be an annual topic in Washington D.C. for the next 8 years.
Highlights of the Tax Reform Bill
Detail of Tax Reform Changes Affecting Individuals
Detail of Tax Reform Changes Affecting Businesses
This year-end tax planning letter is based on the preliminary understanding of the new tax bill. The law is subject to change and likely will via various Technical Correction bills over the next year.
Finally, remember that this letter is intended to serve only as a general guideline. Your personal circumstances will likely require a careful examination. Please don’t hesitate to reach out to us with questions or for additional strategies on reducing your tax bill.
While many of our tax advisors will be enjoying the holidays with their families, we will have team members on hand through the end of the year to assist with any time sensitive questions you may have regarding these changes. Please call our office at 972-503-1040.
The technical information in this newsletter is necessarily brief.
No final conclusion on these topics should be drawn without further review and consultation.
See Also: Important Update on Property Taxes and Other Year-End Steps