By Chris A. Miller, CPA/PFS, CFP®, MBA
We are writing to address two topics – 1) to give you a very brief overview of federal income and estate tax reform bills pending in the US Congress and 2) to help you think about year-end tax planning now, even given the current uncertainty about tax reform legislation.
Pending Federal Tax Reform Legislation
On November 16th, the US House of Representatives passed a tax reform bill (the “Tax Cuts and Jobs Act”, HR 1), and the US Senate is now considering a bill with the same name but with somewhat different provisions. The Senate will resume deliberations following its Thanksgiving recess. However, it may be mid to late December before we know if both houses of Congress can agree on the specifics of tax reform and pass legislation which President Trump is willing to sign. It is presently expected that any tax reform legislation passed will generally take effect in 2018, although certain depreciation and other provisions may apply in 2017.
Many political commentators indicate that it is probable that a tax reform bill in some form is likely to pass both houses of Congress and be signed by President Trump. Even though the House and Senate bills are somewhat different, we can look to the common provisions in the two bills to get a sense of what may be included.
Here is a table from the American Institute of CPAs showing a very brief comparison of the provisions of each bill.
There are many provisions of each bill not included in this table, including the specifics of business depreciation, home gain exclusions, business and individual credits eliminated, and business interest limitations, to name just a few. Please see us if you would like a more comprehensive list of the proposals.
Year End Federal Income and Gift Tax Planning
So how does one engage in year-end federal tax planning given the uncertainty of pending tax reform legislation? Even before the final proposals are known, we believe it is helpful to think about potential planning steps in the following groups.
1 – Fully fund 2017 tax benefits under the current law – “use them or lose them”. There are several income tax benefits available to taxpayers in or for 2017, provided a taxpayer takes timely action to utilize the benefit – once the deadline has passed you can’t take advantage of the benefit. A partial list follows of these benefits follows, and none of the benefits for 2017 are affected by the pending tax reform legislation. Qualification criteria apply to each benefit, so please contact us for specifics.
- Contributions to qualified retirement plan accounts, including: traditional IRA and Roth IRA accounts (must be made by April 17, 2018), salary deferral elections for qualified employer retirement plans (401(k), 403(b), 457, SIMPLE IRA, etc.), and deferrals must be made for payroll paid by December 31, 2017, employer discretionary contributions to profit sharing plans (generally for self-employed individuals), which must be made by the due date, plus extensions, of the employer’s 2017 income tax return.
- Contributions to qualified accounts/plans for medical expenses, including: Health Savings Accounts (contributions must be made by April 17, 2018) and Flexible Spending Accounts (contributions must be made by December 31, 2017).
- Contributions to qualified education accounts, including: Coverdell Education Savings Accounts (contributions must be made by April 17, 2018) and Section 529 Qualified Tuition Programs (check with your state to see the deadline specific for your state plan).
- Non-charitable gifts (typically to or for family members) – the annual gift tax exclusion for non-charitable gifts (gifts of present interests) is $14,000. The gift must be a completed gift by December 31, 2017, i.e., checks written to family members must either be accepted and deposited by the donee by year end, or be given to the donee by a cashier’s check.
2 – Manage the amount of your 2017 income so you maintain eligibility for 2017 tax benefits. Eligibility for several tax benefits in 2017 depends on keeping your income below a specified level. Qualification criteria not listed may apply to these benefits, so please contact us for specifics. Examples include:
- Lower tax rates for long term capital gain and qualified dividends (CGQD)– a 0% CGQD rate applies for taxpayers in the 10% or 15% income tax brackets, a 15% CGQD rate applies for those in the 25%, 28%, 33% and 35% income tax brackets, but a 20% CGQD rate applies for those in the 39.6% bracket. The key is to avoid moving from the 15% rate to the 25% rate, or from the 35% rate to the 39.6% rate.
- Tax free Social Security benefits –social security benefits are taxed when your “combined income” (adjusted gross income, tax exempt interest and half of your social security income) exceeds $25,000 for an individual and $32,000 for a married couple.
- Ability to deduct up to $25,000 of losses from real estate with active participation – the deduction is reduced by 50% of modified adjusted gross income in excess of $100,000 (reduced amounts apply for a married taxpayer filing separately).
- Ability to deduct contributions to traditional IRA accounts – when you are covered by a workplace retirement plan, your ability to deduct make IRA contributions phases out for modified adjusted gross income between $62,000 and $72,000 for a single individual and between $99,000 and $119,000 for a married couple. Other higher limits apply when you are married and only your spouse is covered by a workplace retirement plan.
- Ability to make direct contributions to Roth IRA accounts – phases out for modified adjusted gross income between $118,000 and $133,000 for single, married filing separately and head of household taxpayers, and between $186,000 and $196,000 for married taxpayers.
- Ability to deduct student loan interest – phases out between modified gross income between $65,000 to $80,000 for single taxpayers and between $135,000 to $165,000 for married taxpayers.
- Full deduction for itemized deductions and personal exemptions – phase out begins for adjusted gross incomes of $261,500 for single individuals and $313,800 for married taxpayers. Other limits apply for head of household and married filing separately taxpayers.
- Full use of the personal exemption for alternative minimum tax – phases out for alternative minimum taxable income between $120,700 and $337,900 for single taxpayers and between $160,900 and $498,900 for married taxpayers.
- Ability to claim education credits – the American Opportunity Tax Credit phases out for modified adjusted gross income of between $160,000 and $180,000 for married taxpayers and between $80,000 and $90,000 for all others. The Lifetime Learning Credit phases out between modified adjusted gross income of $111,000 and $131,000 for married taxpayers and between $55,000 and $65,000 for all others.
- Avoidance of Net Investment Income Tax and Additional Medicare Tax on Earned Income– the 3.8% net investment income tax on investment income and the .09% Medicare tax on earned income can only apply when modified adjusted gross income exceeds $250,000 for married taxpayers and surviving spouses, $125,000 for married filing separately taxpayers and $200,000 for all other taxpayers.
- Avoidance of “kiddie tax” on a child’s unearned income – a child avoids having to pay tax on his or her income at their parent’s rate if the child’s unearned income (other than wages or self-employment income) is $2,100 or less.
3 – Consider the effect of anticipated significant differences in the amount of your income or other tax circumstances in 2017 and 2018. Generally, you can benefit when you equalize your marginal tax rates between years by moving income and deductions between years. Right now, we don’t know what marginal tax rates may apply for 2018. However, if you know that there will be a material difference between the income you will recognize in 2017 and in 2018 or you will have a material change in your tax circumstances, you may benefit from shifting income or deductions between years even given the uncertainty of tax rates in 2018. Here are some examples of income differences or changes in tax circumstances – you began working or stopped working in either year, your filing status will change (marriage, divorce, death of a spouse), you have or anticipate a material gain or loss in either year, or your business income will change significantly. See below about potential ways to shift income or deductions between years.
4 – Consider the potential limitation of itemized and non-itemized deductions in 2018 under present tax reform proposals. You should consider if you would benefit from paying in 2017 the deduction items which might be limited for 2018 and subsequent years under the reform proposals.
- Student loan interest (eliminated under the House proposal)
- Medical costs (eliminated under the House proposal)
- State income tax and property taxes (limited under the House proposal and eliminated under the Senate proposal), unless you are subject to the alternative minimum tax in 2017
- In addition, the reform proposals increase the standard deduction to approximately $24,000 for married taxpayers and to $12,000 for individual taxpayers. If you anticipate that your 2018 itemized deductions will be less than these amounts, then you may want to accelerate your 2018 medical expense, charitable contributions, home mortgage interest payments and miscellaneous itemized deductions into 2017.
5 – Consider the timing of business income and deductions.
- The reform proposals would lower the tax rate on C Corporation taxable income to 20% (for 2018 in the House proposal and beginning in 2019 in the Senate proposal), so it may be advantageous for C Corporations to accelerate deductions into 2017 or to delay recognition of income until 2018 or later years.
- The reform proposals would create a new lower individual tax rate for certain business “pass through” income from partnerships (and LLCs), S Corporations and sole proprietorships reported on individual tax returns. The benefit may not be available for owners of certain personal service businesses, e.g., physicians, attorneys, architects and consultants. If the provisions apply, it may be advantageous to accelerate business deductions into 2017 or to delay recognition of business income until 2018 or later years.
- The House and Senate proposals eliminate the Domestic Production Activities Deduction beginning in 2018. If your business generates this deduction, you may want to try to maximize it in 2017, e.g., if your deduction was limited in prior years by the amount of employee wages, you may want to accelerate employee wages otherwise payable in 2018 into 2017.
6 – Consider what means are available to you to shift income and deductions between tax years. If you determine that it may be beneficial for you to shift income or deductions between years, you may want to consider the following ways to do that.
For Individuals –
- Negotiate with employers the payment dates for bonuses or commission income.
- Choose the sale date for asset sales (stocks, mutual funds, homes, real estate), and consider election out of otherwise mandatory installment sale provisions.
- Consider “harvesting losses” inherent in investment assets, but ensure you comply with the “wash sale” rules which might limit the deduction of those losses.
- Choose whether you hold income producing assets (stocks, bonds and mutual funds) in taxable accounts or tax deferred retirement accounts and annuities.
- Choose the dates at which you make Roth IRA conversions, make “in-plan” Roth conversion elections inside your employer’s retirement plan, or take IRA or pension distributions in excess of your annual required minimum distribution – all of which generate taxable income.
- Choose the date at which you pay tax deductible items.
- Consider gifting appreciated securities you would otherwise sell.
- Consider making your annual IRA required minimum distribution directly to a qualified charitable organization.
For business entities and an individual’s business activities, including rental properties –
- Choose the time at which you bill customers/clients.
- Consider the date at which you pay for or incur expense. For cash basis taxpayers, payment by credit card counts as a cash payment.
- Consider the timing of capital expenditures and repairs and maintenance projects.
- For property placed in service in 2017, consider the use of accelerated depreciation methods, Section 179 expensing of capital purchases, and bonus depreciation – or to choose/elect not to use them for 2017 purchases.
- For self-employed individuals, consider the amount of your business’ discretionary profit sharing contribution for 2017.
Accordingly, even with uncertainty about whether a tax reform bill may become law, a prudent taxpayer may still engage in year-end tax planning.