With tax reform proposals winding their way through Congress, year-end tax planning has become infinitely more complex. There’s a great deal of uncertainty over whether and when tax reform will be implemented and which proposals from the bills will make their way into any final legislation that’s signed into law. The good news is that there are steps to take before December 31 that can reduce your 2017 tax liability.
Ordinarily, the best year-end tax strategies depend on your marginal tax rate this year and next. If you expect your marginal tax rate to remain about the same or decline in 2018, you should consider strategies for deferring income to 2018 and accelerating deductions into 2017.
On the other hand, if you think your marginal rate will go up next year, you may be better off doing the opposite: accelerating income and deferring deductions. That’s because this year’s income would be taxed at a lower rate and next year’s deductions would be more valuable. But keep in mind that, even if your marginal rate will increase next year, you’re probably better off accelerating deductions into 2017 that you believe will be eliminated in 2018. After all, a less valuable deduction this year is better than no deduction at all.
Unfortunately, tax reform efforts make it difficult to predict your tax situation in 2018. Current proposals, if they become law, will lower taxes for many people. But not everyone will be better off. For example, changes to the income ranges for tax brackets could cause some taxpayers’ marginal rate to go up, even without taking into consideration the reduction or elimination of various tax breaks. As of this writing, the newly proposed brackets vary between the House and Senate bills, creating uncertainty for many people about whether their marginal tax rate will increase or decrease next year. A proposed increase in the standard deduction would lower taxes for those who don’t itemize, but the elimination of many itemized deductions in the House and Senate bills could raise taxes for those who previously enjoyed significant write-offs for things like medical expenses, state and local taxes, and miscellaneous itemized deductions. The proposed elimination of personal and dependent exemptions could also have a negative tax impact on some families.
Techniques for deferring income until 2018 include delaying self-employment income, taking your year-end bonus early next year, postponing the sale of appreciated investments and putting off non-required retirement plan distributions. To accelerate deductions into this year, you might consider prepaying state and local income and property taxes, prepaying your January mortgage payment, boosting your 2017 retirement plan contributions and incurring elective medical expenses by the end of the year. Some of these deductions may be reduced or eliminated in 2018, so this could be an especially powerful strategy this year. But various rules and limits apply, so be sure to consider those before taking action.
If you’re subject to alternative minimum tax (AMT), careful planning is critical. An AMT repeal is included in tax reform legislation, but it likely wouldn’t go into effect until 2018. Therefore, 2017 AMT planning is still important.
Traditionally, higher-income taxpayers have postponed expenses that are deductible for regular tax purposes but not for AMT purposes — such as state and local taxes and miscellaneous itemized deductions — if they’re at risk for owing the AMT. But if these deductions might be eliminated beginning in 2018, deferring them may not be a wise strategy.
Many taxpayers who’ll owe the AMT this year will benefit, however, from deferring items that are deductible for both regular tax and AMT purposes and that are expected to still be deductible for regular tax purposes in 2018, such as charitable contributions. Say you’re in the 39.6% regular tax bracket and this year your income falls within the AMT “sweet spot,” which enjoys a 28% marginal rate. These deductions will be more valuable next year if you expect to be in a higher tax bracket. You may also benefit by accelerating some income into this year.
Consider Taking Action by December 31
You may be able to help make 2018 a happier new year by considering these last-minute 2017 tax-saving tips:
Make charitable donations. The future of the estate tax is uncertain, but even if it’s repealed, it likely won’t be permanent. And it isn’t proposed to kick in until 2024 under the House bill. Making lifetime charitable donations can help reduce your taxable estate and benefit your favorite organizations. In addition, by making donations to qualified organizations during your lifetime, rather than at death, you may benefit from income tax deductions. If your tax rate does go down in 2018, the deductions will provide more tax savings this year. To take a 2017 charitable donation deduction, the gift must be made by December 31.
Sell investments at a loss to offset capital gains you’ve recognized this year. You may be able to lower your 2017 tax bill by selling investments that are now worth less than what you initially paid for them. You can offset the resulting capital losses against capital gains you may have recognized earlier in the year. If your losses for the year exceed your gains, you can deduct up to $3,000 of losses against other income, and you can carry forward any excess to deduct in future years.
Take retirement plan RMDs to avoid a 50% penalty. If you have traditional IRAs (not Roth IRAs) or an employer-sponsored defined contribution plan, such as a 401(k) plan, you generally must begin taking annual required minimum distributions (RMDs) after you reach age 70½. You also could be required to take RMDs if you inherited a retirement plan (including Roth IRAs). If you don’t comply, usually RMDs must be taken by December 31, you may owe a penalty equal to 50% of the amount you should have withdrawn but didn’t.
Make 2017 annual exclusion gifts. Even in a potentially changing estate tax environment, making annual exclusion gifts before year end can still benefit your estate plan. The 2017 gift tax annual exclusion allows you to give up to $14,000 per recipient tax-free — without using up any of your gift and estate or generation-skipping transfer (GST) tax exemption. (In 2018, the exclusion amount increases to $15,000.) The gifted assets are removed from your taxable estate, which can be especially advantageous if you expect them to appreciate. That’s because the future appreciation can avoid gift and estate taxes. Because the exclusion doesn’t carry over from year to year, you should consider using your 2017 exclusion by December 31.
Given the uncertainty over the timing and content of new tax legislation, it may be advisable to delay implementing year-end planning, if practical, until the tax reform picture becomes clearer. But don’t wait too long; some year-end strategies take time to execute. Please contact us with questions on how tax reform legislation may affect your year-end tax planning.