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Year End Tax Planning Amid Possible Tax Reform
As many of you know there is much discussion in Washington these days about possible tax reform. I emphasize possible since nothing is definite and it may not be definite until after the first of the year. With this uncertainty in mind, I thought it would be helpful to review some of the major changes being considered as well as possible end of year tax planning ideas to consider. Until legislation is passed and signed, we may not know which ideas will turn out to be the best!
Earlier this month the House of Representatives passed its’ version of tax reform, while the Senate is expected to vote in the next several days on its’ version. There are significant differences between both bills, so even if the Senate bill passes there will be a conference between both chambers to hammer out a compromise bill which will then need to be voted on again by both chambers. Hence, while the stated goal of those in Congress is to pass legislation before the end of the year, this could easily slip into January.
What follows are major highlights of the two bills. This is not meant to be all-encompassing, so please keep that in mind if you have been keeping up with all the details of the two proposals.
Tax Rates for Individuals
The House version reduces the number of tax brackets from seven down to four, though there is technically a fifth bracket for those who make over $1M per year. The Senate version keeps seven brackets but reduces the actual tax rates. If there were no other changes to the tax code this would mean a lower tax obligation for everyone, but we need to look further into the elimination of certain deductions.
Increase in the Standard Deduction
Both versions of the reform call for a doubling of the standard deduction. For single filers, the deduction will rise from $6,350 to $12,000, and for married filers it would rise from $12,700 to $24,000. (You may see $24,400 in other articles as it would be adjusted for inflation in 2018.) For many of our clients and many people who live in high tax states like NJ, NY, and CA, folks choose to itemize rather than take the standard deduction since they have more itemized deductions. But, by increasing the standard deduction this much, a larger number of folks, including our clients, will benefit more by not itemizing. Especially since many of the itemized deductions may be going away! (see below for more)
Let’s say your itemized deductions (state and local taxes, mortgage interest, charitable) comes to $30,000 per year. Now let’s assume the deduction for state and local taxes is no longer allowed and your itemized deductions only come to $15,000 per year. In this case you would not itemize if your standard deduction is $24,000. (Unintended consequence: this now creates a disincentive to do more charitable deductions. Currently, the charitable deduction is one of the best deductions! I’ll have more to say about this below.)
Elimination of Personal Exemptions
In addition to the standard deduction you can claim a $4,050 exemption from income for yourself, spouse, and dependents. Both versions of the tax reform bills eliminate personal exemptions. This is something that would hurt families, especially larger families. There are different proposals to expand the child tax credit which would potentially negate the elimination of personal exemptions. We’ll have to see how this all gets negotiated though.
Repeal of State and Local Tax Deduction
This may be the most important of the changes to itemized deductions. Both the Senate and House bills eliminate the deduction for state income taxes as well as local taxes including property taxes. There is one exception to the discussion. The House bill preserves the deduction for up $10,000 of real estate taxes. For folks who live in NJ, NY, and CA the elimination of these deductions represents a very significant change. It should also be noted that these deductions have effectively been ‘lost’ for many people due to the Alternative Minimum Tax (AMT). When a taxpayer is subject to AMT these deductions are not allowed. So, in one sense if you have been subject to AMT, the ‘loss’ of these deductions is not a big deal. Furthermore, given the potential repeal of the AMT (see below), if the partial deduction of real estate taxes survives, it could help some people who were in AMT!
Medical Expense Deduction
The House bill eliminates this deduction while the Senate version preserves this deduction. Should be interesting to see how this one gets resolved in conference.
Repeal of Alternative Minimum Tax (AMT)
Both bills repeal the AMT tax system. This is one of the few ‘reform’ ideas that will help to simplify things just a bit. The AMT system is basically an ‘alternate’ method of calculating your tax liability. In this alternate tax calculation, certain deductions/exemptions are not allowed: state and local taxes, miscellaneous itemized deductions, and personal exemptions being the most important. As stated above, the loss of some of the deductions/exemptions may not be a big deal for those who were in AMT. For many residents of NJ, NY, and CA you are likely familiar with this.
Summary and Potential Planning Ideas
As stated at the beginning, this is only a summary of the major tax reform changes being considered in Washington. There are many other changes not covered here. With that, I’d like to review a few ideas for end of year tax planning.
First, of all the deductions that a taxpayer should consider accelerating before the end of the year the most important would be charitable contributions. Even for folks who are subject to AMT this year, you will likely benefit from increasing your charitable deductions. Given the potentially severe limitations of many other itemized deductions (medical, state and local taxes) combined with the higher standard deduction it is likely that far fewer taxpayers will be itemizing their deductions in the future if some version of tax reform passes. Given that you may not be itemizing, the deduction for your future charitable contributions may effectively be ‘lost’ from a tax standpoint. (There are obviously still very good reasons to still give to charities!)
Second, and of much lesser impact, would be to consider accelerating any state income taxes or property tax payments. For those of us subject to AMT you would not want to accelerate these payments since you would not benefit from doing so. It is also important to note that while accelerating these payments may be helpful in 2017, the decision is very dependent on one’s specific situation.
Third, is the acceleration of medical expense deductions. There is a significant limitation on the deduction of medical expenses to begin with, so far fewer taxpayers can take advantage of this. If you think you will get some benefit from deductions already incurred in 2017 and can accelerate more into December then this may be helpful.
Fourth, if possible, defer income into 2018. While this is specific to each taxpayer, it could be helpful to defer income into 2018 if you can, since tax rates may very well be lower next year.
In summary, with these ideas it is also best to consult with your tax and financial professional regarding your personal situation!