Tax planning isn’t typically anyone’s favorite part of the year—especially when major tax reform is involved. Typical year-end tax planning advice expounds on the virtues of accelerating deductions and deferring income, where opportunities are both possible and economically viable.
With tax reform poised to pass Congress on December 21st and head to President Trump for his signature before Christmas, the strategy takes on a higher sense of urgency.
Income tax rates will drop for many business and individual taxpayers starting on January 1, 2018. Many popular tax deductions, especially for individual taxpayers, will be limited or eliminated under tax reform.
What Is the Tax Cuts and Jobs Act of 2017?
The Tax Cuts and Jobs Act of 2017, or tax reform, involves some tax simplification and reduction of the marginal tax rates for C corporations, individuals, and even for business income from pass-through entities (Partnerships, LLCs and S Corporations).
For individuals in the top marginal 2017 federal tax brackets (potentially as high as 44% *), the economic value of deductions taken in December of 2017 versus 2018 could be significant. This is true particularly where the new limitations on deductions included in the Tax Cuts and Jobs Act of 2017 impact taxpayers.
For individual taxpayers, the typical items that can be accelerated by paying in December, such as payment of real estate taxes, sales tax, state and local estimated tax payments and/or 2017 state taxes not otherwise due till April of 2018 for 2017 taxes, and charitable contributions, may be worth more on the dollar by paying in December versus next year. (Note: If you are typically in alternative minimum tax, or AMT, there may be little-or-no advantage to accelerating itemized deductions.)
Conversely, deferring income in general may be beneficial. Conferring with your investment advisor to accelerate and harvest any portfolio loss positions could potentially result in more after-tax savings.
While you consider specific yearend tax planning strategies, note some of the key components of the Tax Cuts and Jobs Act of 2017, below.
Key Components of the Tax Cuts and Jobs Act of 217
- Seven individual tax brackets with a top rate of 37%, versus 39.6% for 2017. Net investment income tax 3.8% continues to apply to joint filers with over $250,000 in income.
- Increased standard deductions to $24,000 for married filing joint and $12,000 for single filers.
- Repeal of personal exemptions.
- Repeal of the 80% deduction allowed for contributions to purchase seats at college sporting events (for example, college donations for season ticket upgrades).
- New limits on deduction for state and local taxes. Limited to $10,000 for joint files, any combination of real estate, state income or state sales taxes.
- Child tax credit expanded to $2,000.
- New three-year holding period for capital gains treatment on “carried interests.”
- Elimination of the “individual mandate” penalty for failure to purchase health insurance under the Affordable Care Act.
- Elimination of Alimony payments as a deduction for divorce settlements.
- Increased income limits on the amount of allowed charitable deductions.
- Home mortgage interest deduction limited to $750,000 of acquisition debt on primary or secondary residences. (Prior acquisition debt in place maybe grandfathered under old rules) and Equity/LOC interest no longer deductible.
- Elimination of deduction for tax preparation fees, unreimbursed employee business expenses, and other miscellaneous itemized deductions.
- Doubling of the exemption (to $11.2 million, indexed) from federal estate and gift tax. Washington State Estate Tax would still continue to apply to estates of over $2 million).
- AMT retained, but with a higher exemption of $109,400 versus $86,200 for 2017.
- Elimination of the Pease phase out on itemized deductions for high-income taxpayers.
- New limits on the deduction and carryover of net operating losses.
- Elimination of deduction for entertainment expenses. Business meals still generally deductible at 50%.
- 21% top corporate tax rate for C corporations effective 1/1/2018.
- 20% deduction for qualified pass-through business income from LLCs, partnerships and S corporations. Exceptions may apply based on non-owner wages and/or pass thru share of foreign earnings.
- Repeal of the corporate AMT.
- Temporary full expensing of property placed in service after September 27, 2017, for the next five years followed by phase out.
- New limits for deductions for business interest expense.
- New limits on the deduction for net operating losses.
- Elimination of like-kind exchanges except for real estate assets.
- Elimination of non-taxable treatment for many fringe benefits and/or ability for businesses to claim a deduction.
- Elimination of the Domestic Production Activity Deduction.
- Expanded limitations on compensation deductions for highly paid executives.
- Change to a territorial taxation system, where U.S. corporations are no longer taxed in the U.S. on the foreign earnings of their foreign subsidiaries.
- One-time transition tax (deemed repatriation of earnings) on previously deferred foreign E&P, which, at the election of the taxpayer, can be spread out over eight years. The portion of the E&P that consists of cash or cash equivalents is taxed at 15.5%, and remaining E&P is taxed at 8%.
- Please see our article on how the Tax Cuts and Jobs Act will affect tax-exempt organizations and private foundations.
What You Should Do Before December 31, 2017
- Accelerate purchase of depreciable assets to take advantage of the full expensing provision included in the tax reform legislation for property placed in service after September 27, 2017. This will offset taxable income at the 2017 higher tax rates.
- Defer recognition of income to 2018 where possible. Take advantage of the lower rates that apply starting January 1, 2018.
- Consider whether you will have adequate tax basis in your S corporation, LLC, or partnership activity to deduct any net operating loss you may receive from the activity in 2017.
- Consider disposing of a passive activity to trigger suspended passive losses. The losses may be deductible not only sooner, but at a higher marginal tax rate in 2017.
- Consider possible accounting/tax method changes that would allow more deduction into 2017, versus 2018.
- LLCs and partnerships will need to address the new partnership audit rules, including potentially amending LLC and partnership agreements to address the new rules.
- Consider ways to maximize the domestic production deduction through accelerated wage payments to business owners. This may make sense where the 50% of wages limitation applies and the owners’ wages are allocable to production activities.
- Consider maximizing retirement plan contributions.
- The same approach of accelerating deductions and deferring income—mentioned above—will likely produce the biggest tax savings and tax deferrals at year end 2017.
- To learn the top five year-end planning ideas for individual taxpayers for 2017, please see Celia Davis’ article on getting ahead of tax reform.
- Consideration should be given by C Corporations to repatriate any high tax E&P pools before the year end.
Of course, each individual or business must decide whether to implement specific year-end strategies based on the context of their unique situation. Accordingly, it could be extremely beneficial to have a conversation with your CPA now about how the potential changes might impact you.
Please contact Rick Cooley to discuss how planning might be beneficial.
* 39.6% Top Marginal Rate, plus 3.8% Net Investment Income Tax Rates, plus deduction phase outs approximate 44%.
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