On December 20, 2017, Congress passed (on a party-line basis) the biggest tax reform law in thirty years, one that will make fundamental changes in the way you, your family and your business calculate your federal income tax bill, and the amount of federal tax you will pay. Since most of the changes will go into effect next year, there's still a narrow window of time before year-end to soften or avoid the impact of crackdowns and to best position yourself for the tax breaks that may be heading your way. Taxpayers should understand that a majority of the tax reform provisions are applicable only through 2025. Here's an overview of some last-minute moves you should consider.
General Planning Opportunities
The general plan of action to take advantage of lower tax rates next year is to defer income into next year or accelerate deductions into this year. Some possibilities follow:
- State and Local Tax Issues. After 2017, individuals (as opposed to businesses) will only be able to claim an itemized deduction of up to $10,000 ($5,000 for a married taxpayer filing a separate return) for the total of (1) state and local property taxes; and (2) state and local income taxes. To avoid this limitation, pay the last installment of estimated state and local taxes for 2017 no later than December 31, 2017, rather than on the 2018 due date. Only prepay state and local taxes if the 2017 deduction is not otherwise limited by the AMT. But don't prepay in 2017 a state income tax bill that will be imposed next year (i.e., 2018) – Congress says such a prepayment won't be deductible in 2017. However, Congress only forbade prepayments for state income taxes, not property taxes, so a prepayment on or before December 31, 2017, of a 2018 property tax installment is apparently permissible.
- Postpone IRA Conversion. If you are about to convert a regular IRA to a Roth IRA, postpone your move until next year. That way you'll defer income from the conversion until next year and have it taxed at lower rates.
- Roth Recharacterization. Earlier this year, you may have already converted a regular IRA to a Roth IRA but now you question the wisdom of that move, as the tax on the conversion will be subject to a lower tax rate next year. You can unwind the conversion to the Roth IRA by doing a recharacterization—making a trustee-to-trustee transfer from the Roth to a regular IRA. This way, the original conversion to a Roth IRA will be cancelled out. But you must complete the recharacterization before year-end. Starting next year, you won't be able to use a recharacterization to unwind a regular-IRA-to-Roth-IRA conversion.
- Delay Large Gifts. Individuals contemplating making large gifts, resulting in gift or GST taxes, should consider delaying such gifts until 2018.
- Postpone Debt Cancellation. The reduction or cancellation of debt generally results in taxable income to the debtor. So, if you are planning to make a deal with creditors involving debt reduction, consider postponing action until January to defer any debt cancellation income into 2018.
- Accelerating Charitable Contributions. Consider accelerating 2018 charitable contributions to 2017, if it appears your itemized deductions will not exceed the new larger standard deduction in 2018.
- Cash Basis Business—Defer Billings. If you run a business that renders services and operates on the cash basis, the income you earn isn't taxed until your clients or patients pay. So, if you hold off on billings until next year—or until so late in the year that no payment will likely be received this year—you will likely succeed in deferring income until next year.
- Accrual Basis Business—Defer Income. If your business is on the accrual basis, deferral of income till next year is difficult but not impossible. For example, you might, with due regard to business considerations, be able to postpone completion of a last-minute job until 2018, or defer deliveries of merchandise until next year (if doing so won't upset your customers). Taking one or more of these steps would postpone your right to payment, and the income from the job or the merchandise, until next year. Keep in mind that the rules in this area are complex and may require a tax professional's input.
Other Year-End Strategies for Individuals.
Here are some other last-minute moves that may save tax dollars in view of the new tax law:
- Take Advantage of Increased AMT Exemption. The new law substantially increases the alternative minimum tax (AMT) exemption amount, beginning next year. There may be steps you can take now to take advantage of that increase. For example, the exercise of an incentive stock option (ISO) can result in AMT complications. So, if you hold any ISOs, it may be wise to postpone exercising them until next year. And, for various deductions (e.g., depreciation and the investment interest expense deduction), the deduction will be curtailed if you are subject to the AMT. If the higher 2018 AMT exemption means you won't be subject to the 2018 AMT, it may be worthwhile, via tax elections or postponed transactions, to push such deductions into 2018.
- Moving Expense Deduction Suspended. The new law suspends the deduction for moving expenses after 2017 (except for certain members of the Armed Forces), and suspends the tax-free reimbursement of employment-related moving expenses. So, if you are in the midst of a job-related move, try to incur your deductible moving expenses before year-end, or if the move is connected with a new job and you are getting reimbursed by your employer, press for a reimbursement to be made to you before year-end.
- Accelerate Like-Kind Exchanges. Like-kind exchanges are a popular way to avoid current tax on the appreciation of an asset, but after December 31, 2017, such swaps will be possible only if they involve real estate that isn't held primarily for sale.
- Accelerate Business Entertaining Costs. For decades, businesses have been able to deduct 50% of the cost of entertainment directly related to or associated with the active conduct of a business. For example, if you take a client to a nightclub after a business meeting, you can deduct 50% of the cost if strict substantiation requirements are met. But under the new law, for amounts paid or incurred after December 31, 2017, there's no deduction for such expenses.
- Accelerate Employee Business Expenses. Under current law, various employee business expenses (e.g., employee home office expenses), are deductible as itemized deductions if those expenses plus certain other expenses exceed 2% of adjusted gross income. The new law suspends the deduction for employee business expenses paid after 2017. Also, now would be a good time to talk to your employer about changing your compensation arrangement—for example, your employer reimbursing you for the types of employee business expenses that you have been paying yourself up to now, and lowering your salary by an amount that approximates those expenses. In most cases, such reimbursements would not be subject to tax.
Please keep in mind that we have described only some of the year-end considerations in light of the new tax law. If you would like more details about any aspect of how the new law may affect you, please do not hesitate to call.
The following is additional detail regarding the new tax law.
Individual Taxation Changes and Considerations
Lower Tax Rates Coming.
There will be seven individual income tax brackets under tax reform. The top individual income tax rate for ordinary income will be 37%.
Tax rates for married individuals filing joint returns and surviving spouses.
“If taxable income is:
The tax is:
Not over $19,050
10% of taxable income.
Over $19,050 but not over $77,400
$1,905, plus 12% of the excess over $19,050.
Over $77,400 but not over $165,000
$8,907, plus 22% of the excess over $77,400.
Over $165,000 but not over $315,000
$28,179, plus 24% of the excess over $165,000.
Over $315,000 but not over $400,000
$64,179, plus 32% of the excess over $315,000.
Over $400,000 but not over $600,000
$91,379, plus 35% of the excess over $400,000.
$161,379, plus 37% of the excess over $600,000.
Disappearing or Reduced Deductions, Larger Standard Deduction
Beginning next year, the Tax Cuts and Jobs Act suspends or reduces many popular tax deductions in exchange for a larger standard deduction.
- Individuals (as opposed to businesses) will only be able to claim an itemized deduction of up to $10,000 ($5,000 for a married taxpayer filing a separate return) for the total of (1) state and local property taxes; and (2) state and local income taxes.
- Under current rules, alimony payments generally are an above-the line deduction for the payor and included in the income of the payee. Under the new law, beginning in 2019, alimony payments aren't deductible by the payor or includible in the income of the payee, generally effective for any divorce decree or separation agreement executed after 2018. For any divorce decree or separation agreement executed prior to 2019, the new law will apply if such agreement is modified after 2018 and the modification expressly provides that the new law applies to the modification.
- The itemized deduction for charitable contributions won't be chopped. But because most other itemized deductions will be eliminated in exchange for a larger standard deduction (e.g., $24,000 for joint filers), charitable contributions after 2017 may not yield a tax benefit for many because they won't be able to itemize deductions.
- The new law temporarily boosts itemized deductions for medical expenses. For 2017 and 2018 these expenses can be claimed as itemized deductions to the extent they exceed a floor equal to 7.5% of your adjusted gross income (AGI). Before the new law, the floor was 10% of AGI, except for 2017 it was 7.5% of AGI for age-65-or-older taxpayers. But keep in mind that next year many individuals will have to claim the standard deduction because many itemized deductions have been eliminated.
- The principal residence mortgage interest deduction will be limited to interest on $750,000 of indebtedness, for loans after 2017.
- Elimination of personal exemptions, the deduction for home equity debt, miscellaneous itemized deductions subject to the 2% floor (e.g., investment advisory fees and tax preparation fees), the Pease rule (i.e., phase-out of itemized deductions), the deduction for casualty losses (except for Federally declared disasters), and moving expenses (except for certain military personnel).
- Estate, Gift and GST tax exemptions will double to $10 million (expected to be $11.2 million for 2018 with inflation indexing). Thus, for a married couple the combined exemptions would be $22.4 million in 2018.
Some Items Not Changing for Individuals
- The preferential top rate (i.e., 20%) on capital gains and qualified dividends.
- Annual exclusion gifts ($15,000 for 2018).
- The 3.8% net investment income tax is not changing, thus, net investment income (e.g., interest, dividends, capital gains, annuity income, rents, etc.) will be taxable to the extent it exceeds the applicable thresholds (e.g., single taxpayers $200,000, married filing jointly $250,000).
- A taxpayer’s ability to sell specific lots of securities. The original tax reform bills in the House and Senate would have forced FIFO treatment for the sale of securities (e.g., stocks).
- Stretch-out distributions for beneficiaries of IRAs and other qualified plans.
- Rules for excluding gain on the sale of a principal residence.
Business Taxation Changes and Considerations
Lower Tax Rates Coming for Businesses.
The Tax Cuts and Jobs Act will reduce tax rates for “c corporations”, effective for the 2018 tax year. Additionally, other businesses, including those operated as pass-throughs (such as partnerships, limited liability companies taxed as partnerships or s corporations, and s corporations) may see their tax bills cut.
- The graduated “c corporation” tax rates ranging from 15% to 35% will be reduced to a flat 21% rate.
- The corporate AMT is fully repealed beginning in 2018.
- A new like-kind exchange rule limits exchanges to real estate not held primarily for sale.
- The IRC section 179 deduction will double to $1 million, subject to phase-out.
- Doubling of bonus depreciation to 100% and expansion to include used property. The effective date is for assets acquired and placed in service after September 27, 2017 and before January 1, 2023.
- Pass-through entities (e.g., partnerships, s corporations, and sole proprietorships) will be entitled to a 20% qualified business income deduction. The provision is applicable for business owners with income under $157,500 ($315,00 for married filing jointly). In addition, the benefit is subject to phase-out.