Year-End Tax Planning in Conditions of Uncertainty

With December 31, 2017 fast approaching, and with the “sausage-making” going on in Congress with respect to so-called “tax reform,” it is difficult to know what to rely upon when considering year-end tax planning.  This past week the House of Representatives passed their version of tax reform and the Senate Finance Committee approved their plan.  The full Senate will take up their plan after Thanksgiving.  If the Senate approves a plan, then the differences between the House and Senate bills will have to be reconciled with the resulting bill subject to approval by the two chambers once again.  All this is to be done before Christmas so that the president can sign the legislation before year end.

So what tax-planning steps should you consider now?  If you wait to start planning until after seeing whether tax reform is enacted, you may find yourself without sufficient time to determine and execute strategies during the busy year-end holiday season.  Many changes are proposed, and every taxpayer will be affected.  The changes are so many that there will be interplay between provisions, and taxpayers having similar total income will be treated very differently depending upon their individual circumstances.  Here are some general considerations, but you should undertake a detailed tax projection calculation to confirm whether any of these suggestions could be beneficial to you.  Undertaking “scenario planning” will help you be ready to act by year-end.

1.      After 2017, the top individual ordinary income tax rate remains 39.6% in the House bill but is cut to 38.5% in the Senate bill.

a.      Defer income to 2018 and accelerate deductions to 2017.

b.     If you are not in the top bracket, then you should examine the proposed tax rate brackets to see what your tax rate may become after 2017.

2.      After 2017, many itemized deductions are repealed.  The House bill will only allow a real property tax deduction of up to $10,000 on your principal residence, mortgage interest on up to $500,000 of acquisition debt (with pre-November 2, 2017 debt grandfathered) on your principal residence, and charitable contributions.  The Senate bill will not permit any tax deductions, but allows medical, mortgage interest on up to $1,000,000 of acquisition debt on your principal residence, and charitable contributions.

a.      Pay your real estate tax and state income taxes in 2017.

b.     Pay down home equity borrowings as that interest won’t be deductible after 2017 if the use of the borrowings cannot be traced to expenditures for home improvements or for the purchase of business or investment property that would still permit deductible interest.

c.      If your total itemized deductions approximate the proposed increased standard deduction of approximately $24,000 for joint filers, or $12,000 for singles, then you should “bunch” your deductions into every other year, beginning with 2017.

3.      After 2017, the alternative minimum tax is repealed.

a.      Defer exercising incentive stock options until after 2017 to avoid AMT.

4.      After 2017, a recharacterization of a Roth IRA conversion will not be permitted.  Under current law, recharacterization is permitted until October 15^th of the year following the year of conversion, giving a generous window of time to unwind the conversion if the value of the account falls below the amount of conversion income.

a.      Examine your 2017 conversions of traditional IRAs to Roth IRAs to see if the value of the account has dropped and make the recharacterization before the end of 2017 if necessary.

5.      After 2017, the Senate bill would require the use of “first-in first-out” identification of basis in securities for determining gain or loss, repealing the “specific identification” method.  It appears that the change might also encompass in-kind charitable contributions and gifts.

a.      Use the specific identification method for choosing the specific lots of securities to sell or to donate before 2018.  For example, choose high basis securities when selling and choose low basis securities when donating to charity.

6.      After 2017, tax-deferred, like-kind exchanges will be limited to real property.

a.      Enter into any non-real estate exchanges before the end of 2017.

7.      After 2017, partnership, S-corporation, and sole proprietorship net business income will be taxed less.  The House bill uses a 25% tax rate on passive business income and on 30% of nonpassive business income.  The House bill also has a 9% tax rate for very small businesses.  The Senate simply uses a 17.4% deduction.  The reduced tax will not apply to professional service business income.

a.      Defer business income to 2018 and accelerate deductions to 2017 to boost the amount of net business income subject to the lower tax.

b.     Fiscal year pass-through businesses should consider changing their tax year to a calendar year to gain advantage of the lower tax rates sooner, permanently saving tax.

8.      The C corporation income tax rate will be lowered to 20% for tax years beginning after 2017 in the House bill or after 2018 in the Senate bill.

a.      Again, defer income and accelerate deductions.

b.     If starting a new business, carefully consider whether a C corporation entity might be a better choice than a tax partnership or S corporation.