Last Minute Tax Planning Now that “Tax Reform” is Enacted

The House and Senate approved the Tax Cuts and Jobs Act bill December 20, 2017.  The President signed it December 22, 2017.  The tax bill is massive, weighing in at 1,097 pages including the Conference Committee report.  It will take some time to digest all the changes, but every taxpayer and business is affected.  What can you do right now to cut your taxes?

Accelerate Deductions

Deductions save more taxes when tax rates are high.  Since overall tax rates will decline in 2018, it may make sense to prepay some expenses by December 29^th, such as paying your January 2018 home mortgage payment early, advance funding your 2018 charitable giving, prepaying any 2017 state income taxes that would otherwise be due as an estimated tax payment in January or would be due with your tax return, and harvesting any capital losses in your investment portfolio.  Check your individual circumstances.  If your income will be higher in 2018, you might be in a higher tax bracket next year.  Note that prepaying in 2017 your 2018 state income tax will not be deductible according to the Conference Committee report.  It is uncertain whether prepaying your 2018 real estate tax will be deductible, but the report did not expressly prohibit it. On December 27, 2017, the IRS released an advisory that "A prepayment of anticipated real property taxes that have not been assessed prior to 2018 are not deductible in 2017."

The standard deduction will be increased in 2018 to $24,000 for joint tax returns and $12,000 for singles.  If your total itemized deductions approximate these amounts, you may wish to “bunch” your deductions into every other year to more efficiently use your deductions.  For example, you may wish to bunch deductions into 2017 and then again in every odd numbered year.

Delay Income

Send invoices late in the month to avoid receipt in December, defer deliveries of merchandise to customers, and work with your employer to postpone receipt of a bonus while avoiding constructive receipt.  Postpone converting a traditional IRA to a Roth IRA until 2018.  Delaying income to 2018 may allow it to be taxed at lower tax rates.  Again, you must look at both 2017 and 2018 taxes to know the right course of action for your situation.

Roth IRA Recharacterizations

The ability to recharacterize a Roth IRA conversion is repealed after 2017.  If you have already converted a traditional IRA to a Roth IRA during 2018, you may wish to consider unwinding the conversion by a recharacterization by December 29^th in a couple of circumstances.  First, if the value of the account has declined from the value at the time of conversion, recharacterize so that you don’t pay tax on value that no longer exists.  Second, if the account hasn’t appreciated too much, consider recharacterizing now and reconverting in early 2018 if your tax rate on the reconversion will be less than your 2017 tax rate on the original conversion.

If Subject to 2017 Alternative Minimum Tax

If you are subject to AMT in 2017, and the amount of the AMT exemption has been fully phased out due to high income, then you are subject to an effective 28% Federal tax rate.  Since the impact of the individual AMT is greatly reduced in 2018 and likely not to apply, you might find that your marginal 2018 tax rate is greater than 28%.  In such a case, you should consider exercising nonqualified stock options, accelerating bonuses, or converting a traditional IRA to a Roth IRA before the end of 2017.  In addition, you should consider deferring charitable deductions to 2018.  Incentive stock options should be exercised in 2018 when the AMT is much less likely to apply to the AMT ISO preference.

Business Equipment

If you are planning to purchase business equipment in 2018, consider purchasing and placing in service the equipment before the end of 2017.  Bonus depreciation is increased to 100% for equipment and machinery purchased and placed in service after September 27, 2017.  Taking bonus depreciation in 2017 when tax rates are high will likely save more taxes than if done in 2018.

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.

Selected 2018 Inflation-Indexed Figures

Many contribution and deduction amounts in the tax law are indexed for inflation.  Many also have statutory adjustments.  While there remains uncertainty about whether Congress and the President will enact “Tax Reform” before the end of 2017, some important 2018 inflation-adjusted figures have been released and are as follows:

1.        The top 39.6% ordinary income and 20% long-term capital gain tax rates apply when taxable income exceeds $480,050 for joint filers (up from $470,700 in 2017) and $426,700 for single filers (up from $418,400 in 2017).  For trusts and estates, the top rates apply when taxable income exceeds $12,700 (up from $12,500 in 2017).

2.         Itemized deductions and personal exemptions begin to “phase-out” once adjusted gross income exceeds $320,000 for joint filers (up from $313,800 in 2017) and $266,700 for single filers (up from $261,500 in 2017).  These phase-outs do not apply to trusts and estates.

3.        The personal exemption is $4,150 (up from $4,050 in 2017).

4.        The contribution amount for traditional and Roth IRAs remains $5,500 (the same as in 2017).  For those who are age 50 and older, the additional “catch-up” contribution is $1,000 and is not indexed for inflation.

5.        The modified adjusted gross income phase-out range for contributions to Roth IRAs is from $189,000 to $199,000 for joint filers (up from $186,000 to $196,000 in 2017); and from $120,000 to $135,000 for single filers (up from $118,000 to $133,000 in 2017).

6.        The contribution amount for traditional and Roth 401(k) accounts increases to $18,500 (up from $18,000 in 2017).  For those who are age 50 and older, the additional “catch-up” contribution remains $6,000 (the same as in 2017).

7.        The limit on the annual additions to a participant's defined contribution account increases to $55,000 (up from $54,000 in 2017).

8.        The annual exclusion from gift tax increases to $15,000 per donee (up from $14,000 in 2017).

9.        The lifetime exemption from estate, gift, and generation-skipping transfer taxes increases to $5,600,000 (up from $5,490,000 in 2017).

10.    The Social Security tax wage base increases to $128,700 (up from $127,200 in 2017).

11.    The maximum annual contribution to a health savings account increases to $3,450 (up from $3,400 in 2017) for an individual-coverage-only health plan, and $6,900 (up from $6,750 in 2017) for a family-coverage health plan.  For employees age 55 and older, the additional HSA "catch-up" contribution is $1,000 and is not indexed for inflation.

Actions to Consider in Response to the Equifax Data Breach

There are three major credit reporting agencies:  Equifax, Experian, and TransUnion.  According to the Wall Street Journal, there is also a smaller, fourth agency called Innovis.  These companies collect our personal and financial data.  The Equifax website states that it “organizes, assimilates and analyzes data on more than 820 million consumers and more than 91 million businesses worldwide, and its database includes employee data contributed from more than 7,100 employers.”  Whenever we consumers apply for credit, purchase insurance, apply for a job, rent an apartment, purchase the latest cell phone on contract, etc., the businesses we patronize will query the databases of the credit reporting agencies to check our credit scores and history before deciding to do business with us.  The data these agencies collect are precisely the high-quality data that identity thieves crave to wreak havoc in our personal and financial lives.  It therefore came as a shock when we learned a couple weeks ago that the Equifax database was breached by hackers this summer, particularly when it was revealed that there was a software security patch published in March that would have plugged the security hole in the company’s system.  Reportedly the data exposed includes names, Social Security numbers, birth dates, addresses, and driver licenses as well as some credit card numbers and other unidentified data.

So now what do we do?  There have been many articles written in the press about steps you can take to try and protect your online financial accounts and your personal identity.  Based upon my review, here are some steps (not exhaustive) you should consider:

1.      First, go to www.equifaxsecurity2017.com and click the Potential Impact button.  That will link you to a page where you can enter some basic information and find out if your personal information has been exposed.

2.      If your data was exposed, you can enroll in a free year of identity theft protection and credit file monitoring from Equifax in a product called TrustedID Premier.

3.      Go to your online financial accounts and change the challenge questions that you must answer.  Challenge questions appear if you try to log in to your account from a computer that hasn’t been verified with the institution (via a “cookie” on your computer).  Many of these challenge questions can be answered or inferred from the very information that was stolen.  Therefore, it is better to choose more difficult questions that can’t be answered from your now exposed information.

4.      Go to your online financial accounts and sign up for email and text alerts every time there is a transaction, or a change to your username or password, access from a different computer or device, or a change to any other personal account information.  This will allow you to more closely monitor your accounts for fraudulent activity.  But don’t click on any email links as it could be an imposter email.  Instead, login to your online account to review the activity.

5.      Go to your online financial accounts and enroll in two-factor authentication if it isn’t already enabled.  Two-factor authentication requires the entry of a temporary code that is sent by text to your cell phone if there is a log-in attempt from a computer that is unknown to the institution’s website.  Typically you will have accessed your online accounts from your home and work computers and those computers will have been registered with the websites.  The two factors are entering information you know (username and password) and entering a code from something in your personal possession (cell phone).  Since the identity thieves won’t have your cell phone, you have a strong layer of added protection.  Microsoft and Google also have two factor applications which you can use for your different accounts.

6.      If you are not using strong passwords unique to each financial account, you should do so.  Weak passwords are oftentimes based upon personally identifiable information.  To be able to keep track of strong, unique passwords, you need to use a password manager such as LastPass or 1Password among others.  In addition, you may wish to change and strengthen your account usernames which often are just your name or email address.

7.      Set up fraud alerts with the three credit reporting agencies.  You will be alerted if someone applies for credit in your name.  But an alert comes after the fact and is not preventative.  Fraud alerts typically last 90 days and must be renewed for continued coverage.  An extended alert of 7 years requires proof of identity theft.

8.      A more effective action is to freeze your credit history with each of the credit agencies.  The press is reporting that the credit reporting agencies are trying to persuade people to not freeze their credit (maybe because they will lose revenue?).  They emphasize the hassle that you will endure.  If you push ahead, then they try and get you to “lock” instead of “freeze.”  Evidently there is a meaningful difference between the two.  You will need to evaluate the difference to see what is best for you.  Those who have frozen their credit describe the process of temporarily unfreezing as necessary as not being that difficult.  There is typically a small charge for placing the freeze and for temporarily lifting the freeze.  Be sure to consider the freeze for your spouse and children.  Note that a credit freeze does not protect against unauthorized access to your online accounts.

9.      Be careful of suspicious emails or telephone calls purporting to come from Equifax or other companies, or even the police.  If these communications ask you to click on a link, to provide personal information, or to make a payment, it is very likely these contacts will be from scammers.

10. Carefully review monthly statements from your credit card companies, banks, or other financial institutions.  Contact the institution if you see something suspicious, even if it is for a very small amount of money.

11. Check your credit reports often.  You are entitled to a free report once every 12 months from each of the three major credit agencies.  Select one agency every four months.  Use the federally authorized www.annualcreditreport.com website and avoid similarly named websites that try and trick you into a membership or into paying a fee if you don’t cancel within a certain number of days.

12. Keep your computer operating system and antivirus software patched and up-to-date.  Manually click the update buttons every couple of weeks instead of relying completely on automatic updates.  Sometimes there are large updates that aren’t automatically installed.  Do a deep antivirus scan of your computer and attached hard drives every couple of weeks.  Be sure to routinely back up your critical computer data.

13. Get more information at the Identity Theft Resource Center.

14. Implementing these suggestions is time consuming.  However, we must consider that our personal identifying information is now readily available to bad actors.  Therefore, acting sooner rather than later is important in preventing problems in the future.

The Long-Term Care Insurance Decision

Medical advances have lengthened life expectancy, but as we live longer we will have physical and mental incapacities that will require assistance with activities of daily living (ADL).  The six basic ADLs are:  eating, bathing, dressing, toileting, transferring (walking) and continence.  Statistics show that nearly 7-in-10 people who reach age 65 will need some form of assistance with ADLs.  Alzheimer’s and other forms of dementia are the number one cause for claims in nursing homes.

Long-term care costs are expensive, and there are a variety of ways in which people may receive assistance.  A private room in a nursing home had a median annual cost of $91,250 in 2015; an assisted living facility had a median annual cost of $43,200 in 2015; and home health aid services had a median annual cost of $45,760 in 2015.  The average length of stay in a nursing home is three years.  A longer stay can really increase the costs to the family.

Many people in their late 40’s and 50’s have seen their own family members struggle with long-term care decisions including how to pay for such care.  It is important to note that health insurance coverage, including Medicare (which is Federal government health insurance for those age 65 and above), do not cover the costs of long-term care (except that Medicare covers 100 days of skilled nursing care).  Medicaid (which is health insurance for the very poor, funded by a partnership of Federal and State governments) does pay for nursing home care, but you must be impoverished to receive the insurance.  Long-term care costs are already high and they increase every year.  With respect to paying long-term care expenses there are three basic approaches:  paying the costs from your savings and investments, paying the costs with long-term insurance, or relying on Medicaid.

When the Affordable Care Act (a.k.a. Obamacare) was enacted, it included a provision called the Community Living Assistance Services and Supports Act to pay long-term care expenses if those enrolling in the coverage paid enough premiums to pay for all the expenses.  The government quickly discovered that the cost of care would far exceed the funding received from premiums and so the provision was abandoned before it became effective.  Recently, an article in the New York Times addressed Medicaid funding issues and the payment of long-term care expenses.  The article described the hard decision of whether someone should pay the premium costs of buying long-term care insurance.  The author concluded that it would be foolish to pay for premiums because the government will eventually come around to providing such coverage for everyone.  But this seems to be wishful thinking and a very irresponsible conclusion to me, waiting for the government to come to our rescue, when current entitlements are projected to run out of money and overwhelm the fiscal budget!

For those with modest assets of maybe several hundred thousand dollars or less, Medicaid planning may be the best route.  For those with more wealth of up to $5 million or maybe even $10 million, long-term care insurance may not actually be necessary to pay your costs, but the insurance could be very effective in preserving your estate for your heirs.  For those with more than $10 million, self-funding may be the most appropriate approach.

The best time to apply for long-term care insurance is probably before age 60.  As we age we tend to have more health problems which makes it harder to be accepted by the insurance company.  Good health can save premium dollars with a preferred health rating.  Poor health makes one uninsurable.

There are three basic types of long-term care insurance.  The traditional policy where you pay annual premiums for pure long-term care insurance.  Many insurance companies have abandoned these policies in recent years as their actuarial assumptions understated the cost of providing the insurance.  The other two types of policies are hybrid plans, one combining long-term care insurance with an income annuity and the other combining it with life insurance.  The hybrid policies tend to have higher premiums because the policies provide annuity or life insurance benefits in addition to the long-term care insurance.  Hybrid premiums are typically paid as a single premium or as a fixed payment over a period of time such as 10 years.  However, the hybrid policies may have less restrictive underwriting, the premiums usually won’t increase, and your heirs may receive money back if long-term care benefits aren’t used (the premiums are in effect returned by a death benefit).  Hybrid policies may also be surrendered for a return of some or all the premiums if you decide not to continue the policy, whereas premiums paid in a traditional policy are not recoverable.

Two decisions must be made:  1) whether to self-fund or purchase long-term care insurance, and 2) if insurance will be purchased, what type of policy should be purchased.  The answers depend upon your circumstances and you will be well served to be advised by someone knowledgeable in this area.  It is easy to procrastinate making these tough decisions and to find yourself in an endless analytical loop.  You must press forward until reaching a decision that makes the most sense for you.  Otherwise, a failure to plan will leave you exposed to future circumstances.

Your Solo-401(k) May Be Required to File Form 5500-EZ by July 31st

Solo-401(k)s or Uni-Ks are a great retirement plan for self-employed individuals.  The amount of deductible contributions you can make depends upon your net business income and your age.  The maximum for 2016 contributions is $59,000.  This amount consists of the following layers:

·        Standard 401(k) maximum contribution of $18,000.

·        Catch-up contribution of $6,000 if you are at least age 50 by the end of the year.

·        Profit-sharing contribution of $35,000 (defined contribution maximum of $53,000 as indexed for 2016 less the standard 401(k) amount of $18,000 that counts against the limit).  Note that the profit-sharing contribution is limited to either 20% or 25% of business net income depending upon the type of business entity.

Qualified retirement plans such as 401(k)s must file an annual Form 5500 with the IRS by the last day of the seventh month following the end of the plan year.  An extension is available.  Form 5500 is very complicated.  An easier Form 5500-EZ is available for a one-participant plan, and is only required if total plan assets at the end of the plan year exceed $250,000.  If plan assets do not exceed $250,000, then there is no required tax return filing.  A one-participant plan means:  1) a plan that covers and provides benefits to only you (or you and your spouse), and you (or you and your spouse) own the entire business (which may be incorporated or unincorporated) or 2) a plan that covers and provides benefits to one or more partners (or partners and their spouses) in a business partnership.  If you have multiple plans they must be aggregated for the $250,000 test.

A late filing penalty of $25 a day (up to $15,000) applies if Form 5500-EZ is not filed on time.  Filing Form 5500-EZ can sometimes be overlooked since the account is often considered just a personal investment account.

New Extension Granted for Certain Estates to Make the Portability Election

Prior to 2011, if the decedent spouse did not fully utilize his or her estate tax exemption in the estate plan, the unused portion was wasted and was not available to be used by the surviving spouse.  After 2010, the tax law was changed to permit an election whereby the unused exemption could be “ported” to the surviving spouse and add to that spouse’s own personal exemption amount.  The ported exemption is allowed for both gift and estate tax exemptions but not for the generation skipping transfer tax exemption.  The election is made by filing a timely estate tax return (Form 706, including a timely filed extension) for the decedent spouse.  The decision to make the portability election is not always an easy one to make because the cost of preparing a Form 706 can be expensive (depending upon the type of assets owned by the decedent spouse) and it is possible that the ported exemption may not ever be needed to exempt the surviving spouse’s estate from estate tax.  In addition, the portability election is often overlooked because its availability is not widely known or fully understood.

In Revenue Procedure 2014-18, the IRS granted an extension until December 31, 2014 to make the portability election for small estates that weren’t otherwise required to file an estate tax return and had missed the filing deadline.  Since this time the IRS has had to deal with numerous private letter ruling requests asking for extensions of time to make the election.  The IRS has now issued Revenue Procedure 2017-34 granting a permanent extension period.  The due date of the portability election is now extended to the later of January 2, 2018 or the second anniversary of the decedent’s death.  After this time period expires, a late filed portability election can only be made after seeking a private letter ruling from the IRS.

Only estates that are not otherwise required to file an estate tax return are permitted to use the Rev. Proc. 2017-34 extension period.  An estate is generally required to file an estate tax return if the total gross estate plus adjusted taxable gifts and specific exemption is more than the basic exclusion amount for the year of death (e.g., $5,490,000 for deaths in 2017).  In addition, the decedent must have died after 2010 and have been survived by a spouse, and an estate tax return must not have been previously filed.

The portability election can provide valuable estate tax benefits, but there can be reasons not to make the election.  The new revenue procedure allows small estates additional time to make this analysis.