Tax Reform: The New 20% Qualified Business Income Deduction

The Tax Cuts and Jobs Act passed Congress on December 20, 2017 and was signed into law by the President on December 22, 2017 (the enactment date) and is generally effective for tax years beginning after 2017.  This is the fourth in a series of articles reviewing some of the more important changes.  This post deals with the new 20% deduction for qualified business income.

Qualified Business Income

QBI is domestic ordinary income less deductions.  QBI does not include wages earned as an employee or guaranteed payments received as a partner of the business.  S corporation shareholder-employees must be paid a reasonable wage for their work.  However, there is no such requirement to pay a reasonable guaranteed payment to a partner of a partnership.  QBI does not include investment income such as interest, dividends, or capital gain, but “business” interest income is included.  QBI includes ordinary gains and losses on the sale of business assets, but not §1231 capital gain.  A QBI loss in one tax year carries over to the next year in calculating the 20% QBI deduction.  QBI does not include business income of a “specified service business.”

Specified Service Business Income

With an exception for “small” taxpayers, specified service business income is not eligible for the 20% QBI deduction.  Specified service businesses are defined as those in the fields of:  health, law, accounting, actuarial science, performing arts, consulting, athletics, financial & brokerage, investment management, trading, dealing in securities, or any business where the principal asset of the business is the reputation or skill of one or more of its owners or employees.  Importantly, engineering and architecture are excluded from this definition.

There is much uncertainty in applying this definition.  Many business entities have several different business activities that can be distinguished one from another.  Does the predominant activity govern the whole or are they separately accounted for?  While special tax rules have applied to service businesses for many years, in many situations it is not always clear how the definition applies.

A special “small” taxpayer exception permits the 20% QBI deduction for specified service businesses.  A taxpayer is considered “small” if taxable income does not exceed $315,000 for those filing a married joint tax return and $157,500 for others.  The deduction for small taxpayers phases out over the next $100,000 of taxable income for MFJ and $50,000 for others.  A very high marginal tax rate applies during the phaseout range, perhaps 175% times the normal tax rate, so managing taxable income near the threshold levels is extremely important.  On the other hand, deductions lowering taxable income in the threshold range are very valuable.

Amount of the Deduction

The deduction is often termed the 20% “pass-through entity” deduction.  That is a bit of a misnomer in that an entity is not required.  The deduction applies to sole proprietorships as well.  In addition, it is not the entity that claims the deduction, it is the individual, trust or estate that owns the business that claims the deduction.  The deduction is not available for C corporations.

The 20% QBI deduction is effective for tax years beginning after 2017 but not after 2025.  It is unknown when the deduction takes effect for fiscal year pass-through entities.  One line of thought is that since the deduction is taken by the entity’s owners, the income from the entity’s fiscal year ending in 2018 should be eligible.  Another line of reasoning is derived from looking at how the IRS applied the effective date of the domestic production activities deduction.  The DPAD is claimed under Section 199.  The 20% QBI deduction is claimed under Section 199A.  There are many similarities between the two provisions.  The DPAD was enacted to apply to tax years beginning after 2004.  In Notice 2005-14, the IRS interpreted the effective date to apply to fiscal year pass-through entities in tax years beginning after 2004 and not tax years ending after 2004.  Assuming a similar interpretation, the 20% QBI deduction may not apply to fiscal year pass-through entity income until the fiscal year beginning after 2017.  Note that the new law repeals the DPAD for tax years beginning after 2017 to coincide with the start of the 20% QBI deduction.

The deduction lowers the top 37% Federal tax rate to a 29.6% effective tax rate.  The deduction is not a deduction for adjusted gross income, nor is it an itemized deduction.  The deduction is a calculation for taxable income.  The deduction is permitted for alternative minimum tax without adjustment.  The deduction is only for income tax, not for the net investment income tax or for the self-employment tax.  The deduction is not permitted in calculating a net operating loss.

Limitations on the Amount of the Deduction

The 20% QBI deduction cannot exceed 20% of the excess of taxable income over net capital gain.  Net capital gain is the excess of net long-term capital gains over net short-term capital losses.  In addition, for taxpayers with taxable income equal to or above $415,000 for a married taxpayer filing a joint tax return; or $207,500 for others; the deductible amount for each trade or business is limited to the greater of:

·      50% of W-2 income allocable to the QBI of the business, or

·      The sum of 25% of W-2 wages plus 2.5% of the unadjusted basis of tangible, depreciable property for which the depreciable period has not ended

The depreciable period begins on the date the property is first placed in service and ends on the later of 10 years after that date or the last full year in the applicable recovery period.  There is some uncertainty whether property that has been “expensed” under Section 179 can be included in the 2.5% limitation.  Property that has received 100% bonus depreciation is included because the deduction is considered depreciation.

W-2 payments to S corporation owners are included in the W-2 limit, but equivalent payments made by a partnership or sole proprietorship to an owner do not count for the W-2 limitation because such payments are not in fact reported on Form W-2.

Small Taxpayer Exception

The W-2/unadjusted basis limitation doesn’t apply if taxable income is equal to or less than $315,000 for a married taxpayer filing a joint tax return or $157,500 for other filing statuses.  But the limitation phases in during the next $100,000 / $50,000 of taxable income.  During the phase-in range, if the W-2/unadjusted basis limit is lower than 20% of QBI, then the phase-in percentage times the difference is subtracted from 20% of QBI.

Specified service businesses will be subject to both a phase-in of the W-2/unadjusted basis limitation and to the 20% QBI deduction phase-out during this income range.

It is important to note that while the overall deduction is limited to 20% of ordinary taxable income, any type of taxable income (including capital gains) counts in the W-2/unadjusted basis limit phase-in range or in the specified service business phase-out range.

Implications

Below is a bulleted list of possible planning steps that should be considered to enhance the amount of the 20% QBI deduction.  The use of the word “small” means that the small taxpayer exception is met.  The use of the work “large” means that the W-2/unadjusted basis limit applies or that the deduction has phased out for a specified service business.  The following list is based upon the commonly accepted interpretation of the statute.  Some advisors are suggesting an alternate interpretation of how owner compensation is treated for purposes of computing the deduction.  In this alternate interpretation, owner compensation does not reduce QBI and owner W-2 wages are not included in the W-2 wage limitation calculation.  If this alternate interpretation ends up being correct, the implications listed below could change.

·      “Small” S corporations may wish to become an LLC partnership or LLC sole proprietorship to avoid shareholder W-2 reasonable compensation that doesn’t qualify as QBI.  But consider whether S corporation payroll tax savings and the tax cost of liquidating the corporation outweigh the benefits of the 20% QBI deduction.

·      “Small” partnerships should avoid guaranteed payments to partners as such payments don’t qualify as QBI.

·      “Large” S corporations should be sure that enough W-2 is paid to avoid the W-2 limitation.

·      “Large” sole proprietors with insufficient employee W-2 may wish to become S corporations so that a portion of the owner’s compensation can be reported as W-2 wages and to save payroll tax on S corporation profit distributions.

·      A business with low wages may wish to “own” its equipment rather than “leasing” it to qualify for the 2.5% of unadjusted basis test.  Or the business may wish to hire employees instead of using independent contractors.

·      Paying a portion of business income as W-2 wages to the owner only reduces the 20% QBI deduction to the extent the owner’s wages and other non-QBI exceed itemized or other tax return deductions because of the overall 20% of taxable income limitation.

·      “Small” wage earners may want to become independent consultants to qualify their income for the 20% deduction.

·      Individuals making gifts in trust may wish to set up separate trusts for each beneficiary, instead of using a single pot trust for multiple beneficiaries, to get multiple small taxpayer limitations.

·      Retirement plan contributions may be less advantageous because the deduction may reduce the 20% QBI deduction, yet when distributed will be subject to the full income tax rate.  On the other hand, such contributions could be very valuable for a specified service business in the taxable income phase-out range.

·      A “large” service business with capital or expansion needs may consider converting to a C corporation for the low tax rate.

·      A C corporation in combination with a pass-through entity could make sense for a service business in managing the taxable income phase-out threshold.

·      “Large” taxpayers whose 20% QBI deduction is limited by the 20% ordinary taxable income limit can increase the deduction by generating other non-capital gain income, such as by a Roth IRA conversion.  The marginal tax cost of the additional income will be reduced by the increased deduction.

New 2018-2025 Supplemental Wage Withholding Rates

Supplemental wages include bonuses, commissions, stock option income, and other income earned outside of regular payroll amounts.  Federal income tax withholding on supplemental wages is computed under one of three methods:

1.      Mandatory flat-rate method.  When supplemental wages exceed $1 million during a calendar year, federal income tax withholding must be at the highest ordinary income tax rate.  In 2017, this rate was 39.6%.  For 2018-2025, the flat-rate drops to 37%.

2.      Optional flat-rate method.  For supplemental wages (paid separately from regular wages) of $1 million or less during a calendar year, federal income tax withholding must be at the third lowest ordinary income tax rate.  In 2017, this rate was 25%.  For 2018-2025, the flat-rate drops to 22%.

3.      Aggregation method.  For supplemental wages of $1 million or less during a calendar year, the supplemental wages can simply be added to regular wages to determine the amount of federal income withholding for that payroll period.

In addition, back-up income tax withholding is required on payments to a person that had either a missing or an incorrect taxpayer identification number on a required information return filing (e.g., Form 1099).  The back-up withholding rate must be at the fourth lowest ordinary income tax rate.  In 2017, this rate was 28%.  For 2018-2025, the flat-rate drops to 24%.

Some taxpayers with supplemental wages fall into the trap of thinking that the optional flat-rate withholding pays all of the federal income tax due on those wages.  For example, employees with nonqualified stock option income or bonus income may have had 22% in federal income tax withholdings, but much or all of those supplemental wages may be subject to higher ordinary income tax rates (e.g. 24%, 32%, 35%, or 37%).  Therefore, it is important that such individuals estimate what the total income tax will be on those supplemental wages and set aside any shortfall in order to have the cash needed to fully pay the total income tax when the tax return is due.

Tax Reform: Changes to Business Loss and Net Operating Loss Deductions

The Tax Cuts and Jobs Act passed Congress on December 20, 2017 and was signed into law by the President on December 22, 2017 (the enactment date) and is generally effective for tax years beginning after 2017.  This is the third of a series of articles reviewing some of the more important changes.  This post deals with changes to the deduction of nonpassive business losses and to net operating losses.

Current Year Excess Aggregate Net Business Losses

Excess aggregate net business losses of individuals and trusts/estates are not allowed for the year of loss.  This is a significant but not well publicized change for those who are impacted.  The excess business loss limitation sunsets after 2025.

·      An excess business loss is the amount over $500,000 MFJ or $250,000 for other individuals and trusts/estates.  Thus, other income such as wages or portfolio income cannot be sheltered from income tax to the extent of the excess loss.

·      The excess loss is treated as a NOL carryforward even if the taxpayer doesn’t otherwise have an actual NOL for the year.  Treating excess losses as part of a NOL limits the future deduction to 80% of taxable income.  See discussion below.

·      Business losses can arise from a sole proprietorship, a partnership, or an S corporation.  The determination is made at the partner and S corporation shareholder level.

·      The excess business loss is a new, fourth loss limitation rule:  1) tax basis, 2) at-risk basis §465, 3) passive activity loss §469, and 4) excess business loss §461(l).

Net Operating Losses

NOLs generated in tax years beginning after 2017 may only be carried forward and not carried back to earlier tax years to get a tax refund.  An exception is provided for certain farm losses.  The NOL changes are permanent and do not sunset.

·      Post-2017 generated NOLs will have an indefinite carryover period instead of the current 20-year carryover period.

·      However, post-2017 generated NOLs may only offset 80% of taxable income.

·      Pre-2018 NOLs are grandfathered and can offset 100% of taxable income and can also be carried back.  Therefore, depending upon facts and circumstances, it may be good tax planning to make the 2017 NOL as high as possible.

Tax Reform: Changes to the Standard Deduction, Exemptions, and Itemized Deductions

The Tax Cuts and Jobs Act passed Congress on December 20, 2017 and was signed into law by the President on December 22, 2017 (the enactment date) and is generally effective for tax years beginning after 2017.  This is the second of a series of articles reviewing some of the more important changes.  This post deals with changes to the standard deduction, personal exemptions, and itemized deductions.  Unless otherwise specified, these changes start in tax years beginning after 2017 and sunset after 2025.

Standard Deduction

The standard deduction increases from $13,000 in 2018 to $24,000 for married filing joint returns, from $6,500 to $12,000 for single taxpayers, and from $9,550 to $18,000 for head of household.  It is estimated that the percentage of taxpayers itemizing deductions will decline from 40 million to 9 million because of the increase in the standard deduction.  The additional standard deduction for the elderly and the blind is retained.

Personal Exemption

The personal exemption of $4,150 in 2018 is repealed as well as the rule phasing out the personal exemption when AGI exceeds a certain threshold (e.g., $320,000 MFJ).  However, the $100/$300/$600 personal exemptions of trusts and estates are not repealed.

Medical Itemized Deduction

The medical deduction is retained.  A favorable change was made retroactively for 2017 and for 2018.  The AGI percentage threshold that must be reached before medical expenses become deductible is lowered from 10% to 7.5%.  The percentage threshold reverts to 10% after 2018.

State and Local Tax (SALT) Itemized Deduction

The sum of state and local income or sales tax plus real and personal property tax is limited to $10,000 for MFJ, singles, and trusts and estates.

·      Real and personal property and sales taxes attributable to businesses reported on Schedules C, E, or F are deductible on those schedules and are not repealed or limited.

·      But individual income taxes attributable to business profits reported C, E, or F are considered itemized deductions and are subject to the $10,000 cap.

·      Foreign income taxes may be deducted without regard to the limit if they are not claimed as a credit.

·      However, foreign real property tax is no longer deductible unless it is incurred in a business.

·      Generation skipping transfer tax paid on a taxable trust distribution is not limited.

·      The new tax law specifically states that no 2017 deduction is permitted for prepaying 2018 state income tax.  What about excess 2017 prepayments applied to 2018 state tax?  Typically, refunds of overpaid state estimated taxes are taxable in the year of receipt if a tax benefit was received from the deduction.  Will this continue to be the rule?

·      Prepayments in 2017 of 2018 real estate tax was not specifically prohibited, but the IRS issued an advisory (IR-2017-2010) stating that the deduction would not be allowed if assessment of the tax did not occur before 2018.

·      The $10,000 tax deduction limit applies to both singles and MFJ, a marriage penalty.  This makes it harder for a MFJ couple to benefit from itemizing their remaining deductions because of the higher MFJ standard deduction.

·      There is no real impact of the $10,000 SALT limit for taxpayers subject to the AMT under old law.

·      If making gifts in trust for children, consider setting up separate trusts for each child beneficiary to get multiple $10,000 SALT limits instead of using a single trust for all the children.

Interest Itemized Deduction

Interest paid on total mortgages not exceeding $750,000 for debt incurred after 12/15/2017 is deductible for principal and/or secondary residences.  Refinancing of mortgages incurred on or before 12/15/17 is treated as incurred on the same date of the original debt (meaning the old $1 million limitation continues to apply).

·      Written binding contracts entered into before 12/15/2017 to purchase a principal residence before 1/1/2018, where the home is actually purchased before 4/1/2018, can still use $1 million limit.

·      Home equity loan interest after 2017 is not deductible with no grandfathering of existing loans.

·      Consider the “interest tracing” rules to preserve the home equity loan interest deduction if the loan was used to improve the home or used to acquire an investment.

·      The investment interest expense deduction is retained.

·      The mortgage insurance premium deduction expired at the end of 2016 and was not renewed.

·      Pay off non-deductible home equity debt.  Re-borrow it later to invest in a business or other investment.

Charitable Contribution Itemized Deduction

Charitable contributions are still allowed as itemized deductions.  However, with the increase in the standard deduction and with the $10,000 SALT limitation, the number of taxpayers benefiting from itemizing charitable donations is expected to fall significantly, particularly so for those who have no home mortgage interest expense.

·      The charitable contribution deduction is limited to a percentage of adjusted gross income for individuals.  The new law increases the limitation to 60% of AGI (from 50%) for cash donations made to public charities.

·      A carryover of unused pre-2018 cash contributions would continue to be limited to 50% of AGI.

·      No change was made to the 30% and 20% of AGI limitations for the donation of long-term appreciated property.

·      The 5-year carryover of excess contributions is retained.

·      However, the 80% deduction for contributions to obtain rights to purchase college athletic event seating is repealed.

·      Taxpayers age 70 ½ or older with traditional IRAs can make a direct charitable gift to a public charity (but not to a DAF) of up to $100,000 out of the IRA to get around the higher standard deduction and satisfy their RMD.

Casualty and Theft Loss Itemized Deduction

The casualty and theft loss itemized deductions are repealed except for casualty losses in presidentially declared disaster areas.

Miscellaneous Itemized Deductions Subject to the 2% of AGI Floor

The deduction of miscellaneous itemized expenses subject to the 2% AGI floor is repealed.  Examples of these types of expenses include:  tax preparation fees, home office, license fees, professional dues and subscriptions, legal fees for tax advice, unreimbursed employee business expenses, job hunting costs, investment management and advice, hobby loss expenses, and excess expenses upon a termination of a trust or an estate.

Miscellaneous deductions not subject to the 2% AGI floor are retained.  These include gambling losses to the extent of winnings and the deduction for estate tax paid on items of income in respect to a decedent (IRD).  Trusts and estates must distinguish administrative expenses not subject to the 2% floor from miscellaneous itemized deductions that are subject to the floor and therefore no longer deductible.

“Pease” Limitation on Itemized Deductions

Prior law required a reduction to the amount of the itemized deduction when a taxpayer’s AGI exceeded a certain threshold.  The reduction was generally 3% of the amount of AGI in excess of the threshold.  This provision was in effect a hidden 1.2% tax rate and was often referred to as the “Pease” limitation, named after the Senator who proposed the provision.  This limitation is repealed.

“Bunching Itemized Deductions”

If necessary, “bunch” remaining deductible itemized deductions into every other year to get over the increased standard deduction hurdle.  For example, if you bunched your 2018 itemized deductions into 2017 (e.g. by prepaying 2017 SALT and donations), then bunch your 2019, 2020, & 2021 itemized deductions into 2020.

Tax Reform: Individual Income Tax Rate Cuts

The Tax Cuts and Jobs Act passed Congress on December 20, 2017 and was signed into law by the President on December 22, 2017 (the enactment date).  The legislation is massive, running 1,097 pages with committee reports.  Congress authorized the Treasury Department to write “legislative” regulations, so the law won’t be settled for years to come.  Further, a technical corrections bill is expected.  Every individual and business will be impacted and whether you win or lose depends on your circumstances:  where you live, how you earn income, and the form of your business entity.  The business tax cuts are generally “permanent” but the individual tax cuts are temporary, sunsetting after 2025.  The massive number of changes, the temporary nature of many of the significant changes, and the risk of change in future political power bring a real sense of disruption and uncertainty.  Long-standing tax laws, to which people have organized their businesses and personal lives, have changed and will likely change again in the next eight years.  Generalizations will be dangerous.  Professional advisors will need to “unlearn” the old ways of planning and embrace the challenge of learning how to plan in the new landscape of “tax reform.”

Because so many tax laws have changed, I will be posting a series of articles reviewing some of the more important changes.  This first post deals with individual income tax rate cuts.

Married Filing Joint, Ordinary Income Tax Rates—2018

Prior Law		New Law
$19,050	10%	$19,050	10%
$77,400	15%	$77,400	12%
$156,150	25%	$165,000	22%
$237,950	28%	$315,000	24%
$424,950	33%	$400,000	32%
$480,050	35%	$600,000	35%
$480,051+	39.6%	$600,001+	37%

Single, Ordinary Income Tax Rates—2018

Prior Law		New Law
$9,525	10%	$9,525	10%
$38,700	15%	$38,700	12%
$93,700	25%	$82,500	22%
$195,450	28%	$157,500	24%
$424,950	33%	$200,000	32%
$426,700	35%	$500,000	35%
$426,701+	39.6%	$500,001+	37%

Trust/Estate, Ordinary Income Tax Rates—2018

Current Law		New Law
$2,600	15%	$2,550	10%
$6,100	25%
$9,300	28%	$9,150	24%
$12,700	33%	$12,500	35%
$12,701+	39.6%	$12,501+	37%

Long-Term Capital Gain and Qualified Dividend Tax Rates—2018

Rate	MFJ	Single	Trust/Estate
0%	$77,200	$38,600	$2,600
15%	$479,000	$425,800	$12,700
20%	$479,001+	$425,801+	$12,701+

Observations Regarding the New Tax Rates

·      The lowered tax rates are effective only for tax years beginning in 2018 through 2025 after which the prior law rates return.

·      The reduced top rate is still higher than the 2012 tax rate of 35%.

·      There is a sweet spot between $165,000 and $315,000 of MFJ taxable income where the tax rate is significantly reduced.

·      There is no “marriage penalty” for the first 5 rate brackets.  Previously this was true only for the first 2 brackets.

·      Although not shown, the head of household brackets vs. single brackets are better only for the first three instead of all seven brackets as was the case previously.

·      The brackets are indexed by the slower link-chained inflation method (C-CPI-U vs CPI-U) where the consumer is assumed to be able to substitute cheaper products in response to increased prices.  The new method does not sunset.

·      With rates scheduled to increase after 2025, Roth retirement account contributions should be considered before then.

·      Tax savings should be invested for retirement as increasing deficits will likely affect Social Security and Medicare benefits for the upper middle class.

·      Although estates and electing trusts can use a fiscal year to defer income tax, most should think about a calendar year for the lower tax rates.

·      The preferential long-term capital gain and qualified dividend tax rates are no longer linked to the ordinary tax rate brackets.

·      The 3.8% net investment income tax under the Affordable Care Act remains and applies when modified adjusted gross income exceeds:  $250,000 MFJ; $200,000 single; and $12,500 trusts and estates

“Kiddie Tax” Simplified

The current nightmare of preparing income tax returns of children under age 19 (24 if a full-time student) is simplified.  Instead of using the parents’ tax rates, and lumping siblings together, a child’s unearned income is taxed using the trust and estate tax rate brackets for both ordinary and capital gain rates for unearned income.  The child’s earned income is taxed under the rates for single individuals.  However, simplification comes at a cost for families not in the highest income tax bracket because the top trust ordinary and capital gain tax rates are reached at only $12,500 of taxable income.

Individual Alternative Minimum Tax Retained

Surprisingly, the AMT was retained at the last minute as part of the horse trading to secure votes from key senators.  Repealing the AMT would have been a great simplification to the law and it is disappointing to see that it remains.  The exemption from AMT was increased slightly but the exemption phase-out threshold was dramatically increased.  For MFJ, the exemption is increased from $86,200 to $109,400 with phaseout starting at $1,000,000 up from $164,100.  For a single, the exemption is increased from $55,400 to $70,300 with phaseout starting at $500,000 up from $123,100.  The $24,600 exemption for an estate or trust is not changed and the phase-out continues to start at $82,050.

Observations Regarding the AMT

Those paying 2017 AMT may find their marginal tax rates increasing in 2018 when AMT is less likely to apply.  For example, at $500,000 of taxable income the rate would increase from the 28% AMT rate to the 35% regular tax rate.  With the dramatic changes to itemized deductions, AMT will be less likely to apply, although it will continue to apply in a couple of circumstances.  First, those exercising and holding incentive stock option stock will continue to risk incurring the AMT.  Second, because regular tax rates were cut but AMT tax rates were not cut, it is possible upper middle-class taxpayers will continue to be subject to the AMT, but at a higher income level.  As generalizations are dangerous, it is important to run tax projection calculations to determine how the AMT may apply to taxpayers in the future.

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.