Congress appears poised to enact a major tax reform law that could potentially make fundamental changes in the way you and your family calculate your federal income tax bill, and the amount of federal tax you will pay. This letter is designed to help you cope with the changes Congress is hammering into shape right now—to take advantage of tax breaks that may be heading your way, and to soften the impact of any crackdowns. Keep in mind, however, that while most experts expect a major tax law to be enacted this year, it's by no means a sure bet.
At the start of 2017, the possibilities were real that tax changes under tax reform might be retroactive to January 1, 2017, or mid-year 2017. Now that both the House and Senate have finally weighed in with their respective versions of the Tax Cuts and Jobs Bill (HR 1), taxpayers no longer need to worry about the reach of tax reform back into 2017 for the most part. Most provisions are being made effective for tax years beginning after December 31, 2017
, with mortgage interest and expensing deductions perhaps the only prominent exceptions (carrying November 2, 2017 and September 27, 2017, effective dates, respectively). However, preparations for year-end planning now become even more critical because of the changes in the treatment of certain income and expense items that would take place under tax reform staring January 1, 2018
Moving income from 2017 to 2018 can save an individual taxpayer from less than $50 in tax to over $50,000 or more, depending upon the taxpayer’s tax bracket. Since the brackets are applied to taxable income, however, taxpayers should precede income-shifting techniques with a calculation of how the loss of certain deductions and credits in 2018 under tax reform will net against any benefit from income recognized in 2018. Credits, which are deducted from taxable income, also should be computed.
Capital gains rates.
The current law rates of zero, 15 percent and 20 percent rates (28 percent for collectibles) on long-term capital gains will not change under tax reform. HR 1, however, does make provision to integrate these rates into the new tiered ordinary income rate structure. The House version, for example, provides that the 15-percent rate would begin in the case of a joint return or surviving spouse, at $77,200; and the 20 percent rate begins in the case of a joint return or surviving spouse, at $479,000. Short-term gains would be taxed on the new, ordinary income tax rates. Year-end tax planning for capital gains, therefore, should follow the usual advice of harvesting losses to balance gains. It should also be noted that one version provides for the basis in securities sold to be determined on a first in first out basis, which could significantly impact the amount of taxable gain recognized on sales.
The standard deduction for 2018 would be almost double that of 2017 (from $12,700 to $24,400 for joint filers and from $6,350 to $12,000 for single filers. Net taxable income might not be reduced by that amount, however, when comparing 2017 with 2018 since personal exemptions ($4,050 per person) would be eliminated in 2018. Dependency exemptions, however, would be replaced with an enhanced child credit and family tax credit, further complicating the computation to determine the most favorable balance of 2017 income that might be deferred into 2018.
Net savings from the higher 2018 standard deduction will be offset for many taxpayers proportionate to the extent of their itemized deductions for 2017 that exceed the 2017 standard deduction. Nevertheless, most taxpayers in that situation should try to accelerate 2017 itemized deductions, not only to offset 2017 income that will be taxed at higher rates than in 2018 but also simply because 2017 will be the last opportunity to claim certain itemized deductions if tax reform passes.
Mortgage interest deduction.
The Senate bill would leave the current itemized deduction for mortgage interest untouched, except for home equity loan interest, which would be disallowed starting in 2018 (with no grandfather provision for existing loans). Under the House bill, November 2, 2017, is a pivotal date that prevents most year-end planning. For taxpayers who have incurred mortgage debt prior to November 2, 2017, all the current rules for deducting mortgage interest would apply: up to $ 1 million of acquisition indebtedness, whether on a principal residence or second home; and interest on up to $100,000 in home equity indebtedness, will continue as an itemized deduction. Debt refinanced after that date would also continue to be deductible in full up to the $1 million/$100,000 limits. Also under the House bill, for taxpayers who enter into a written binding contract before November 2, 2017, the related debt would be treated as being incurred prior to November 2, 2017.
Under the House bill, mortgage debt incurred after November 2, 2017, would also be deductible but only if secured by the taxpayer’s principal residence and only to the extent of up to $500,000 indebtedness. No second-home mortgages would be deductible, nor home equity loans.
For those homeowners who may be better off taking the higher standard deduction in 2018, accelerating one month’s mortgage payment from early January to late December may create a slightly higher interest deduction in 2017. Generally, however, a taxpayer should first check with their mortgage lender to determine whether that year-end payment would be reflected in their 2017 Form 1098.
State and local taxes.
The Senate bill would eliminate all itemized deductions for state and local taxes. The House bill would allow only a deduction for property taxes paid up to $10,000 on a principal residence.
Payment of all state and local income taxes for 2017 during 2017 may be advisable to preserve itemized deductions for those amounts. This itemized deduction in the past has required payment of, in addition to simply liability for, the tax in the same tax year. Under that rule, payment made with the state or local return filed in the next tax year would become an itemized deduction in the year the return is filed. Likewise, overpayment of state and local taxes has usually been deductible in the year of payment unless it is unreasonable, with income recognition of the excess attributable to the next tax year.
State and local taxes paid by businesses continue to be deductible. Taxpayers entitled to a home office deduction may therefore allocate property taxes for the home office as a home office expense.
The House bill would repeal the medical expense deduction while the Senate bill maintains it. In any case, for those taxpayers who see their total medical expenses for 2017 exceeding that deduction’s 10 percent adjusted gross income floor should consider accelerating expenses when possible into 2017.
Both the House and Senate bills preserve the itemized charitable deduction. Nevertheless, the proposed increase in the standard deduction in 2018 will likely not make itemizing charitable contributions worthwhile for potentially millions of individuals. With 2017, practically speaking, being the last year for taking a charitable deduction for those taxpayers, they should consider accelerating contributions into 2017 whenever possible. In addition to cash, property donations (contributions of lightly-worn clothing, household items, etc.) before year end should be considered.
Miscellaneous itemized deductions.
Under both House and Senate bills, individuals would not be allowed itemized deductions for tax preparation and similar expenses. Tax preparation fees for businesses would continue to be deductible.
Under the House bill but not the Senate bill, alimony payments would no longer be deductible by the payor and includable in the payee’s income. The provision would be effective for any divorce decree or separation agreement executed after 2017 and to any modification after 2017 of any pre-2018 agreement if expressly provided for within the modification.
Taxpayer have been allowed an above-the-line deduction for moving expenses incurred in connection with starting a new job under the at-least 50 mile rule. The House and Senate bills would repeal this deduction, except for certain members of the armed services, effective for tax years beginning after 2017.
Employers can still pay an employee’s moving expenses but, after 2017, they will be considered compensation to the employee without the benefit to the employee of an offsetting deduction. In the past, employer-paid moving expenses have been considered qualified fringe benefits excluded from the employee’s gross income.
Major changes in connection with education expenses will be felt by some taxpayers under the House and Senate bill. Student loan interest would no longer be deductible. Graduate students and others will realize taxable income on qualified tuition reductions, and employer-provided education assistance will no longer be excluded from income.
Here are some "last minute" moves that could wind up saving tax dollars in the event tax reform is passed:
- 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 can be received this year—you will succeed in deferring income until next year.
- 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 job until 2018, or defer deliveries of merchandise until next year. 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.
- The exercise of an incentive stock option (ISO) can result in AMT complications. But both the Senate and House versions of the tax reform bill call for the AMT to be repealed next year. So, if you hold any ISOs, it may be wise to hold off exercising them until next year.
- If you've got your eye on a plug-in electric vehicle, buying one before year-end could yield you an up-to-$7,500 discount in the form of a tax credit. The House-passed bill, but not the one before the Senate, would eliminate this credit after 2017.
- If you're in the process of selling your principal residence and you wrap up the sale before year end, up to $250,000 of your profit ($500,000 for certain joint filers) will be tax-free if you owned and used the property as your main home for at least two of the five years before the sale. However, under the House-passed bill and the bill before the Senate, the $250,000/$500,000 tax free amounts would apply to post-2017 sales only if you own and use the property as your main home for five out of the previous eight years.
- If you expect to itemize deductions in 2017, pay the last installment of estimated state and local taxes for 2017 by Dec. 31 rather than on the 2018 due date, or prepay real estate taxes on your home.
- Neither the House-passed bill nor the bill before the Senate would repeal the itemized deduction for charitable contributions. Since most other itemized deductions would be eliminated in exchange for a larger standard deduction (e.g., in both bills, $24,000 for joint filers), charitable contributions after 2017 may not yield a tax benefit for many. If you think you will fall in this category, consider accelerating some charitable giving into 2017.
- The House-passed bill, but not the one before the Senate, would eliminate the itemized deduction for medical expenses. If this deduction is indeed chopped in the final tax bill, and you are able to claim medical expenses as an itemized deduction this year, consider accelerating "discretionary" medical expenses into this year. For example, order and pay for new glasses, arrange to take care of needed dental work, or install a stair lift for a disabled person before the end of the year.
- Under the House-passed tax bill but not the version before the Senate, alimony payments would not be deductible by the payor or includible in the income of the payee, generally effective for any divorce decree or separation agreement executed after 2017. If you're in the middle of a divorce or separation agreement, and you'll wind up on the paying end, it would be worth your while to wrap things up before year end if the House-passed bill carries the day. On the other hand, if you'll wind up on the receiving end, it would be worth your while to wrap things up next year.
- Both the House-passed bill and the version before the Senate would repeal the deduction for moving expenses after 2017 (except for certain members of the Armed Forces), so if you're about to embark on a job-related move, try to incur your deductible moving expenses before year-end.
Please keep in mind that we've described only some of the year-end moves that should be considered in light of the tax reform package currently before Congress—which, it bears emphasizing, may or may not actually become law. If you would like more details about any aspect of how the proposed legislation may affect you, please do not hesitate to call.
Very truly yours,
Sherman, Barber & Mullikin