Another year end is rapidly approaching so it is once again time to consider end of the year tax planning. This year there is even more uncertainty than usual with the possibility of extensive modifications and changes to the tax code that, if passed, will seriously alter the tax landscape for 2018 and subsequent years.
Planning and Preparation
When the future is uncertain there is often strong motivation to wait and see what actually emerges, and, although this is often an effective course of action, it pays to plan now and be prepared to act.
To start with, take the time now to gather data in preparation for filing – even though the actual 1099s and W-2s won’t be received until the end of January. Make your best projection of anticipated income, deduction, and tax liabilities and work from there.
As always, determine if your anticipated withholding and estimated tax payments will be sufficient to avoid any underpayment of estimated tax penalties. In order to avoid an underpayment, each quarter you must pay through withholding or estimated tax payments 25 percent of the following: 90 percent of the current year’s tax liability, or 100 percent of the prior year’s tax liability (110 percent if you are married and make more than $150,000 per year, or if you are single and make more than $75,000 per year).
If you find that you have not paid enough to avoid estimated tax penalties in the first few quarters, you may want to increase withholdings from income, such as your salary or a pension. Withholding is considered paid evenly throughout the year, even if it’s done later in the year, so it is a good tool to help reduce or avoid estimated tax penalties.
If you are anticipating a refund, you will want to give a high priority to filing your return early as concerns over identity theft have delayed processing of refunds, particularly claims involving the earned income tax credit. The sooner you are able to file your return, the sooner your refund claim will be processed. Start assembling your data so that you can move promptly when the official W-2s, 1099s, and other tax reporting documents are received.
Consider Ways to Potentially Reduce Tax Liabilities for 2017
Once you have the data, you can consider ways to potentially reduce your tax liabilities for 2017.
Accelerating deductions into the 2017 tax year or delaying the receipt of income to the 2018 tax year is often a good strategy, and these approaches may be particularly valuable in light of the nature of the proposed tax changes being discussed in Washington. Some of the proposals currently being debated are to reduce tax rates for 2018 and future tax years and to reduce or eliminate many current itemized deductions in order to facilitate an increased standard deduction. These proposals include eliminating the state and local tax income deduction and limiting the mortgage interest and state and local property tax deduction. There is also talk of eliminating the alternative minimum tax for 2018.
Ultimately, the potential expansion of the standard deduction may reduce the value of itemized deductions in 2018. Thus, taxpayers may want to consider the following:
- Accelerate deductions by making any anticipated 2018 charitable contributions in 2017 and prepaying your property and state income taxes in 2017. Although you can’t deduct prepaid interest, you can pay your January mortgage payment in December, as the interest due in January is interest due on December’s loan balance.
- Check eligibility for casualty loss deductions. Given the number of natural disasters that have afflicted us all this year, there may very well be casualty loss deductions available.
- Another option to reduce taxes would be to sell some investments that have created a capital loss. This can reduce, if not eliminate, capital gains. In addition, if you do not have enough capital gains to offset such capital losses, you can take a net loss of $3,000 each year against ordinary income, with any excess being carried over to future years.
- If you own a business that has excess cash on hand, consider whether there is a need for any large purchases (i.e. equipment or vehicles) that you may be able to expense in the current year.
- On the income side, if you have any control over when a bonus or other income will be paid, put it off until January. If you are a cash-based business owner, delay billing a customer until 2018. Consider maximizing your 401(k) or other retirement plan contribution to reduce your taxable income. Starting now, instead of in December, gives you more time to spread those deductions over multiple pay periods.
The above strategies not only take advantage of reducing taxable income in a high-bracketed year, but could also bring you below certain income thresholds that limit itemized deductions, disallow certain credits or subject you to the net investment income tax.
Although the current proposals to modify the income tax code contemplate that generally rates will be lower in 2018 and itemized deductions will accordingly be less valuable—particularly if the standard deduction is substantially increased—it is possible that, in your individual circumstances, your taxable income in 2018 will be substantially higher than in 2017. Further, while many taxpayers will pay at reduced marginal rates under the proposed tax bracket structure, there will be a small contingent of taxpayers that will wind up in a higher marginal tax bracket. In these cases, there may be an advantage to accelerating income into 2017 or deferring deductions to 2018.
Steps to take to accelerate income into 2017 may include:
- Taking a bonus or collect outstanding income before year end.
- Taking retirement distributions (but be wary of the 10 percent penalty for early withdrawal).
- Selling some investments in order to take some of those profits or accumulated long-term capital gains in 2017.
- On the deduction side, consider paying your state estimated tax payments in January (if allowed by your state) and delaying any large business-asset purchases that can be expensed immediately.
Here are some additional year-end planning opportunities to consider:
- If you are 70½ or older, you can satisfy your minimum required distribution from retirement accounts by making a charitable contribution directly to a charity from your individual retirement account. This amount can thereby be excluded from your income. This strategy has the potential to affect how much of your Social Security is taxed and how much you will pay for Medicare parts B and D. This strategy can also be beneficial if your deductions aren’t high enough to itemize. Make sure the charity sends an acknowledgement to you.
- If your income is too high to claim education credits for your children, you may have some opportunity in the last year of college. If your child lands that new job and provides more than half of his own support in the same year tuition is paid (for or by himself), he or she can be eligible for the $2,500 American Opportunity Tax Credit (and you can ask him or her to give it back). Some colleges require payment for the spring semester in December of the prior year. If you opt for a tuition payment plan, you should be able to pay some of that in the current year.
- If you are in a low tax bracket in a particular year, consider converting a traditional IRA to a Roth IRA. You will have to pay the tax on it now, but it will grow tax-free and you won’t be taxed when you take distributions in retirement.
- If you plan to gift money to an adult child who is in the 10 percent to 15 percent tax bracket, consider gifting him or her appreciated securities. When he or she sells, the capital-gains tax rate is zero percent. You can gift up to $14,000 in 2017 to any individual without gift-tax consequences. If married, your spouse can also gift that amount to the same person.
- Also, don’t forget to use any money you have contributed to a flexible spending account. These accounts are “use it or lose it” accounts. Some employers have grace periods or the option to roll over $500 to the following year. Check with your employer.
- If you are paying education or medical costs for someone else, pay them directly to the educational institution or the medical provider. Direct payments are not counted toward your annual gift-tax exclusion.
- When estimating your income in any given year, don’t forget to consider whether you are subject to the alternative minimum tax. Current tax proposals would eliminate the alternative minimum tax for 2018, but for some taxpayers there will be unintended negative consequences as a result of taking advantage of the alternative minimum tax in 2017. Be sure to project both alternatives.
Be mindful that five significant personal tax benefits are scheduled to expire in 2017 and were not extended at the end of 2016. These tax benefits include the “above the line” tuition and fees deduction, the exclusion from income of certain mortgage debt forgiveness, the deduction for private mortgage insurance, the enhanced medical expense deduction for taxpayers over age 65, and the energy efficient home improvement credit. Although these could possibly be extended for 2017 in the year end scrum of tax changes, they are not currently contemplated to continue.