Tax planning at the present time is difficult given the uncertainty over the Tax Cuts and Jobs Act (“Act”). As of the date of this newsletter, both the House and Senate have passed separate versions of the Act that contain significant differences. These differences must be ironed out before a final tax reform bill can be presented and voted on by both chambers. A conference committee of representatives from both the House and Senate are scheduled to begin work on a combined bill this week. The goal is to get a reconciled bill to President Trump before Christmas, but there is no guarantee that will happen. Based on what both versions of the Act look like now, it looks like very few of the proposed tax changes will be retroactively applied. Highlighted below are some of the overall themes of tax reform as it applies to individuals:
- Lower tax rates and fewer income brackets
- Fewer itemized deductions but higher standard deduction amounts
- No personal exemptions
- Larger/new dependent (child and non-child) tax credits
- Eliminate the Alternative Minimum Tax (“AMT”)
- Higher estate tax exemptions
- Stricter rules for exclusion of gain on home sales
If and when a bill passes, it will be the most sweeping tax reform in over thirty years. We will not know the final details until later this month and maybe not until next year. We continue to monitor the status of these bills and intend to update you once tax reform is complete.
Despite the uncertainty, it still makes sense to consider tax planning moves that can help lower your tax bill this year and next. The general strategy of deferring income to next year and moving up deductions to this year makes sense for most people, given that tax rates are going down and many itemized deductions are being eliminated. Here are some items for you to consider.
Postpone Income until 2018. A few ways to do this:
- If you are a participant in a retirement plan and have not maxed out your pre-tax contributions for 2017, it is always a good idea to do so to get the benefit of tax-deferred growth. Make sure you are contributing as much as your budget allows, or at least up to the point of getting the full amount of a company match.
- If a Roth or partial Roth conversion makes sense for you, consider waiting until after January 1st. If you have already completed a conversion for 2017, you can “undo” it before you file your 2017 tax return through a Roth recharacterization.
- If you own a business and are a cash-basis taxpayer, consider waiting until late in the year to send out invoices. This way you likely won’t receive payment until 2018 when you have to claim the payment as income. Also consider prepaying some business expenses.
Accelerate Deductions. Given that the standard deduction under both the House and Senate tax reform bills would almost double from the current level, many people who itemize their deductions will no longer need to do so. It makes sense for these people to accelerate payment of certain expenses into 2017. Some thoughts:
- Consider scheduling elective medical procedures to increase the amount of your medical expenses or prepay real estate or state or local income tax early (not advised if you are subject to the AMT).
- Make charitable donations this year instead of waiting until next year. Although the deduction for gifts to charity are unchanged in both versions of the tax bill, the higher standard deduction next year may mean you are unable to deduct your donations.
What follows are some other strategies that always make sense:
Donate Appreciated Stock or Mutual Fund Shares. This allows you to deduct the fair market value of the securities and avoid paying capital gains tax. On the other hand, if you have securities that have decreased in value, sell them first to secure a tax write-off and donate the proceeds.
Qualified charitable distributions. If you are over 70 ½, the best approach might be to arrange to have money transferred directly from your IRA to the charity, a so-called Qualified Charitable Distribution (“QCD”). You can contribute up to $100,000 annually using this method. The benefit is two-fold: QCDs count toward your annual required minimum distribution and they directly reduce your adjusted gross income, which can lower the impact of the net investment income tax, phase-outs of itemized deductions and personal exemptions, and Medicare part B and D premium surcharges.
Give Appreciated Securities to your Children. If you want to help your adult children, give them shares of appreciated securities instead of cash if they are in a lower income tax bracket than you. For 2017, if your single child has taxable income of less than $37,950, his or her long-term capital gain tax rate is 0%. So, instead of selling shares to give cash to your children, give them the shares and let them sell them. This only works with children who are old enough to be exempt from the “kiddie tax” which generally means they must be 19 or older and out of school, or 24 or older if they are still in school. In 2017, you can give up to $14,000 a year ($28,000 if you are married) to an individual and not have to file a gift tax return.
Spousal IRAs. Generally, individuals who are unemployed are not permitted to contribute to IRAs because they do not have eligible compensation. However, the employed spouse is allowed to make an IRA contribution on behalf of a non-working spouse if certain conditions are met: you and your spouse must file a joint tax return and the amount of earned income on your tax return must be at least equal to the amount you contribute to your IRAs. These so-called spousal IRAs are subject to the income limitations shown below.
Health Savings Accounts (“HSA”). HSAs are here to stay. If you are covered under a qualifying high-deductible health care plan either at work or individually, consider opening and funding an HSA. Annual contribution limits for 2017 are $3,400 for individual coverage and $6,750 for family coverage, plus catch-up contributions of $1,000 for participants who are 55 and older. Contributions are tax deductible and, unlike IRAs, there are no income limits. Earnings in these accounts are tax-free and withdrawals are tax-free if used for qualifying medical expenses. The contribution limits increase in 2018 to $3,450 for individual coverage and to $6,900 for family coverage. A related strategy: you are allowed a once-in-a-lifetime transfer from a regular IRA to an HSA, provided that you are covered by an eligible health care plan for at least 12 months after the transfer. The transfer amount is limited to the maximum allowed HSA contribution for the year minus any contributions you’ve already made. This strategy works best if you don’t have cash outside the IRA to contribute to the HSA.
Finally, here are the annual limits applicable to 2018 for retirement plans, payroll tax and estate and gift tax:
Retirement Plan Limits.
- Maximum contributions to company-sponsored 401(k), 403(b) and 457 plans increases by $500 for 2018: $18,500 with a catch-up contribution of $6,000 allowed for individuals 50 and older.
- IRA and Roth IRA contribution limit: remains unchanged at $5,500 plus $1,000 catch-up for age 50 and older.
- IRA deductions phase out for taxpayers over certain income levels:
|Single and covered by workplace plan||$63,000-$73,000|
|MFJ with spouse covered by plan||$101,000-$121,000|
|MFJ for spouse not covered by plan||$189,000-$199,000|
- Contributions to a Roth IRA are phased out starting at AGI of $120,000 for single taxpayers and $189,000 for married taxpayers filing jointly.
Payroll Tax. The Social Security wage base will increase to $128,400 in 2018. The Social Security tax rate paid by employers and employees stays at 6.2%, while the Medicare portion for both stays at 1.45%. Under both versions of the tax reform bill, it appears the .9% Medicare payroll tax continues to apply to single filers with modified adjusted gross income in excess of $200,000 and for couples with modified adjusted gross income in excess of $250,000. If you think your joint income will be subject to this tax, you could ask your employer to increase your federal tax withholding for the remainder of the year.
Estate and Gift Tax. Both the House and Senate bills increase the Federal estate tax exemption amount substantially – the House version to $10,000,000 and the Senate version doubles it. The House version also repeals the estate and generation-skipping tax in six years. If these changes don’t make it into law, the Federal estate tax exemption amount will increase by $110,000 in 2018 to $5,600,000. The estate tax rate will remain at 40%. For gift tax purposes, the annual gift tax exclusion amount increases from $14,000 to $15,000 in 2018.