By: Susan Goddard & Sabrina Greninger
Changes in the tax law are very likely in the near future. Legislation is currently underway for massive tax reform. What changes will pass and when they will happen are still being debated. Even in these uncertain times, there are some tax planning opportunities which should be taken advantage of before year-end to minimize your taxes.
Tax Reform Proposals
Some notable changes besides a lower tax rate and fewer tax brackets are:
- A doubled standard deduction (from $12,700 to $24,000 for married and joint filers and from $6,300 to $12,000 for single filers)
- Removal of personal exemptions ($4,050 for each person claimed on the tax return)
- An overhaul of what is allowed for itemized deductions – removal of medical expenses, state income taxes, and a cap on real estate taxes paid
- Elimination of the Alternative Minimum Tax
- Repeal of the deduction phase-out for high-income taxpayers
There are currently disagreements between the House and the Senate at this time over several items, so it is unsure what changes will be implemented or when they will occur.
2017 Tax Rates
The individual income tax rates for 2017 are unchanged and the tax brackets have been slightly adjusted to account for inflation. This results in a top tax rate of 39.6% on ordinary income, 20% top tax rate on capital gain and qualified dividend income, and 3.8% net investment income tax on investment income.
Traditional Tax Planning Items
Regardless of the tax reforms to come, there are some tax planning opportunities under the current law which should be considered before the end of the year.
Taxpayers that might lose some of their itemized deductions in future years, as outlined in the current tax overhaul, should consider accelerating certain deductions that taxpayers have control over. Some things to consider when making year-end decisions regarding itemized deductions are outlined below.
Consider pre-paying the Tennessee Hall Tax and other state taxes before December 31. With the potential removal of the state income tax deduction looming for 2018, paying as much state tax early will be beneficial. Making the payment for state tax this year ensures the taxpayer will get the benefit of deducting the full state tax payment. If you make estimated payments for other states, consider paying the fourth quarter estimate before December 31, rather than waiting until January 15. This strategy may not be advisable if you are subject to the Alternative Minimum Tax (AMT) in 2017.
Consider pre-paying real estate taxes before December 31. Another potential change under the current proposal is a limit on real estate taxes. Taxpayers with real estate taxes larger than $10,000 should consider paying real estate taxes before December 31. This will maximize the benefit of those tax payments, and may even get you a small discount for paying early depending on your county. However, if you are subject to AMT, this may not be beneficial.
Contribute publicly held securities that have appreciated in value to charity. This is a highly advantageous strategy. This charitable gifting approach provides taxpayers with two benefits: a deduction for the fair market value of the security rather than the lower cost basis up to 30% of adjusted gross income (or 20% if contributed to a private foundation) and the capital gain on the appreciated security is not taxed. Only appreciated securities held longer than one year are eligible for a full fair market value deduction.
Give to a Donor Advised Fund. One way to help accelerate charitable giving for 2017 is to give to a donor-advised fund. A donor-advised fund is a philanthropic vehicle that allows donors to make a charitable contribution, receive an immediate tax benefit, and then recommend grants from the fund over time to various charitable organizations of the donors’ choosing. An easy way to think about a donor-advised fund is to consider it a charitable savings account. If you want to accelerate charitable giving for 2017, but don’t have any charitable organizations in mind to give to, a donor-advised fund is a great approach.
Noncash Contributions. Remember that you should get a receipt from the charity for all donations of property, including clothing and household items. The receipt should contain the name of the charity, date of the contribution, and a reasonably-detailed description of the donated property. If a donation is left at a charity’s unattended drop site, keep a written record of the donation that includes this information, as well as the fair market value of the property at the time of the donation and the method used to determine that value. There are several helpful guides online that outline the fair market value for items commonly donated to resale charities such as Goodwill and the Salvation Army. One of them can be found at https://satruck.org/Home/DonationValueGuide.
Giving IRA distributions directly to the charitable organization. If you are 70 ½ or older, you can make a direct donation from your IRA to a charitable organization up to $100,000 per tax year. The donation must be made to a charitable organization other than a private foundation or donor advised fund. The charitable organization must provide an acknowledgment letter stating the value received and that no goods or services were provided in return. One of the benefits of the direct charitable donation from your IRA is that the distribution counts towards your Required Minimum Distribution. In addition to that, the direct charitable donation is excluded from income, lowering your AGI.
Health Savings Accounts
If you have a Health Savings Account, be sure to maximize your contributions for the year. Contribution limits for 2017 are $3,400 for an individual, $6,750 for a family, and an additional $1,000 for those 55 or older. You must have a high deductible health plan to contribute to an HSA. Contributing to a Health Savings Account (or HSA) is a way for you to be able to get an “above the line deduction” for your health care costs without having to incur medical expenses in excess of the AGI threshold.
Maximize 401K and IRA contributions
One thing that should remain unchanged by the tax reform proposal is the deduction for retirement savings. It may be worth assessing your 401K and IRA contributions for 2017 and make sure you have maximized contributions to get as much benefit as possible. This is an extremely valuable benefit, as it allows more of your money to be put to work for your future, and it lowers your tax liability. The limit for 2017 401K contributions remains at $18,000 with an extra $6,000 allowed for those aged 50 or older. The limits for IRAs are $5,500 with an extra $1,000 allowed for those aged 50 or older.
Required minimum distributions
As the end of the year approaches, make sure you have taken the required minimum distribution from your retirement accounts if you are age 70 ½ or older. The penalty for not taking required distributions is severe – a 50% excise tax on the amount not distributed as required. Contact your financial advisor to make sure you have taken the required distributions before year end. The beginning date for your first required minimum distribution for IRAs is the calendar year in which you reach age 70 ½ or it can be delayed until April 1 of the next year. For 401k, profit-sharing, or other defined contribution plans it can be delayed until April 1 of the year after you retire. If you are about to turn age 70 ½, you can plan to take your first distribution in the tax year which results in lower tax. Be aware if you defer the first distribution to April 1 of the following year, you will have two payments to report in that year.
Converting some of your traditional IRA to a Roth IRA may be beneficial if your 2017 taxable income and top tax bracket will be substantially less than normal for you. For example, if you have an abnormal loss from an active trade or business or if you are expecting a net operating loss. Converting from a traditional IRA to a Roth IRA provides several benefits. You will pay tax on the converted income, but Roth IRAs growth is tax-free and distributions from Roth IRAs are also tax-free as long as you are aged 59 ½ or older. Much like contributions to an IRA, conversions can be done up to the original deadline of the tax return – April 15. The advantage of doing a conversion in a year with less income is you pay tax now and avoid paying the tax in future years when you may be in a higher tax bracket.
Tax loss harvesting is the practice of selling stocks, mutual funds, exchange-traded funds and other securities that are now worth less than what investors paid for them. By realizing or “harvesting” losses, investors are able to offset taxes on gains from other investments. For investments held in taxable accounts, this can be a way to take advantage of positions that have experienced a loss and allow the tax savings to offset gains elsewhere. If you can work this strategy into your typical portfolio rebalancing, it can be an excellent way to manage your investments in a tax-efficient manner. It is important to be aware of wash sale rules when choosing this strategy. Your investment advisor could help determine if the timing is right to consider harvesting some losses for this tax year.
Other Planning Items
Re-visit estate planning and wills
The end of the year is an appropriate time to review and update your will and estate planning for changes in circumstances that may have occurred in the past year. Updating the beneficiary designations on your pension plan and other retirement accounts, as well as your life insurance policies, is important because failing to name beneficiaries or keep designations current to reflect changing circumstances can create substantial difficulties and expenses (both emotional and financial), and may lead to unintended estate, gift, and income tax consequences.
Annual exclusion gifts
It is still unknown at this time what changes may be made to the estate tax and gift tax. The most powerful – and simplest – estate planning technique remains giving gifts up to the annual exclusion. The annual exclusion for 2017 remains at $14,000 and is set to increase to $15,000 for 2018. Individuals can make an unlimited number of gifts of up to $14,000 per recipient, per calendar year, without any gift tax consequences. By removing the value of the gift itself and any income and growth from the donor’s estate, these gifts can result in substantial tax savings over time, assuming the estate tax remains. These transfers may also save overall income taxes for a family when income-producing property is transferred to family members in a lower tax bracket (who are not subject to the “kiddie tax”). If appreciated stock is gifted to someone in the 10%/15% tax bracket, such as an older child or elderly relative, they might be in a position to sell the stock with a 0% capital gains tax rate.
- Consider the timing of a gift. If you are considering making a gift over $14,000, you might make part of the gift at the end of December and the other part at the beginning of January.
- If you are making a gift to a child that is married, consider making a gift to their spouse as well.
- Payments directly to the provider of medical services or tuition fees made directly to a school are additional ways to give, which are not considered gifts under the gift tax laws.
The tax environment as we know it could be dramatically changed soon, regardless of which tax reforms get implemented. Make sure to take advantage of the tax planning opportunities available under the current law while you still can. Careful planning with your tax advisors at LBMC can help you make the most of this unique time.
The LBMC Wealth Advisors Team wishes you and your family a very Merry Christmas and a prosperous New Year!
Susan Goddard is a senior manager in the LBMC tax practice. She practices primarily in the wealth management group, focusing on all aspects of income tax planning, financial consulting and estate planning. Contact her at 615-309-2353 or firstname.lastname@example.org. Sabrina Greninger is a senior accountant on LBMC’s wealth advisors team. She primarily works with investment partnership, real estate, and individual clients tax returns and consulting. Contact her at 615-309-2239 or email@example.com.