2017 Tax Planning
11/22/2017

Although enactment of final tax reform legislation is not yet a sure thing, the odds have increased sufficiently over the past several weeks to make some preparations for year-end planning advisable. 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 starting January 1, 2018.

This article takes a look at some of the year-end planning that might be considered by individual taxpayers in anticipation of final tax reform legislation that would follow the existing House and Senate bills. Where relevant, the differences between House and Senate versions of HR 1 are considered.

Rate brackets. 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 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 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.

Standard deduction. 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 would 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 taxpayer 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 in 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.

Comment. 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.

Medical expenses. 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.

Charitable deductions. 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. Individuals might be reminded to pay for tax services rendered in 2017 before year-end 2017 to take advantage of this sunsetting provision on their 2017 tax year returns.

Alimony expenses. 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 executes after 2017 and to any modification after 2017 of any pre-2018 agreement if expressly provided for within the modification.

Comment. The alimony deduction has been an above-the-line deduction, not dependent upon itemizing deductions. The current law’s deduction/inclusion regime generally produces a net benefit for the divorced couple since the payor typically has the higher income and alimony amounts have typically been negotiated with such net tax benefit in mind. As a result, there may be a year-end rush by some divorcing couples to get divorce agreements finalized by year end 2017.

Moving expenses. Taxpayer have been allowed an above-the-line deduction for moving expenses incurred in connection with starting a new job under at at-least-50 mile rule. The House and Senate bills would repeal this deduction, effective for tax years beginning after 2017.

A limited year-end strategy might include moving to a new location quickly before 2018 and then finding a permanent position there. Under Code Sec. 217(c)(2)A), during the 12-month period immediately following a taxpayer’s arrival in the general location of his new principal place of work, the taxpayer must be a full-time employee, in such general location, during at least 39 weeks; or, during the 24-month period immediately following his arrival in the general location of his new principal place of work, the taxpayer is a full-time employee or performs services as a self-employed individual on a full-time basis, in such general location, during at least 78 weeks, of which not less than 39 weeks are during the 12-month period.

Comment. 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. Wage gross-ups, however, may still be allowed.

Education expenses. 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, the above-the-line deduction for educational expenses that ended after 2016 will not be renewed, graduate students and others will realize taxable income on qualified tuition reductions, and employer-provided education assistance will no longer be excluded from income.

Comment. Students will no longer be entitled to these write-offs to defray the cost of their education. They might need to re-evaluate various enrollment commitments now, before being locked into 2018 treatment. Also in the House Bill: the American Opportunity Tax Credit, the Hope Scholarship Credit and the Lifetime Learning Credit would be consolidated into an enhanced American Opportunity Tax Credit. Within those credits and especially relevant to year-end tuition payments, Code Sec. 25A(g)(4) would continue to provide that qualified expenses paid during one tax year for an academic period that begins during the first three months of the following tax year may be considered for the credit for the tax year in which the expenses are paid.

By George Jones, Wolters Kluwer News Staff

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