Five Individual Year-End Tax Planning Steps for Tax Reform
Author: Kori Zey
As reported in our accompanying alert, the House and Senate passed the Tax Reconciliation Act of 2017 (formerly the Tax Cuts and Jobs Act of 2017) on December 20, 2017. At this time, the only remaining step needed to enact this significant tax legislation is President Donald Trump’s signature. The tax bill includes many provisions that will affect individuals, businesses, exempt organizations and trusts and estates—learn more through BKD’s Tax Reform Resource Center. With most of these changes scheduled to take effect January 1, 2018, and year-end rapidly approaching, here are five steps to guide your year-end tax planning strategies before December 31, 2017.
Step 1: Review Your Current Tax Situation
The tax bill makes changes to the seven individual income tax brackets, roughly doubles the standard deduction, repeals the personal exemption, makes significant changes to itemized deductions and modifies the individual alternative minimum tax (AMT). The effect of these changes will vary greatly depending on your personal tax situation. To properly evaluate the effect of these changes, you’ll need to know a few things based on your most recent tax return. Review your 2016 Form 1040, U.S. Individual Income Tax Return and 2016 Schedule A (Form 1040), Itemized Deductions, and take note of the following amounts on your Form 1040:
- Filing status (line 1): Your filing status, i.e., single, married filing jointly (MFJ), etc., determines a number of items on your tax return, including your tax bracket, limitations on deductions and the phaseout of items like the AMT.
- Adjusted gross income (AGI) (line 37): Several limitations under current tax law are limited based on a percentage of this number. Many of these limitations are temporarily modified or repealed under the new tax bill.
- Itemized (or standard) deduction (line 40): Fewer individual taxpayers will itemize deductions starting next year due to the near doubling of the standard deduction and changes that curtail many popular itemized deductions, including the state and local income tax deduction, home mortgage interest and certain miscellaneous itemized deductions. See our previous alert for more on these changes.
- Exemptions (line 42): Personal exemptions are eliminated for the 2018–2025 tax years under the tax bill.
- Taxable income (line 43): Your marginal tax rate under the individual income tax brackets is based on your filing status.
- AMT (line 45): Under the AMT, several deductions, such as the itemized deduction for state and local income taxes, aren’t allowed in the tax calculation. Knowing whether you’ll be subject to the AMT in 2017 is important when evaluating planning strategies such as accelerating state income tax payments before year-end.
Step 2: Consider Any Changes to Your Tax Situation
Did you change jobs in 2017? Do you expect to start a business in 2018? Once you’ve reviewed your 2016 tax return, consider how your tax situation may have changed in 2017 and how you expect it to change in 2018. These factors will be important for evaluating the potential effect of the new tax bill.
Step 3: Evaluate the Timing of When You Receive Income
The changes to the individual income tax brackets mean most taxpayers will see lower tax rates starting next year. Here are some year-end strategies that may allow you to defer income until 2018 to take advantage of these lower tax rates:
- If you’re an employee and receive discretionary bonuses, lump sum payments or other lump sum payments not subject to the rules governing deferred compensation plans, review the timing of these payments with your employer to see if you can delay payment until after December 31, 2017.
- Consider waiting to take action on stock options. Those with nonqualified stock options, which allow you to choose to exercise the option sometime between the vesting and expiration date, generally will include the difference between the stock’s fair market value and exercise price in ordinary income in the year the options are exercised. Waiting to exercise vested nonqualified stock options until 2018 may be less taxing than doing so in 2017.i
- Wait to take your first year required minimum distributions or elective distributions from an individual retirement account (IRA) until after December 31, 2017.
Step 4: Assess the Timing of Business Income & Deductions
Business deductions will generate a greater tax benefit in 2017 than in 2018 under lower tax rates. If you own and operate a business that isn’t taxed as a C corporation, consider the following strategies that may help reduce your personal income tax liability:
- Place qualifying assets in service before December 31, 2017, to take advantage of the 100 percent bonus depreciation when effective tax rates are higher.ii
- Evaluate possible changes to your business’s methods of accounting for income and deductions to see if there’s an opportunity to accelerate deductions or defer income.
- Use cost segregation studies to help accelerate depreciation deductions on buildings. Read our article “How Will Tax Reform Affect Cost Segregation Deductions?” for more on this and other deduction timing strategies for real estate holdings.
- Defer pass-through business income into 2018 to potentially take advantage of the new pass-through business deduction of 20 percent of qualified business incomeiii under the tax bill.
If you have net operating loss carryovers, you may benefit by accelerating income into 2017 or deferring expenses into 2018, allowing you to offset income at current ordinary tax rates.
Step 5: Evaluate the Timing of Your Itemized Deductions
As discussed in Step 1, the tax bill makes several significant changes to many itemized deductions. There are several possible planning strategies to consider acting on before year-end as a result of these changes.
If you do not anticipate being subject to the AMT in 2017 based on your evaluation in Steps 1 and 2 above:
- Consider payment of certain taxes: The bill limits the itemized deduction for taxes paid to $10,000. Consider paying the following taxes before December 31, 2017, to take advantage of the deduction still available for 2017. Here are some guidelines for evaluating possible action:
- Make payments of state and local income taxes for 2017 on or before December 31, 2017. The tax bill specifically prohibits a deduction for payment of taxes paid beyond the year in which the tax is imposed. Therefore, there isn’t a benefit in prepaying state and local income tax beyond the amount due for the 2017 tax year.
- If you typically deduct state and local sales taxes instead of income tax, consider making big purchases and pay the related sales tax on or before December 31, 2017.
- For property taxes assessed on or before December 31, 2017, but not due until after that date, i.e., payment is in arrears, consider prepaying this amount.
- Consider paying other deductions: The tax bill repeals miscellaneous itemized deductions subject to the 2 percent AGI limitation for the 2018–2025 tax years. Where the amount of the following categories of expenses are known on or before December 31, 2017, consider payment before year-endiv:
- Unreimbursed employee business expense
- Dues and subscriptions
- Investment management fees
- Tax preparation fees
Regardless of being subject to the AMT in 2017, making additional charitable contributions on or before December 31, 2017, may increase the benefit of your income tax deduction for these amounts. Here are some considerations for making these contributions:
- Review our article “2017 Charitable Giving Reminders” to see how you can avoid unintended tax results from your charitable giving.
- Consider contributing to a donor-advised fund, which would allow you to receive an immediate tax deduction but allow you to designate the amount and recipient of fund distributions in future years.
- Consider contributing securities that have appreciated in value. Note the deduction allowed for these types of contributions is limited to 30 percent of AGI.
- Make a qualified charitable distribution from your IRA of up to $100,000 if you are 70½ or older.
Check in with BKD’s Tax Reform Resource Center often to keep up with developments, and contact your trusted BKD advisor to learn more about how possible tax changes may affect your situation before year-end.
i A decision to exercise stock options should take into consideration your taxable income in the year you exercise your options as well as the stock market’s overall outlook; contact your BKD tax and investment advisors for assistance in making this decision. All investment advisory services are provided separately by BKD Wealth Advisors, LLC, an SEC-registered investment advisor.
ii Definition of qualified property expanded by removing requirement that original use begin with taxpayer.
iii Deduction doesn’t apply to specified service businesses, except in case of taxpayer whose taxable income doesn’t exceed $157,500 for single filers ($315,000 MFJ) with a phaseout beginning at the same levels over the next $50,000 ($100,000) of taxable income. Qualified business income is all domestic business income other than investment income (except income from publicly traded partnerships that’s eligible for inclusion), investment interest income (other than qualified real estate investment trust and corporate dividends), net capital gain, foreign currency gains, etc. The deduction is limited to the greater of 50 percent of W-2 wages paid with respect to the business or 25 percent of W-2 wages paid plus 2.5 percent of the unadjusted basis of all qualified property.
iv A deduction will be allowed in 2017 only to the extent these expenses exceed 2 percent of your AGI.