Tax Reform and Year-End Planning: Top Tips for Individuals and Businesses

With the House of Representatives and the Senate each passing their own version of a tax reform bill, it looks increasingly likely that sweeping changes to the tax code will be implemented soon. With 2018 quickly approaching, now is the time to consider year-end tax strategies to help you maximize your deductions and minimize your tax bill in the face of the rapidly changing tax landscape.

2017 Planning Ideas for Individuals

1. State and Local Tax Deduction: With the suspension of state and local tax deductions, taxpayers, who itemize their deductions and are not subject to the alternative minimum tax in 2017, should make state income tax payments for their expected 2017 state tax liability prior to Dec. 31, 2017. If real estate taxes exceed $10,000 a year, consider prepaying amounts due in 2018 by Dec. 31, 2017.

House and Senate Bill Summary: Under both bills, the itemized deduction allowed for state and local income tax and personal property tax would be eliminated. However, real property taxes would still be deductible up to $10,000 for married filing jointly taxpayers and $5,000 for individual taxpayers.

2. Mortgage Interest Deduction: If a taxpayer has a home equity mortgage, any amounts due for 2017 should be paid by Dec. 31, 2017. This will provide the maximum deduction to taxpayers in the event the Senate version of the bill is passed. Consider ways to convert the home equity mortgage debt to either business or investment debt to maximize deductions in later years.

House Bill Summary: The mortgage interest deduction limitation would be reduced from $1,000,000 to $500,000 for debt incurred after Nov. 2, 2017. Additionally, the bill would only allow a mortgage interest deduction on the taxpayer’s principal residence.

Senate Bill Summary: The mortgage interest deduction would be suspended through 2026 on interest resulting from home equity indebtedness. The mortgage interest deduction limitation of $1,000,000 would be retained for interest resulting from acquisition indebtedness.

3. Miscellaneous Itemized Deductions: If a taxpayer will be itemizing their deductions in 2017, they should consider making payments prior to Dec. 31, 2017 for employee business expenses, investment fees, and tax preparation services in order to ensure these payments are deductible.

House Bill Summary: The bill would eliminate the itemized deductions for medical expenses, employee business expenses, and tax preparation services.

Senate Bill Summary: The bill would eliminate all itemized deductions subject to the two percent floor, including employee business expenses, investment fees, and tax preparation services. However, the current deduction for medical expenses would be retained.

4. Charitable Contributions: If a taxpayer’s marginal tax rate is expected to be lower in 2018, consider accelerating charitable contributions to be made in 2017 to offset the higher tax rate. For larger gifts, a taxpayer may want to consider making a charitable contribution to a donor advised fund. A taxpayer with unrealized gains in stocks and bonds should consider contributing the lowest basis securities to charity before Dec. 31, 2017. Additionally, if a taxpayer makes contributions to a university in exchange for seating rights at athletic events, those contributions should be made prior to Dec. 31, 2017 so that 80 percent of the contribution will be deductible as a charitable contribution.

House and Senate Bill Summary: Under the House’s bill, the AGI limitation on cash charitable contributions would increase from 50 percent to 60 percent. Additionally, the current rule allowing for an 80 percent deduction for contributions to universities in exchange for athletic seating rights would be repealed.

5. Sale of Principal Residence: If a taxpayer is in the process of selling their house, they should consider whether they will qualify for the exclusion from gain on sale under the new tax bills. For example, if they have not used the house as their principal residence for five of the previous eight years but have used it as their principal residence for two of the past five years, the taxpayer should attempt to close on the sale of the house prior to Dec. 31, 2017.

House and Senate Bill Summary: The exclusion on gain on the sale of a principal residence of up to $500,000 for married filers and $250,000 for single filers will remain in place. In order to qualify for the exclusion, the new bills require that the taxpayer owned and used the home as their principal residence in five out of the previous eight years (up from the current requirement of two out of the previous five years). Additionally, the House bill begins a phase out of the exclusion for taxpayers making $250,000 gross income and completely phases out the exclusion at $500,000 gross income.

6. Basis in Marketable Securities: Taxpayers, with multiple lots and varying tax basis, who are considering selling marketable securities, should consider the sale prior to Dec. 31, 2017 in order to minimize the amount of taxable gain on the sale. Under the current system, a taxpayer’s basis in the sale of individual marketable securities (except mutual funds) is determined under a specific identification method.

House Bill Summary: The House’s bill does not address this issue.

Senate Bill Summary: Under the Senate’s bill, a taxpayer’s basis in the sale of certain marketable securities would be required to be determined using a first-in-first out basis in most circumstances.

7. Conversion of IRA Contributions: A taxpayer who has converted a traditional IRA to a Roth IRA and would like to recharacterize the conversion back to a traditional IRA, to avoid the tax, must do so prior to Dec. 31, 2017. Beginning in 2018, the recharacterization may not be available.

House and Senate Bill Summary: The current provision allowing a taxpayer to recharacterize any contribution to an IRA, traditional or Roth, during the tax year to another IRA, traditional or Roth, prior to the due date of tax return will be repealed.

8. Alimony Payments: A taxpayer who is currently negotiating a divorce settlement should consider the new provision in the House’s bill in conducting their negotiations.

House Bill Summary: Under the House’s bill, alimony payments will no longer be deductible to the taxpayer making the payments. The recipient of alimony payments would no longer be required to include the payments as income.’

Senate Bill Summary: The Senate’s bill does not address this issue.

2017 Planning Ideas for Businesses

1. C-Corporation Tax Rate: With the lower tax rate for C-corporations potentially set to begin in 2018, C-corporations should accelerate payment on as many expenses as possible so that they are made during 2017. This will reduce the amount of 2017 income taxed at the current, higher rates and maximize the income taxed and the lower rates beginning in 2018.

House Bill Summary: Under the House’s bill, there will be a 20 percent flat corporate tax rate for all C-Corporations beginning in 2018. The rate will be 25 percent for all personal service corporations.

Senate Bill Summary: Under the Senate’s bill, there will be a 20 percent flat corporate tax rate for all C-corporations beginning in 2018. The special tax rate for personal service corporations will be eliminated.

2. Like-Kind Exchanges: Under both tax bills the use of like-kind exchanges for personal property will be eliminated. Taxpayer’s considering a like-kind exchange involving personal property should complete the change prior to Dec. 31, 2017 so that the gain on the exchange will be deferred.

House Bill Summary: Under the House’s bill, deferral on gain in a like-kind exchange would be limited to real property.

Senate Bill Summary: The Senate’s bill also limits the deferral on gain in a like-kind exchange to real property. However, the Senate’s bill adds an exception for exchanges in which the property in a like-kind exchange is received prior to Dec. 31, 2017, even if the like-kind exchange is not completed at this date.

3. Sale of Patents: In order to secure long-term capital gain rates, a taxpayer should complete the sale or exchange of a patent, which has not been commercially exploited, prior to Dec. 31, 2017.

House Bill Summary: Under the House’s bill, the provision providing that the gain on a sale or exchange of a patent prior to its commercial exploitation is treated as long-term capital gain will be repealed.

Senate Summary: The Senate’s bill does not address this issue.

For questions on how these year-end planning techniques apply to you, please contact your KSM advisor. Check back on our blog for updates on long-term planning considerations resulting from the new tax bills and, when the final bill is signed into law, a full breakdown of the relevant tax provisions.