Year-end Planning and the Proposed Tax Law Changes
House and Senate Proposed Tax Law Changes
Over the past few weeks both Congress and the Senate released their versions of proposed changes to US tax law. It's important to recognize that substantial changes will likely be made before any law is enacted. We will have to watch as the negotiations evolve over the next several weeks as to what the final legislation looks like.
Most proposed changes take effect in 2018. However, as has been the trend with other recent tax law changes, there will likely be sunset provisions, phase-outs, and other provisions that need to be considered.
With that said, we want to nevertheless summarize a couple of the key proposals and the related actions that might be considered.
Personal income tax rates
The income tax brackets differ between the Senate and House bills.
The House bill reduces the current marginal income tax brackets to four from seven — 12%, 25%, 35% and 39.6%. The Senate bill has a broader range of brackets and introduces a 38.5% top rate. Both bills generally apply the top rate to taxable income over $1.0 million for a couple filing jointly. Under current tax law, the income subject to the maximum rate kicks in closer to the $500,000 range, so the proposed changes do cause a portion of higher income earners to be taxed at a lower rate.
Pass-through tax rates
Most of our business owner clients have corporate structures that cause the income from their business to flow through to their personal tax return. Thus, their income is subject to personal income tax rates (as opposed to being the taxed as a corporation). With certain restrictions, particularly with respect to personal service corporations, the house bill provides for a maximum 25% tax rate on this pass-through income. The Senate bill is somewhat more convoluted but also provides for a lower income tax structure for pass-through entities.
Capital gains and dividends
Earlier indications were that there would be a reduced tax rate introduced for capital gains and dividends, but the rates remain the same under both proposed bills at 20%. Additionally, the net investment income tax also remains in place, which adds an additional tax of 3.8% for higher income taxpayers.
The House bill repeals the deduction for state and local income and sales taxes but retains the deduction for real estate taxes subject to a $10,000 yearly cap. The Senate bill completely eliminates any deduction for state and local taxes, including real estate taxes.
With respect to mortgage interest, the House bill limits the write-off to essentially a $500,000 mortgage. The Senate bill retains the existing limit of $1.0 million. There are also new limits introduced with regard to second homes.
Charitable contributions essentially remained unscathed. The House bill does allow for a higher amount of deductions based on your adjusted gross income for the year. Current legislation allows for 50% of your adjusted gross income and the house bill increase this to 60%.
The medical expense deduction is repealed under the House bill. The Senate bill retains the deduction to the extent the expenses exceed 10% of your adjusted gross income.
For taxpayers that don’t itemize their deductions, both bills provide for a higher amount that can be used as a “Standard Deduction,” but both also eliminate the “Personal Exemption.” The net result is an incremental increase in the amount of income that can be excluded for these taxpayers.
Alternative Minimum Tax (AMT)
As many of you know, our tax system requires a second calculation of your tax liability to ensure you pay at least a minimum tax rate. This is known as the Alternative Minimum Tax (AMT). Both bills eliminate the AMT.
Under the House bill, the federal estate tax would be eliminated beginning in 2024. Between now and then, the exemption amount for each individual would be doubled (the 2018 exemption is $5.6 million per person). The Senate bill doubles the estate tax exemption but does not provide for repeal.
Other proposed changes
We have only covered what we consider the more key and relevant proposals. There are several other changes included within the proposals that we continue to monitor and determine the impact for our client planning.
What Can We Do
It’s difficult to plan based on proposed tax law changes. However we do have a general idea of what’s on the horizon – and we clearly know current tax laws. So here are some actions you can take now. Note that tax planning is always based on your specific circumstances. Listed below are a few ideas for you to consider.
- Begin planning now – A lot of the planning involves getting things done by December 31. So we still have plenty of time to consider what planning needs to be implemented before year-end. Don’t procrastinate.
- Defer income to next year – It appears that in most circumstances, all other things being equal, you should push taxable income into 2018 where possible.
- Maximize your retirement contributions - Make sure you're contributing the maximum amount allowed to any retirement plan such as a 401(k) or IRA. Note that some plans need to be established by December 31st but can be funded in 2018 (and still get the deduction for 2017).
- Fund a 529 plan - To reduce your state income taxes, consider funding a College Savings Plan for a child, grandchild, or other relative.
- Accelerate deductions - Try to pay for any expenses that you would otherwise take in 2018 before the end of this year. One example would be to make a charitable contribution (possibly though the use of a donor advised fund) before the end of 2017 for contributions that you would otherwise make in future years (for example, add up what you plan on giving in the next few years and instead make the contribution in 2017).
- Pay your state and local taxes before year-end - This recommendation generally applies irrespective of any tax law changes. However, given that it appears there will be limitations beginning in 2018 with respect to the deductibility of state taxes, it makes sense to pay these taxes before December 31. For example, if you have a January 15 estimated quarterly income tax payment due, pay it before December 31. Also, for those clients that are using “safe-harbor” rules for their state income taxes (and plan on paying the balance due in April), instead consider paying the anticipated balance before year-end.
- Don’t forget AMT – Remember that the Alternative Minimum Tax can have a material impact - and sometimes cause us to actually reverse what we would otherwise recommend (such as accelerating income and possibly deferring deductions). Thus, you need to use tax-planning software that takes the AMT into consideration.
- For business owners – There are several planning items particular to planning for business owners and these need to be considered now as implementation sometimes takes longer. One item to consider is whether it makes sense to purchase equipment or other items that would typically be depreciated over several years and elect to take the entire write off in 2017 using the Section 179 election.
We will be working with our clients and their CPAs over the next few weeks to make sure we have carefully considered their planning needs. If you have any questions concerning your circumstances, please feel free to contact us.