By William J. Hufnell, CFP®, CPA
Cutting to the Chase
Given proposed tax law changes, the best tax planning strategies to employ now generally involve deferring income until after 2016 and accelerating your deductions into this year.
With the recent election results, it appears we are on the cusp of some rather significant changes to both individual and corporate tax laws. We are still very early in the process, but proposals floated by the President elect and Congress have some common themes that can assist us currently with our tax planning strategies.
The 3 main common themes are:
- Lower tax rates are on the way.
- Fewer deductions will be available after this year.
- Lower (or the elimination of) estate taxes.
Lower Tax Rates
Under our current tax system, the highest federal tax bracket is 39.6% and the lowest tax bracket is 10%. In total, there are seven regular income tax brackets. Both the House of Representatives and the President-elect have proposed plans that would reduce the number of brackets down to three: 33%, 25% and 12%.
Both the President-elect’s and the House of Representatives’ proposed plans take aim at itemized deductions, which includes items such as state taxes, real estate taxes, mortgage interest and charitable deductions.
The plans vary drastically but they both limit or eliminate certain itemized deductions. The plan proposed by the House essentially eliminates all deductions except for mortgage interest and charitable contributions. President-elect Trump’s plan would limit deductions to a dollar amount, currently believed to be around $200,000.
Elimination of Federal Estate Taxes
The federal estate tax is eliminated under both the House and Trump plans. As many of you are aware, the federal estate and federal gift tax laws are very much intertwined. It appears, however, that neither plan currently addresses lifetime gifting. If the federal estate tax law is repealed but no changes are made to the gift tax laws, our focus would likely shift more towards testamentary (at death) gifting.
Specific Strategies to Consider Now
- Pay your 2016 state income taxes before December 31, 2016.
- If you have a mortgage, make the January 1, 2017 payment now.
- Accelerate charitable contributions into this year that you would otherwise make in future years. Note that many of our clients use a donor advised fund, which allows them to benefit from making a contribution this year but also allows them to grant out to charities anytime in the future.
- Defer gains on the sale of any securities.
- Recognize any security losses this year.
- If you own a business, take advantage of the immediate right off for capital expenditures that are allowed under Section 179 of the Internal Revenue Code. The Section 179 deduction allows you to immediately write off certain capital expenditures (that would typically need to be capitalized and depreciated over several years).
- If you can defer billing for your services, send out your invoices at the beginning of January so that you will receive the payment/revenue next year and likely pay taxes at the new lower rates.
- Do not make any “taxable” gifts this year. However, for those that are accustomed to making the annual tax-free gifts to their children or others, continue to do so.
Other Proposed Changes of Significance
The House plan appears to provide a 50% exclusion for most investment income (capital gains, dividend income and interest income). So if you were in the new 33% bracket, you would pay 16.5% on your investment income. Note also that under both plans, the (dreaded) 3.8% Medicare surcharge on investment income for high-income taxpayers would be eliminated.
Pass-Though Entity Income
A proposal of significant magnitude is included currently in the House proposal. Most small businesses are structured in a way that the income from the business “passes through” to the business owner’s individual (Form 1040) tax return. The business owner then reports and pay taxes on this business income based on his or her personal tax circumstances. Therefore, if the taxpayer were in the 39.6% bracket (which, could change to 33%) his or her business income would be subject to this 39.6% tax rate. The House proposal would limit the tax rate to 25% for all pass-through income.
I want to reiterate that we are clearly in the very beginning stages and that it is impossible to predict what will come out in the final legislation. We will continue to monitor this and provide our advice as things evolve. As always, if you have any questions specific to your circumstances, please call us at 410-626-8198 to discuss.