by Gregory S. Dowell
December 8, 2017
The following letter was prepared and distributed to clients and friends of Dowell Group, LLP. The letter discusses individual and business tax planning ideas that may be appropriate in certain situations. This does not represent tax advice, as every situation must be considered on its own merits. We always encourage our clients to contact their tax professionals for advice specific to their situation.
Dear clients and friends,
Proper planning for taxes is key for many taxpayers. In a normal year, planning calls for a taxpayer to take stock of their situation, and to determine what steps should be taken to optimize the income tax picture.
As usual, our leaders in government have chosen to act at the last minute, making it difficult (if not impossible) to take proper planning steps. With no idea as to how the Senate and the House will reconcile key differences in their tax bills, all of us are shooting at a moving target.
In this communication, we will provide checklists of actionable items you may wish to consider in the remaining days of 2017. Those checklists will be broken out between individuals and businesses for your ease of use. Please note that we have also included some non-tax matters for individuals to consider in these final days of 2017.
We are also providing you with a summary, as best we can, of how tax reform might affect individuals, businesses, estate & trusts, and investors. Tax reform will prove to be a very personal matter for most taxpayers, in that each taxpayer’s specific situation may dictate specific actions. When it comes to tax reform, a one-size solution will not fit all taxpayers in all cases.
Unfortunately for taxpayers in the U.S., the situation will remain fluid and will be subject to change right up to the date that the House and Senate agree to a compromise (if such a date occurs). Even then, the bill has to be signed by the President to become effective. What we can tell you is that there will often not be a clear decision path at this time; you may find yourself hedging bets. We suggest that you check our website often for updates (www.dowellcpa.com). We have many articles posted on the site that are specific to individuals, business owners, fiduciaries, and nonprofits.
We began the year as Bass, Solomon & Dowell, LLP, a firm founded by Ray Bass, Harold Solomon, and Greg Dowell in 1992. After 25 years of service and growth, we carry on the efforts of those three founding partners under the new banner of Dowell Group, LLP. Whether you might be a client or a friend of the firm, we also want to take the time to thank you. We know that we would not be here without you. Whatever your faith or spiritual beliefs, we wish you peace and good health this holiday season and in the years ahead.
Dowell Group, LLP
2017 YEAR-END CHECKLISTS
Regardless of whether any tax reform bills pass or not, these are some actions you should consider in the remaining days of 2017:
Individuals – Year-End Tax Planning
- Flexible Spending Account – Consider where you stand for this year, and determine if you need to adjust the deductions for next year in your employer’s health flexible spending account (FSA).
- Health Savings Account – Make sure you have maximized contributions to your health savings account (HSA). There is a catch-up contribution of $1,000 for those over age 55.
- 401(k) plans – fully fund, if you are able, for 2017.
- Capital gains and losses – Determine the net short and long-term capital gains and losses recognized thus far; also consider any significant capital gain distributions you might receive from mutual funds or partnership investments, and take into account any capital loss carryovers. Once you understand the overall amounts of net gains and losses, strategize what action you may want to take by the end of this year. It may be appropriate to “harvest” capital losses in your account to offset gains (however, see discussion immediately following on “wash” sales).
- “Wash” sales – You might have a stock or bond that shows a loss, but you want to continue to hold that security because you think the price will recover. That security can be sold and the loss recognized, as long as the security is not repurchased for 30 days; if purchased before 30 days, the sale is deemed to be a “wash” sale and the loss is disallowed.
- Make an estimate of this year’s tax liabilities – If your situation has been volatile this year, make a quick projection of your Federal and State income taxes to see if you have paid in an adequate amount of Federal and State income taxes. If you are short, you may be able to increase withholdings or bump up the estimated tax payments before year-end. If you look to be overpaid, you can reduce the final quarterly installments.
- Postpone or accelerate income and deductions – With tax reform looming (see below) many taxpayers will want to defer income into the future, where tax rates are expected to decrease, and accelerate deductions into the current year, where tax rates are expected to be higher.
- Charitable contributions – Consider making any additional charitable gifts by the end of the year. Gifts are only deductible if made to an organized 501(c)3 charity. Be sure to get a receipt from the charity as evidence of the timely gift. See below for a discussion on tax reform, which generally would encourage a taxpayer to make gifts in 2017 and could thus impact your strategy.
- Charitable contributions of appreciated stock – Donating appreciated securities is an effective way of meeting the desire to support a charity while allowing the donor to deduct the full fair market value of the gift. The donor will not pay tax on the capital gain of those securities that were gifted.
- Non-cash charitable contributions – Consider making additional noncash charitable gifts by the end of the year, but pay particular attention to the substantiation rules if you are claiming that the fair market value of your gifts exceeded $250. Make a detailed dated list of the donated items and their condition, and affix the list to the receipt; it’s a good idea to take a picture of the goods as well.
- Prepay expenses – Consider using a credit card to prepay expenses that can generate deductions for this year (charitable, business, and medical expenses are good examples). Again, see the below discussion on tax reform to see if accelerating deductions is right in your case.
- If you will likely owe State income taxes – If you expect to owe state and local income taxes when you file your return next year, consider asking your employer to increase withholding of state and local taxes (or pay estimated tax payments) before year-end to pull the deduction of those taxes into the current year, as long as doing so won’t create an alternative minimum tax (AMT) problem. Importantly, see the discussion below on tax reform, given that state income taxes may not be deductible in the future.
- AMT – Estimate the effect of any year-end planning moves on the alternative minimum tax (AMT) for 2017, keeping in mind that many tax breaks allowed for purposes of calculating regular taxes are disallowed for AMT purposes. These include the deduction for property taxes, state income or sales taxes, miscellaneous itemized deductions, and personal exemption deductions. Other deductions, such as for medical expenses, are calculated in a more restrictive way for AMT purposes. As a result, in some cases deductions should not be accelerated, as they will provide little or no tax benefit.
- Bunching deductions in one year – Saving tax over a 2-year period may be achieved by “bunching” miscellaneous itemized deductions and medical expenses in a single tax year. Because these are subject to AGI phase-outs, bunching the deductions in a single year might allow the largest deduction possible. This strategy may particularly be important with tax reform, see below.
- Contested state income taxes -You may want to pay any contested State income taxes to be able to deduct them this year while continuing to contest them next year.
- Roth conversion – Converting traditional IRAs into Roth IRAs, can be a good planning idea, but you will need to consider the effects of tax reform before making a conversion in 2017. Keep in mind that such a conversion will increase adjusted gross income in the year of conversion. An ideal time to convert is when you are currently in a lower tax bracket and you expect future tax brackets to increase. This strategy is also good for those who anticipate that they may not need to use their IRA funds in their retirement.
- Roth recharacterization – If you converted assets in a traditional IRA to a Roth IRA earlier in the year, the assets in the Roth IRA account may have declined in value. If left as-is, you could wind up paying a higher tax. You can back out of the transaction by re-characterizing the rollover via a trustee-to-trustee transfer. You can later reconvert to a Roth IRA.
- Required Minimum Distributions (RMDs) – RMDs must be taken from your IRA, 401(k) plan, or other employer-sponsored retirement plan if you have reached age 70-1/2. Failure to take a required withdrawal can result in a penalty of 50% of the amount of the RMD not withdrawn. If you turned age 70 ½ in 2017, you can delay the first required distribution to 2018, but if you do, you will have to take a double distribution in 2018 (the amount required for 2017 plus the amount required for 2018). Taking a double distribution in 2018 may be advantageous if tax reform passes and your overall tax rate decreases in 2018.
- Gifting RMD to charity – As noted above, an RMD must be taken from your retirement plan if you reached the age of 70 ½ in 2017. An RMD can be gifted directly to charity; the RMD does not create income for the taxpayer, and the taxpayer does not get a charitable deduction. This satisfies the taxpayer’s need to take an RMD for the year. Up to $100,000 in a tax year may be excluded from a taxpayer’s income under this provision. This is a good strategy if you are a supporter of charitable causes and if you do not need the funds for your lifestyle.
- Gifts to family or friends – Make gifts sheltered by the annual gift tax exclusion before the end of the year. You can give $14,000 in 2017 to each of an unlimited number of individuals. You can also gift $28,000 to one person by using your spouse’s exclusion, but note that the IRS requires you to file a gift tax return in this situation.
- Education funding –If educational funding is an issue in your family, consider funding 529 plans by the end of the year.
- Marriage or divorced during the year – If you married during the year, no matter what date, you and your spouse will file either as married with a joint return or as married filing separately. In most cases, it is advantageous to file married joint. Your incomes and deductions will be combined, and that often leads to increased tax liabilities for the year, compared to when you were both single. If divorced during the year, you will file as single or head of household, and you will need to make sure you have paid adequate taxes. If you had a change in marital status, we suggest you call your tax professional.
- Dispose of passive activities – The owner of a business should consider disposing of a passive activity in 2017 if doing so will allow the owner to deduct suspended passive activity losses.
- Increase basis –The owner of an interest in a partnership or an S corporation may need to increase the basis in the entity so that the owner can deduct a loss from it for 2017.
Individuals – Other Considerations at Year-End
- Review your portfolio – The end of the year is a perfect time to analyze your holdings and determine if the risk tolerances and asset allocations are still appropriate for your investment objectives. Consider your age, health, and family issues.
- Review the beneficiary designations – Review the beneficiaries named on retirement accounts or insurance policies; consider if assets are titled correctly; determine if a family member should be added as a signer on an account.
- Wills and Trusts –If you have not set up wills and trusts, then contact your attorney; call us if you need a reference. If it has been many years since you had your wills and trusts drafted, set up a meeting with your attorney or CPA to review the documents, including the named beneficiaries, guardians, and executors.
- Grantor (“Living”) trusts – If you have substantial assets, you should likely have a grantor (also known as living or revocable) trust. Be sure that all of your brokerage accounts are re-titled in the name of the trust.
- Power of Attorney – As part of the review of wills and trusts, also consider powers-of-attorney and health care powers-of-attorney you have in force (or should have in force) for all of your family members.
- Insurance – Review the various types of insurance coverages you have in place and re-examine your needs. This includes homeowner’s, auto, life, health, disability, umbrella liability, and long-term care.
- Family meeting – Consider having a family meeting to give an overview of your investments and objectives, charitable giving strategies and desires, the location of key documents, and names of your key advisors (CPAs, attorneys, bankers, insurance agents, investment advisors, etc.).
- Safe deposit box –Make a special point to visit your safe deposit box and inventory (and organize) the contents. Make sure your executor, spouse, or other key person knows where the key is kept.
Businesses – Year-End Tax Planning
- Expensing equipment purchases under Code Section 179 – Businesses should consider making expenditures that qualify for the business property expensing option; this allows businesses to immediately expense (rather than depreciate) the cost of new equipment. The expensing limit is $510,000 for 2017, and the limit starts to phase-out when property placed in service exceeds $2,030,000.
- Filing due dates – Remember from last year that C corporation and partnership filing deadlines have been swapped. Partnership returns will be due March 15th, while C corporation returns are due on April 15th.
- Bonus depreciation – Businesses also should consider making expenditures that qualify for 50% bonus first year depreciation if bought and placed in service this year. The bonus depreciation deduction is permitted without any proration based on the length of time that an asset is in service during the tax year. As a result, the 50% first-year bonus is available even if qualifying assets are in service for only a few days in 2017.
- Income and expense timing – Due to possible lower rates in 2018, most businesses will want to consider deferring income to 2018 and accelerating deductions to 2017 – but see the discussion on tax reform below.
- AMT exposure – Many C corporations with a net operating loss for the year assume that they will not have an income tax liability. While they may not have a regular income tax liability, in many cases the C corp will have a liability for the alternative minimum tax (AMT).
- Reasonable compensation – Shareholder-employees must take reasonable compensation for their services, and this continues to be a focus of the IRS. On the positive side, taking reasonable compensation can also open the door to larger retirement plan contributions for the employee-owners.
- Retirement plans – It is too late to set up a 401k or a Simple plan for 2017, but some options are still available to save on a business owner’s 2017 taxes. If you are self-employed and haven’t done so yet, consider setting a self-employed retirement plan. This is also a good time to consider which retirement plan is the right one for your business for 2018 and future years.
- Cancellation of debt – Considering also the effects of possible tax reform, analyze the specific facts and consider the effect on income and income taxes if debt is cancelled in 2017 or 2018.
- Research and development credit – The calculation for the R&D credit is complicated and will typically require a great deal of analysis. However, it provides a credit for every qualifying dollar spent on research and development activity. Historically, the credit has had limited immediate impact to start-up businesses because it was only helpful if the entity had taxable income. However, the credit can now be used (in a diminished capacity) as a refund to offset payroll taxes. In another change, privately-held businesses can now claim the R&D credit against the AMT. This is important because many new businesses have net operating losses in the early years, which pushes the business into AMT, limiting their ability to benefit from the R&D credit. Tax reform, however, is threatening this credit – read below.
Tax reform is the elephant in the room when it comes to this year’s tax planning, and no one knows what the final product of the House and Senate bill will be. With that limitation in mind, we offer the following thoughts on planning in anticipation of tax reform:
- Tax rate reductions – Both bills are consistent in providing lower income tax rates for most individuals and businesses. With lower rates possibly on tap for the future, the logical step would be to defer income to 2018 whenever possible. For individuals, the number of tax brackets will likely shrink and, while the top rates are relatively unchanged, the base to which those rates are applied has been expanded.
- Year-end bonuses – Employees who receive year-end bonuses may want to see if their employer will defer the bonus until 2018.
- IRA conversions – Converting a traditional IRA to a Roth possibly should be pushed off until 2018.
- Cancellation of debt – If you are in the midst of making a deal with creditors to cancel or reduce debt, which will result in taxable income, try to postpone the cancellation until 2018.
- Itemized deductions in general – Lower tax rates in the future and higher rates in 2017 would tend to push a taxpayer to take as many itemized deductions in 2017 as possible, where the deductions will provide the greatest tax savings.
- Mortgage interest deduction – the House bill would allow the interest on the first $500,000 of mortgage debt to be deductible, while the Senate bill would retain the current deduction, but would eliminate the interest deduction for home equity debt.
- Deduction for state and local taxes – State and local taxes include state and local income taxes, sales tax, and real estate taxes. Both bills would limit or eliminate many of these deductions, which is a significant issue for taxpayers who live in states that have a high level of these taxes overall (think NY, CA, and IL, for instance). While there are differences in both bills, in general, both bills would eliminate the deduction for state and local taxes, but would allow a deduction of up to $10,000 for real estate taxes on your home. With these deductions in jeopardy of being eliminated in 2018, consider having your employer withhold more state income taxes from your wages; if you pay estimates, consider paying the 4th quarter tax installment by December 31st. Many states assess real estate taxes in arrears, so that in 2017 a homeowner will be paying 2016 taxes. If that is your situation, consider contacting your county to see how you can prepay some of your real estate taxes that will not be billed to you until 2018.
- Charitable contributions – While contributions to charity would be allowed under both bills, lower tax rates in the future would mean that those charitable deductions will be more valuable to you in 2017. In addition, because both bills would raise the level of the standard deduction (thereby making the standard deduction higher than the itemized deductions for many taxpayers; see below “Standard deductions”), it is possible that charitable deductions made in 2018 or later years will not provide a tax benefit (again, making the case to accelerate those deductions into 2017).
- Medical expenses – The House bill would eliminate a deduction for medical expenses, while the Senate bill would retain the deduction. Bear in mind that under current law it takes a considerable amount of medical bills in a given year to gain a deduction (the deduction is the amount by which those bills exceed 10% of a taxpayer’s adjusted gross income). If you have had significant medical expenses in 2017 and think you will be entitled to a deduction, and with the potential that the House bill might prevail, an individual taxpayer might consider accelerating medical deductions into 2017.
- Alternative minimum tax – The House bill would eliminate the AMT, while the Senate bill would increase the amount of income exempted from the AMT until 2026. If you are planning to have an income event in 2017 that would generate AMT, like the exercise of a stock option, consider pushing off that event until 2018, when there will be no AMT.
- Electric vehicles – If you are considering buying an electric vehicle, the House bill would eliminate the $7,500 federal tax credit, while the Senate bill would continue to allow the credit. To be safe, you may consider buying that vehicle in 2017.
- Sale of your principal residence – Under current law, taxpayers who own and use their house as their principal residence for 2 out of the 5 years before the sale will qualify to exempt $500,000 of their gain if married filing jointly or $250,000 if single. Under the House and Senate bills, the exemptions for gain only exist if the house is used as the principal residence for 5 out of the previous 8 years.
- Alimony payments – Under the House bill, effective for divorce decrees or agreements entered into after 2017, alimony payments would not be deductible to the payor and would not be taxable income to the recipient. Depending on whether you are the payor or the payee, this may compel you to attempt to finalize the divorce in 2017 or to defer it until 2018.
- Moving expenses – Both bills would eliminate the deduction for moving expenses after 2017.
- Standard deductions – Both bills are similar in that they would raise the standard deduction to approximately $12,000 for single taxpayers and $24,000 for married taxpayers filing jointly (although the Senate bill has this expiring in 2026).
- Personal exemptions – Both bills would eliminate all personal exemptions.
- Section 179 and depreciation changes – Both bills would increase the ability to immediately write-off capital investments, rather than expensing them over years via depreciation. The House bill would push the annual limit of 179 expenses to $5 million, while the Senate would limit the 179 deduction to an annual amount of $1 million. Depreciation lives would generally be shortened under both bills.
- Corporate tax rates – both bills would cut the corporate tax rate (for “C” corporations) to 20%, but the House would make this effective in 2018, while the Senate would push this to 2019.
- Business owners – Due to an anticipated cut in tax rates for corporations and individuals, if your business is on the cash basis, consider pushing off billings to your customers until late in December or into January, so that the cash payments are not received until 2018. If your business is on the accrual basis, you may be able to postpone completion or deliveries until 2018 and thereby push the taxable income into 2018.
- AMT for corporations – The House bill would eliminate AMT for corporations. The Senate bill would keep the corporate AMT as it presently exists.
- Net operating losses (“NOLs”) – Both bills would eliminate the carryback provisions for NOLs, although both bills would allow NOLs to be carried forward to future years. Both bills would also introduce a cap as to the amount of taxable income that an NOL could offset in a given year.
- Cash-basis of accounting – Both bills would increase the gross revenue limits on the businesses that are allowed to use cash-based accounting. The House would allow business with $25 million of income to be cash-based, while the Senate bill would allow up to $15 million of income.
- Research & development credit – Bear in mind that the R&D credit was just recently made permanent for the 2016 tax year. The Senate shows us again what “permanent” means in Washington, as the Senate bill would eliminate the R&D credit.
ESTATE, TRUST, AND GIFT TAXES:
- Estate taxes – The House bill would repeal the estate tax after January 1, 2025; until then, the exclusion amount is effectively doubled from current levels to $10 million per person, and is adjusted for inflation. The Senate version would double the exclusion to $10 million, adjusted for inflation, but then would return the exclusion to $5 million per individual in the year 2026.
- Generation-skipping taxes – This effects any inheritance a taxpayer might leave to grandchildren. The House bill would eliminate the GST on January 1, 2025; until then, the GST exemption amount is doubled from current levels to $10 million per individual, adjusted for inflation. The Senate bill would double the exemption to $10 million, adjusted for inflation, but then would return the exemption to $5 million per individual in the year 2026.
- Gift tax – The gift tax would stay in effect in both bills, with both bills doubling the exclusion to $10 million per individual (adjusted for inflation), but the Senate bill would return the exclusion amount to $5 million in the year 2026.
- Cost basis of stock – The House bill contains no change in how investors would track and allocate their stock basis in the event of a sale; the Senate bill would require that the shares acquired first would be the first to be sold, thus eliminating an investor’s ability to pick and choose which lots of shares (high cost per share or low cost per share) that are being sold.
- Investment fees – The House bill would parallel current law, so that investment fees would be deductible if they exceed 2% of a taxpayer’s adjusted gross income. The Senate bill would eliminate this deduction entirely, until the year 2026.
- Like-kind exchanges – Under both bills, like-kind exchanges would only be allowed for real property; personal property would not be eligible.
- 529 plans – Currently, 529 plans allow for funds to be saved and used for qualified higher education expenses (think college). Both bills would expand the usage to K-12 expenses, with a $10,000 annual per beneficiary limit. The Senate bill would also include the ability to use the funds for home-schooling.