On November 2, 2017, Congress released full details of 2018 tax reform proposals. Summary version found here. Previously we had a skeleton (or less) version of the proposed tax changes. The majority of that outline remains intact.
It is expected that this bill will be pushed through the house quickly with an expectation that by mid-December it is signed into law. Once signed into law a significant amount of tax benefits we have now will be repealed.
Important to note is that the details we see today are NOT law. It is a solid framework of what to expect when tax reform does become law. You should expect that some of these proposals are negotiation tools.
When whatever version of tax reform becomes law you will have to react quickly to implement the proper strategies by year-end.
Establishing an “if this, then that” scenario analysis for your deductions is advised. If you wait to understand the rules and implement the strategies in mid to late December, you might not have time.
To help you, I outlined some of the anticipated changes for 2018 along with suggested actions to take prior to December 31, 2017. My focus is on you as an individual taxpayer. I will complete a similar outline for entrepreneurs later.
Remember, filing a tax return is recording history. If you do not take action or take the incorrect action there are rarely second chances available to pay less tax.
Prior to implementing any of these suggestions below, I suggest talking to a qualified tax advisor.
One good reason to talk to a tax advisor is that there are certain taxpayers who be in a higher marginal tax bracket in 2018. Below is a chart that is compliments of Michael Kitces:
Are you in a red zone? If you are then are a taxpayer in a higher tax bracket under the new law. Your deductions might be worth more in 2018 than 2017. Your deductions might be worth nothing in 2018 and/or 2017. It is not straightforward for everybody.
Important to note is that the tax proposal eliminates the Alternative Minimum Tax (AMT). Hooray! Although, that’s more reason for an “if this, then that” analysis by year-end.
The 2018 standard deduction would increase to $12,000 for single and $24,000 for married filing jointly.
There are significant changes to a few popular itemized deductions:
- State and Local Income taxes are repealed
- Real property taxes are capped at $10,000
- Medical expense deduction is eliminated
- Some 2% of AGI deductions are eliminated
The combination of these changes and the higher standard deduction makes the itemized deduction extinct for many of you.
There is a high probability that you will benefit from accelerating these deductions into 2017. Below I will address those strategies for the various itemized deduction categories.
Contribute to a Donor-Advised Fund
If you took my advice earlier in the year, you would have opened and contributed to a Donor Advised Fund (DAF).
In general, you will benefit from a DAF by accelerating multiple years’ worth of charitable contributions.
EXAMPLE: You donate $5,000 a year to various charities. In 2017 you donate $50,000 to a DAF. For the next 10 years, you trickle out $5,000 a year to each charity through the use of a DAF. You receive a deduction for the full $50,000 in 2017 while meeting your charitable goal for the next 10 years.
It’s possible you’re a heavy donor and see no problem exceeding the new standard deductions. In this case, there is good news.
Under current law, annual donations are limited to 50% of AGI. Going forward, this limit is increased to 60% of AGI. The 5-year carryforward remains in effect for unused amounts.
Bunching charitable contributions or donating appreciated stock might become the new norm in future years. This might not be the last time you use a DAF.
Pay State Income Taxes
Starting in 2018, state income taxes will no longer be deductible. Pay your 4th quarter estimate or consider pre-paying 100% of your anticipated state income tax liability by year-end.
The downside of paying your state income taxes in 2017 is that you may lose the benefit to AMT.
Maybe it’s time to move to a no income tax state?
Prepay personal residence and/or vacation real estate taxes in excess of $10,000
While state income taxes are gone, you can still deduct your real property taxes (i.e. personal residence and vacation home). Personal property taxes are no longer deductible.
However, real property taxes will be limited to $10,000 under the new law.
If your real property taxes exceed $10,000 then it seems obvious to accelerate payments into 2017. Yet, if you do this, you could lose the benefit to AMT just like with state income taxes.
Watch your Medical Expenses
Under current law, medical expenses are deductible as itemized deductions to the extent expenses exceed 10% of AGI. This threshold made it hard for many to receive a tax benefit. For those unfortunate enough to exceed that threshold, the tax benefit is no longer available.
If you exceed the limit in 2017 then considering paying any outstanding bills prior to year-end.
Unreimbursed Employee Expenses and Tax Prep Fees
If you’re waiting to pay your tax preparation fees or pay for unreimbursed business expenses… don’t. These deductions are gone under the new law.
Interesting enough, investment management fees are still deductible under the new law. Problem is, actually receiving a tax benefit will be more difficult. Exceeding 2% of AGI and the higher standard deduction when there are limited real property taxes and no state income taxes will prove difficult for most.
Reduction in deductible mortgage interest
There was a lot of talk about a repeal of the mortgage interest deduction. It’s an expensive tax benefit for the Federal government, but in the end, it will be kept around.
Although, at a limited level.
The mortgage interest deduction will be permitted on the first $500,000 of mortgage debt versus $1,000,000 of today. Mortgage debt is defined as debt on your primary residence and only on “acquisition indebtedness.” Acquisition indebtedness is debt borrowing to acquire, build, or substantially improve that primary residence.
What is eliminated is “home equity indebtedness” (mortgage debt used for any purpose besides acquiring, building, or substantially improving the primary residence).
Unlike the rest of the proposal, this is to be effective “immediately”, as of November 2nd of 2017, if it ultimately passes into law. This means any remaining interest payment made on home equity indebtedness through the end of the year is NOT deductible. Earlier payments are deductible.
It might be time to reconsider your payback strategy with your home equity indebtedness. The after-tax rate of the loan may no longer be the best use of your money.
Don’t be too worried because out of fairness any acquisition indebtedness up to $1,000,000 prior to November 2, 2017, are grandfathered.
Refinancing pre-November 2nd acquisition indebtedness remains deductible as long as the refinance does not increase the debt balance above the remaining acquisition indebtedness balance at the time.
Because mortgage interest is typically paid in arrears you might be able to pay your January mortgage interest before year-end to receive the deduction now. Rather than 12 payments in 2017, you could have 13.
Buy your Plug-In Electric Vehicle
December 31, 2017, is your last chance to receive the $7,500 tax credit.
Last Chance for Live and Flip
I considered saving this for the entrepreneur article but it’s worth showing it here.
Under current law, if you make a house your primary residence for 2 out of 5 years you can sell the house and use the $250,000 single or $500,000 married exemption to offset profit on the sale.
This created an incentive for individuals to buy a fixer-upper, live in it, fix it, and sell it. Doing this potentially every two years. It was a great way to make significant tax-free income.
Over concerns that this rule was being abused, Congress put a stop to this by changing the rules on using the primary residence exemption to be 5 out of 8 years. Adding another hurdle, the exemption can only be used once every 5 years!
This is also trouble for those who would turn a rental property into their personal residence for two years. Ultimately selling the property under the primary residence exclusion leading to the majority of appreciation tax exempt.
Another note is that married couples with AGI in excess of $500,000 will see this exclusion phase out by $1 for every $2. Single taxpayers can use $250,000 of AGI prior to phase-outs.
Is there time to sell your highly appreciated property by year-end?
Cash in Series EE or I savings bonds for college expenses
If you have Series EE or I savings bonds with the intention to pay for your or your child’s college expenses cash them in now. Your ability for tax-free interest when used for college expenses is repealed.
Extra payment on your Student Loan
If your student loan interest is paid in arrears then you might be able to pay your January payment and receive a deduction before this tax benefit goes away in 2018.
There are plenty of deductions worth accelerating into 2017. If you start piling up these deductions now, then you could benefit from matching these deductions with income.
Primarily through a Roth Conversion.
If you need more convincing prior to accelerating income into 2017 through a Roth Conversion, consider this. There is a lot of discussions that the current stretch IRA rules that allow you to draw down an inherited IRA over your life will be changed to a required 5-year drawdown.
This would mean that an IRA you leave to your family could be cut in half by income taxes. It will be a great revenue booster and negotiation tool.
In addition all of these reasons, it could literally add years to the life of your nest egg.
Last Chance for Roth Recharacterizations
One of my favorite rules is being eliminated. Under the old law, you could convert funds to a Roth IRA, and wait until October 15th the following year to recharacterize the funds.
This was a perfect strategy for taking advantage of the investment’s appreciation or depreciation. It also took the pressure off being “perfect” in your calculation of the conversion. Effective tax year 2018 this strategy will be eliminated.
Essentially this means that a Roth Conversion is irrevocable once made. Putting more pressure on calculating the correct amount to convert.
If you plan on converting funds in January 2018 then keep this in mind. If you want to have fun with the recharacterization for one last time then 2017 is your year.
To Roth or not to Roth
Knowing you can’t recharacterize your Roth contribution will we be forced to wait until the contribution deadline to fund your Roth?
If you end up exceeding the income threshold to contribute to a Roth IRA you can no longer recharacterize these funds to a Traditional IRA. Yes, you can withdraw the excess contribution, but you could end up with $0 contributed to an IRA if your income exceeds the threshold, and the time to contribute to a Traditional IRA ends.
Keep this in mind if you have automatic transfers to a Roth IRA going into 2018.
On another note, the backdoor Roth contribution rules remained intact.
Tax Loss Harvesting
Probably the most interesting part of the tax proposal is that the capital gains tax bracket will remain the same as the old system. This creates an interesting dynamic of tax bracket management that will need to be reviewed.
In fact, there is a bit of a crossover where short-term capital gains could be at a lower tax rate than the long-term capital gain rate due to the differences in brackets. I suspect this will be revised before final.
Tax loss harvesting could play a powerful role in managing your bracket in 2017 versus 2018. Many of your will be in a lower tax bracket tomorrow than you will today. The math on that is easy… harvest the loss today.
Plan on managing the 3.8% Medicare surcharge. All signs point towards this sticking around until health care is addressed.
Private Activity Bond Investments
Private activity bonds will no longer be tax-exempt.
You should always make the right investment decision first. Then find the most tax efficient way to do it.
If private activity bonds are no longer tax-exempt, is there a better investment available?
Sell your ISO’s
When exercising ISO’s it throws you into AMT. When you sell the stock, you get a tax credit for the AMT you paid.
With AMT being eliminated in 2018 there is potential that your AMT carryovers are eliminated with it. This means you would incur capital gains but you would have no credit offsetting the tax. Fortunately, under the current proposal, this is addressed and you could use your carryovers. However, this is a negotiation tool to watch.
I suspect this list will be added to and revised in the coming days after taking time to digest some of the new proposals. Stay tuned for updates and revisions.
Coming later in the week, I am putting together a similar list for entrepreneurs.
Do you want to understand how to make your money work for you and keep more of what you have earned?
Disclaimer: This article is provided for general information and illustration purposes only. Nothing contained in the material constitutes tax advice, a recommendation for purchase or sale of any security, or investment advisory services. I encourage you to consult a financial planner, accountant, and/or legal counsel for advice specific to your situation. Reproduction of this material is prohibited without written permission from Nate Byers a Madison, WI CPA Financial Advisor, and all rights are reserved. Read the full Disclaimer in the footer below.