Year End Tax Planning for Individuals
Year-end 2017 tax planning presents a unique set of challenges. Uncertainty exists regarding proposed tax reform legislation — uncertainty related to the changes themselves, as well as their timing. Will changes come into play for tax year 2018, or will they be retroactive to 2017?
What we do know is that essentially the only real change between tax rules for 2016 and 2017 is the inflation adjustments to various items that we generally see every year. Tax brackets, the standard deduction, retirement plan contributions and income limitations will be slightly increased for 2017. However, while tax reform hasn’t happened yet, there are still some strategies to save tax dollars before the end of 2017.
Speed up deductions, Defer income:
If possible, paying your mortgage and state income taxes due in January by December 31 is one way to increase your 2017 deductions. If you expect to owe state and local income taxes when you file your return next year, consider asking your employer to increase withholding before year-end or pay 4th quarter estimate(s) in December to pull those deductions into 2017. Another reason to pay your 2018 state income tax bill early: The deduction for state and local taxes is in jeopardy. Congress would like to eliminate or reduce the deduction. If the proposal by current leaders to double the size of the standard deduction comes to realization, this could be the last year that many taxpayers benefit from itemizing.
One very important note to make concerning accelerating your deductions: If you’re subject to the alternative minimum tax, you don’t benefit from deducting state and local taxes. Many deductions allowed for purposes of calculating regular taxes are disallowed for AMT purposes including state income taxes, state property taxes, miscellaneous deductions, and personal exemptions. If you believe you will be subject to AMT for 2017, these types of deductions should not be accelerated.
Parents of college students may want to pay tuition bills due in January before December 31 so they can take full advantage of the American Opportunity tax credit. The credit is worth up to 100% of the first $2,000 spent on qualifying expenses and 25% on the next $2,000, up to a maximum of $2,500 for each qualifying student. Married couples filing jointly with modified adjusted gross income (MAGI) of up to $160,000 can claim the full credit; those with MAGI of up to $180,000 can claim a partial amount.
If you become eligible in December to make health savings account (HSA) contributions, you can make a full year’s worth of deductible HSA contributions for 2017.
Deferring income until 2018 might be another smart strategy because the income may be taxed at a lower rate if the tax brackets change for 2018. Self-employed taxpayers can send invoices to customers in late December to defer payments until next year. If you expect to receive a bonus, ask your employer to hold off on paying it until January. Keep in mind, though, that if your employer has already announced that it will pay bonuses in December, if the check is issued in December it’s taxable income for 2017, even if you wait until next year to cash the check.
Charitable giving:
Consider making charitable contributions before Dec. 31. Giving appreciated stock (a stock whose value exceeds its cost basis) can offer a greater benefit than giving cash, since it will eliminate the capital gain. For example, if you own a stock that was purchased years ago at a very low cost, and its value has grown over the years, if you sell the stock, you’ll need to report and pay tax on the capital gain, which could be substantial. However, donating the stock to a qualified charity eliminates the capital gain and provides a tax deduction for the current fair market value of the stock on the date of the donation. Just keep in mind that donations of appreciated stock are limited to 30 percent of adjusted gross income versus the 50 percent limitation for cash donations. Any excess deduction may be carried forward to the next tax year.
Making qualified charitable distributions (QCD) from your IRA is another opportunity for those who qualify. The benefit of doing a QCD to fulfill your IRA required minimum distribution (RMD) obligation is that your RMD is excluded from your income altogether. The requirements for donating all or a portion of your IRA RMD include:
- IRA owner must be age 70 and a half or older.
- Charitable distribution must be made from a traditional IRA or ROTH IRA.
- $100,000 annual limit per taxpayer.
- QDC must be made directly from the trustee of your IRA to a qualified public charity. The check cannot be made payable to the IRA Owner, private foundation or donor advised fund.
Maximize your 2017 retirement contributions:
If you participate in an employer-sponsored 401K plan, you should contribute at least enough to realize any potential “employer match.” Also consider increasing your deferral contribution for your last few paychecks of 2017 to maximize your tax savings.
Capital gains and losses and qualified dividends
Look for any potential capital loss positions in your portfolio to offset any realized capital gains before year-end. After netting total realized capital losses against realized capital gains, you can deduct a maximum of $3,000 of capital losses against earned or other types of income for the same year. Any capital losses exceeding $3,000 may be carried forward to be used against future realized capital gains.
Something to keep in mind if you have potential capital gains is a zero percent long-term capital gain tax rate for taxpayers in the 15% or less federal tax bracket. In 2017, that applies to married filers with taxable income up to $75,900 and single filers with taxable income up to $37,950.
For the same taxpayers in the 15% or less federal tax bracket, this zero percent rate also applies to qualified dividends (generally dividends on U.S. individual stocks owned for more than the 60-day holding period). However, it does not pertain to non-qualified dividends (i.e., dividends on some mutual funds, REITS, MLPs and employee stock options). Non-qualified dividends are taxed the same as ordinary income.
For those taxpayers who pay tax rates greater than 15 percent and less than 39.6 percent, you can still take advantage of the lower rate on long-term capital gains and qualified dividends. While the tax rate qualified dividends and long-term capital gains is capped at 20 percent for taxpayers in the 39.6 percent tax bracket, keep in mind that you may be subject to the 3.8 percent surtax on net investment income if your adjusted gross income is more than $200,000 (single filers) and $250,000 (married filers).
Pending tax reform opportunities:
The likelihood of comprehensive tax reform is high. Tax reform will most likely bring lower tax rates and greater limitations on deductions. Now is the time to consider deferring income to 2018, if possible. Also consider accelerating deductions to 2017 as they will be worth more at 2017’s higher tax rates.
While the outlook for tax reform is still uncertain, this appears clear: Tax rates are unlikely to go up in 2018, and there’s a good chance that they’ll go down for most taxpayers. That makes some year-end tax strategies even more attractive this year than they’ve been in the past.
We will continue to monitor any potential tax reform, and publish an update if/when anything is signed into law. Please contact us with any year-end tax planning questions. You can contact me directly at 952-476-7109 or victoria_elliott@copelandbuhl.com.