Year-end tax planning can provide most taxpayers with a good way to lower a tax bill that will otherwise be waiting for them when they file their 2017 tax return in 2018. Since tax liability is primarily keyed to each calendar tax year, once December 31, 2017 passes, your 2017 tax liability for the most part, good or bad, will mostly be set in stone.
Year-end 2017 presents a unique set of challenges for many taxpayers because of current efforts by Congress and the Trump Administration to enact tax reform legislation, the scope of which has not been seen since 1986, according to supporters. Whether this ambitious plan will be successful by the end of this year remains uncertain; but the reasons to prepare to maximize any benefits if it does happen are indisputable. Both talk of lower tax rates, and fewer deductions, requires careful monitoring at this time, with “contingency” plans ready to go before year-end should these changes occur retroactively to January 1, 2017, or starting in 2018, either immediately or under phased-in schedules.
Tax reform, although important, is not the only reason to engage in year-end tax planning this year. Other changes in the tax law, made by the IRS and the courts, have already taken place in 2017. Opportunities and pitfalls within these recent changes–as they impact each taxpayer’s unique situation—should not be overlooked. This particularly rings true as we approach year-end 2017.
Year-end planning, with or without the prospect of tax reform, should start with data collection and a review of prior year returns. This includes losses or other carryovers, estimated tax installments, and items that were unusual. Conversations about next year should include discussions of any plans for significant purchases or dispositions, as well as any possible life cycle events.
Income tax rates
One of the most significant factors in tax planning for individuals is their tax bracket. The most direct control taxpayers have over their tax bracket rests in their ability to control the timing of income and deductible expenses. For example, taxpayers who expect to be in a lower tax bracket in 2018 should consider deferring income to 2018 and accelerating deductions into 2017. Also relevant are “tax reform” proposals that may compress tax brackets and lower tax rates. These changes could present year-end tax planning opportunities for taxpayers depending on when any proposed rate changes under tax reform go into effect.
Taxpayers holding investments, whether in the form of securities, real estate, collectibles, or other assets, often have an opportunity to reduce their overall tax bill by some strategic buying, selling, or exchanging for like-kind property toward the end of the year. Especially balancing tax considerations with other factors is part of the challenge in dealing with investments, including: the ordinary income tax rates, the net investment income tax rate, the capital gain rates, and the alternative minimum tax (AMT).
Capital gains and losses
As an economic incentive for individuals to save and invest, gains from the sale of capital assets held for more than one year unless offset by losses, as well qualified dividends received during the year, may be taxed at rates lower than ordinary income tax rates. Most types of nonbusiness property used for personal or investment reasons, such as stocks and bonds, are capital assets. The tax rate on long-term capital gains and qualified dividends for individuals is 20 percent, 15, percent, or 0 percent depending on their income tax bracket. Those rates may or may not be revised under tax reform.
Generally, taxpayers must offset their capital gains with capital losses before applying the tax rates. Thus, cashing out stock and bonds with a built-in loss (called “harvesting losses”) can be a simple means of providing a loss to be taken against capital gains and, to a lesser extent, other income. If capital losses exceed capital gains for the year, individuals are only allowed to deduct up to $3,000 of the losses, whether net long-term or short-term capital, gain against ordinary income. Any net capital losses above $3,000 must be carried over and deducted in subsequent years. In realizing losses, however, investors should be careful not to be trapped by the “wash sale” rules that prevent taxpayers from claiming any loss from these types of transactions if they acquire substantially identical stock or securities within 30 days before or after the sale.
Certain items are deductible only to the extent they exceed an adjusted gross income (AGI) floor; for example, aggregate miscellaneous itemized deductions are deductible only to the extent they exceed two percent of the taxpayer’s AGI. Thus, year-end and new-year tax planning might consider ways to bunch AGI-sensitive expenditures in a single year, so that particular deductions exceed their applicable floors and the taxpayer’s total itemized deductions exceed the standard deduction.
External influences such as changes in the tax law, however, may be only part of the reason for taking some action before year’s end. Changes in your personal and financial circumstances, such as marriage, divorce, a newborn, a change in employment, a new business venture, investment successes and downturns, may require a change-in-course tax-wise since last year. As with any “life-cycle” change, your tax return for this year may look entirely different from what it looked like for 2016. Accounting for that difference now, before year-end 2017 closes, should be an integral part of your year-end planning.
The last few months of the year also provide an important “last chance” to change the final course of your businesses tax year before it closes for good. For the 2017 tax year, many businesses are looking for clarity with respect to available credits and deductions. With the exception of a handful of industry specific tax credits and deductions that expired at the end of 2016, most previously temporary credits and deductions were permanently extended by the Protecting Americans from Tax Hikes Act of 2015 (PATH Act). A few others were extended for 5 years through 2019. The final scope of tax reform legislation if enacted, however, remains tentative at this time. At a minimum, tax reform legislation is expected to result in a reduction of corporate and individual tax rates. Further, all businesses should be aware of “full expensing” under proposed tax reform that will be equivalent to 100 percent bonus depreciation. Even if this measure is now passed, however, businesses should be aware that bonus depreciation under current law drops from 50 percent to 40 percent after the 2017 tax year ends.
New 25 percent “pass-through” rate
Also critically important for small business owners is a proposed maximum 25 percent tax rate on business income passed through from sole proprietorships, partnerships and S corporations. Administration officials have promised to consider rules that would prevent pass-through owners from converting their compensation income taxed at higher rates into profits taxed at the 25 percent level, particularly service providers, such as accountants, doctors, lawyers, etc. Nevertheless, this potential opportunity should be watch carefully by all small businesses as year-end approaches. And some business owners who may not qualify for the 25 percent rate might also consider incorporation if a proposed 20 percent corporate income tax rate is enacted.
Effective year-end tax planning by its nature requires the correct execution of specific timing rules under the tax code. Due especially to the current uncertainties surrounding tax reform, taxpayers must be particularly nimble and prepared to implement timing strategies well into December.
- For businesses, the IRS and the courts generally require use of the accrual method whenever inventories are used. For an accrual-basis taxpayer, the right to receive income, rather than actual receipt, determines the year of inclusion in income.
- Under the cash receipts and disbursements method (cash method), all items constituting income, whether in the form of cash, property, or services, must generally be included in income for the tax year in which the items are actually or constructively received; and deductions are generally taken into account for the tax year in which actually paid.
The cash method, which is required to be used by almost all individual taxpayers, generally allows a cash-basis taxpayer to exercise some control over the year of income or deduction by accelerating or deferring receipts and payments. Thus, timing, and the skilled use of timing rules to accelerate and defer certain income or deductions, is the linchpin of year-end tax planning. For example, timing year-end bonuses or year-end tax payments, or timing sales of investment properties to maximize capital gains benefits should be considered. So, too, sometimes fairly sophisticated “like-kind exchange,”installment sale” or “placed in service” rules for business or investment properties come into play. In other situations, however, implementation of more basic concepts are just as useful. For example, taxpayers can write a check or can charge an item by credit card and treat these actions as payments. It often does not matter for tax purposes when the recipient receives a check mailed by the payor, when a bank honors the check, or when the taxpayer pays the credit card bill, as long as done or delivered “in due course.”
Please feel free to call our offices if you have any questions about how year-end tax planning might help you maximize your tax savings. Our tax laws operate largely within the confines of “the taxable year.” Once 2017 is over, tax savings that are specific to this year may be gone forever.