The tax bill has been passed by Congress and is expected to be signed by the President later this week. Throughout this process, we have been continually asked what year-end planning clients should consider in light of the bill. Unfortunately, there is no easy answer. The tax bill is largely aimed at corporate income tax reform with some provisions targeted towards individuals. Most individual taxpayers will experience modest changes in their overall income tax bill and whether they pay more or less will depend on the type and amount of their income and deductions, though most will experience a reduced tax liability for the next few years.
Highlights of the Tax Changes for Individuals
Individual Income Tax Rates – Below are some of the tax rate changes under the bill:
Capital Gains – There are no changes except for an adjustment of the brackets to coincide with the changes to the regular tax rates. The Net Investment Income tax of 3.8% is still applicable for investment income over $200,000 for individuals and $250,000 for couples filing married filing jointly.
Alternative Minimum Tax – Exemption increases to $109,400 from $86,200 and the phase-out will begin at $1,000,000 rather than $164,100 for married filing jointly.
Standard Deduction – Deduction is increased to $24,000 for a couple and $12,000 for singles.
Property Taxes, State and Local Income Tax and Sales Tax – The combined itemized deduction for all these types of taxes is limited to $10,000.
Mortgage Interest Deduction – Existing mortgages are grandfathered, but the deductible mortgage interest paid on new loans is limited to balances up to $750,000 for couples. Also, going forward taxpayers are limited to two qualified residences and there is no deduction for home equity loan interest.
Charitable Contributions – Largely unchanged, but there is an increased limitation on cash contributions to public charities from 50% of AGI to 60% of AGI. Additionally, contributions to colleges and universities for athletic event seating priority are no longer deductible.
Miscellaneous Itemized Deductions – These deductions have been repealed.
Estate and Gift Taxes – The exemption for Estate, Gift and Generation-Skipping Transfer Taxes has doubled to $11.2M per person. The tax rate of 40% remains unchanged.
Pass-through Income – Permits a deduction equal to 20% of “domestic qualified business income”. Generally, the deduction will be permitted for pass-through business income that is not related to a professional service type business.
Sunset Provisions – The individual changes to the tax law are scheduled to sunset, or revert back to the current law, after December 31, 2025.
How to Plan for Year-end
Since we now know the details of the final bill, what actions should you consider before year-end? Below is a list of items to consider, but be mindful that none should be implemented without a tax projection performed by your CPA.
With the increased standard deduction and limitations on the deductibility of property, state income and sales taxes, the number of individual taxpayers electing to itemize their deductions is expected to fall from around 30% in 2017 to 5% in 2018. Accordingly, many taxpayers who currently itemize will benefit from accelerating state income tax and property tax payments into 2017 as well as making large purchases subject to sales taxes and making charitable contributions this year. Accelerating these deductions may not only increase the permissible deduction but also increase the value of the deduction to the extent a taxpayer’s effective rate decreases under the new tax act.
A unique charitable contribution to consider before year-end is related to donations for preferred seating at college and university athletic events. Contributions to colleges and universities for athletic event seating priority are no longer deductible. Most colleges and universities are allowing donors to pre-pay these donations for future years prior to 12/31/2017. If you are currently making a preferred seating donation, consider contacting the school to inquire about pre-payment options.
One caveat that must be considered on accelerating these payments is the impact they might have on the Alternative Minimum Tax (“AMT”) liability of the taxpayer. Under current law, the ultimate tax benefit may be limited by the amount of AMT paid by the taxpayer and this can only be determined by running a tax projection.
Overall, income tax rates for individuals are decreasing. To the extent a taxpayer has the ability to change the timing of a bonus or exercise of a stock option, an analysis should be done by your CPA to determine if there is a benefit under the tax proposals to defer income to 2018.
Another variable in analyzing whether to change the timing of income recognition is the pass-through taxation proposals. These provisions are intended to give small businesses organized as sole proprietorships or pass-through entities tax breaks similar to corporations. The types of businesses that will benefit from these provisions are limited. To the extent a business has the ability to determine the timing of income recognition or expense, they might consider deferring the income and going ahead with the expense. This would push income to a potentially lower tax year and keep the deduction in a higher tax year lowering the overall tax rate. Again, you must consult your CPA before taking these steps since each situation is unique and might not result in the desired benefit.
The exemption amount for gift, estate and generation-skipping transfer taxes is going to increase from $5,600,000 to $11,200,000 (for 2018) per person. Because of this large increase, taxpayers should generally not make taxable gifts during 2017 since the tax can be reduced or eliminated by waiting until 2018. This will not impact annual exclusion ($14,000 for 2017 and $15,000 for 2018) gifting plans.