Year-End Tax Strategies…Maybe?

Tax planning concept

Year-End Tax Strategies…Maybe?

 Neal Price, CPA, CFA®, CFP®, Principal

November 29, 2017

Last year at this time, we wrote that a Republican Administration and Congress would likely lead to some sort of tax reform. We expected that ordinary income tax rates would fall in 2017 and beyond, and that it made sense to consider accelerating deductions and other ways to reduce income in 2016.

Well, the idea was right, but here we are with just a month left in the year with little clarity regarding what will happen.

The House and Senate have each drafted tax legislation, and while there are many provisions that still need work, there is enough similarity between the bills that some year-end tax moves may be prudent.

As of this writing, there is a flurry of activity, in an effort to get a bill passed by the Senate. If that effort is successful, the House and Senate bills will have to go through a reconciliation process in hopes of negotiating a mutually agreeable package that can be signed into law, all by year-end or sooner.

It is important to note that passage (and the effective date) of any type of legislation is far from certain. So as is the case with all tax-related matters, we urge you to consult your tax advisor before implementing any strategies. (In particular, please note that we have not considered the impact of the Alternative Minimum Tax–which may go away in future years–on the ideas below.)

The general theme of our note last year was accelerating deductions into 2016 to get the benefit from the current tax rates, rather than taking deductions at what we expected to be lower rates in 2017 and beyond. While that still holds today, we see an even greater opportunity to side-step some of the proposed changes to deductions.

While “simplification” is one goal of the proposed legislation, the significance of the changes will do anything but simplify things as we all transition from the current system of income and deductions to the proposed–if it even happens.

Defer Income to Future Years

If tax rates are lower in the future, then pushing income into 2018 and beyond may be helpful. If you have a business or profession that allows some flexibility around when to recognize income, moving that income into a year where your tax rate is lower may be beneficial.

Prepay State Income Taxes

One provision of both bills is to eliminate the deduction for state and local income taxes. So if you make estimated tax payments at the state level, consider paying the 4th quarter state estimated income tax payment prior to year-end. That’s just two weeks or so before they’re due January 16, 2018, but it can make a huge difference in the tax benefit you get on your federal tax return.

Prepay Property Taxes

Another provision of the House tax bill is to limit the deduction for property taxes to $10,000 per year. Under the Senate version, this deduction is eliminated entirely.

So if you live in an area with high property taxes, this can be a significant change. Fortunately, many counties allow prepayment of these taxes, meaning you may be able to pay some or all of next year’s property taxes now.

While the process can be a bit tricky and is different from one jurisdiction to the next, we think it’s worthwhile. Consider a homeowner with a $20,000 annual property tax bill who is in a 35% marginal tax bracket. By paying the full 2018 taxes before the end of this year, the homeowner would get a $20,000 deduction, instead of being limited to just $10,000 next year (under the House bill). At a tax rate of 35%, that creates an immediate and permanent tax benefit of $3,500. And under the Senate bill, the tax benefit from paying today would be double, or $7,000.

For our Illinois-based clients who live in Cook or Lake County, please see our article How to Prepay Your Property Taxes.

If you live elsewhere, try searching online for “how to prepay {name of county / state} real estate taxes,” or give us a call.

Accelerate Charitable Contributions

While there are no changes to the charitable contribution deduction, both tax bills include a significant increase in the standard deduction. This, coupled with the possibility of eliminating or limiting deductions such as medical expenses, state and local taxes and property taxes, means that many taxpayers will no longer itemize deductions. If this applies to your situation, you may benefit significantly by lumping a few years of charitable deductions into this year, before the changes take effect and while you still itemize.

Even if you don’t necessarily want to make gifts to charities today, it may be wise to open a Donor Advised Fund. This allows you to take a tax deduction today for the value of the contribution, and then distribute funds over time (maybe a period of many years). Last year, many of our clients took advantage of creating or adding to existing Donor Advised Funds, and we expect more to do so this year.

Gift Appreciated Securities to Charities

We think that it’s always wise to consider making sizable charitable contributions using appreciated securities (those held for longer than one year). You’ll get a tax deduction for the value of the property contributed and avoid paying taxes on the gain. Even if it’s something you still want to own, it often makes sense to gift the securities and immediately repurchase it with cash, which effectively steps-up the basis and minimizes future tax gains.

Admittedly, there’s nothing new about this strategy and we use appreciated securities to fund direct donations as well as funding Donor Advised Funds. But given that the stock market is at historic highs, it’s a prudent reminder to take advantage of this idea.

One thing that is new is a provision in the Senate bill that would eliminate the ability to  pick tax lots when selling or donating securities, and instead require investors to use their oldest holding or an average cost basis (depending on the type of security). This small change makes a big difference in our ability to do tax planning.  If this change is enacted, it makes donating appreciated securities slightly less attractive since we will no longer be able to choose which tax lot to use.

While this change will mostly affect how we manage portfolio changes in the future, it’s another piece of the puzzle that suggests taking advantage of funding Donor Advised Funds with appreciated securities now.

What to Do Now

If any of the above ideas might apply to your situation, please talk with us and your tax advisor soon. Some of these strategies – like prepaying property taxes, setting up a Donor Advised Fund and gifting appreciated securities – have to be done before December 31st and take time to implement. We urge you to act now and avoid the risk of not getting things done in time.

As we noted at the start, we can’t be certain that any legislation will actually pass and be implemented. But even if nothing happens, for many taxpayers there’s no significant downside to pursuing these ideas. We believe there may be a chance for real savings for certain clients, but as with all planning, each individual’s situation is unique.

As always, we would welcome the opportunity to discuss your situation and answer any questions you may have.


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