Congress has voted to pass a major rewrite to the tax code that the President will soon sign into law. The complex nature and late timing of the bill make year-end strategic decisions difficult to evaluate. You may want to connect with your tax-preparer to ask if there are any tactics specific to your situation that come to mind that could be accomplished on short notice. If you do receive advice, or have a plan in mind from an outside source, be sure to inquire about pros and cons of any decision, in particular if large dollar amounts are involved. Keep in mind that some proposed changes that were originally in the act were removed at the last minute, while other topics that had not been discussed were unexpectedly included. In the near term, these are highlights of provisions that may be relevant for your plans.
A number of allowable itemized deductions are going away starting with the 2018 tax year. In particular, there will be a cap on state and local tax deductions for $10,000 total. The law appears to limit the ability to prepay 2018 state income tax before 2017 year-end just to obtain the Federal deduction. It is still possible to pay 4th quarter state tax estimates by December 31st to obtain the deduction this year, rather than waiting to make the payment in January of 2018. One may also be able to pay 2018 property taxes in advance, if the local authority permits and one does not escrow payments with a mortgage. Note that these items are adjustments for the alternative minimum tax (AMT) under current law, which means lumping any extra payments into 2017 may result in little or no tax benefit if they trigger AMT or you are already in AMT.
Change in Tax Brackets and Tax Rates
While filers are likely to lose itemized deductions, resulting in higher taxable income, that income will be taxed within new brackets and rates that are generally beneficially. For most taxpayers, the new figures will produce a small reduction in marginal tax brackets.
Change to the Standard Deduction
Starting 2018, the standard deduction will be $12,000 for individuals and $24,000 for married couples, compared to $6,350 for individuals and $12,700 for married couples presently. While these standard deductions are higher, the new laws eliminate personal and dependent exemptions entirely. In other words, the increase in the standard deduction is not truly a doubling of the standard deduction, rather it is a consolidation of the standard deduction and personal exemptions into a single figure. For families with children, an expanded child tax credit may make up for lost personal and dependent exemptions.
Notably, those who have itemized deductions that are close to $12,000 for individuals and $24,000 for married couples should examine if they may end up using the new higher standard deductions instead of itemizing at all. Not itemizing may make filing and record keeping easier for a number of taxpayers. However, if one expects to be just under or just over the new thresholds, proactive planning could add substantial value. For example, one could combine together several years’ worth of charitable gifts to a donor advised fund in one year, in order to clear the standard deduction hurdle and obtain the tax benefit that would otherwise be missed if smaller gifts were made over a series of years.
Most planning strategies for individuals remain intact. Those with employer retirement plans will still benefit from tax deductible contributions and tax deferred growth. Preferential tax treatment of long-term capital gains and qualified dividends still exists. Education savers can use 529 plans for tax-free growth, with expanded use for limited K-12 needs in addition to college. AMT still exists, though is expected to impact fewer households. The sale of a primary residence may still receive preferential treatment to reduce capital gains. As new strategies emerge over the coming months (or even years) from the changes, we will work with clients on an individual level to navigate the legislation.
For in-depth analysis on the new tax legislation please refer to Schwab’s resource center.