Year-end Tax Planning Strategies
Despite the current uncertainties, keeping the line on your taxable income is more important than ever. Absent any last minute legislation, the top federal income tax rate for 2017 remains at 39.6%, but higher-income individuals can also be hit by the 0.9% additional Medicare tax on wages and self-employment income and the 3.8% Net Investment Income Tax (NIIT), which can both result in a higher-than-advertised marginal federal income tax rate.
Before we get to specific suggestions, here are two important considerations to keep in mind.
1. Effective tax planning requires considering both this year and next year—at least. Without a multiyear outlook, you can’t be sure maneuvers intended to save taxes on your 2017 return won’t backfire and cost additional money in the future.
2. Be on the alert for the Alternative Minimum Tax (AMT). Although there has been talk about repealing the AMT, it is still on the books and needs to be considered in all of your planning because what may be a great move for regular tax purposes may create or increase an AMT problem. There’s a good chance you’ll be hit with AMT if you deduct a significant amount of state and local taxes, claim multiple dependents, exercised incentive stock options, or recognized a large capital gain this year.
This letter presents some planning ideas to consider while there is still time to act before the year-end. Some of the ideas may apply to you, some to family members, and others to your business.
Consider Deferring Income and Accelerating Deductions
Due to the time value of money, it’s better to pay taxes later rather than sooner (assuming your tax rates won’t be appreciably higher next year).
Therefore, strategies that defer income from the current year to later years and those that move deductions from later years into the current year are always popular. These time-honored strategies could be particularly effective this year if tax reform with lower tax rates is enacted, but doesn’t take effect until next year.
Accelerate Itemized Deductions in 2017
If you currently take advantage of itemized deductions, you may want to accelerate next year’s deductions into this year. First, you’ll get the benefit of the additional tax deductions this year—that’s always good. Furthermore, if tax reform is enacted and effective next year, not only may your tax rate be lower next year, thereby reducing your tax savings from the deductions, but some of these deductions could be limited, eliminated, or rendered useless by an increased standard deduction.
For example, you might consider pursuing elective medical procedures if you think total medical expenses will exceed 10% of your adjusted gross income or paying property taxes and/or state income taxes early. But, watch out for the AMT, as these taxes are not deductible for AMT purposes.
Increasing charitable contributions you make this year is also a good idea. Consider taking the following measures:
• Make charitable contributions you would normally make in early 2018 at the end of 2017. Note that donations charged to a credit card are deductible in the year charged, not when payment is made on the card. Thus, charging donations to your credit card before year-end enables you to increase your 2017 charitable donations deduction even if you’re temporarily short on cash.
Defer Income until 2018.
There are various ways to defer income until the following tax year. For example—
• If you’re in business for yourself and a cash-method taxpayer, you can postpone taxable income by waiting until late in the year to send out some client invoices. That way, you won’t receive payment for them until early 2018.
Of course, before deferring income, you must assess the risk of doing so. You might also consider prepaying a reasonable amount of deductible business expenses such as office supplies and repairs and maintenance before the end of this year. Setting up a retirement plan and/or making additional deductible retirement plan contributions for the year is another idea.
• If you’re a participant in a 401(k) plan and have not already maxed out your elective contributions to the plan this year, consider increasing contributions through the year-end. Depending on your employer’s plan, you may be able to contribute 100% of your compensation up to $18,000 ($24,000 if you are age 50 or older).
Tax-smart Strategies for Your Business
Ramp up Investments in Equipment, Software, and Certain Real Property. If you have plans to buy a business computer, office furniture, equipment, vehicle, or other tangible business property or to make certain improvements to real property, you might consider doing so before year-end to capitalize on the following tax breaks:
• Section 179 Deduction. For 2017, the maximum Section 179 deduction is $510,000 (assuming property purchases for the year don’t exceed $2,030,000). Therefore, an eligible business can often claim first-year depreciation write-offs for the entire cost of new and used equipment and software additions and eligible real property costs.
Note: Watch out if your business is already expected to have a tax loss for the year (or close) before considering any Section 179 deduction, as you cannot claim a Section 179 write-off that would create or increase an overall business tax loss. Also, you might want to consider delaying purchases in excess of $510, 000 until next year as it is possible that next year’s expensing allowance could be even more generous. Please contact us if either of these situations applies to your operation.
• First-year Bonus Depreciation. Above and beyond the Section 179 deduction, your business also can claim first-year bonus depreciation equal to 50% of the cost of most new (not used) equipment and software placed in service by 12/31/17. Note that 50% bonus depreciation deductions can create or increase a Net Operating Loss (NOL) for your business’s 2017 tax year. You can then carry back the NOL to 2015 and 2016 and collect a refund of taxes paid in one or both of those years. Please contact us for details on the interaction between asset additions and NOLs. The bonus depreciation rate is scheduled to drop to 40% for property placed in service in 2018.
Set up Tax-favored Retirement Plan. If your business doesn’t already have a retirement plan, now might be the time to take the plunge. Current retirement plan rules allow for significant deductible contributions. Even if your business is only part-time or something you do on the side, contributing to a SEP-IRA or SIMPLE-IRA can enable you to reduce your current tax load while increasing your retirement savings. With a SEP-IRA, you generally can contribute up to 20% of your self-employment earnings, with a maximum contribution of $54,000 for 2017. A SIMPLE-IRA, on the other hand, allows you to set aside up to $12,500 for 2017 plus an employer match that could potentially be the same amount. In addition, if you will be age 50 or older as of year-end, you can contribute an additional $3,000 to a SIMPLE-IRA. If you’re age 50 or older as of year-end and your business has no employees, a solo 401(k) can allow for a contribution of up to $60,000.
Making the Most of Year-end Investment Moves
Depending on your taxable income, the 2017 federal income tax rates on long-term capital gains and qualified dividends are 0%, 15%, and 20%, with the maximum 20% rate affecting taxpayers with taxable income above $418,400 for single taxpayers, $470,700 for married joint-filing couples, and $444,550 for heads of households. High-income individuals can also be hit by the 3.8% NIIT, which can result in a marginal long-term capital gains/qualified dividend tax rate as high as 23.8%. Still, that is substantially lower than the top regular tax rate of 39.6% (43.4% if the NIIT applies).
Holding on Longer Can Lower Your Taxes.
If you hold appreciated securities in taxable accounts, owning them for at least one year and a day is necessary to qualify for the preferential long-term capital gains tax rates. In contrast, short-term gains are taxed at your regular rate, which can be as high as 39.6% (43.4%, if the NIIT applies). Be sure to consider this when evaluating your investment portfolio.
Whenever possible, try to meet the more-than-one-year ownership rule for appreciated securities held in your taxable accounts. (Of course, while the tax consequences are important, they should not be the only consideration for making a buy or sell decision.)
Harvest Capital Losses.
Biting the bullet and selling some loser securities (currently worth less than you paid for them) before year-end can be a tax-smart idea.
The resulting capital losses will offset capital gains from other sales this year, including high-taxed short-term gains from securities owned for one year or less.
For 2017, the maximum rate on short-term gains is 39.6%, and the 3.8% NIIT may apply too, which can result in an effective rate of up to 43.4%. However, you don’t need to worry about paying a high rate on short-term gains that can be sheltered with capital losses (you will pay 0% on gains that can be sheltered).
If capital losses for this year exceed capital gains, you will have a net capital loss for 2017. You can use that net capital loss to shelter up to $3,000 of this year’s high-taxed ordinary income ($1,500 if you’re married and file separately). Any excess net capital loss is carried forward to next year.
Selling enough loser securities to create a bigger net capital loss that exceeds what you can use this year might also make sense. You can carry forward the excess capital loss to 2018 and beyond and use it to shelter both short-term gains and long-term gains recognized in those years.
Ideas for the Office
Maximize Contributions to 401(k) Plans. If you have a 401(k) plan at work, it’s just about time to tell your company how much you want to set aside on a tax-free basis for next year. Contribute as much as you can stand, especially if your employer makes matching contributions. You give up “free money” when you fail to participate to the max for the match.
Adjust Your Federal Income Tax Withholding. If it looks like you are going to owe income taxes for 2017, consider bumping up the federal income taxes withheld from your paychecks now through the end of the year. When you file your return, you will have to pay any taxes due less the amount paid in and/or withheld. However, as long as your total tax payments (estimated payments plus withholdings) equal at least 90% of your 2017 liability or, if smaller, 100% of your 2016 liability (110% if your 2016 adjusted gross income exceeded $150,000; $75,000 for married individuals who filed separate returns), penalties will be minimized, if not eliminated.
Review Your Health Insurance Costs and Coverage
Make Sure You Have Adequate Health Insurance Coverage. If you and your family don’t have adequate medical coverage (referred to as minimum essential coverage), you may be subject to a penalty. Although there has been talk about repealing this penalty, it is still on the books and needs to be considered. Medical insurance provided by your employer or through an individual plan purchased through a state insurance marketplace generally qualifies as adequate coverage. The penalty amount varies based on the number of uninsured members of your household and your household income. If you have three or more uninsured household members, the penalty could be $2,085 or more for 2017.
Take Advantage of Flexible Spending Accounts (FSAs). If your company has a healthcare and/or dependent care FSA, before year-end you must specify how much of your 2018 salary to convert into tax-free contributions to the plan. You can then take tax-free withdrawals next year to reimburse yourself for out-of-pocket medical and dental expenses and qualifying dependent care costs. Watch out, though, FSAs are “use-it-or-lose-it” accounts—you don’t want to set aside more than what you’ll likely have in qualifying expenses for the year.
If you currently have a healthcare FSA, make sure you drain it by incurring eligible expenses before the deadline for this year. Otherwise, you’ll lose the remaining balance. It’s not that hard to drum some things up: new glasses or contacts, dental work you’ve been putting off, or prescriptions that can be filled early.
Consider a Health Savings Account (HSA). If you are enrolled in a high-deductible health plan and don’t have any other coverage, you may be eligible to make pre-tax or tax deductible contributions to an HSA of up to $6,750 for a family coverage or $3,400 for individual coverage.