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Today, the House and Senate passed the 2017 Tax Reform Act. The Act more closely resembles the Senate’s previous bill, albeit with several twists that reflect the compromises required to reach the final version. Most of the provisions have an effective date of January 1, 2018.
In the following article, we unwrap five ideas and possible action items for year-end consideration, along with a summary of some of the key provisions. While the Act includes significant reform for corporations and pass-through entities, this article focuses on the provisions most impacting individual taxpayers.
Ordinary Income Tax Rates
The Act modifies the individual income tax brackets from those previously contained in the House and Senate passed versions. These rate changes will sunset as of January 1, 2026 and revert back to the 2017 brackets unless extended by later Congressional action.
The following new rates will apply effective January 1, 2018:
|10%||$0 – $9,525||$0 – $19,050|
|12%||$9,526 – $38,700||$19,051 – $77,400|
|22%||$38,701 – $82,500||$77,401 – $165,000|
|24%||$82,501 – $157,500||$165,001 – $315,000|
|32%||$157,501 – $200,000||$315,001 – $400,000|
|35%||$200,001 – $500,000||$400,001 – $600,000|
Note that the Act does not repeal the net investment income (NII) tax or additional Medicare tax.
Capital Gain Tax Rates (No Tears for Omitted FIFO)
The current Capital Gain and Qualified Dividend Tax Rates are not changed. With the anticipated adjustments, the 20% Long Term Capital Gain Tax Rate thresholds are $479,000 for married filing jointly and $425,000 for single and for married filing separate.
To the relief of many, the Act does not include the First in First out (FIFO) provision for sales, gifts and dispositions of securities that was in the Senate’s version of the bill. Therefore, recent discussions and comments regarding planning recommendations, such as accelerating into 2017 the gifting of low basis appreciated stock and the sale of high basis marketable securities, are no longer relevant.
Also, the Senate’s proposed requirement that taxpayers must live in their personal residence for 5 out of the 8 years preceding the sale in order to qualify for the capital gain exclusion ($500,000 for married couples and $250,000 for single individuals) did not make the Act. The requirement remains at 2 out of the 5 years preceding the sale.
IDEA NUMBER ONE
Acknowledging obvious limitations given the proximity to year-end, particularly for W-2 wage earners, consider deferring ordinary income items into 2018 if your income tax brackets will decline. Other strategies to reduce taxable income in 2017 include ensuring you have maximized all of your retirement deferrals for the year, to the extent this opportunity may exist. If you are the owner of a pass-through entity or self-employed, review your current compensation levels to ensure that you are able to maximize your retirement deferrals for the year even if the actual transfer will not take place until 2018 for SEP-IRA and Individual 401(k) participants.
The Act nearly doubles the standard deduction, which will be indexed for inflation beginning after 2018. These increases will sunset after December 31, 2025.
The standard deductions are as follows:
The Act also eliminates personal exemptions but increases the Child Tax Credit.
IDEA NUMBER TWO
If your itemized deductions in 2018 will not exceed the increased standard deduction in 2018, consider advancing charitable contributions into 2017. If you wait until 2018 to make the contribution, the deduction would essentially go unused. If you are unsure of the object of your charitable affections, consider creating a Donor Advised Fund (DAF), which allows an immediate charitable deduction but enables you to make final gifts out of the DAF at a later date.
IDEA NUMBER THREE
Even if your itemized deductions will exceed the increased standard deductions for 2018, perform a tax rate analysis with your tax advisor to determine if your effective tax rate will decline in 2018. If so, consider still accelerating charitable gifts into 2017 due to the increased impact of the deductions against your higher taxed 2017 income.
State, Local and Property Deductions
Arguably one of the most controversial elements of previous versions of the reform bill was the reduction or elimination of the state and local tax (“SALT”) deduction. While the battle of wills around this deduction was deemed nearly insurmountable by many pundits, a compromise was in fact struck.
When the House’s original bill called for the complete repeal of the SALT deductions, many commentators quickly made sweeping recommendations for "must-do" year-end tax planning to include the pre-payment of such tax in order to advance the deduction into 2017. This, in hindsight, was the proverbial “getting out over one’s skis”. First, the deduction is in fact retained in the Conference bill, although with a combined limit (including property taxes) of $10,000 per individual taxpayer.
Secondly, the final version of this Act specifically precludes taking a 2017 deduction for pre-paid 2018 state and local income taxes.
Notably, there is not an equivalent limitation on the prepayment of state or local property tax. However, it may not be possible to prepay county property taxes that have not been yet been assessed. Some states require payment in the year assessed and some states require payment in arrears for taxes assessed the prior year. Regardless, many tax advisors warn there may be an absence of infrastructure at the county level to maintain a credit should they receive a prepayment.
IDEA NUMBER FOUR
For the reasons stated above, do not pre-pay 2018 state and local income tax. However, if you are scheduled to make a 2017 estimated state tax payment in January, consider paying that amount by year-end. Additionally, where allowable by your county, consider a pre-payment of 2018 property tax. Both of these pre-payments should only be made if (1) the added deduction will not be eliminated under the current 2017 itemized deduction limitation rules and (2) you are not currently subject to (and this would not cause exposure to) AMT. You should consult your tax advisor for an analysis of these options.
Mortgage Interest Deduction
While there is little to do for year-end 2017 planning, it is notable that only new acquisition indebtedness will be limited to the reduced $750,000.
Miscellaneous Itemized Deductions
IDEA NUMBER FIVE
Consider prepaying some miscellaneous itemized deductions before year-end subject to the same caveats noted above: if (1) the added deduction will not be eliminated under the current 2017 itemized deduction limitation rules and (2) you are not currently subject to (and this would not cause exposure to) AMT. Again, your tax advisor should be engaged to run the necessary analysis for such options.
Gift and Estate Tax Provisions
The increased exemptions provide many opportunities for planning such as significant additional lifetime gifts to Dynasty Trusts, as well as many other planning strategies that will be discussed in subsequent articles. It will also be important to review Wills and Revocable Trusts to make sure the funding clauses in these estate documents still meet your goals when taking into account the higher exemptions. While no action is required before year-end, review and planning around the increased exemptions should be high on priority lists for 2018.
The new Act comes with challenges and opportunities. Your Oxford team of advisors are available, in conjunction with your Tax and Legal Advisors, to help you navigate the impact the Act may have on your family’s specific situation.
For more on this topic, view the article 2017 Tax Reform Act: Reference Guide to Key Provisions.
The above commentary represents the opinions of the authors as of 12.20.17 and is subject to change at any time due to market or economic conditions or other factors.Print