Year-end tax planning is going to be more difficult this year, in view of the uncertainty surrounding the tax reform currently proposed in the House and the Senate. Nevertheless, there are still a number of things you can do to reduce your tax bill for 2017.
There are major changes in the proposed tax legislation for 2018, so we need to think about both 2017 and 2018.
Itemized Deductions vs Standard Deduction
Most taxpayers are entitled to the Standard Deduction, so unless your deductible items add up to more than the Standard Deduction there is no need to keep track of them. A single person, for example, gets an automatic deduction of $6,350, and a married couple filing jointly gets $12,700. Under the proposed tax legislation, these amounts will be increased to $12,200 and $24,400 respectively. That’s the good news. The bad news is that expenses that were previously deductible may not do you any good if they fall below the new levels. The other bad news is that even if your itemized expenses are greater than these new amounts, many of the expenses that are currently deductible may either be eliminated or severely limited in the future. These include:
Medical expenses – You can currently deduct medical expenses that exceed 10% of your income (7.5% if you are 65 or older). This deduction is scheduled to be eliminated, so it would be wise to take care of any medical issues before the end of the year, and be sure to pay for them before December 31.
State and local income taxes – Your state tax is currently deductible, but the deduction will be eliminated under the current plans. If it looks as if you will owe state tax for 2017, it would be wise to make an estimated payment before December 31.
Property taxes – This deduction would be limited to $10,000 in 2018. Property taxes are typically paid in two installments – in Los Angeles, they are due on November 1 and February 1 – so why not pay both installments before year-end.
Mortgage interest – Deductibility of new mortgages will be limited, but existing loans will be unchanged. If you make your January payment in December, you could get a deduction this year that may not help you if you wait until next year.
Charitable donations – If you can deduct itemized expenses in 2017, but not in 2018, it would be advisable to make next year’s donations in 2017.
Unreimbursed employment expenses – Business expenses for employees (NOT self-employed or 1099 workers) will not be allowed under the proposed rules. These include union and professional dues, education expenses, home office expense, mileage, travel and meals, and other usual and necessary expenses incurred for the convenience of your employer, but which the employer will not reimburse.
You may find it appropriate to change your status from employee to independent contractor, if you meet the criteria, as many of these expenses will still be deductible from self-employment income. This can be a complex decision, so consult a tax specialist before making the change.
Be sure to pay for any such expenses before December 31, while they are still deductible. You could also purchase required equipment and supplies that you expect to need next year.
Defer Income / Accelerate Deductions
There are opportunities to defer income items that would be taxable this year, and move them into next year. You may also be able to pay certain deductible expenses this year that you might have waited to pay next year. This strategy only makes sense, of course, if you are not expecting to be in a higher tax bracket next year.
If you have business income – self-employed, partnership, etc. – you can delay billing your customers or clients, so you don’t receive payment until after December 31. Similarly, you can speed up payment of some of your expenses to get a deduction this year. Pass through income, such as partnership and S Corp income, may be taxed at lower rates under the new legislation, depending on your situation. If this is the case, then it would be wise to defer as much income as possible to next year. Speak with a tax specialist about this.
If you have a rental property, and your income is under $100,000, you may be eligible to deduct up to $25,000 of rental losses against your regular income. The deduction phases out completely when your income goes over $150,000. It is a good incentive to defer income or accelerate expenses if you are in this range.
Talk to your employer about receiving any year-end bonus after December 31, so you don’t pay tax on it until next year.
Alimony under current divorce agreements may continue to be deductible, but will be eliminated for future separation agreements. It may be wise to finalize your agreements before the end of the year.
Alternative Minimum Tax (AMT)
For many taxpayers, particularly those with higher incomes, there is currently a limit to the benefit you can get from certain deductible expenses. There are phase-outs as your income rises, but another very important consideration is the Alternative Minimum Tax (AMT). The expenses most likely to be affected are state and local income taxes (especially in California, New York and other high-tax states) and office and employment expenses. If you are subject to the AMT, accelerating payment of these expenses will not do you any good. You should speak with your tax advisor about other possible strategies for 2017.
The AMT will be eliminated under both the House and Senate proposals. This will reduce the complexity of your return, and very possibly result in a lower tax bill. Important – if you plan to exercise Incentive Stock Options (ISOs) and you do not plan to sell them immediately, you may be wise to wait until next year, when they will not result in an AMT expense.
Take Losses Before Year-End
If you have losses on taxable investments, think about selling them this year. They will offset any capital gains you may have, but even if your losses are more than your gains, you can use up to $3,000 to reduce other income, and you can carry any excess losses forward to future years.
Make the maximum contributions to your retirement plans.
You can deduct contributions of $18,000 (more if you’re over 50) to your 401(k) plan – but at least make sure you contribute enough to get the full amount of your employer’s matching program.
You may be able to deduct up to $5,500 (more if you’re over 50) to a traditional IRA. If you don’t make a contribution before the end of the year, you have until April 15th. Contributions to a ROTH IRA are not deductible, but penalties are much less severe if you have to withdraw funds early.
If you’re self-employed or have an S Corporation, you can contribute to a SEP IRA or a similar plan. You can deduct approximately 20% of your self-employment income, up to $54,000. The good news is that you can make your contribution all the way up to the filing deadline, including extensions, which gives you plenty of time to calculate your income. If you have an S Corp, you can also take advantage of a SEP IRA.
Don’t take money out of your traditional IRA or 401(k) plan if you are under 59 ½ years old. There is a 10% penalty on top of the regular tax, and some states have an additional penalty. Before you take an early withdrawal, though, remember that you may be able to borrow from your 401(k). There are also penalties for early withdrawal from a ROTH, but your original contributions are not taxed a second time.
You can take a distribution from your IRA without a penalty if you are a first-time home buyer, if you make qualified tuition payments, and several other special situations. Remember that if you have a 401(k), and plan to make tuition payments, roll the 401(k) over into a traditional IRA first.
Consider rolling over your traditional IRA into a ROTH IRA. You will pay tax on the full amount when you roll it over, but if you expect to be in a low tax bracket this year, for any reason, this might be a good time to do it. Also, there is no required minimum distribution from a ROTH IRA after age 70 ½.
Start taking minimum required distributions from your traditional IRA if you turn 70 ½. There is a 50% tax if you don’t.
Charitable donations are a nice deduction, assuming your total deductions exceed the Standard Deduction. As suggested above, the standard deduction will probably increase next year, so it may be wise to make your 2018 donations this year to get a larger benefit from the deduction.
If you have shares of stock that have appreciated in value, consider donating the stock to charity. If you have owned the stock for more than one year, you can deduct the entire appreciated value of the stock, and avoid capital gains tax or Net Investment Income Tax (NIIT).
You can make tax-free gifts of up to $14,000 ($28,000 for a married couple) per recipient. (Remember that gifts are not taxed to the recipient, but to the giver). Gifts in excess of this amount require filing a gift tax return, but you won’t actually pay tax until you go over your lifetime limit of $5,490,000.
Qualified payments for tuition or medical expenses are not considered a gift, as long as they are paid directly to the educational institution or the medical provider.
Avoid the “Kiddie Tax”
If your dependent children (under 19, or under 24 if they are full time students) have investment income over $2,100, it will be included in your income, and taxed at your full rate, including NIIT. So think carefully before you give them stocks to sell to pay for college.
You can deduct 100% of qualifying asset purchases up to $500,000 (with phase-outs if your total purchases exceed $2 million) under Section 179. This is a tremendous incentive to buy capital assets which you would otherwise have to expense over several years. There are exclusions, but many of the excluded items are eligible for a 50% special depreciation allowance in the year of purchase.
These are terrific deductions. If you are planning to buy assets, buy them before year-end, and reduce your taxes for 2017.
Individual tax returns for 2017 are due on April 17, 2018, or may be extended to October 15. Remember that it is an extension to file only, but taxes are still due on April 17. Form 1065 Partnership (including LLC) Returns are due on March 15, as are Form 1120S subchapter S corporation returns. Single member LLCs do not file Form 1065, so they are due with individual returns on April 17.
Form 1099-Misc and Form W-2 must be issued to employees and contractors, as well as to the IRS or Social Security Administration, by January 31. It’s a good idea to confirm all employee information and W-9 information before the end of the year. Remember that Form 1099-MISC must be issued to all individuals and partnerships to whom you paid over $600 during the year. There are penalties for not filing these forms.
Corporations and Partnerships
The proposed tax changes include a significant reduction in tax rates on business income. This includes income from C Corporations as well as S Corporations and partnerships. As the rules become clear, there will be a need to map out strategies to get the best benefit from the changes.
There are very specific rules related to S Corps and Partnerships, and now is a perfect time to be sure you in compliance before year-end. It would be a shame to lose out on the tax benefits of these business entities.
S Corp Salary – If you have a Subchapter S Corporation, don’t forget that you are required to pay yourself a reasonable salary. A major benefit of having an S Corp is that not all of your profits need to be subject to employment taxes, but you do need to pay yourself a salary, and issue yourself a W-2 as an employee. Issuing yourself a 1099 is not a substitute. Setting up W-2 payments after year-end is annoying, and there are stiff penalties for late payment of employment taxes, so take care of it before the end of the year.
Retirement plans – As discussed above, there are opportunities for S Corp shareholders and partners in partnerships and LLCs to make very substantial tax-deferred contributions to SEP and other retirement plans. The contributions are a percentage of your partnership income or your S Corp salary. It is important to remember that the retirement plans MUST be in the name of the S Corp or the partnership. Individual shareholders and partners cannot have their own SEP plans.
Health Insurance – Your health insurance payments may be deductible on your personal return if you are a shareholder in an S Corp or a partner in a partnership or LLC, and you meet certain requirements. Remember, though, that the payments must be made by the corporation or LLC – or reimbursed if you make the payments yourself.
Payments made by your S Corp must be included as compensation on your W-2, but are not subject to payroll taxes. Make this clear to your payroll processing company.
Payments by your partnership or LLC are treated as distributions.
If you have a single member LLC, you can make payments from your business or personal account.
Do you need your LLC or S Corp? – Are you getting any real benefit from it? If you are in a state that has a minimum LLC or S Corp tax, you may be paying for something you don’t really need. California’s minimum tax is $800, and you’re also paying for a relatively expensive tax return. If limited liability is a big concern, consider buying insurance that offers appropriate protection. Closing the LLC or S Corp before year-end won’t reduce your 2017 tax bill, but it will cut future costs… See the article I wrote earlier on this website.
Corporation and pass-through tax rates will be much lower under the proposed tax legislation, so it may be wise to revisit the decision to operate as an S Corp or a C Corp.
I would be pleased to discuss your tax planning issues.