By Barry Williams, CPA, JD
With the U.S. Senate’s passage of tax reform legislation on Dec. 2, 2017, both chambers of Congress have weighed in on their own versions of tax reform. The next step in the process is for House and Senate members to work together to reconcile the differences (a conference committee). Once reconciled, the revised legislation will once again go to the House and Senate for passage. If passed, it goes to the president for his signature. After all those steps are completed, taxpayers can plan their tax strategies with certainty.
Does this mean taxpayers should not make changes until there is finalized tax legislation signed by the president? No. Taxpayers should do year-end tax planning this year as they always have, following time-tested strategies. They should also use the pending legislation to consider possible alternate scenarios. Planning now is an effective way to enhance your financial position by reducing tax payments. With tax reform proceeding, taxpayers should be prepared to act if the legislation is signed into law and to be ready with appropriate strategies to deal with different possibilities.
The first step for year-end tax planning is to have good information available on your 2017 income and deductions so your CPA has what he or she needs to assist you. For many, that includes gathering tax records and documenting 2017 income, gains and losses, and deductions. While some taxpayers do not want to take the time at year end to do this, it makes preparation of the final documentation much easier and you can maximize the savings with up-to-date information. In some areas this information is reasonably easy to obtain. Investment statements often have the year-to-date investment income, gains and losses, and investment expenses summarized, and W-2 income to date is generally provided on your latest pay stub.
So what planning methods can be used when tax laws could be changing? The Pennsylvania Institute of Certified Public Accountants (PICPA) released its CPA Tax Reform Poll on Nov. 29, in which active-licensed CPAs gave their insight on year-end tax tips. More than half of the respondents are advising their clients to defer income into 2018 or another tax year in the future. There are two ways this can benefit you. First, it can shift income into a year where it may be taxed at a lower marginal tax rate. For example, if you reduce your income by $10,000 in 2017 and are in the 28 percent marginal tax bracket, the tax reduction in 2017 would be $2,800. If that income is then taxed in 2018 and you are in the 22 percent marginal tax bracket, you pay $2,200 in 2018. This is a $600 tax savings based upon the possible marginal tax bracket reduction under the new legislation. Second, if the marginal tax rate remains the same, you have the use of $2,800 of income tax deferred into 2018.
Taxpayers defer income based upon the types of income they have on their tax return. If income is from a W-2, it can be more difficult to defer to 2018 or later than it would be for a self-employed taxpayer. An employee may be able to defer the payment of a bonus into the next tax year if that is a practice an employer follows. The self-employed can mail their bills later in December so that it defers the receipt of cash until the next year, postponing that income if you are a cash-method taxpayer. Longer-term deferral strategies can benefit an employee who receives a W-2. By contributing to a traditional IRA, a 401(k), and other qualified retirement plans, taxpayers can achieve a deferral of taxable income as long as the contributions have not already been maximized. Roth IRA contributions can provide taxpayers with an opportunity to turn taxable income into permanent tax-free income if held in the Roth IRA for the required period of time.
The CPA Tax Reform Poll provided other ideas for year-end tax tips that involved increasing deductions and losses to reduce taxable income. On the deduction side, “bunching strategies” can be used to increase itemized deductions in 2017 by accelerating certain payments from 2018 into 2017. A “bunching strategy” for itemized deductions involves accumulating deductions so they are high enough in one tax year to exceed the standard deduction amount for that year. The standard deductions for 2017 for single and married-filing-jointly taxpayers are $6,350 and $12,700 respectively. In both the House and Senate legislation, the standard deductions would nearly double for both, to $12,700 and $24,800 respectively. Considering the possibility of such an increase in the standard deduction amounts, a bunching strategy for 2017 would be a worthwhile strategy. The possibility that 2017 may be the last year that a taxpayer can deduct state and local income taxes and sales tax, accelerating into 2017 the state and local taxes you would normally pay when you file your tax return as well as fourth-quarter estimates takes into account both the bunching strategy and changes possible in the new legislation. Other itemized deductions can be used in these strategies, such as charitable contributions and real estate taxes. One point of caution: be aware of the alternative minimum tax (AMT). Accelerating tax deductions can impact the applicability of this tax.
For further guidance on year-end tax saving strategies, see the "Tax Planning in Uncertain Times" post on Oct. 23 by Nancy Montanye, CPA, CFP. The IRS provides various publications in the areas of income, gains and losses, and deductions that a taxpayer can access, such as Publication 17 – Your Federal Income Tax. Please remember that tax planning strategies can be extremely complex and involve multiple strategies based upon a taxpayer’s unique tax situation. The PICPA can assist you in locating a CPA to help you successfully achieve your goals.
Barry Williams, CPA, JD, is dean of the McGowan School of Business at King’s College in Wilkes-Barre, Pa. Williams holds a JD from Widener University, a master’s degree in taxation from Villanova University, and an MBA from Wilkes College. He serves as a member of PICPA’s CPA Image Enhancement and Relations with Schools and Colleges committees.
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