Since the likelihood for comprehensive tax reform is high, now is an optimal time to position yourself for change. Although new provisions won’t likely go into effect until 2018 or later, they could still impact 2017 year-end planning. Reforms, if enacted, will likely bring lower rates, particularly for business income, so be prepared to accelerate deductions (worth more at higher tax rates) and defer income so it can be taxed at lower rates. Here are a few additional things to keep in mind.
- Maximize value of gift and estate tax exclusions.
Consider using lifetime as well as annual gift, estate, and/or generation skipping tax exclusions while you're alive. Even with portability, families with taxable estates will be better off — meaning they’ll pay less gift and estate tax — if they make lifetime gifts, that move the current value of gifts, and their future appreciation, out of taxpayers' estates.
- Use the AMT to your advantage.
If you believe you'll be subject to the alternative minimum tax (AMT) in 2017, consider accelerating ordinary income items such as IRA distributions, which would be taxed at 28 percent under the AMT rather than at rates as high as 39.6 percent under the regular tax. That said, if you expect to be subject to the AMT again next year, you probably don't want to accelerate tax.
To better plan, determine whether you're likely to be subject to the AMT — and whether actions you're considering might trigger or increase it. Two income items that can trigger or raise the AMT include long-term capital gains and qualified dividend income, which can use up your available AMT exemption. Other income items that can trigger or raise the AMT include accelerated depreciation adjustments, tax-exempt interest on certain private-activity municipal bonds and, in certain situations, exercising incentive stock options, which create AMT preferences that are added back to your income when calculating your AMT tax.
- Help kids save for retirement.
Do your children or grandchildren have earned income? If so, help them set up retirement accounts. Gift children or grandchildren money to fund a Roth IRA. Funding accounts in years when a child is subject to low income tax rates, coupled with future tax-free appreciation, is a powerful wealth-transfer planning tool. One caveat: Watch out for the "kiddie tax," which generally taxes unearned income in excess of $2,100 (for 2017) of children under 19 and full-time students under 24 at their parents' marginal rate, assuming it's higher.
- Practice tax efficient investing.
Always measure investment performance based on net after tax return. Taxable interest may be subject to income tax rates as high as 39.6 percent — plus the 3.8% net investment income tax (NIIT) — while a lower yield tax-exempt bond may actually have a higher after-tax rate of return. Short-term capital gains are taxed at ordinary rates, so be aware of your holding period when selling stocks and other securities.
Remember to check your tax basis before selling stocks. If you acquired different blocks of the same stock at different prices, sell the blocks of higher-basis shares when divesting only a portion of your holding. This reduces your current gain recognition.
- Use asset location to optimize after-tax returns.
In addition to your asset allocation, consider the asset “location” of your investments. Investments that generate ordinary income might be best concentrated in tax-deferred accounts like 401ks or IRAs or tax-free accounts like Roth IRAs. More tax-efficient investments like those that generate long-term capital gains or tax-exempt income should be more heavily weighted toward taxable accounts.
- Give wisely.
Charitable giving is a flexible tax-planning tool that enables you to control the source, form, amount, and timing of your donations.
Be prepared to accelerate deductions — worth more at higher tax rates — and defer income so it can be taxed at lower rates.
- If you're over 70 1/2, making a gift of up to $100,000 directly from your IRA avoids the 50 percent charitable contribution limit and state income tax in states that don't recognize the charitable deduction. It also keeps your modified adjusted gross income low to minimize NIIT exposure. If made from your IRA, the gift also counts toward your required minimum distribution for the year. Note that donor-advised funds and supporting organizations aren’t eligible recipients.
- When making charitable gifts as part of your estate plan, consider making those gifts from pre-tax retirement accounts (like traditional IRAs or 401(k) plans) rather than other estate assets that receive a basis step-up at your death. By donating pre-tax retirement accounts, the beneficiary will avoid income recognition on future distributions.
- Markets have been hitting historic highs, and donating appreciated stock — as long as it would qualify for long-term capital gain treatment if you sold it — receives a fair market value deduction and avoids capital gains. But don’t donate stock worth less than your basis. Instead, sell the stock, deduct the loss, and donate the cash proceeds to charity.
- Consider accelerating charitable gifts from future years. Make donations to a donor-advised fund or private foundation this year before proposed lower tax rates (which reduce the value of such deductions) and/or deduction caps potentially come to pass. Then, at a later time, you can donate to the particular charitable organizations you want to support.
Several estate planning devices, such as intra-family loans, charitable lead trusts, and grantor-retained annuity trusts, greatly benefit from low interest rates. And gifting discounted interests in family-owned entities remains a viable planning technique for 2017, since proposed regulations that would restrict valuation discounts on closely held business interests remain stalled in Washington.
With open questions around reform, individual taxpayers would be well-served by preparing a two-year income projection.
Each year, the IRS warns taxpayers about the dangers of identity theft and fraudulent returns. While the IRS reported nearly 275,000 fewer victims in 2016 than 2015, it’s still important to be vigilant and take every opportunity to protect your personal information. Contact the IRS immediately if you notice suspicious activity, such as receiving a call from someone asking you to pay back taxes with a credit card or receiving a letter about a refund when you didn't yet file your return.
With open questions around reform, individual taxpayers would be well-served by preparing a two-year income projection. Pose some what-if scenarios and see how your projection fares under different tax rate and deduction assumptions that have been put forth in reform proposals. Your model will likely point you to further potential year-end planning ideas.
For additional information, consult our 2017-2018 Tax Planning Guide and, as always, if you have questions, feel free to give us a call.