Congress has just passed, and the President has just signed the Tax Cuts and Jobs Act, which is considered by many to be the biggest federal tax change in more than three decades. Although my continued study of the bill will reveal additional opportunities that I will share with you, I wanted to provide some of my ideas about tax planning before year-end.
1. Accelerate Itemized Deductions
Starting in the 2018 tax year, the standard deduction increases from the current $6,350 to $12,000 for individuals, and from $12,700 to $24,000 for married couples. Combined with eliminations of many deductions, the increase will make 2017 the last year to itemize deductions for many people. Furthermore, a decrease in marginal rates will generally decrease the tax benefit of deductions in 2018.
Pay state and local taxes before year-end. One of the biggest changes in the new bill is that state and local tax deductions will be capped at $10,000. For anyone who earns income for which tax hasn’t been withheld, it is prudent to pay all 2017 estimated state taxes this year, instead of waiting until next year. If possible, pre-pay your 2018 property tax now and take advantage of the currently unlimited deduction available for 2017. On the other hand, you cannot do the same for your income tax. The Act contains a special rule to prevent prepayment of income taxes, which mandates that 2018 state income tax paid in 2017 is still considered as paid in 2018. In order to deduct state and local taxes in 2017, you must itemize deductions. Also, if you are subject to AMT tax in 2017, there will be no savings for paying state and local taxes prior to year-end.
Accelerate charitable giving. The new bill retains charitable contributions as an itemized deduction, but temporarily increases the individual percentage-of-income limitation for cash gifts from 50% to 60%. Although the overall impact on charitable giving is uncertain, the bill takes away certain tax incentives of charitable giving by increasing the standard deduction and reducing income tax rates.
Pre-pay miscellaneous deductions. Job expenses, moving expenses, tax prep fees and investment expenses will disappear under the tax reform. If possible, take advantage of these deductions before year-end, while they are still available.
2. Defer Income to 2018
Most taxpayers will find that they are in a lower tax bracket in tax year 2018. Business owners can delay the payout of their income to the next year, or talk to clients about delaying payment for tax benefits. Employees can request that their annual bonuses be paid after year-end.
3. Utilize Pass-Through Entities to Lower Income Tax
One of the tax reform’s most sweeping changes is the tax regime that applies to pass-through businesses, such as sole proprietorships, partnerships, S-corporations and limited liability companies taxed as partnerships or S-corporations. Under the current tax regime, owners of pass-through businesses pay tax at their individual tax rates. The owners report income from businesses on their personal income tax returns, whether or not the business distributes the income to the owners.
In an effort to reduce the tax burden on owners of pass-through businesses, the new tax bill will provide a 20% deduction applied at the owner level. For example, an owner whose income tax rate is 32% will have an effective tax rate of 25.6% for his pass-through business income, or 32% x (100% – 20%).
However, only a Qualified Trade or Business may receive this deduction. The definition of Qualified Trade or Business excludes Specified Service Businesses, which includes:
- any trade or business involving the performance of services in the fields of health, law, consulting, athletics, financial services and brokerage services;
- any trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees or owners, and;
- any trade or business which involves the performance of services that consist of investing and investment management, trading, or dealing in securities, partnership interests or commodities.
Although many small businesses might be excluded, many can still claim the deduction on income from Specified Service Businesses if the owner’s income is below $157,500 for an individual or below $315,000 for those filing jointly.
This deduction will be temporarily available until 2025.
4. Should You Convert an S-corp to a C-corp?
The corporate income tax rate is being reduced from 35% to 21%, and the corporate alternative minimum tax is being repealed. Unlike the deduction for pass-through businesses, this corporate tax cut is permanent. Therefore, a C-corp will be more attractive to pass-through business owners in higher tax brackets.
However, the decision to convert an S-corp or other pass-through entity to a C-corp should be well thought-out. An S-corp that has been converted to a C-corp cannot jump back to being an S-corp for five years. Also, a C-corp is still double-taxed, which is to say that when profit is paid out to owners as dividends, the owners pay tax as individuals, even though those funds have already been taxed at the corporate level. The aggregate tax on the income paid as dividend will exceed the maximum 29.65% that applies to owners of pass-through businesses. However, if the business owner plans to reinvest income into growing the business and offer it in a public offering, a C-corp might work better.
5. Timing Your Business Expenses
Some business expenses will not be deductible after December 31st, 2017. The new bill eliminates deductions for entertainment expenses and membership dues for any club organized for business, pleasure, recreation or other social purposes, even if they are related to business activities. The deduction for qualified transportation fringe benefits to employees is also eliminated, except as necessary for the safety of an employee in commuting between work and home.
Business owners might choose to pre-pay their vendors while their tax bracket is slightly higher in 2017.
6. Grow Your 529 Education Savings Plans
A popular education savings plan that parents use is the 529 plan, which is similar to a Roth IRA, where you can contribute after-tax money to grow earnings tax-free and make tax-free withdrawals. Many states also allow deducting contributions up to a certain amount, providing state income tax savings.
Before the tax reform, withdrawals from 529 plans were tax-free only when the funds were used to pay for college. Starting in 2018, parents can use the funds to pay for K-12 private schools and even homeschooling costs, up to $10,000 per year per child.
You can make contributions of up to $14,000 for 2017 or $15,000 for 2018 without triggering the gift tax. If you intend to use 529 plan accounts for your children’s education, it would be a good idea to make a contribution for 2017.
7. Re-characterize a Converted Roth IRA
Current law allows an individual to put traditional IRA retirement assets into a Roth IRA through a Roth conversion. While a Roth conversion helps make future growth tax-free, you have to pay income tax on the amount you convert in the year of the conversion. Before the tax reform, an individual could wait until the overall tax liability was clear at the end of the year, and had an option to recharacterize a Roth to a traditional IRA by October 15th of the next year.
While one can still convert a traditional IRA to Roth, converting back to the traditional IRA won’t be possible anymore. If you made a Roth conversion in 2017, and were thinking about converting back due to a high tax impact, you have until December 31st, 2017 to do that.
8. Consider New Opportunities for Dynasty Planning and Asset Protection
The doubling of the estate, gift and GST tax exemptions to $10 million per person or $20 million per married couple opens a significant, once-in-a-lifetime opportunity for you to protect more assets than ever. Combined with the IRS’s withdrawal of the anti-discounting section 2704 regulations earlier in 2017, this tax reform opens the door for dynasty trusts, family partnerships, discounted gifts and other strategies that could shield entire fortunes for your beneficiaries.
Be aware that the increased exemption for estate tax and GST tax expires on December 31st, 2025. You may be tempted to wait, given that eight years may feel like forever. But remember that this tax legislation is likely to be heavily modified if the political pendulum swings in the other direction in 2018 or later.
Planning to minimize income taxes is a balancing act. I hope to answer your questions about the tax reform and work with you to take full advantage of the opportunities.
Contact Jiah Kim & Associates
If you would like more information about taking advantage of tax reform, please feel free to schedule a confidential consultation at Jiah Kim & Associates. You can reach us by phone at (646) 389-5065, or book an appointment online now.
This blog post is written for educational and general information purposes only, and does not constitute specific legal advice. You understand that there is no attorney-client relationship between you and the blog publisher. This blog should not be used as a substitute for competent legal advice from a licensed professional attorney in your state.