Strauss Attorneys, PLLC – Year End Tax Letter

By Lorin G. Page, J.D., L.L.M.

As we approach the end of 2017, we at Strauss Attorneys, PLLC would like to remind you of measures you can take to minimize your income tax liability. By taking proactive steps to secure credits and deductions, or accelerating or postponing income or deductions, a savvy taxpayer can significantly lower his income tax liability. This letter begins by highlighting a few changes to the tax landscape in 2017 and proceeds to summarize a number of strategies that can be employed to save money.

Extraordinary Changes to the Tax Landscape

As you may know, Congress is negotiating the largest tax reform legislation since the mammoth 1986 revisions. At the time of this writing, the House has passed H.R. 1. The Senate’s bill contains major differences, and so it is difficult to know precisely what will come out of the reconciliation process. What follows, therefore, is necessarily only a broad outline of the impending changes to the tax code. Below we cover some of the major changes, focusing first on individual income taxation and then addressing business taxation.

Individual Income Tax Changes

Income tax brackets

The House plan currently consolidates the income tax brackets from seven to four brackets: 12 percent, 25 percent, 35 percent and a top rate that stays at 39.6 percent for millionaires. The Senate retains the seven brackets of 10 percent, 12 percent, 22.5 percent, 25 percent, 32.5 percent, 35 percent and 39.6 percent for high-income individuals and couples, but raises the income thresholds for each (various other Senate versions have changed the brackets).

State and local tax deduction

The state and local tax deduction allows taxpayers to deduct amounts paid for state and local income, sales and property taxes from their federal income tax. Both the House and Senate bill largely eliminate these deductions (though the House bill retains a property tax deduction capped at $10,000).

Mortgage Interest Deduction

The Mortgage Interest Deduction is one of the most significant federal tax deductions for most middle class Americans. The House bill caps the deduction at $500,000, but the Senate bill retains the current $1 million cap on the deduction.

Elimination of Tax Credits and Deductions

To pay for the above tax cuts, the proposed bills do away with many long-established and fundamental tax credits and deductions. Perhaps the most significant change in the tax-reporting of the average American is the elimination of personal exemption (e.g. claiming dependents on your tax return). In exchange, the bill provides for a doubling of the standard deduction. Combined with the repeal of a number of other exemptions, deductions and credits, this should result in simpler tax reporting for individuals. Some of the exemptions, deductions and credits the House bill repeals are:

• Deductions:
  • Student Loan interest
  • Tuition and Fee
  • Casualty losses
  • Medical expenses
  • Alimony
  • Tax Preparation
  • Moving expenses
• Exclusions:
  • Employer provided housing
  • Achievement awards
  • Dependent care assistance programs
  • Qualified moving expense reimbursement
• Credits:
  • Hope Scholarship
  • Lifelong Learning
  • Energy Credits (modified rather than eliminated).

The Senate bill, on the other hand, retains many of these tax breaks, including crucial ones like the medical expense deduction and educational savings accounts.

Estate, Gift and Generation Skipping Transfer Taxes

The House bill will immediately double the amount of inherited wealth that is exempt from the estate tax from $5.5 to $11 million, and will completely eliminate the estate tax after 2025. The Senate bill doubles the exemption, but never repeals the tax entirely. The bill also provides significant changes to Generation Skipping Transfer (GST) Tax. In addition, the bills would decrease the gift tax rate to 35% and would complete eliminate portability (the ability of spouses to use each other’s unused exemption amount) in 2024.

Alternative Minimum Tax Repeal

Under the House plan, beginning with the 2018 tax year, the Alternative Minimum Tax (AMT) would be repealed. The AMT is “in addition to baseline income tax for certain individuals, corporations, estates, and trusts that have exemptions or special circumstances allowing for lower payments of standard income tax.”[1] Despite the repeal, the bill does allow for the carryforward of a portion of unused AMT credit to be claimed as either a “non-refundable credit” or a “refundable credit” in future tax years. The most recent version of the Senate plan, however, would keep the AMT for corporations.

Business Income Tax Changes

Corporate Tax Rates

Perhaps the most significant change in the proposed legislation for the business community, both the House and the Senate tax plans reduce the corporate tax rate from 35 to 20 percent. The difference is that the House bill immediately cuts the corporate tax rate but the Senate delays the reduction by one year in order to pay for certain other cuts.

Pass-through Business Rates

Another major revision in the tax code, and that which is most likely to affect small businesses, is the plan to change the tax rate for pass-through business entities such as partnerships and S corporations. Currently, these entities pay taxes at the individual income tax rate of their owners, but the House plan creates a new 25 percent tax for these entities. This has massive implications, as it creates the possibility that individuals in higher income tax brackets could exploit this generous rate by establishing pass-through entities, moving to a 25 percent rate from 35 or 38.5. The House bill does include certain provisions meant to protect against this, but it is unclear to what extent they will be effective at preventing such tax arbitrage. Perhaps for this reason, the Senate has instead left pass-through rates alone and created a new 20% deduction for pass-through businesses as well as other investment incentives.

Miscellaneous Business Tax Changes

• Increased Expensing – Among the most significant changes for businesses would be the ability to immediately deduct a greater amount of business expenses, rather than depreciating them over a period of years, which would have a massive impact on business tax reporting.
• The House Bill proposes certain limitations on use of Net Operating Loss Carryforwards.
• Like-Kind Exchanges, which provide for tax deferral if proceeds from the sale of capital gains property are reinvested in certain circumstances, would be limited to real property.

Tax Legislation Planning Opportunities

The proposed tax overhaul entails a number of possible tax planning opportunities for individuals and businesses. A full exploration of these is beyond the scope of this letter, but here are a few things to consider consulting with your tax professional about:

• Accelerate losses and defer gains – capture losses in 2017, when tax rates are likely to be higher. Those deductions will mean less on a dollar for dollar basis under lower income tax rates.
• Timing of bequest funding – delay funding bequests until next year if there is estate tax exposure, or, alternately, to accelerate funding bequests if there is an opportunity for arbitrage between the donor’s and the beneficiaries’ tax rates.
• Time sale of securities or other business expenses – accelerate capital losses or business expenses to this year, as they will mean more under higher tax brackets, or, alternately, it may make sense to delay certain business expenses until next year in order to take advantage of immediate expensing.
• Accelerate itemized deductions – many itemized deductions might be eliminated next year, so make sure you take advantage of those that will be repealed.

Ordinary Changes to the Tax Landscape

Other changes to the tax code that will affect many Americans are the annual increases in amounts of certain available deductions and credits. The IRS website provides the following information about the contribution limits for retirement plans phase-outs for 2018:

• For single taxpayers covered by a workplace retirement plan, the phase-out range is $63,000 to $73,000, up from $62,000 to $72,000.
• For married couples filing jointly, where the spouse making the IRA contribution is covered by a workplace retirement plan, the phase-out range is $101,000 to $121,000, up from $99,000 to $119,000.
• For an IRA contributor who is not covered by a workplace retirement plan and is married to someone who is covered, the deduction is phased out if the couple’s income is between $189,000 and $199,000, up from $186,000 and $196,000.
• For a married individual filing a separate return who is covered by a workplace retirement plan, the phase-out range is not subject to an annual cost-of-living adjustment and remains $0 to $10,000.

The income phase-out range for contributing to a Roth IRA increases to $120,000 to $135,000 for singles and heads of household, up from $118,000 to $133,000 in 2017. The range for married couples filing jointly is $186,000 to $196,000, up from $184,000 to $194,000, and for a married individual filing a separate return, it remains $0 to $10,000.

Finally, what hasn’t changed:

• The limit on annual contributions to an IRA remains unchanged at $5,500. The additional catch-up contribution limit for individuals aged 50 remains at $1,000.
• The catch-up contribution limit for employees aged 50 and over who participate in 401(k), 403(b), most 457 plans and the federal government’s Thrift Savings Plan remains at $6,000.

Current Planning Opportunities – Credits and Deductions

Putting aside the prospect of a change in the tax code beginning next year, there are a number of things you can do this year to minimize your tax exposure. Most year-end income tax planning strategies fall into two broad categories: first, maximizing available credits and deductions, and second, accelerating and postponing income and deductions. Perhaps the best way to minimize your tax liability is to be aware of all tax credits and deductions for which you may qualify. If you file your own taxes, this entails properly understanding credits and deductions to which you are entitled. But even if you work with a tax professional, it is important that you be sure to fully inform them on changes in your life that may help you qualify.

The following are among the life changes that often significantly impact income tax liability:

• Marriage, divorce or death of a spouse.
• Birth of a child
• Child aging out of child credit
• Casualty losses
• Medical procedures
• Moving
• Increased College or Tuition Expenses
• Employment changes
• Retirement
• Bankruptcy
• Inheritance
• Business Success of Failure

If you have experienced any of these during the last year, be sure to investigate how they may affect your eligibility for credits or deductions and, therefore, your overall income tax liability. In depth discussion of available credits and deductions is beyond the scope of this letter, but it is helpful briefly to review some of the most significant. Major deductions include the following:

• Business Use of Car – you may deduct the entire cost of operation if you use it only for work (subject to limits), or only the cost of its business use if you use the car for both business and personal purposes.
• Business Use of Home – you can take a deduction for the value of portions of your house used exclusively and regularly as principal place of business for your trade or business; as a place where you meet and deal with your patients, clients, or customers in the normal course of your trade or business; as business storage or as rental space.
• Home Related Expenses – deductible expenses for business use of your home include the business portion of real estate taxes, mortgage interest, rent, casualty losses, utilities, insurance, depreciation, maintenance, and repairs. You may not deduct expenses for lawn care in general or for painting a room not used for business.
• Business Travel Expenses – the ordinary and necessary expenses of traveling away from home for your business, profession or job.
• Bad Business Debt – you may be entitled to a deduction if there was an intention at the time of the transaction to make a loan and not a gift AND you have no reasonable expectation that the nonbusiness bad debt will be repaid.
• Depreciation – for certain capital expenditures, machinery, equipment, buildings, vehicles, and furniture, you can deduct a part of the cost every year until you fully recover its cost.
• Taxes – you may be able to deduct certain non-business taxes if you itemize deductions using Form 1040: state, local and foreign income or real estate taxes, as well as state and local personal property and general sales taxes.
• Medical Expenses – you can deduct the part of your medical and dental expenses that is more than 10% of your adjusted gross income (AGI), or if either you or your spouse was born before January 2, 1950, you can deduct the amount that is more than 5% of your AGI.
• Student Loan Interest – you can reduce your income subject to tax by up to $2,500 by deducting the cost of interest paid on your student loan. The student must be you, your spouse, or your dependent and enrolled at least half-time in a degree program. The loan must have been taken out solely to pay qualified education expenses and cannot be from a related person. This deduction phases out at $160,000 if married filing a joint return or $80,000 if single, head of household, or qualifying widow(er).
• Educational Savings Plans – if you participate in a qualified tuition program (QTP) or “529 plan,” earnings from the plan are generally tax-free if the total distribution is less than or equal to adjusted qualified education expenses.

In addition to deductions, which lower the amount of your taxable income, you may also qualify for tax credits, which can further chip away at the total tax owed.

• Earned Income Tax Credit – you may qualify for this credit if you work, have a Social Security number and have an income below specific thresholds.
• Child Tax Credit – you may be able to claim the child and dependent care credit if you paid expenses for the care of a qualifying individual to enable you and your spouse filing a joint return to work or actively look for work.
• Adoption Credit – if you adopted a child, you may be eligible for a credit of up to $13,400 per child for qualified adoption expenses paid and an exclusion for employer-provided adoption assistance. The credit is nonrefundable, which means it is limited to your tax liability for the year.
• Education Credits – if you, your spouse, a student you claim as a dependent on your return, or a third party paid qualified tuition expenses in 2017, you may be eligible for either the American Opportunity Tax Credit or the Lifetime Learning Credit.
• Credit for the Elderly or Disabled – if you are aged 65 or older or retired on permanent and total disability and received taxable disability income for the tax year and meet certain income limits, you may qualify for a credit of between $3,750 and $7,500.
• Mortgage Interest Credit – in North Carolina, first time home buyers and veterans who meet certain income requirements may qualify for a Mortgage Credit Certificate from your local or state government that allows you to claim a tax credit for a portion of your annual mortgage interest expense.
• Residential Energy Efficient Property Credit – if you buy certain home energy efficiency equipment, including solar hot water heaters, solar electric equipment and wind turbines, you can qualify for a credit of 30 percent of the expenditures made by a taxpayer during the taxable year for qualified equipment.
• Nonbusiness Energy Property Credit – if you make certain qualifying energy efficient improvements to you home, such as insulation, water heaters or air systems, you may qualify for a credit of up to $500, only $200 of which can be for windows.
• Electric Vehicle Credits – purchases of a qualifying electric vehicle can result in a credit of as much as $7,500 against your income tax. To qualify, you must purchase a new vehicle made by a manufacturer that complies with the Clean Air Act and weighs 14,000 pounds or less.

The deductions and credits listed above are among the most significant for the average taxpayer, but there are many others that may apply to specific circumstances.

Timing Income and Deductions

Aside from simply taking credits and deductions, a significant aspect of year-end tax planning, and one that many people fail adequately to utilize, is taking measures to shift income or deductions from one year to another. This is especially important for taxpayers who know they will be in different income brackets in different years; by shifting income into years in which you are in a lower bracket or shifting deductions into a year in which you are in a higher bracket, you can significantly reduce your overall, combined taxable income for those years. For instance, if you are nearing the end of your career and expect to transition from a high annual income to a lower annual income, you may be able to delay some income until after January 1^st. But even if you are likely to be in the same bracket, you can still benefit from postponed income and accelerate deductions by taking advantage of the time value of money.

One can utilize several strategies to postpone income:

• Arrange with your employer to have a bonus delayed until 2017
• Delay billable services
• Delay debt forgiveness income
• Hold onto appreciated assets until next year
• Structure or avoid mandatory like-kind exchange treatment
• Minimize retirement distributions
• Take an eligible roll over distribution from a qualified retirement plan
• Postpone a conversion from a traditional IRA to a Roth IRA
• Enter into installment contracts to postpone income.

Similarly, there are many ways to accelerate deductions into the current year:

• Maximize Health Savings Account contributions
• Maximize IRA charitable contributions
• Bunch itemized deductions into 2017
• Pay expenses on credit to generate current deductions
• Settle insurance claims to maximize casualty loss deductions
• Make energy saving improvements before January 1^st.
• Pre-pay state, local or foreign taxes
• Charitable deductions – donate appreciated long term capital gain property
• Pre-pay higher education costs

As we approach the end of 2017, thinking through and speaking over these matters with your professional advisors – CPAs, financial advisors and attorneys – can help you minimize your income tax liability and save you considerable money. If you have any questions about these matters, or indeed, about any of your estate planning, business, tax or legal matters, we would be happy to assist in any way we can. Please contact our Asheville office at 828-258-0994 or our Hendersonville office at 828-696-1811 to schedule an appointment.

[1] https://en.wikipedia.org/wiki/Alternative_minimum_tax