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Year-End Tax Planning Has Never Before Been More Important

Added by Richard G. Smith in Articles & Publications, Tax Law on December 4, 2017

Tax planning is always important, and it is always more important as we approach the end of the year. When a taxpayer can defer income or accelerate deductions, there is often at least the advantage of the time value of money in paying taxes next year instead of this year. This year, the likelihood of tax reform makes tax planning even more important. For most taxpayers, rates will be lower in 2018 under the new tax plans. That probability increases the advantages of deferring income into 2018 or accelerating deductions into 2017. There are also some other, more nuanced, provisions of the new tax bills that taxpayers and their advisors need to factor into their tax planning.

The House and Senate bills have some significant differences, and it is possible that no bill will pass at all. However, some common and important features of the bills include the following:

  • Corporate Tax Rate Reduction: The most signficiant feature of both bills is the reduction in the maximum tax rate from 35% to 20% The Senate bill would delay the implementation of this change to 2019.
  • Pass-through Taxes for S Corps, Partnerships and Sole Proprietorships: The new House bill would impose a new tax on these entities at a maximum 25% rate, which would be in lieu of the tax on the pass-through income at the individual level.[1] This could be a significant advantage for small business owners, who might otherwise be subject to a 35% or 39.6% tax rate. It makes accelerating deductions a good tax strategy for 2017, since a dollar of deduction in 2017 will save 39.6 cents of taxes where next year it might be a 25 cent savings.
  • Bonus depreciation: Under current law, full expensing of equipment purchases is being phased out, with 50% allowable in 2017. The new bills would expand that deduction and increase it to 100% for five years. There would have been an advantage already in making equipment purchases by year-end, since the current law would decrease the percentage to 40%. Depending on the effective date of this provision, it may be an advantage to defer such purchases until 2018 when the 100% deduction will be available. However, a key transitional provision of both bills is to allow deduction of purchases in 2017 if made after September 27, 2017. Thus, it may be appropriate to gamble on whether the bills pass and the effective date stays intact, in order to accelerate a 100% deduction into the 2017 year.
  • Individual Tax Rate Reduction: Both bills reduce the tax rates and change the income levels at which each rate is effective. This is projected to lower taxes for most individuals for five years, although the Senate version increases the rates after that time.
  • Increased Standard Deduction: For lower income Individual taxpayers, the greatest tax relief will likely be from the planned doubling of the standard deduction. However, personal and dependency exemptions would be eliminated, and for a married couple with two children, the combined tax benefit would actually be less under the new bill.
  • Loss of Most Itemized Deductions: Only mortgage interest (up to certain limits) and charitable contributions would be deductible. (The House bill allows some property tax deductions.) The combination of the increase in the standard deduction and the loss of many itemized deductions makes it more important to maximize these deductions in 2017. The higher standard deduction means that itemized deductions that had value for taxpayers prior to 2018 no longer will save taxes if the total deductions are less than the new standard deduction amount ($24,000 for married couples filing jointly under the House bill).
  • Alternative Minimum Tax: The new law is likely to eliminate the AMT, which has increasingly captured portions of the middle class. Taxpayers would be benefitted by deferring tax preference items or adjustments that the ATM captures.
  • Estate tax changes: This is one of the biggest areas of disagreement so far between the House and Senate bills. The House bill would double the exemption to $11 million and then repeal the tax in 2024. The Senate bill would also increase the exemption, but does not have repeal provisions.

Taxpayers are encouraged to consult with their tax advisers about the possible effect of the new laws on their individual and business tax liability. As noted, it is always wise to maximize deductions that are not affected by the new laws, such as retirement plan and charitable contributions.[2]

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[1] The Senate bill does not include a new tax but allows a 17.4% deduction for these entities against business income. Under both versions, professional organizations would not be eligible for the lower rate or the deduction.

[2] This conclusion could vary if the taxpayer expects to be below a 25% marginal tax rate in 2017 or a 20% rate for corporations, and would expect to be at those rates for 2018. In those cases, a deduction in 2018 will be worth more than a deduction in 2017. However, it will always be appropriate to maximize retirement plan deductions, since those are available each year up to a maximum amount and are not affected by timing considerations.