Taxpayers who wait until the ink is dry on the sweeping Republican tax-reform plan could leave some money on the table. While the vast majority of changes won't take effect until January, procrastinators might miss out on key tax breaks before then.
The waning weeks of 2017 are shaping up as a time when year-end planning becomes particularly important, especially for people who won't be able to take advantage of several key deductions that could disappear. Only about 30% of individual taxpayers currently itemize deductions, and that could drop to around 10% with the proposed changes. Even for people who continue to itemize, plenty of familiar deductions might no longer be available.
As a rule, taxpayers often find it worthwhile to defer income into the next year and take as many deductions and credits as possible in the current year. "With tax reform, that strategy makes even more sense," said Mark Luscombe, principal federal tax analyst at Wolters Kluwer Tax & Accounting.
Most people can't do much to delay salary income. But for those who can ask their employer to defer year-end bonuses or delay their own invoices for a personal business, that income likely will be taxed at somewhat reduced rates next year.
"Most people in most brackets will get at least some benefits (from the proposed lower rates)," said Luscombe, referring to House and Senate bills that had been passed as of early December.
To itemize or not to itemize
On the deduction side, there are several year-end planning opportunities. People who itemize might want to focus on deductions that, as of early December, were slated to get cut entirely or scaled back. These include the proposed elimination of the federal deduction for state/local income taxes and a possible new $10,000 annual deduction cap on real estate taxes.
Other itemized deductions likely will continue to be available, but only for people who itemize, such as the deduction for charity donations and that for mortgage interest, which could be scaled back a bit.
Year-end planning opportunities thus might include prepaying a property-tax installment due early in 2018, making an premature estimated state-tax payment or writing an early mortgage check prior to Jan. 1. Also, the waning weeks of 2017 could be a time to double-up on charity donations that might not deliver any tax benefits next year, depending on your circumstances. Donations can be made by credit card prior to Jan. 1 and applied for 2017, even if the bill isn't paid for weeks or months later.
For certain deductions that have thresholds to meet, it can be beneficial to bunch expenses and utilize them in alternate years. This is true of medical expenses, which are currently deductible only to the extent they exceed 10% of a person's adjusted gross income. As of early December, the House bill would repeal this deduction, though the Senate version would retain it, allowing deductions above 7.5% of AGI temporarily before reverting to 10% in 2019.
This creates an opportunity to utilize the medical-expense deduction, possibly by prepaying certain items during 2017, if you are near this year's threshold.
Making a move
Deductions for tax return preparation fees and personal property taxes also are on the chopping block. And if you plan to move your residence and deduct moving expenses, it might pay to be wise to make a move before January. That deduction is scheduled for repeal under both bills (except for active-duty military members under orders to move).
Both the House and Senate bills in early December contained provisions to scrap the personal exemption deduction, though there's not much taxpayers can do to plan around the loss of that tax break. As an offset (at least partially), both the House and Senate bills would roughly double the standard deduction — a move that would make itemizing less attractive for millions of Americans.
Incidentally, the general strategy of deferring income and accelerating deductions doesn't make sense for people subject to the Alternative Minimum Tax. Complicating matters, the AMT would be repealed under the House bill but not under the Senate plan.
Another year-end strategy involves harvesting investment losses. Prior to the end of December, it might pay to evaluate your various investments held in taxable accounts. Check your stocks, mutual funds or other securities to see which ones are showing unrealized gains and losses.
For tax purposes, if you sell certain investments to realize losses, you can use them to offset gains taken in the same year. If you wind up with losses that exceed your gains, you can use up to $3,000 of excess losses as a deduction against ordinary income each year, with any balance carried forward. This loss-harvesting strategy isn't affected by the tax-reform bills.
New capital-gain wrinkle
While neither the House nor Senate bills propose significant changes regarding capital gains, there's a provision that could affect people who do a lot of buying and selling of stocks, mutual funds and exchange-traded funds in taxable accounts. Under existing law, if a taxpayer has bought shares in a company or fund at different prices, he or she can specify which shares are being sold first (assuming they aren't all liquidated at once). Doing so can help minimize taxable gains (or maximize deductible losses).
The House bill would continue this treatment. But under the Senate bill, taxpayers who sell only some of their shares would be deemed to have sold shares in the order they were purchased. This first-in, first-out treatment could result in a larger taxable gain, assuming the stock or fund has appreciated. The provision is expected to raise $2.4 billion for the government over 10 years.
"Investors would be forced to sell their stocks, mutual funds and ETFs in which they hold multiple positions in the order in which they bought them," noted Thomas Faust Jr., chairman and CEO of investment firm Eaton Vance. He opposes the measure, arguing that the change "would perversely (cause) investment decisions to be based increasingly on tax implications."
Reform and the tax gap
A key focus of the Republican tax bills is to make filing easier for millions of Americans. Whether simplification also helps to reduce the amount of unpaid taxes remains to be seen. The Government Accountability Office, in a new report, estimates Americans pay 81.7% of the taxes owed on a voluntary and timely basis. The report looked at individual, corporate, estate, excise and employment taxes from 2008 to 2010.
According to the report, which relies on Internal Revenue Service estimates, taxpayers collectively owed $2.5 trillion in taxes annually, of which $2.04 trillion was paid in a timely and voluntary manner. Another $52 billion was collected in late payments and enforcement actions, with the IRS estimating $406 billion will never be paid.
Reach the reporter at email@example.com or 602-444-8616.