On Saturday, December 2, 2017, at about 2:00 AM, Eastern Standard Time, the US Senate passed the most comprehensive tax reform bill in more than thirty years: the Tax Cuts and Jobs Act. Previously, in mid-November, the House of Representatives had passed a version of the same bill. Now, one of the most anticipated and intently watched pieces of legislation since the election of President Trump goes to a House-Senate committee for reconciliation and a final vote by both chambers.
While the law is not final, the picture is becoming clearer for how changes in the tax laws will affect most taxpayers. On Friday, December 1, as the final modifications to the Senate version were being hammered out before voting, we had the opportunity to participate in a webinar hosted by Robert Keebler, CPA, a leading authority in tax planning and accounting for high net worth individuals and estates. Bob suggests ten key points from the new tax bill that you will want to discuss with your accountant. This is especially time-sensitive information, as several of these involve year-end tax planning in light of the new law, which will take effect on January 1, 2018. While we should caution that the bill will not be finalized until the end of the reconciliation process and the final vote by the House and Senate, some aspects are well enough established that you may be well advised to make some strategic decisions now. And of course, as the bill takes its final shape, we will provide updated information.
- Accelerate itemized deductions. Because the new tax law is likely to reduce the number and types of deductions for individuals, you should take these expenses before the end of the year in order to take advantage of the current law’s more liberal provisions. After January 1, 2018, many individual filers will no longer be able to deduct expenses like tax return preparation fees, unreimbursed employee business expenses, investment expenses, and state or local taxes, including income taxes (property taxes up to $10,000 will probably maintain deductibility; there should be no effect on deductibility of home mortgage interest). So, to extent possible, pay those expenses before the end of the year, while you can still deduct them. If your state has an income tax, consider making your estimated tax payment in December rather than January and discuss with your account about prepaying some of your 2018 taxes in 2017.
- Timing on securities sales. The new tax law requires individuals to use “first-in, first-out” (FIFO) accounting for securities sales. Where investors were formerly able to designate which purchase lot they were selling, enabling the sale of securities with a higher cost basis for tax-loss purposes, the new law requires that the securities held the longest be sold first. Typically, these securities will have the lowest cost basis, resulting in higher capital gains upon sale (and higher taxes paid on those gains). So, if you have multiple positions in a security and some have a higher cost basis, you may wish to consider designating those less-profitable lots for sale before the end of the year, while you still can.
- Alternative Minimum Tax (AMT) Repeal Planning. The new law will almost certainly repeal the AMT (this was in the House version) or at the very least, significantly raise the threshold. For high net worth individuals who have been subject to the AMT in the past, the benefits are obvious. If you can delay income until the new law takes place on January 1, 2018, you should have a conversation with your accountant about how such a delay might affect your tax liability.
- Alimony agreements. The payment of alimony will no longer be deductible for the payor for divorces after the tax bill is enacted. Therefore, it would be wise to talk with your attorney and accountant if you are currently attempting to finalize the alimony provisions of your pending divorce.
- Roth recharacterization. Formerly, those who converted traditional IRAs to Roth IRAs had the ability to “recharacterize,” or perform a reversal of the conversion. Typically, an individual might do this because of a change in anticipated future tax liability or a drop in anticipated future income that makes the tax-free distribution rules for Roth IRAs less advantageous. But under the new law, such “U-turns” are no longer allowed. If you are considering “Rothification” of your traditional IRA, you should probably consult with your advisors as soon as possible, because the option will go away at the end of 2017.
- Estate tax planning. The new tax law substantially raises the amount of an estate’s value excluded from estate taxes. If you utilize trusts, gifting, or other legal strategies to mitigate estate tax liability, you should consult with your advisors to see if such strategies should be reviewed, or if they are even still necessary. Bear in mind that estate tax laws have changed before, so the new statutes could be altered in the future. But now is a good time to assess your current situation.
- Timing business expenses. Because the Tax Cuts and Jobs Act makes lowering the business tax rate–including the rate for sole proprietorships, partnerships, and personal service corporations (LLCs)–a central aim, many business organizations are likely to be in lower effective tax brackets on January 1, 2018, than at present. “Pass-through” businesses like sole proprietorships, partnerships, and LLCs get an exclusion on 23 percent of their income if they earn less than $250,000. Additionally, the top marginal rate for such businesses drops from 39.6 percent to just below 30 percent. This means that it may make sense to pay business expenses in 2017, at the higher rates of taxation, to generate a larger tax benefit.
- Business taxation. Another core principle of the new tax law is to reduce the taxes paid by corporations, since the US reportedly has the world’s fourth-highest statutory rate of income taxation. Accordingly, in the House version, the top corporate tax rate goes from slightly less than 40 percent down to 20 percent, and the Senate proposal mandates a 20 percent flat corporate rate in perpetuity. For this reason, corporations have a huge incentive to defer income into 2018, where possible.
- S corporation vs. C corporation. In light of the significantly lowered corporate tax rate, the advantages that formerly accrued to small “pass-through” businesses of organizing as an S corporation are no longer as persuasive. Even with the proposed exclusion from taxation of a percentage of pass-through income, the reduced corporate rate may be a bigger savings. S corporation owners should consult with their CPA and consider their individual situations.
- Intentionally defective nongrantor trust (IDGT). This one gets a little more complicated. IDGTs are essentially trusts with a “built-in flaw” that forces recognition of income from the assets contained in the trust for income tax purposes, but not for estate tax purposes. Typically, the beneficiaries of such trusts are children or grandchildren, who receive assets for which the income taxes have already been paid by the grantor, while excluding the assets from consideration for estate or other death transfer taxes upon the passing of the grantor. However, with the new, much higher thresholds for estate assets subject to estate taxes, avoiding estate taxes may be less of an issue. Those utilizing these trusts may wish to review their estate planning documents with their attorney to see if changes are advisable.
As mentioned previously, none of the provisions of the law have been finalized, as of this writing, and the law will not take effect until reconciliation is complete, there is a vote in both the House and the Senate and President Trump signs the final bill. However, it seems very likely that the above ten topics will be a feature in the law when it is finalized. We recommend consulting with your CPA, attorney, and/or financial advisor before year-end to see if any of the above strategies would be beneficial. And of course, as the law proceeds toward enactment, we will update you on any changes or other strategic considerations.