Tips on How to Handle Some of the Tax Reform Provisions
As the House and Senate reconcile their versions of the tax reform bill, there are certain provisions that warrant the attention of accountants and taxpayers alike.
AccountingWEB presented some questions to Gary DuBoff, principal in the Tax and Accounting Department at MBAF — a top 40 public accounting firm — on how to tackle the changes, should they go into effect. He offered his perspective on some of the important elements of the bill: whether to make donations by the end of this year to take advantage of deductions, understanding how federal tax reform will affect state tax changes, paying state taxes in advance, and what to do with investments.
AW: Why should charitable contributions be made before the end of the year, and how should they be made?
DuBoff: With the pending tax legislation in Congress, there are number of reasons why accelerating your 2018 charitable donations before the end of 2017 may make sense.
- In general, charitable donations before the end of the year will be deductible when paid. Making cash donations via credit card may ease the pain of having to write an actual check in 2017, and can be paid after the end of the year in 2018, with your credit card balance due.
- Of course, using long-term appreciated securities is a much more tax efficient way to make your contribution as opposed to cash, since you will avoid having to pay tax on the appreciation and the deductible gift value will be deemed to be the FMV [fair market value] of the security on the date of the gift.
- If you itemize your deductions in 2017, and your total deductions including charity are more than the standard deduction for your filing status but less than the standard deduction under the proposed law ($12,000 single or $24,000 MFJ), you would be better served making the donation in 2017.
- It is expected that the tax brackets and tax rates will be lower in 2018 under the proposed law (both House and Senate), therefore the deduction could be worth more in 2017, albeit a small consolation in some cases. It will be depend on a number of factors. However if you know you would be in the highest tax brackets under current and proposed laws (39.6 percent in 2017 and potentially 38.5 percent in 2018).
AW: How will changes to federal estate tax impact state changes?
DuBoff: Under the both the House and Senate plans, it’s expected that we would have doubling of the lifetime estate and gift tax exemption to $11 million. Under the House plan, there could be a repeal of the estate tax effective for decedents dying after 2024. Having said that, most states have their own system of exemptions, inheritance taxes, and thresholds for filing. One thing is certain, states do not have to adopt the Federal estate tax and many are decoupled from the Federal estate tax system currently. Consequently, if the States choose not to raise exemptions or eliminate their state estate tax there might be a ripple effect, in that taxpayers may exit their respective states looking for a lower estate cost for their family legacy. If on the other hand they choose to adopt the Federal exemptions or repeal, it would put a strain on the already depleted budgets of state houses across the country. This is a no-win situation for many states struggling with public pension and other debts too large to support their failing infrastructure and needs of their general population.
AW: Can individuals pay some of their state taxes that they may owe next year in advance (by the end of 2017) since state taxes are not going to be deductible in 2018? How is that possible?
DuBoff: Both the House and Senate agree that State and Local Taxes will not be deductible in 2018. A D.C. Christmas miracle aside, we expect this to be the law in 2018. So, what is a taxpayer to do? Most taxpayers pay as they go, and to the extent they still have a balance due come January 15, 2018 or April 16, 2018 they may still benefit from paying and deducting their 2017 state and local taxes in 2017. Most jurisdictions allow for quarterly estimated tax payments, with paper vouchers or electronic payments. The risk every taxpayer must recognize with this strategy is twofold:
- Payments may not be deductible if they are already subject to the Alternative Minimum Tax (AMT) in 2017, or may only be partially deductible if the December state and local prepayments put them into the AMT.
- Any overpayments of their 2017 deductible state and local tax will be subject to tax in 2018 whether they are refunded or applied toward 2018. There could be an ancillary benefit as the tax rates and tax brackets in 2018 may be lower than in 2017. However, if their income is higher in 2018 it could backfire and they could pay more tax than they received a benefit for in 2017.
For those taxpayers who are subject to the 3.8 percent Medicare Tax on Net Investment Income (the NIIT tax), some of their state and local tax payments attributable to investment and passive income could be deductible even if they are subject to the AMT on their Federal income. Last but not least, Real estate taxes are also destined to be reduced to $10,000. Therefore, prepaying real estate taxes that are assessed and determinable, might provide a tax benefit in 2017, unless you are subject to the AMT.
AW: What should individuals do in terms of investments before the end of the year?
DuBoff: There are no capital gains tax rate provisions in either bill. So the general rules of tax loss harvesting and deferral of gain is the tried and true approach in normal circumstances. However, there is an arcane provision in the Senate bill, and that could have an impact on those clients who have low basis shares and high basis shares of stock in their investment accounts. The adequate (specific) identification rules will be repealed and the First-In, First-Out (FIFO) method of reporting cost basis on securities sales and other dispositions of securities will be the only method available. This provision is expected to raise over $3 billion in revenues for the government over a 10-year horizon. The consequences from a practical perspective is that in a rising market, the low basis shares will need to be sold first and the ability to tax harvest will be limited. There is still some time to make changes in 2017 to minimize this impact. For example, gift the low basis shares in 2017 before the law takes effect, and or harvest the high basis shares now. Another strategy could be to segregate the high and low basis shares into separate investment house accounts, thereby eliminating the possibility of triggering the reporting of this onerous tax basis methodology.
Read more articles about tax legislation on our content series Tax Reform Watch.