2018 Tax Reform Thoughts and Planning

/ Chris Arena, CPA, PLLC/

As the year draws to a close, I wanted to make sure that I got my thoughts on the proposed tax reform bills to my clients and partners. Let’s kick things off with a high-level summary of the tax reform bill that passed the Senate. This bill is likely to be substantially similar to the final bill that passes reconciliation, as the Senate bill passed with a very slim margin and cannot afford to lose votes due to any further changes. However, it is subject to change in the reconciliation process and I don’t own a crystal ball! With that caveat in mind, here are the major changes:

  1. Across-the-board lowering of tax brackets
  2. Keeps the Alternative Minimum Tax, but reduces the impact it will have on many taxpayers
  3. Approximately doubles the standard deduction, but removes personal exemptions and changes certain itemized deductions
    1. No deduction for state income taxes
    2. Limitation of $10,000 on property taxes
    3. No changes to mortgage interest or charity deductions
    4. Lowers the threshold to be able to deduct medical expenses to 7.5% of AGI, down from 10% for most taxpayers
  4. Doubles the child tax credit and makes many more taxpayers eligible to claim it
  5. Allows 529 Saving Plans to be utilized for K-12 private school costs in addition to college costs
  6. Repeals the individual mandate for healthcare (no penalty for not carrying healthcare)
  7. Doubles the lifetime Estate tax limit (Currently approximately $5mm of assets per person is exempt from tax, increasing to $10mm)
  8. Reduces the corporate tax rate to 20%
  9. Reduces the taxability of pass-through income for business that don’t pay corporate taxes (partnerships and S-Corps)
  10. Various other changes that are either too small to mention or won’t have an impact on most of my clientele

 

Based on the above summary of changes, I want to share a few tax planning strategies with you to take advantage before the year turns over to 2018:

  • Both the Senate and House bills call for repeal of the deduction for State income taxes. This means that if you expect to owe State tax, pay it now so that we can deduct it on your 2017 tax return. If you wait and pay it in April, it will become non-deductible and you may lose a significant benefit.
    • ACTION: Make your 4th Quarter estimate by the end of this month, and if you think you may owe more than what you’ve paid via estimates, make an additional payment now
  • Itemizing your deductions will be much “harder” in 2018 than 2017, due to the larger standard deduction. Therefore, any itemized deductions such as property taxes, mortgage interest, and charity may lose their value in 2018 if you find yourself taking the new standard deduction (expected to be $24,000 for married taxpayers)
    • ACTION: “Prepay” as many itemized deductions as you can in 2017. E.g., Make your 2018 charitable donations now.
  • The tax reform bill calls for significant reduction in corporate rates and a reduction on pass-through business taxation. As a result, any deduction will have more value in 2017 than it will in 2018. Cash basis taxpayers (most small businesses and most of my clients) can prepay expenses in order to deduct them in 2017, even if you won’t need what it is you’re paying for until 2018
    • ACTION: Prepay expenses and purchase equipment before the end of the year to maximize the value of your deductions
  • The threshold for being able to deduct medical expenses drops to 7.5% of AGI in 2018, meaning a family earning $150k/year in 2018 will be able to deduct any medical expenses above $11,250, instead of only those above $15,000 per current law.
    • ACTION: Delay paying medical expenses until 2018 if possible, as you will be more likely to be able to deduct them (only if you expect to itemize deductions under new law)
  • Pass-through entities will likely be even more tax-advantageous than they currently are under new law. The proposed Senate bill includes a deduction for pass-throughs equal to 23% of income, meaning a business that profits $100k will only pay tax on $77k of income. This deduction is limited to 50% of wages paid, in order to encourage reasonable compensation and limit abuse
    • ACTION: If you are a sole-proprietor, consider forming an S-Corporation in 2017. 12/22 Update - The final bill allows for a 20% pass-through deduction instead of 23%, and it applies to sole proprietors as well

The tax reform bill is wide-ranging and complex, and my thoughts above are only intended to provide a summary overview of the proposed changes and a few “can’t miss” tax planning opportunities. Overall, the tax bill does not simplify the code as promised, but it does provide tax reductions to the vast majority of Americans, especially those who are taxed at the highest brackets.

It is my pleasure providing you with the best tax advice I can under the information that is available, and I will strive to continue to update you as the reform process continues to move through conference. If you have questions about the bill which aren’t covered above, please don’t hesitate to reach out.