Dear Clients & Friends:
We once again find ourselves meshed in uncertainty related to tax reform. As you know, there is a tax bill in the works. The House passed its tax reform bill on November 16th and the Senate passed its version early in the morning on December 2nd. Now both versions of the bill go to the Joint Conference Committee which drafts a compromise bill which must be voted on again by both houses of Congress. If the compromise bill is passed by both houses, then of course the president signs the bill (or vetoes it). Rather than muddy up this communication with the details of tax reform, we have prepared a separate schedule with a summary of what we consider to be the most significant changes in the house and senate bills as of this writing. These bills are huge and are game changers in many respects. We’ve all read the news about the changes in individual tax brackets, standard deductions, and corporate tax rates, but there is much more. We recommend that you skim the tax reform attachment first (original located here: Tax Reform Summary, updated version located here: Updated Tax Reform Summary) and then read this letter, which refers to it in numerous instances. The compromise bill will differ from both the house and senate bills, so nothing is certain until the final vote happens. One more comment up front – most of the provisions in both bills are effective in 2018 but a few are effective this year. Note the effective dates for each provision as you go through the schedule.
Year-end planning for individuals
Determine your marginal tax bracket – In order to evaluate the effects of year-end maneuvers, there is no single piece of information more important than one’s marginal tax bracket. The regular 2017 federal tax rates can be found at http://taxfoundation.org/article/2017-tax-brackets. These rates apply to federal taxable income. If one is subject to the alternative minimum tax (AMT) the marginal rate may be 26% or 28%. Furthermore, a whole slew of deductions and credits are phased out as income increases yielding even higher effective marginal tax rates. Throw in the 3.8% tax on net investment income (NIIT) if applicable, and the top Oregon marginal rate of 9.9% and it’s conceivable to have an effective marginal tax rate of well over 50%. In that case, if for example, you donate $10,000 to charity or spend another $10,000 on business expenses, you may only be out of pocket for half of the cost. Tax Reform Comment – the rates for 2017 will not change but the rates in 2018 and future years would.
Some ideas to lower your 2017 and/or future year tax bills:
- Contribute to an IRA by April 18th of 2018. Note that the deduction phases out as income increases if one or both spouses (if married) are covered by an employer plan. That aside, maximum contributions for 2017 and 2018 have not changed from 2015 – $5,500 plus another $1,000 catch-up contribution for those who are age 50 or older as of 12/31/17. You or your spouse must have earned income to contribute. Also note that if you are subject to the 3.8% net investment income tax which is driven by adjusted gross income, a deductible contribution will reduce that tax as well.
- Contribute to a Roth IRA – If you are willing to forego a current tax deduction, consider a Roth IRA instead. Although you won’t save any taxes today, the earnings in the account are never taxed, even upon withdraw, if you follow the rules. Allowable contributions for 2017 phase out beginning at modified adjusted gross income of $186,000 for taxpayers filing jointly and $118,000 for single and head of household taxpayers.
- Don’t’ forget to take the Required Minimum Distribution (RMD) from your retirement plan – Taxpayers who are at least 70½ must take their RMD no later than 12/31/17. If however, you reach age 70½ in 2017, your first RMD can be delayed until April 1, 2018. Also, see (4) under “multiple strategies for charitable gifting” below.
- Consider bunching your itemized deductions in one year instead of spreading them over two years. Tax Reform Comment – this is especially true with the scheduled increase in the standard deduction and the possible repeal of deductions for state and local income taxes and (partial repeal of) property taxes. If you do not expect to be able to itemize deductions in future years with these changes, you might consider accelerating deductions for taxes and charitable contributions for example. However, bunching deductions to avoid the overall limit on itemized deductions will be moot if tax reform passes as that provision is repealed in both the house and senate bills.
- Consider multiple strategies for charitable gifting – (1) Make charitable donations of appreciated stock held for longer than one year. This avoids taxation of the gain and yields a full fair market value deduction; (2) If you want to make large gifts in 2017 (especially given the prospect of tax reform), consider a “donor advised fund” which allows you to transfer and take a deduction for property transferred this year while having the fund dole out the funds to qualified charities at a later date. Consider Oregon Community Foundation if you’re interested; (3) Consider setting up one of a variety of charitable trusts thereby enabling you to gift property this year and take a charitable deduction for the value of the property less the remainder interest. Some charities have “pooled income funds” which are similar but take the paperwork burden off the donor; (4) Consider ability to transfer up to $100,000 tax-free from a traditional IRA to charity for owners who have reached age 70 ½ – This tax-free rollover can even satisfy an owner’s required minimum distribution for the year. Tax Reform Comment – Again, deductions are likely to provide greater benefit in 2017 than in future years so if you’re considering a large charitable gift, it’s best to act now.
- Don’t forget that expenses incurred in conjunction with volunteer activities often produce deductions
- Consider donating to the Oregon Cultural Trust – If you donate up to $500 on a single return or $1,000 on a married filing joint return to qualifying cultural organizations, you can donate a like amount to the OCT and receive a 100% Oregon tax credit. This has the potential to save you more than the donation amount! More info is available at culturaltrust.org.
- Sell loss stocks before year-end if you expect net capital gains for the year.
- Recognize long term gains – Net long-term capital gains and qualified dividends are subject to a favorable federal tax rate. The maximum federal rate is 20% (plus the 3.8% NIIT if applicable) but drops to 15% for those in the 25%, 28%, 33%, and 35% regular tax brackets. It drops to 0% for those in the 10% or 15% regular tax brackets. Therefore, if your taxable income is reasonably low, you might be able to recognize long term capital gain or qualified dividend income at no federal tax cost. State taxes will of course apply. Tax Reform Comment – note that the changes in tax brackets for 2018 and beyond will also affect the levels at which the various capital gain rates apply so it’s possible you’ll get a better deal by deferring gains into the future. That said, you would never want to waste the 0% capital gain bracket.
- Pay state taxes before year-end – If you expect to owe state income taxes for 2018 next April, consider paying them prior to December 31st to avail yourself of the deduction unless you expect to be subject to AMT in which case the deduction would provide no benefit. Tax Reform Comment – Consider comment under bunching itemized deductions above.
- Contribute to an FSA – If your employer offers a flexible spending account, sign up!
- Consider an installment sale of property vs an outright sale for cash in order to spread revenue over multiple years. Tax Reform Comment – you might be in the position to benefit from deferring all gains to future years and reporting none in 2017.
- Consider disposing of passive activities with suspended losses to unrelated parties prior to year-end. Tax Reform Comment – Because rates would decrease in the future, you generally will benefit more from deductions in 2017 thus a move such as this will likely be more beneficial in 2017 than in future years.
- Consider the status of business activities as passive or non-passive – The effects of classification are many, including deductibility of passive losses, income subject to the 3.8% NIIT, and application of Oregon’s special reduced pass thru entity rate.
- Gift appreciated stock held for over a year to a child in a low tax bracket assuming the child is not subject to the “kiddie tax”. Your holding period and basis carry over to the child, who can sell and recognize long term capital gain. If their other income is sufficiently low, they may incur zero federal tax cost on the sale. See estate and gift tax rules below however.
- Make expenditures that qualify for one of several energy credits – Given the fact that these credits may expire at the end of this year, it may be now or never. Examples of qualifying expenditures are home insulation, high efficiency HVAC systems and water heaters, and qualified fuel cell motor vehicles. Tax Reform Comment – The bills contain a whole array of changes to energy credits in the future. Notably, the house version repeals the plug-in vehicle credit. If you’re in the market for one, you should consider buying it and placing it in service before year end.
- If you’re in the process of selling your principal residence – Tax Reform Comment – Consider changes in both the house and senate bills to sales starting in 2017. Attempt to close your sale before year end if the changes are problematic.
Year-end planning for businesses
- Purchase fixed assets before year end and take the section 179 deduction – Businesses can expense up to $510,000 of qualifying fixed asset purchases for years beginning in 2017. The dollar limitation phases out dollar for dollar as total qualifying purchases exceed $2,030,000. Example – if a business purchases $2,130,000 of qualifying assets, the 179 limitation is $410,000. Assets can be new or used and generally include tangible personal property, although some real property qualifies – notably qualified leasehold improvement, restaurant, and retail improvement property. Tax Reform Comment – Both the house and senate bills significantly increase the 179 limitations in the future. Consider deferring purchases of qualifying assets to the extent they cause your business to exceed the 2017 limitation in favor of making the purchases in 2018 or later.
- Purchase fixed assets before year end and take bonus depreciation – For those who either purchase assets in excess of their 179 dollar limitation and/or are limited due to the phase out rules, bonus depreciation is the next best thing. For assets placed in service in 2017, the first year bonus rate is 50%. For assets placed in service in 2018, the rate is 40%. And for assets placed in service in 2019, it’s 30%. After that, it’s gone, unless extended. Qualifying assets must be new and have a depreciable life of 20 years or less or be “qualified improvement property”. The rules are too voluminous to recite here but suffice it to say that you may be able to write off 50% of certain real property improvements in the year placed in service. Tax Reform Comment – Both the house and senate bills increase the bonus percentage to 100% for assets place in service after 9/27/17. The house bill expands the definition of qualifying property to include used property as well.
- Purchase a business vehicle before year end – The amount of depreciation allowable will vary depending on whether the vehicle is rated at over 6,000 pounds GVW. If so, depreciation is available on the same basis as other fixed assets (i.e. section 179 expensing and bonus depreciation). Caveat – the section 179 deduction for SUVs is limited to $25,000. If rated at less than 6,000 pounds GVW, depreciation is limited based on published “luxury auto limits” which generally equate to a maximum deduction of $3,160 plus $8,000 bonus in year one. Of course, all deductions are only allowable to the extent of business use. Tax Reform Comment – Both the house and senate bills have provisions which would increase allowable depreciation. The house provisions are effective for vehicles placed in service after 9/27/2017 and the senate for vehicles placed in service after 12/31/2017.
- Determine whether your business qualifies for the Work Opportunity Tax Credit – This credit applies to employers who hire individuals in groups whose members historically have low employment such as veterans, ex-felons, TANF recipients, and many more. Tax Reform Comment – The house bill repeals this credit but only for individuals who commence work for the employer after 12/31/17. If your business is considering hiring someone who qualifies for the credit, consider hiring them now.
- Create basis to absorb owner losses – Make sure the owner(s) of an S corporation or partnership have ample basis to deduct losses prior to year-end. Tax Reform Comment – Freeing up losses in 2017 will likely provide a higher tax benefit than in future years with planned tax rate reductions.
- Consider whether your business activities in another state create “nexus” requiring the filing of a state tax return and payment of the taxes that go along with it. It is sometimes possible to manage activities so that nexus is not created; each state’s rules are different. It is worth noting that states have increasingly abandoned the physical presence nexus standard in favor of an economic presence nexus standard.
- Does your business qualify for research and development credits? The R&D credit is now a permanent tax credit. If your business engages in activities which are intended to develop or improve a product or process, is technological in nature, and which uses a process of experimentation to resolve technical uncertainty, you might qualify. Tax Reform Comment – Fortunately, the R&D credit is one of few spared by both the house and senate bill.
- If your business is considering a like-kind exchange of property other than real estate – Tax Reform Comment – Consider that both the house and senate tax bills would eliminate tax-free treatment for exchanges completed after 12/31/2017.
Estate & gift environment
The United States has a unified transfer tax system which limits the amount one can transfer to others during their lifetime and at death combined without paying transfer taxes. For 2018, the estate and gift tax exemption is $5,600,000 and the top federal estate and gift tax rate is 40%. The top Oregon estate tax rate is 16%. Note that Oregon has no gift tax! During 2017 and 2018, an individual can make gifts of $14,000 and $15,000 respectively per donee without using any of the exemption amount. If your net worth is over the estate exemption, it makes sense to consider making annual gifts to whittle some of the excess away. If your net worth is less than the federal exemption amount, consider larger gifts to save Oregon estate tax.
In early 2013, Congress made the estate tax portability rules permanent. This means that if one spouse dies without using up all of their exemption amount, the unused amount can, if an election is made, be used by the surviving spouse upon their death. The election must be made on a timely filed federal estate tax return for the first deceased spouse.
Tax Reform Comment – Both the house and senate bills increase the estate and gift tax exemption to a generous $10 million effective for decedents dying and gifts made after 2017. It goes without saying that if your estate is in excess of the current exemption amount, it would behoove you to defer your death until next year.
Other notable information
- Required filing for foreign bank accounts (FBAR) – Significant penalties are imposed for failing to file the required report if you have an interest or signature authority over a foreign bank account at any time during the year. The report is required if the balance in the account reaches $10,000 at any time during the year.
- W-2 and 1099 filing requirements – Penalties for failing to file a required can reach as high as $520 per occurrence. In general, your business is required to file a 1099 if you make payments for services, rents, interest, and more of $600 or more during the year. Forms are required to be provided to the payee and filed with the IRS no later than 1/31/2018.
- Estate and Gift valuation proposed regulations issued in 2016 which would have severely restricted the ability to apply discounts for lack of marketability and control for purposes of valuing business interests were quashed.
We realize that deciding what to do between now and December 31st may be difficult considering the pending status of tax reform. Certainly, there are some actions which will prove wise in either situation. For other moves, you may have to wait and be ready to spring into action at the last minute. We will of course do what we can to help.
We hope the year has been happy and prosperous for your family and loved ones. We are grateful for our client and business relationships and hope we can meet your expectations and give you the service and attention you deserve.
Zirkle, Long & Associates, LLC