Two tax bills enter, one tax bill leaves. The House and Senate have both passed differing versions of a new tax bill. Now the bills go to committee in an attempt to reconcile the differences. Both versions involve increasing the standard deduction, reducing personal income tax rates, and removing many itemized deductions. Both bills also cut corporate tax rates, but this article will focus on the effects on personal income tax.
One thing is clear: If a reconciled bill can be passed, there will be a higher standard deduction, and many itemized deductions will be limited or no longer available. Both the House and Senate bills propose the following:
- Removing the deductions for state and local tax (SALT).
- Removing personal exemptions.
- Capping property tax deductions to $10,000.
- Keeping child tax credits with higher income tests.
- No removal of charitable deductions.
Some differences in the House and Senate Bills are as follows:
- The House Bill eliminates the medical expense deduction above a threshold of AGI whereas the Senate bill keeps it.
- Mortgage interest deduction is limited to interest on a balance of $500,000 on new mortgages in the House; the Senate says the existing $1,000,000 limit is fine but only on loans to buy or improve your home.
- The Senate bill eliminates all miscellaneous itemized deductions.
- The revised Senate bill passed does not repeal the Alternative Minimum Tax (AMT), though it increases the income limits. The house bill eliminates the AMT.
- Both versions have adjusted the various income tax brackets. The Senate version has seven brackets and the House version compresses to four brackets.
There may be some things we can do now, as well as into the future, to increase tax-efficiency. Note that charitable deductions are not an AMT preference item, so they are not recaptured. As a result, it may be wise to look at grouping charitable deductions into a tax year when they can be higher than the increased standard deduction so that they are more effective.
One popular tool for helping aggregate charitable contributions is a Donor Advised Fund (DAF). This mechanism allows you to decide what year is best for a charitable deduction and you contribute to the DAF in that year. The funds go into an account that allows you to make the donation to your ultimate charity at some point in the future. You can also donate appreciated stock to a DAF, eliminating any capital gains on the transfer. Once the funds are in your account, the assets grow until you designate the assets for use by certain charities. Under current tax structure, the deduction can be as large as 50% of AGI for a cash contribution, or 30% of AGI for a donation of appreciated assets. The gift you make to the DAF is irrevocable, just like any other charitable gift. This mechanism would allow a donor to make on-going charitable grants to a philanthropic cause while grouping the donations into one year. In the interim, whatever funds are not granted to charity are invested for future growth. This can be a complicated subject, so you should speak with your wealth manager or financial planner if you’re interested.
There are other planning techniques at year’s end that may be helpful. If you are not currently subject to the AMT, make sure you pay your fourth quarter estimated state income taxes in 2017 even though they can be paid in January of 2018. Avoid owing any state income tax due in April or October of 2018, as that payment is currently deductible for non-AMT taxpayers and may not be deductible at all in 2018. It is possible the state income tax deduction will go away in 2018 and beyond, so paying your state taxes in 2017 may allow you to get a deduction you will no longer be entitled to in the future. If you have significant miscellaneous itemized deductions that can be paid in 2017, making sure they are paid prior to year’s end may make sense for the same reason. Miscellaneous deductions are also an AMT preference item in 2017, so you may not be getting the full benefit of this deduction. Grouping medical expenses and paying them in 2017 may also be safer than waiting to see if this provision is continued.
In summary, there may be significant changes to income tax laws very soon. Therefore, you may want to discuss with your financial team the benefits of grouping charitable contributions with a DAF, accelerating state tax payments, medical deductions, or paying miscellaneous deductions now. In many cases any negative effects would be minimal, and if the tax laws change, it may help a great deal.
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