2017 Tax Planning: Last minute year-end moves for businesses and individuals
Posted on 12.28.17
With the signing into law of the Tax Cuts and Jobs Act (the Act), Congress has enacted the biggest tax reform law in thirty years, one that will make fundamental changes in the way you, your family and your business calculate your federal income tax bill, and the amount of federal tax you will pay. Since most of the changes will go into effect next year, there is still a narrow window of time before year-end to soften or avoid the impact of crackdowns and to best position yourself for the tax breaks that may be heading your way.
Last Minute Moves for Consideration
The general plan of action to take advantage of lower tax rates next year is to defer income into next year. Please note that each taxpayer’s situation is unique and you should speak with your tax advisor before making any decisions. Some possibilities follow:
- Prepayment of taxes. With limitations coming in 2018, many taxpayers are looking to prepay taxes in 2017 to get the full deduction. However, the IRS just indicated that the prepayment of 2018 state and local real property taxes will ONLY be deductible on a taxpayer’s 2017 tax return if those taxes were assessed before 2018. Guidance issued by the IRS on December 27 (IR-2017-210) addressed this matter by clarifying that the tax must have been assessed. The language in the Act addressed income taxes but not property taxes.
- If you are about to convert a regular IRA to a Roth IRA, postpone your move until next year. That way you will defer income from the conversion until next year and have it taxed at lower rates.
- Earlier this year, you may have already converted a regular IRA to a Roth IRA but now you question the wisdom of that move, as the tax on the conversion will be subject to a lower tax rate next year. You can unwind the conversion to the Roth IRA by doing a re-characterization—making a trustee-to-trustee transfer from the Roth to a regular IRA. This way, the original conversion to a Roth IRA will be cancelled out. But you must complete the re-characterization before year-end. Starting next year, you will not be able to use a re-characterization to unwind a regular-IRA-to-Roth-IRA conversion.
- The new law substantially increases the alternative minimum tax (AMT) exemption amount, beginning next year. There may be steps you can take now to take advantage of that increase. For example, the exercise of an incentive stock option (ISO) can result in AMT complications. So, if you hold any ISOs, it may be wise to postpone exercising them until next year. And, for various deductions, e.g., depreciation and the investment interest expense deduction, the deduction will be curtailed if you are subject to the AMT. If the higher 2018 AMT exemption means you won't be subject to the 2018 AMT, it may be worthwhile, via tax elections or postponed transactions, to push such deductions into 2018.
- The itemized deduction for charitable contributions will not be cut. But because most other itemized deductions will be eliminated in exchange for a larger standard deduction (e.g., $24,000 for joint filers), charitable contributions after 2017 may not yield a tax benefit for many because they won't be able to itemize deductions. If you think you will fall in this category, consider accelerating some charitable giving into 2017.
- Under current law, various employee business expenses, e.g., employee home office expenses, are deductible as itemized deductions if those expenses plus certain other expenses exceed 2% of adjusted gross income. The new law suspends the deduction for employee business expenses paid after 2017. So, we should determine whether paying additional employee business expenses in 2017 that you would otherwise pay in 2018, would provide you with an additional 2017 tax benefit.
- Reduction in corporate income tax rate. For tax years that begin after Dec. 31, 2017, the corporate tax rate, which had been at graduated rates as high as 35%, is reduced to a flat 21% rate. Not only does this encourage pushing income into the new year, but it also should cause you to think about converting non–C corporation clients into C corporations, particularly those clients that do not qualify for the new deduction for pass-through income, discussed below. But note that, for corporations that are not personal service corporations and whose taxable income is less than $50,000, their marginal tax rate under the new law is higher than it was previously, so they generally would be better off pushing income into this year until they reach $50,000 of current year taxable income.
- Deduction for pass-through income. For tax years that begin after Dec. 31, 2017, pass-through businesses, e.g., sole proprietorships, partnerships, limited liability companies and S corporations, may be able to take a deduction of up to 20% of their business income. So, in most cases, this deduction will create an incentive to push income into the new tax year and expenses into the current year.
But this new provision is complicated. For example, “specified service trades or businesses,” e.g., businesses that involve performance of services in the fields of health, law, consulting, athletics, financial services and brokerage services, don't fully qualify unless the taxpayer's taxable income is equal to or below $157,500 ($315,000 for married individuals filing jointly) and don't qualify at all if the taxpayer's taxable income is above $207,500 ($415,000 for married individuals filing jointly). As a result, taxpayers who are in those businesses will not want to push income into the New Year if doing so will cause taxable income to exceed the above dollar amounts.
Taxpayers in specified service businesses whose taxable income is too high to qualify for the new deduction should consider incorporating and/or changing/expanding their business model so that they are not specified service trades or businesses. Note that the term “specified service trade” or “business” is defined in terms of already-existing Code Sec. 1202(e)(3)(A), so there is existing guidance on what is and what isn't a specified service trade or business.
- If you run a business that renders services and operates on the cash basis, the income you earn is not taxed until your clients pay. So if you hold off on billings until next year—or until so late in the year that no payment will likely be received this year—you will likely succeed in deferring income until next year.
- If your business is on the accrual basis, deferral of income till next year is difficult but not impossible. For example, you might, with due regard to business considerations, be able to postpone completion of a last-minute job until 2018, or defer deliveries of merchandise until next year (if doing so won't upset your customers). Taking one or more of these steps would postpone your right to payment, and the income from the job or the merchandise, until next year. Keep in mind that the rules in this area are complex and may require a tax professional's input.
- The reduction or cancellation of debt generally results in taxable income to the debtor. So if you are planning to make a deal with creditors involving debt reduction, consider postponing action until January to defer any debt cancellation income into 2018.
- Modification of the limit on excessive employee compensation. A deduction for compensation paid or accrued with respect to a covered employee of a publicly traded corporation is limited to no more than $1 million per year. However, under pre-Act law, exceptions applied for: (1) commissions; (2) performance-based remuneration, including stock options; (3) payments to a tax-qualified retirement plan; and (4) amounts that are excludable from the executive's gross income.
- For tax years beginning after Dec. 31, 2017, the exceptions to the $1 million deduction limitation for commissions and performance-based compensation are repealed.
So, taxpayers that are affected by these changes should: 1) to the extent practical, pay the types of compensation that were covered by an exception under the old rule but which no longer will be excepted, before the beginning of their new year; 2) reconsider their compensation policies for the new year and thereafter.
- Changes to net operating loss deduction rules. For net operating losses (NOLs) arising in tax years ending after Dec. 31, 2017, the current-law two-year carryback is, in almost all cases, repealed. As a result, increasing a current year NOL has a greater value, since creating such an increase will not only increase the client's refund from a carryback but also will be the client's last chance to get a carryback at all for the increased loss.
- For losses arising in tax years that begin after Dec. 31, 2017, the NOL deduction is limited to 80% of taxable income. NOLs incurred this year are not subject to this rule. So, it can be advantageous for a taxpayer with current year and future year losses to push deductions into the current tax year and push income into next year.
- Expensing and depreciation. In general, taxpayers will want to accelerate the purchase of depreciable assets to take advantage of the 100% bonus depreciation provision included in the Act for property placed in service after Sept. 27, 2017. Also note that, under the Act, used property qualifies for bonus depreciation. Accelerating the purchase of qualifying property will offset income taxable at the 2017 higher tax rates.
- On the other hand, because limitations on automobile depreciation are greatly increased for automobiles placed in service after Dec. 31, 2017, many taxpayers will benefit from postponing the purchase of automobiles until 2018.
- Like-kind exchanges. Generally effective for transfers after Dec. 31, 2017, Code Sec. 1031 like-kind exchanges are limited to transfers of real property not held primarily for sale. However, under a transition rule, the crackdown doesn't apply to exchanges of personal property if the taxpayer either disposed of the relinquished property or acquired the replacement property on or before Dec. 31, 2017. If a client can perform either of those actions before Dec. 31 with respect to personal property, he will be able to benefit from the like-kind exchange rules.
- Alternative minimum tax. For tax years that begin after Dec. 31, 2017, the corporate alternative minimum tax (AMT) is repealed. Therefore, corporations that would be subject to the AMT for a year before the repeal are likely to benefit by postponing transactions that result in AMT preferences or adjustments, and/or by not making elections that result in AMT preferences or adjustments, in that year.
- Repeal of domestic production activities deduction. For tax years that begin after Dec. 31, 2017, the domestic production activities deduction (DPAD) is repealed. DPAD is a deduction equal to 9% (6% in the case of certain oil and gas activities) of the lesser of the taxpayer's qualified production activities income or the taxpayer's taxable income for the tax year. Entities that are not C corporations, and that have income that would both increase their current year DPAD if it were recognized this tax year and would not increase their deduction for pass-through income (as described at “deduction for pass-through income” above) if it were recognized in a future year, will likely benefit by recognizing that income in this tax year.
- Liberalization of the long-term contract rules. Under current law, construction companies with average annual gross receipts $10 million or less, that meet certain other requirements, may use the more favorable completed contract method for recognizing income, rather than the less favorable percentage-of-completion method. For contracts entered into after Dec. 31, 2017, that $10 million figure is increased to $25 million. For construction companies whose average annual gross receipts are greater than $10 million and less than or equal to $25 million, it will in most cases be advantageous to postpone entering into a contract until after Dec. 31.
- Limit on deduction of business interest. For tax years that begin after Dec. 31, 2017, every business, regardless of its form, is generally subject to a disallowance of a deduction for net interest expense in excess of 30% of the business's adjusted taxable income. The amount of any business interest not allowed as a deduction for any taxable year is treated as business interest paid or recruited in the succeeding tax year. This new rule does not apply to businesses with average annual gross receipts that do not exceed $25 million. And there are other exceptions as well.
- For decades, businesses have been able to deduct 50% of the cost of entertainment directly related to or associated with the active conduct of a business. For example, if you take a client to a nightclub after a business meeting, you can deduct 50% of the cost if strict substantiation requirements are met. But under the new law, for amounts paid or incurred after Dec. 31, 2017, there's no deduction for such expenses. So if you have been thinking of entertaining clients and business associates, do so before year-end.
- The employer deduction for employee transportation fringe benefits will no longer be allowed. Amounts incurred or paid after Dec. 31, 2017 for employee transportation fringe benefits, e.g., parking and mass transit, will not be deductible. Try to pay for any such already-incurred expenses, e.g., by reimbursing employees, during the last days of December.
As mentioned previously, each taxpayer’s situation is unique and you should speak with your tax advisor before making any decisions. If you have any questions, please contact your Keiter representative or Email | Phone: 804.747.0000. We are here to help.
We will continue to share our insights on the finalized tax changes in the coming months. Additional tax planning resources are included below.
- Tax Update for Individuals
- Tax Update for Businesses
- As 2017 Draws to a Close - Year End Reminders and Tax Filing Deadlines
- 2017 Year End Tax Planning: Are You Prepared?
- 2018 Tax Planning Guide
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