2017 Tax Planning Letter
Dear BMSS Clients and Friends,
As the end of 2017 approaches, you are likely giving consideration to year-end tax planning strategies. For the last several years, we have faced uncertainty regarding whether tax “extender” legislation would pass, and if so, exactly what tax provisions would be extended, or not extended. This year, far greater uncertainty exists regarding tax legislation, including the possibility of major tax reform. This letter highlights some of the planning opportunities and challenges for individuals, estates, trusts and businesses regarding federal taxes.
TAX LEGISLATION UPDATE
Before discussing more general tax planning concepts that might be considered, we will briefly provide an update on where we stand today on the prospects of major tax reform. On November 2, 2017, the House released the Tax Cuts and Jobs Act (H.R. 1). Some of the major provisions, applicable to 2018, include four individual tax brackets (12%, 25%, 35% and 39.6%), a flat corporate rate of 20% and a pass-through business income tax rate of 25%. The bill, if enacted, would repeal alternative minimum tax and limit the home mortgage deduction at $500,000 in debt on future home purchases. The state and local income tax deduction would be eliminated; property taxes up to $10,000 could be deducted. The estate tax would be repealed in 2025, although in the meantime, the exemption level would be doubled. The bill passed the House on Thursday, November 16, 2017.
On November 9, 2017, Sen. Orrin Hatch (R-UT), Chairman of the Senate Finance Committee, released the Senate’s version of a tax reform plan, with some substantial differences. On November 14th, Hatch released the modified chairman’s mark, in effect, the final draft, for the Tax Cuts and Jobs Act. The Senate bill retains the current seven-bracket structure for individuals but lowers rates for several brackets. The Senate bill retains the current home mortgage interest deduction, but eliminates the home equity interest deduction. State and local tax deduction, including property taxes would be eliminated. For pass-through businesses, a 17.4% deduction of pass-through income is provided, instead of a maximum tax rate on the income. The estate tax threshold for tax would essentially be doubled, as in the House bill, but no repeal is scheduled. The Senate bill also added the repeal of the Affordable Care Act individual mandate, a measure that was essentially voted down this summer in a health care plan bill. The full Senate is expected to take up a vote of its version of the Act after Thanksgiving.
If both chambers do pass a tax bill, the differences will still have to be reconciled. Certain issues like the state and local tax deduction and ACA individual mandate repeal could complicate those conference negotiations. A summary contrasting the House and Senate versions of the Act can be read here.
As a result, planning for the 2017 tax year will likely extend into late 2017. BMSS can help you navigate through uncertainties and develop a year-end tax strategy to help minimize your federal tax liability. Please call your BMSS trusted advisor for assistance with your year-end tax planning.
OVERVIEW OF GENERAL GOALS AND OBJECTIVES OF YEAR-END TAX PLANNING
Most traditional income tax planning strategies focus on several key areas:
- planning the timing (deferral or acceleration) of particular items of income or deductions, to the extent that they can be shifted from one year to another in order to take advantage of possible differences in the effective tax rate for the current year and succeeding year(s);
- maximizing, within overall general planning, the character of income (for example qualified dividends and capital gains) that is subject to preferential, lower tax rates than ordinary income; and
- taking advantage of special incentive provisions of the Internal Revenue Code when available such as Section 179 expensing, bonus depreciation, and various credits related to different business or personal activities.
To complicate matters further, these general planning strategies must also consider the impact of taxes other than the regular income tax, such as the alternative minimum tax, the net investment income tax, the Medicare surtax and applicable state and local taxes to name a few. The phase-out or limitation of itemized deductions must also be considered in planning for the timing of certain deductions.
As developments occur with the Tax Cuts and Jobs Act, taxpayers may need to make adjustments to the tax planning strategy they have in place. Year-end strategies for three tax reform outcomes follow. If your objective is the lowest overall tax for 2017 and 2018, then you should consider the following year-end strategies:
- No tax reform until 2018 – accelerate 2018 deductions and defer income
- Tax reform for 2017 and 2018 – maximize new / enhanced deductions
- No tax reform at all – balance taxable income as in prior year planning, and consider the impact of reform later in 2018
The above strategies are general strategies that may or may not be appropriate depending on your particular tax situation. As always, tax planning requires a combination of multi-layered strategies, taking into account a variety of possible scenarios and outcomes. There are various income and deduction items to look at and your BMSS trusted advisor is glad to assist you in order to determine the most beneficial approach to take. With the uncertainty over tax legislation, planning under current law might be prudent; however, you may want to consider leaving the execution of action items from that planning open until as late as possible in the year to allow for adjustments if and when more information is known about tax legislation.
The discussion below reflects tax laws as they currently exist before any possible 2017 legislation. We will keep you updated on any changes as they occur.
Tax Rates and Phaseouts – Individuals
The income tax rates and brackets for 2017 are:
Married Filing Jointly (MFJ)
Married Filing Separately (MFS)
|10%||$0 – $18,650||$0 – $9,325|
|15%||$18,651 – $75,900||$9,326 – $37,950|
|25%||$75,901 – $153,100||$37,951 – $76,550|
|28%||$153,101 – $233,350||$76,551 – $116,675|
|33%||$233,351 – $416,700||$116,676 – $208,350|
|35%||$416,701 – $470,700||$208,351 – $235,350|
|39.6%||$470,701 and greater||$235,351 and greater|
Head of Household (HOH)
|10%||$0 – $13,350||$0 – $9,325|
|15%||$13,351 – $50,800||$9,326 – $37,950|
|25%||$50,801 – $131,200||$37,951 – $91,900|
|28%||$131,201 – $212,500||$91,901 – $191,650|
|33%||$212,501 – $416,700||$191,651 – $416,700|
|35%||$416,701 – $444,500||$416,701 – $418,400|
|39.6%||$444,501 and greater||$418,401 and greater|
Unchanged from 2016, five different rates apply to long-term capital gains and qualified dividends:
- 0% for taxpayers in the 10% and 15% income tax brackets
- 15% for taxpayers in the 25%, 28%, 33%, and 35% income tax brackets
- 20% for taxpayers in the 39.6% income tax bracket
- 25% for unrecaptured Code Section 1250 gains
- 28% for collectible gains and gains on qualified small business stock
Keep in mind the “wash sale rules” when reviewing year-end capital gains and dividends. Wash sales are sales of stock or securities in which losses are realized, but not recognized for tax purposes, because the seller acquires substantially identical stock or securities within 30 days before or after the sale. Nonrecognition, however, applies only to losses; gains are recognized in full.
Under the House bill released on November 2, 2017, a rate threshold definition would be created for each income tax bracket.
Higher-income taxpayers are subject to the Pease limitation. The Pease limitation reduces itemized deductions by 3% of the amount that the taxpayer’s adjusted gross income (AGI) exceeds the thresholds below, but not by more than 80%. For 2017, the threshold amounts are:
- $313,800 for MFJ and Surviving Spouses (SS)
- $156,900 for MFS
- $287,650 for HOH
- $261,500 for single taxpayers
The personal exemption phase-out requires taxpayers to reduce the amount of their exemptions when their AGI exceeds the same threshold levels as the Pease limitation above. The total amount of exemptions that may be claimed by a taxpayer is reduced by 2% for each $2,500 (2% for each $1,250 for MFS), or portion thereof by which the taxpayer’s AGI exceeds the applicable threshold.
Alternative Minimum Tax – Individuals
The possibility of being subject to alternative minimum tax (AMT) should not be ignored, as doing so may negate certain year-end tax strategies. An AMT exemption is allowed; however, the exemption is phased out as taxpayers reach high levels of alternative minimum taxable income (AMTI). For 2017, the exemption amounts are:
- $84,500 for MFJ and SS, phaseout begins at $160,900 (complete phase-out at $498,900)
- $42,250 for MFS, phaseout begins at $80,450 (complete phase-out at $249,450)
- $54,300 for HOH and Single, phaseout begins at $120,700 (complete phase-out at $337,900)
An individual’s tentative minimum tax is generally equal to the sum of:
- 26% of an individual’s taxable excess up to a threshold amount ($93,900 for MFS and $187,800 for all other filers)
- 28% of the individual’s remaining taxable excess.
Net Investment Income Tax (NIIT) – Individuals
The NIIT is a 3.8% Medicare surtax imposed on the lesser of an individual’s (a) net investment income (NII) or (b) the amount of modified adjusted gross income (AGI with foreign income added back) that exceeds the thresholds below:
- $250,000 for MFJ
- $125,000 for MFS
- $200,000 for single taxpayers and HOH
The NIIT generally applies to passive income and is not imposed on income derived from a trade or business or from the sale of property used in a trade or business. NII includes the following:
- Gross income from interest, dividends, annuities, royalties, and rents, provided this income is not derived in the ordinary course of an active trade or business
- Gross income from a trade or business that is a passive activity for the taxpayer
- Gross income from a trade or business of trading in financial instruments or commodities
- Gain from the disposition of property not held in an active trade or business
NII can be reduced by certain investment-related expenses, such as investment interest expense, investment brokerage fees, royalty-related expenses, and state and local taxes allocable to items included in net investment income.
Keeping income below the thresholds, spreading income out over a number of years, or offsetting the income with both above-the-line and itemized deductions are possible approaches to avoid the NIIT. Of course, every taxpayer’s situation is different and planning for the NIIT requires a very personalized strategy. BMSS can help you develop a personalized response.
Additional Medicare Tax – Individuals
An additional 0.9% high income Medicare tax is imposed on wages and self-employment income that exceeds the same thresholds as the NIIT thresholds listed above. Although the thresholds are the same, this additional tax should not be confused with the 3.8% Medicare surtax on NII.
If federal income tax withholdings and estimated tax payments have not been made under a “safe harbor,” you can instruct your employer to withhold additional federal income taxes from your wages before year end to avoid an underpayment penalty related to this tax or the NIIT.
Child and Education Related Tax Benefits – Individuals
Adoption Credit and Adoption Assistance Programs
Most taxpayers can claim a credit for qualified expenses incurred in connection with the adoption of an eligible child. The credit for each adoption is limited to a maximum amount of $13,570 per child for 2017. Additionally, $13,570 received under an adoption assistance program may be excluded from gross income. Both the credit and gross income exclusion are phased out for higher income taxpayers. Different rules apply to domestic children, foreign children, and children with special needs.
Child and Dependent Care (CDC) Credit
Taxpayers who incur expenses to care for children under age 13 (or for an incapacitated dependent or spouse) in order to work or look for work can claim a credit for those expenses. The credit is calculated as a percentage of the expenses incurred, up to a maximum of $3,000 for taxpayers with one qualifying child or dependent and $6,000 for taxpayers with two or more qualifying children or dependents.
Child Tax Credit (CTC)
Taxpayers are allowed an income tax credit of $1,000 for each qualifying child under the age of 17 at the end of the calendar year. The child tax credit is refundable for some taxpayers, but begins to phase-out for higher-income taxpayers at the thresholds below:
- $110,000 for MFJ (complete phase-out at $130,000)
- $75,000 for single taxpayers and HOH (complete phase-out at $95,000)
- $55,000 for MFS (complete phase-out at $75,000)
American Opportunity Tax Credit (AOTC)
The maximum credit that can be taken is $2,500 per eligible student for the first four years of higher education and up to $1,000 is refundable. The AOTC is phased out for single taxpayers with income ranging from $80,000 to $90,000, and for joint taxpayers with income ranging from $160,000 to $180,000.
Lifetime Learning Tax Credit
The lifetime learning credit is a nonrefundable credit for qualified students and is available for all years of postsecondary education. The maximum credit is $2,000 and is phased out for single taxpayers with income ranging from $55,000 to $65,000 and joint taxpayers with income ranging from $112,000 to $131,000. The lifetime learning credit and American Opportunity credit cannot be taken in the same tax year.
Coverdell Education Savings Accounts (ESAs)
ESAs are trust or custodial accounts created exclusively to pay the qualified elementary, secondary and higher education expenses of a single named beneficiary. Annual contributions are limited to $2,000 per beneficiary, but this limit is phased out for higher-income contributors. Contributions may be made to an ESA up to the original due date of the return.
Qualified Tuition Programs (QTP)
A Qualified Tuition Program is an education savings plan designed to help families set aside funds for future college costs. Contributions to a QTP are not deductible, however the earnings in the plan grow tax free, provided they are used for qualified expenses (e.g. tuition, fees, room and board, books, supplies, computers and software) while enrolled at an eligible educational institution.
Educational Assistance Programs
Employees are allowed to exclude from gross income and wages up to $5,250 in annual educational assistance provided under an employer’s nondiscriminatory “educational assistance plan.” Employer-provided educational benefits may also be excludable as a fringe benefit.
Any amount received as a qualified scholarship and used for qualified tuition and related expenses is excludable from income. The exclusion does not apply to any portion of the amount received which represents payment for teaching, research, or other services by the student required as a condition for receiving the qualified scholarship (with limited exceptions).
Student Loan Interest Deduction
Taxpayers may deduct from gross income, subject to certain conditions, interest payments made on qualified education loans. The deduction is an above-the-line adjustment to income that can be claimed by all individuals, not just those who itemize. The maximum deduction of $2,500 is reduced when modified AGI exceeds $65,000 ($130,000 for joint returns) and is completely eliminated when modified AGI reaches $80,000 ($160,000 for joint returns).
Affordable Care Act (ACA) – Individuals
Unless exempt, the ACA requires that all individuals carry minimum essential coverage or make a shared responsibility payment. Individuals with health insurance coverage should determine that their coverage satisfies the ACA’s minimum essential coverage requirements. The following exemptions are available to qualified individuals:
- Religious conscience exemption
- Hardship exemption
- Exemption for members of federally-recognized Native American nations
- Exemption for members of a health care sharing ministry
- Exemption for incarcerated individuals
- Short coverage gap exemption
- Exemption for individuals not lawfully present in the United States
For 2017, the individual shared responsibility payment is the greater of 2.5% of household income that is above the tax return filing threshold for the individual’s filing status, or the individual’s flat dollar amount, which is $695 per adult and $347.50 per child, limited to a family maximum of $2,085. The shared responsibility payment is capped at the cost of the national average premium for a bronze level health plan available through the ACA Marketplace in 2017.
Additional Benefits – Individuals
The PATH Act of 2015 either extended or made permanent the following deductions and credits:
- Above-the-line deduction of up to $250 for certain expenses of elementary and secondary school teachers, including books, supplies, computers, and software
- Above-the-line deduction for qualified tuition and related expenses
- Exclusion of 100% of the gain on the sale or exchange of qualified small business (QSB) stock acquired and held for more than five years.
- Credit for residential energy property
- Exclusion from gross income for discharge of indebtedness on qualified principal residences
- Exclusion from gross income of qualified charitable distributions up to $100,000 from individual retirement plans for individuals aged 70&½ or older
- Itemized deduction for mortgage insurance premiums as qualified residence interest
- Itemized deduction for state and local general sales taxes in lieu of state and local income taxes
- Alternative fuel vehicle refueling property credit (hydrogen refueling property)
ESTATE, TRUST AND GIFT TAXES
The maximum federal unified estate and gift tax rate is 40 percent with a $5,490,000 exclusion for gifts made and estates of decedents. The annual gift tax exclusion allows taxpayers to give up to $14,000 during 2017 ($15,000 for 2018) to any individual (doubled for married individuals who split the gifts), gift-tax free and without counting the amount of the gift toward the lifetime $5,490,000 million exclusion, adjusted for inflation.
Exclusion for Educational and Medical Expenses
In addition to the $14,000 annual exclusion amount, gifts may be made for certain educational and medical expenses, tax free. Any amount paid on behalf of an individual as tuition directly to certain educational organizations for the education or training of such individual is not treated as a transfer by gift for purposes of the gift tax. For medical expenses, the exclusion applies for certain medical expenses paid on behalf of an individual not reimbursed to the individual by insurance. The exclusion for educational and medical expenses is unlimited in amount, and can be made on behalf of anyone you choose, as long as the payments are made directly to the educational institution or health care provider.
Year-End Trust Distribution Planning
For certain trusts that are not required to make distributions, distribution planning is important in order to minimize the overall tax due on the trust’s income. In general, a trust not otherwise required to make distributions is liable for the tax on all of its income if no distributions are made to beneficiaries. If distributions are made, the beneficiary is taxed on the portion of the income distributed, not the trust. Trusts hit the top income tax rate of 39.6% for ordinary income in excess of $12,500 in 2017. For individuals, this amount is $418,400 for single filers, and $470,700 for joint filers. Due to the compressed tax bracket for trusts, distributions to beneficiaries often result in a lower overall tax burden. Of course, all factors should be considered as to whether a distribution is appropriate, not just income tax planning. If a trustee determines that distributions are appropriate, trusts have until 65 days after year-end (March 6, 2018) to make a distribution and treat it as a distribution for the 2017 tax year.
C Corporations continue to face double taxation, with taxes paid once at the entity level and again when dividends are paid to shareholders. Many businesses, however, are not taxed at the entity level as corporations; instead taxable profits and losses are passed through to their owners. With the highest individual tax rate at 39.6% and additional surtaxes on passive income by way of the 3.8% Net Investment Income Tax, minimizing tax remains a challenge in 2017.
Under the Tax Cuts and Jobs Act (H.R. 1), for tax years after 2017, the threshold for companies not allowed to use the cash method of accounting would increase to average gross receipts of $25 million. NOL carrybacks or carryforwards would be limited to 90% of a taxpayer’s taxable income. The bill would increase expensing under Code Section 179 to $5 million and phaseout at $20 million.
Deductions and Credits – Business
The very popular bonus depreciation provision was extended through 2019 by the PATH Act. A depreciation deduction equal to 50% of the basis of qualifying property is available in 2017. The percentage is set to decrease to 40% in 2018 and 30% in 2019. In order to be eligible for bonus depreciation, qualifying property must be new (first-time use) tangible property.
Code Section 179 Expensing
Code Section 179 property includes new or used tangible personal property that is purchased to use in an active trade or business. Under the enhanced expensing, for 2017, businesses can expense up to $510,000 in qualifying expenditures, with no reduction unless expenditures exceed $2,030,000.
Taxpayers can defer the gain (or portion of that gain) on the exchange of like-kind property. A like-kind exchange can involve the exchange of one business for another business, one real estate investment property for another real estate investment property, as well as other qualifying assets. Both the relinquished property and the acquired property must be held for business or investment purposes.
Tangible Personal Property Regulations
The IRS issued final regulations in 2014 that refine and simplify the rules for expensing tangible personal property, including the de minimis safe harbor. For 2017, the safe harbor enables taxpayers to routinely deduct items whose cost is below $5,000 for taxpayers with an applicable financial statement (AFS) and $2,500 for taxpayers without an AFS.
The research credit provides a credit for 20% of qualified research expenses over a base amount. The research credit applies to any amounts paid or incurred for qualified research and experimentation. BMSS has a Research and Development team ready to meet with you to discuss your company’s R&D potential.
Standard Mileage Rate
The standard business mileage allowance rate for 2017 is 53.5 cents-per-mile (down from 54 cents-per mile for 2016).
New Partnership Audit Rules
Audits of many partnerships in 2018 will be subject to new rules regarding the liability of each partner. Amending partnership agreements before these rules take effect could avoid issues in the future.
Health Care Reform – Businesses
Although the primary thrust of the Patient Protection and Affordable Care Act (PPAC) is health insurance reform, the tax law plays a key role in achieving this goal. Below are parts of the reform to health care that continue impact businesses.
Small Employer Health Care Tax Credit
Eligible small employers that maintained a qualifying arrangement were able to claim a 50% tax credit (35% for eligible tax-exempt employers) for non-elective contributions (i.e., premiums) paid for health coverage for their employees. An employer must participate in an insurance SHOP exchange in order to claim the credit. The credit can only be claimed for two consecutive years.
Simple Cafeteria Plans
Certain small employers’ cafeteria plans can qualify as simple cafeteria plans. In order to qualify, an employer’s plan must meet strict contribution, eligibility, and participation requirements. The simple cafeteria plan’s benefit to the employer is that certain nondiscrimination requirements, particularly those that a classic cafeteria plan must meet, are deemed as satisfied.
Shared Responsibility Payments for Large Employers
“Applicable large employers”, employers with at least 50 full-time employees or a combination of 50 full-time and part-time employees, are subject to the employer mandate. Under these rules, if an applicable large employer does not offer minimum essential coverage, or offers coverage to fewer than 95% of its full-time employees, the employer’s assessed shared responsibility payment will be based on the total number of its full-time employees (minus 30) multiplied by $2,000. If it does offer such coverage, the assessed payment amount will be based solely on the number of employees who claimed a premium tax credit for purchasing coverage through the Health Insurance Marketplace. An employee can claim this tax credit because the employee was offered no coverage, the coverage offered was not affordable or the coverage did not meet minimum value standards. Safe harbors are available both for counting full-time employees, and for affordable coverage.
The ACA also requires applicable large employers to file information returns with the IRS and provide statements to their full-time employees about the health insurance coverage the employer offered. This requirement applies even if an applicable large employer does not offer coverage to any of its full-time employees. In general, each applicable large employer may satisfy the information reporting requirement by filing a Form 1094-C (transmittal) and, for each full-time employee, a Form 1095-C (employee statement).
We’re Here to Help You
BMSS understands that the complexity of the tax law can make year-end tax planning overwhelming, but it is a necessity. This letter covered several of the high points, but there are many more strategies that can help reduce your tax liability over a period of time.
Additionally, this update discusses only federal tax planning. State taxes should also be considered since the tax laws of many states do not follow the federal tax laws.
Please contact BMSS if you have any questions regarding the opportunities presented in this letter or to schedule an appointment to develop a year-end tax plan considering your particular circumstances. We look forward to serving you.