Tax saving strategies to implement before year-end
By: Cindy H. Mitchell, CPA
Senior Manager, Taxation Services
Bober Markey Fedorovich
As 2017 starts to wind down, now is the time to think about planning moves that could help lower your tax bill this year and possibly next. Factors that compound the planning challenge this year include President Trump's proposed tax reform.
This tax planning letter focuses on tax moves you can make now, based on current tax law as we know it today. If tax reform is passed and signed before year-end, most provisions of the tax reform will be effective starting in 2018.
Most people want to postpone income until 2018 and accelerate deductions this year to lower their 2017 tax bill. This strategy may enable you to claim larger deductions, credits and other tax breaks for 2017 that are phased out over varying levels of adjusted gross income (AGI). These include child tax credits, higher education tax credits and deductions for student loan interest. Postponing income is also desirable for taxpayers who anticipate being in a lower tax bracket next year due to changed financial circumstances. Note that in some cases it may pay to accelerate income into 2017. For example, this may be the case when a person's marginal tax rate is much lower this year than it will be next year due to a known sale of a capital asset.
Capital Gains and Losses: Avoid paying unnecessary capital gains tax
If you currently have some large realized capital gains, harvest capital losses. You can realize losses on stock while substantially preserving your investment position. For example, you can sell the original holding, then buy back the same securities at least 31 days later. Minimizing the net capital gains will also help lower the 3.8% surtax on net investment income.
Retirement Savings: Consider a Roth IRA
Roth IRA contributions are a good way to put money away for retirement; however, there is not a current-year tax deduction when you put money into the Roth. The good news is that when you do take money out of the Roth via a qualified distribution, it is tax-free, including all earnings. Due to the income limitations on putting money into a Roth account, many people are excluded. One way around this is to make a non-deductible IRA contribution and immediately do a Roth conversion, which converts money from your traditional IRA to a Roth IRA. Assuming you had no other funds in the traditional IRA, the money you convert is not subject to tax in the year of conversion, and it will grow tax-free and will not be taxed again when you withdraw the money for retirement - if it is a qualified distribution. Another benefit is that there are no required minimum distributions for a Roth, unlike a traditional IRA. If you already have a traditional IRA established with pre-tax contributions, you can still do a Roth conversion, but this will likely be subject to tax in the current year.
Employees wishing to defer income to future years should take advantage of maximizing the amount contributed into their employer-sponsored retirement plan. For 401(k) plans, the maximum deferral for 2017 is $18,000 with an additional catch-up contribution of $6,000 for those over 50 years old as of Dec. 31, 2017.
If you have self-employment income, consider putting money into a Simplified Employee Pension (SEP). By contributing money to an SEP you can typically avoid both current-year federal and state taxes on the amount contributed. The maximum SEP contribution for 2017 is $54,000, and it can be funded as late as the due date of your federal tax return, including extensions.
Medical Expense Deductions
For 2017, medical expenses are only deductible to the extent that they exceed 10% of your adjusted gross income (AGI), even for taxpayers over age 65. Medical expenses include health insurance premiums, Medicare premiums, amounts paid to doctors for medical care, prescriptions, etc. The medical expense deduction is currently on the chopping block in the House tax reform proposal.
State and Local Tax Deduction: Pay state income taxes before year-end
If you expect to owe state or local income taxes when you file your return next year, consider paying estimated tax payments before year-end to pull the deduction of those taxes into 2017. You can also prepay any real estate taxes due in 2018. Be sure to measure any alternative minimum tax (AMT) implications of accelerating state and local tax deductions before exercising this planning strategy. If you are subject to the AMT for 2017 or suspect you might be, these deductions should not be accelerated. State and local tax deductions are also on the chopping black in the tax reform proposals.
Charitable Contribution Deductions: Consider a donor-advised fund
Consider making charitable contributions before year-end either in cash or non-cash, such as highly appreciated stocks. You can make contributions at year-end using your credit card, even if the credit card bill is not paid until 2018. You can also write a check to charity and take a 2017 tax deduction, even if the check doesn't clear your bank until January 2018 - just make sure it's postmarked by Dec. 31, 2017, to count this year. Non-cash donations, except publicly traded stock valued over $5,000, need a written appraisal and a letter from the charity acknowledging the donation in order to be deductible.
Consider setting up a donor-advised fund for your charitable wishes. A donor-advised fund allows you to get a current-year tax deduction for the money contributed to the donor-advised fund, while delaying your decision on which charities to support until you're ready. Donor-advised funds can be particularly useful to offset a high-income year or if you have highly appreciated stocks that you want to donate as opposed to recognizing and paying capital gains tax. Donor-advised funds can be started with a minimum $5,000 tax-deductible donation and no out-of-pocket fees to manage. This is an excellent way to leave a legacy and get a great tax deduction up front.
Required Minimum Distributions: Don't forget to take it!
Be sure to take your required minimum distributions (RMDs) from your retirement accounts. These include your IRA, 401(k) plan, or other employer-sponsored retirement plans. RMDs from IRAs must begin by April 1 of the year after you reach age 70 ½. Failure to take a required withdrawal can result in a penalty of 50% of the amount of the RMD not taken.
If you are over 70 ½, you can make a charitable contribution directly from your IRA of up to $100,000 ($200,000 for couples). This satisfies the required minimum distribution requirement and is a benefit for Ohio taxes because you don't have to include the RMD in your Ohio income.
Gifting: Take advantage of the annual gift tax exclusion
Make gifts that are sheltered by the annual gift tax exclusion before the end of the year and save gift and/or estate taxes. The exclusion applies to gifts of up to $14,000 made in 2017 to each of an unlimited number of individuals. You can't carry over unused exclusions from one year to the next. The transfers might also save family income taxes where income-earning property is given to family members in lower income tax brackets who are not subject to the kiddie tax.
These are just some of the year-end steps that can be taken now to minimize your overall tax bill. Each person is different, as is each person's tax situation, so consult your tax accountant to make sure you're making the best decisions for you. But with the proper planning and guidance, everyone can save something on their taxes.