Year-end Tax Planning for Unknown Tax Reform
Year-end tax planning is particularly challenging for 2016 — and it will be all about saving real tax dollars. Beginning Jan. 20, 2017, a Republican president will take office and Republicans will control both the House and Senate. During the election, President-elect Donald Trump made tax reduction a major centerpiece of his economic platform. This past June, the House Republicans released a tax reform blueprint titled “A Better Way.” The possibility of major tax changes for individuals and businesses seems like a lock.
Deferring Income and Accelerating Deductions
The two plans have similarities and differences, but deferring income and accelerating deductions save taxes under both plans. Deferring income and accelerating deductions are common strategies for year-end tax planning and deferring tax payments to a later year is a staple for maximizing cash flow. However, tax reform will impact more than just cash flow; it has the potential to put more money in your pocket. To take advantage of what might be a windfall of savings next year, individuals and businesses may need to re-visit their year-end tax planning strategies.
The tax plans of President-elect Trump and the House GOP both propose lowering the top bracket from 39.6 percent to 33 percent. Therefore, income that can be pushed into 2017 will be taxed at 6.6 percent less.
Some ways to defer income include:
- Request your bonus be paid in January 2017 instead of December 2016.
- Hold off billing for services until next year if you are a cash-basis taxpayer.
- Defer converting a regular IRA to a Roth IRA.
- Defer selling investments at a gain (assuming the sales price would remain fairly consistent).
- For sales that cannot be postponed, structure the deal as an installment sale.
If these last two planning items qualify for capital gain treatment, an additional savings of 3.8 percent may be realized. Both Trump and the House GOP proposed to repeal the Affordable Care Act (commonly known as Obamacare), which established a 3.8 percent surtax on investment income. Along with the bracket rate change, potential savings are 10.4 percent in federal tax. Meanwhile, the existing long-term capital gain top tax rate of 20 percent may be maintained.
Changes are also planned for the deduction side. Although both plans propose to greatly increase the standard deduction to $30,000 for joint filers and $15,000 for single filers, each plan differs on itemized deductions. Trump’s plan caps itemized deductions at $200,000 for joint and $100,000 for single filers. The House GOP plan limits itemized deductions to only allowing mortgage interest and charitable contributions. Year-end planners should consider either accelerating itemized deductions because the deduction is more valuable against 2016’s higher tax rates, losing the deduction altogether based on the standard deduction being higher, or a cap on itemized deductions. Both proposed plans eliminate personal exemptions and the alternative minimum tax (AMT).
Both Trump and the House GOP propose substantial reductions to the current corporate tax rates. Trump proposes reducing the top rate from 35 percent to 15 percent. The House GOP has proposed cutting it down to 20 percent. Corporate AMT would be eliminated under both plans. Major reform on the taxation of small businesses also appears on both plans. Net income on flow-through entities would be taxed at a top rate of 25 percent under the House GOP plan and 15 percent under the Trump plan, instead of being taxed at the higher planned individual rate of 33 percent. The traditional year-end planning tandem of income deferral and acceleration of deductions will have a substantial tax savings impact on corporations and flow-through businesses.
Unlike recent years, year-end tax planning is not about just deferring the tax impact to the following year. Although the specifics of the 2017 tax legislation are still uncertain, overlap of President-elect Trump’s and the House GOP’s plans indicates major tax reform is on its way.