It appears likely that ordinary income tax rates will go down in the future. If that’s the case, it may be wise to defer income to future years where possible, and to accelerate deductions. Many clients do not have much of an ability to defer income, but often can take advantage of the opportunity to take deductions sooner.
It’s important to note that each client situation is unique, so we urge you to consult with your tax advisor before implementing any of these strategies. This is especially true because more and more taxpayers are impacted by the Alternative Minimum Tax (AMT), which creates an entirely different set of rules. (As it happens, one of the proposals that may be considered would eliminate AMT entirely, but it remains to be seen if that will come to fruition.)
POTENTIAL TAX OPPORTUNITIES
For people who itemize deductions on their tax return, perhaps the easiest strategy is to pull deductions into 2016 by prepaying expenses. A few ideas here:
1. Accelerate charitable contributions
This could be as simple as pre-paying your favorite charity now for your 2017 gift. Or, for larger amounts, you could open or add to a donor-advised fund or foundation.
These are vehicles that allow a donor to make a charitable deduction now, and to actually disburse funds to charities later – sometimes many years later. Using these strategies, donors may choose to load up on several years’ worth of contributions in 2016 to take advantage of the charitable deduction at today’s tax rates.
2. Prepay state income taxes
For clients who pay estimated taxes at the state level, it may make sense to pay the 4th quarter estimate prior to year-end. These estimates are due January 16, 2017, so making the payment in December is just a couple of weeks early. But by doing so, the deduction would fall into 2016.
3. Prepay real estate taxes
You may also benefit from paying your 2017 real estate taxes in 2016. In this case, the taxes are typically due in one or two installments around mid-year, so you’d be paying the taxes quite early. Still, the possibility of lower rates next year makes this worth considering. The rules surrounding this vary greatly by county. For our Illinois-based clients who live in Cook or Lake County, here are links to those counties’ websites with more detail:
www.cookcountytreasurer.com/prepayment.aspx
www.lakecountyil.gov/539/Pre-Payments
If you live elsewhere, try searching online for “how to prepay {name of county / state} real estate taxes,” or give us a call.
4. Other thoughts
- More on itemized deductions
Part of one of the tax proposals being discussed would put an overall limit on the amount of itemized deductions. As such, taking more deductions under the current law – and fewer later – may be even more impactful. Other itemized deductions, such as medical expenses (for those who qualify), may also provide a benefit. For some of these, it’s sometimes harder to control the timing of payment. But for any significant deductions, it may be worth considering.
- Capital gains & net investment income taxes
The proposals that we have seen thus far do not suggest any changes to capital gains tax rates. However it is possible that the Net Investment Income Tax – an additional 3.8% tax on investment income for certain taxpayers, designed to pay for the Affordable Care Act – may go away. Unfortunately, it is not often feasible to control the timing of investment earnings. But as we manage our clients’ portfolios, we would generally try to avoid recognizing gains until next year, to the extent practical and given other considerations.
There has also been talk of eliminating estate taxes altogether. We wouldn’t recommend scrapping your estate tax plan anytime soon; even without a federal estate tax, state estate taxes vary widely and there does not seem to be any consideration of those going away. And perhaps most importantly, there are numerous non-tax reasons to have a well-crafted estate plan.
NEXT STEPS
Talk with us and your tax advisor, and take a look at your recent tax returns. This should provide some clues as to the magnitude of your deductions, your tax rate, and other factors. Then, if you think there’s an opportunity, start putting the processes in place to make sure you don’t lose out on this opportunity. For things like setting up a donor-advised fund or prepaying real estate taxes, it may take some time to implement. And with less than six weeks until year-end, now is a great time to start considering these strategies.
We end this note where we began; there is no certainty at this point that taxes will change next year, or when any changes may be effective. So it is important to consider your own situation carefully and proceed thoughtfully. We believe there may be a chance for real savings for certain clients, but as with all planning, each individual’s situation is unique.
As always, we would welcome the opportunity to discuss your situation and answer any questions you may have.
