It’s that time of year when we should think about preparing an estimate of your current year tax liability and see if there are any ways we can reduce your tax liability. If you know of anyone else who may benefit from some tax planning, please feel free to forward the e-mail or have them contact me.
There are several things to consider when doing year-end tax planning: taking advantage of expiring tax provisions, deferring income into the following year and accelerating expenses into the current year. The proper strategy depends on whether or not you anticipate a significant change in income or expenses next year.
The following are some changes in the law that took effect this year, as well as some popular deductions and credits to which you may be entitled.
- Top Tax Rate
For 2017, the top tax rate of 39.6 percent applies to taxable income in excess of $470,700 (joint returns), $418,400 (single).
- Tax Rate on Certain Capital Gains and Dividends
For taxpayers in the 10%-15% brackets, the capital gains rate is zero. For those in the 25% to 35% tax bracket, the capital gains rate is 15%. For those in the 39.6% tax bracket, the rate goes up to 20% with an additional 3.8% tax imposed on net investment income.
- Taxes Still in Effect in 2017
A 3.8 percent tax on net investment income above a threshold amount, and a .9 percent additional tax on wages and self-employment income above a threshold amount. For both taxes, the threshold amount is $200,000 ($250,000 if married filing jointly). Income taken into consideration in calculating net investment income includes most rental income and net gain attributable to the disposition of property other than property held in a trade or business. Thus, this generally covers sales of interests in a partnership or S corporation.
- Increased Threshold for Deducting Medical Expenses
Medical and dental expenses that exceed a certain percentage of your adjusted gross income (AGI) for the year are deductible. For year 2017 the deduction floor is 10 percent.
- Personal Exemptions and Itemized Deductions for High-Income Taxpayers
This year the personal exemptions and itemized deductions for taxpayers are subject to a phase-out that begins with adjusted gross incomes of $261,500 (single) up to $384,000, $313,800 (joint returns) up to $436,300 which has the effect of increasing taxes on affected taxpayers. We need to consider whether these new taxes affect you and, if so, whether you have paid a sufficient amount of taxes through withholdings and estimated tax payments so as to avoid any underpayment of estimated tax penalty. For those with second homes with a mortgage or with high itemized deductions, this could be a significant tax hike.
- Deduction for Eligible Teacher Expenses
An eligible educator can deduct above the line up to $250 of any unreimbursed business expenses for classroom materials, such as books, supplies, computers including related software and services or other equipment that the eligible educator uses in the classroom. Supplies for courses on health and physical education qualify only if they are related to athletics.
- Student Loan Interest Deduction
Student loan interest is interest you paid during the year on a qualified student loan. It includes both required and voluntarily pre-paid interest payments. You may deduct the lesser of $2,500 or the amount of interest you actually paid during the year. The deduction is gradually reduced and eventually eliminated by phaseout when your modified adjusted gross income (MAGI) amount reaches the annual limit for your filing status.
You can claim the deduction if all of the following apply:
- You paid interest on a qualified student loan in tax year 2017;
- You're legally obligated to pay interest on a qualified student loan;
- Your filing status isn't married filing separately;
- Your MAGI is less than a specified amount which is set annually; and
- You or your spouse, if filing jointly, can't be claimed as dependents on someone else's return.
A qualified student loan is a loan you took out solely to pay qualified higher education expenses that were:
- For you, your spouse, or a person who was your dependent when you took out the loan;
- For education provided during an academic period for an eligible student; and
- Paid or incurred within a reasonable period of time before or after you took out the loan.
If you had any student loans during the year and your modified adjusted gross income (MAGI) is within certain limits, you may deduct up to $2,500 of interest paid on that loan in computing adjusted gross income. For 2017, the deductible amount is phased out if your MAGI is between $65,000 and $80,000 ($130,000 and $160,000 if filing a joint return). You cannot take a student loan interest deduction if your MAGI is $80,000 or more ($160,000 or more if filing a joint return). The deduction is not available if your filing status is married filing separately.
- American Opportunity Tax Credit
If you paid any qualified education expenses during the year, you may be eligible for the American Opportunity tax credit. The maximum credit amount is $2,500 per year for each eligible student for first four years of higher education expenses paid. The amount of the credit for each student is calculated as 100 percent of the first $2,000 of qualified education expenses paid for the student and 25 percent of the next $2,000 of such expenses paid. The credit may be reduced, however, depending on your modified adjusted gross income (MAGI). But, if the credit pays your tax down to zero, you can have 40 percent of the remaining amount of the credit (up to $1,000) refunded to you.
For 2017 MAGI must be under $90,000 ($180,000 for joint filers) and you must not have claimed the AOTC or the former Hope Credit for more than four tax years. MAGI between $80,000 and $90,000 ($160,000 and $180,000 for joint filers) is used to determine if there is any reduction. If your MAGI is in excess of $80,000 ($160,000 for joint filers), the amount of the credit is phased out by multiplying the otherwise allowable credit by a fraction, the numerator of which is the amount by which your MAGI exceeds $80,000 ($160,000 for joint filers), and the denominator of which is $10,000 ($20,000 for joint filers). No credit is allowed if your MAGI is $90,000 or more ($180,000 or more for joint filers).
- Alternative Minimum Tax
If you are subject to the alternative minimum tax (AMT), your deductions may be limited. Thus, if we anticipate that you will be subject to the AMT, we need to consider the timing of deductible expenses that may be limited under AMT.
- Other Steps to Consider Before the End of the Year
The following are some of the additional actions we should review before year end to see if they make sense in your situation. The focus should not be entirely on tax savings. These strategies should be adopted only if they make sense in the context of your total financial picture.
- Accelerating Income into 2018
Depending on your projected income, it may make sense to accelerate income into 2017. Besides harvesting gains from your investment portfolio, other options for accelerating income include:
(1) if you own a traditional IRA or a SEP IRA, converting it into a Roth IRA and recognizing the conversion income this year;
(2) taking IRA distributions this year rather than next year only if absolutely needed;
(3) selling stocks or other assets with taxable gains this year;
(4) if you are self employed with receivables on hand, trying to get clients or customers to pay before year end; and
(5) settling lawsuits or insurance claims that will generate income this year.
- Deferring Income into 2018
There are also scenarios (for example, if you think that your income will decrease substantially next year) in which it might make sense to defer income into the 2018 tax year or later years. Some options for deferring income include:
(1) if you are due a year-end bonus, asking your employer to pay the bonus in January 2018;
(2) if you are considering selling assets that will generate a gain, postponing the sale until 2018;
(3) delaying the exercise of any stock options you may have;
(4) if you are selling property, considering an installment sale;
(5) consider parking investments in deferred annuities;
(6) establishing an IRA, if you are within certain income requirements; and
(7) if your employer has a 401(k) plan, consider putting the maximum salary allowed into it before year end.