4 Year-End Tax Tips as Overhaul Looms

Advisors have just a few weeks to counsel clients on how to get ahead of tax changes that are expected to take effect in 2018. There is no final tax bill yet, only a House version and a Senate version, but there are many overlapping provisions that are likely to end up in a final bill, including the elimination of many deductions, and chances are good that Congress will pass a bill this year to take effect next year.

Here are a few strategies that advisors should consider for clients, while closely watching developments in Washington, most of them courtesy of Jill Schlesinger, senior CFP Board ambassador:

1. Prepay local property taxes.

The House and Senate tax bills both limit the deduction of local property taxes to $10,000 from federal income taxes. If your client's property taxes exceed $10,000, she can pay them this year instead of next and claim that deduction on her 2017 tax return. The client may want to contact her local tax department to check on how many quarters of tax payments she can prepay.

Another thing to check: whether making a prepayment, which is considered a preference item for calculation of the Alternative Minimum Tax, will subject your client to the AMT. If the client was subject to the AMT the previous year and her circumstances haven't changed, there's a good chance she will pay it this year, so the benefit to prepaying local property taxes will be limited or nonexistent. Your client may want to consult an accountant about this. Also keep in mind that the AMT is likely to change. The House bill eliminates it; the Senate keeps it but raises the threshold for income subject to the tax.

Clients may also want to prepay state and local income taxes because those deductions, too, are eliminated in the House and Senate bills, but that may be complicated, says Schlesinger. Taxpayers should contact their state and local tax collectors to see how it can be done effectively. Also note that there is talk in Washington that the final tax bill could include a partial deduction for local income taxes for taxpayers in high-tax states like California.

2. Take as many deductions as you can.

About one-third of U.S. taxpayers currently itemize their deductions, but many deductions are on the chopping block. Here again the House and Senate bills differ, so it's not clear yet which ones will be eliminated, changed or maintained. What is likely to happen, however, is a decline in the number of taxpayers who itemize deductions after the current tax year. More taxpayers will instead take the standard deduction, which is essentially doubled in both the House and Senate bills (though the personal exemptions are eliminated). Those taxpayers should take as many deductions possible this year.

Among the deductions that may not be around next year are those for medical and dental expenses (the House bill eliminates it; the Senate expands eligibility), alimony (nixed in the House bill), expenses for job hunting, home offices, tax preparation and professional dues.

3. Defer pass-through income.

Both the House and Senate bills lower the tax rate on pass-through entities so long as they are not from a professional service firm, like a law or accounting firm. If the proposed tax rates are lower than the rate the business currently pays — the rate is now set at the marginal income tax rate of the business's owner — the client should defer 2017 income into 2018. For example, if the owner has a marginal tax rate of 39.6%, the current top marginal rate, he would save on taxes by deferring income into 2018. How much can be deferred given the late date is a question, but in either case there is money to be saved.

In general, the House bill lowers the top rate from 39.6% to 25% and phases in a 9% rate for businesses that earn less than $75,000, and the Senate bill lets pass-through entities deduct 23% of income from taxes. There are a lot more details in each provision about the taxation of pass-through income, so it bears watching to see exactly what is in the final bill.

Sole proprietors who don't operate as pass-throughs may also want to consider deferring income into next year if they expect their tax bracket next year will be lower than it is this year. At this point, however, it's unclear what their next year's tax bracket will be. "That's the maddening part of the whole exercise," says Schlesinger. The House bill has four brackets — 12%, 25%, 35% and 39.6% — and the Senate tax bill has seven: 10%, 12%, 22%, 24%, 32%, 35%, and 38.5%. Both have a zero rate for those with incomes under $9,525 for singles and $19,050 for married couples filing jointly.

4. Consider selling shares of some stocks.

The Senate tax bill requires that investors sell their longest held shares before any others, which potentially upends the tax-loss harvesting strategies that most advisors use to minimize the tax consequences of asset sales. The first in, first out (FIFO) requirement eliminates the discretion to sell those assets that would minimize tax consequences. Investors could not sell only those shares of a particular stock that had the smallest gains or the biggest losses to offset other gains.

Note that the House bill doesn't include this provision and the final Senate bill applies FIFO only to securities sales by individuals, not by mutual funds or ETFs, who were subject to FIFO rules in the initial version of the bill.

Schlesinger suggests that investors consider sales of assets before year end only if they already thinking of selling that stock, apart from any tax rule changes.

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4 Year-End Tax Tips as Overhaul Looms

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