Three Tax Savings Opportunities Before Tax Reform
There is an opportunity for many taxpayers to accelerate some deductions into 2017 to reap significant tax savings. The Tax Reform bill now signed into law nearly doubles the standard deduction while eliminating or limiting certain itemized deductions.
Let's focus on 2 major items in the new Tax law:
- The deduction for state income taxes and property taxes will be limited to a combined $10,000 per year limit for taxpayers itemizing deductions.
- The standard deduction nearly doubles to $24,000 for married status; $12,000 for single.
The best way to show tax savings opportunities is with a simple example. Bob and Sue Brown will file a joint return for 2017 and have the following itemized deductions:
• State income tax paid $7,000
• Property taxes paid $11,000
• Mortgage Interest paid $9,000
• Charitable contributions $4,000
Add up the four amounts and the Browns have $31,000 of itemized deductions for 2017; that is more than the 2017 standard deduction of $12,700, so the Browns will itemize for 2017.
How do things change for 2018 under the proposed tax plans? The Browns get no state tax deduction and the property tax deduction is limited to $10,000. Thus, total itemized deductions for 2018 would be $23,000. This is less than the proposed $24,000 standard deduction, so they would not itemize. UPDATE 12/20/2017: Browns can choose to deduct up to $10,000 of state or property tax, Total itemized is still $23,000.
Why is this important? When you take the standard deduction, it’s as if you’re not getting benefit of your itemized deductions. In other words, if your property tax paid was zero and your charity was zero you’d still have the $24,000 standard deduction.
Tax Savings Opportunity One - Prepay Property Taxes
Here’s the first savings opportunity. The Browns can prepay their property taxes by 12/31/17 (taxes they would’ve paid in 2018). This gives them $11,000 more of deductions in 2017. The Browns are in the 25% tax bracket, so that’s an extra $2,750 in their pocket on the $11,000 deduction (for which they would receive no benefit from in 2018). If they were in the 39.6% tax bracket, that’d be an extra $4,356 in their pocket.
Prepaying property tax isn’t just an opportunity for those who find they may be taking the standard deduction in 2018 under proposed reform. If your property tax is greater than $10,000 and you still plan to itemize because of sizeable other deductions, you should strongly consider prepaying property taxes before 12/31/17 because of the proposed $10,000 limit.
CAUTION: Before writing that check to the county, be sure you are not subject to the AMT (Alternative Minimum Tax) for 2017. The Browns are not subject to the AMT, but you may be. If you are in AMT, you will likely receive no benefit in 2017 from prepaying property taxes. Not sure if you’re subject to AMT? Check with your DHJJ CPA by calling 630-420-1360.
For guidance on how to prepay property tax in DuPage and surrounding counties, visit this link: Where to make your tax prepayment (Note that you can only prepay ½ of the tax for Cook County)
Tax Savings Opportunity Two - Accelerate Charity
Let’s turn to charity for a second tax savings opportunity. The Browns want to continue donate about $4,000 per year for the foreseeable future to their favorite charities. How can they reap tax benefits from giving while taking the standard deduction? The answer: A Donor Advised Fund, or “DAF”. The Browns can front-load future years of charity into the DAF in 2017 and take the deduction on their 2017 tax return. They will deposit $20,000 ($4,000/year for the next five years) into a DAF by 12/31/17. They deduct the extra $20,000 on their 2017 tax return. At a 25% tax rate, that’s an extra $5,000 in their pocket. If they were subject to the 39.6% tax rate, they’d reap savings of $7,920.
It's worth noting that it’s more beneficial to fund the DAF with appreciated securities (held outside of retirement accounts) that you’ve held more than one year instead of cash. You get to deduct the value of the securities and you avoid any capital gains taxes. If you have stocks to contribute to a DAF, start that process now to allow time for stocks to transfer.
With a DAF, you can request grants (donations) to qualifying charities of your choice in future years. Want to learn more about a DAF? Ask your advisor or visit the DAF sites for Schwab or Fidelity.
Tax Savings Opportunity Three - Pay State Taxes by 12-31-17
A third opportunity worth mentioning is to prepay state income taxes by 12/31/17. If you have a 4th quarter tax payment due in January or you anticipate a balance due in April, then you should consider paying those states taxes now. CAUTION: Check exposure to the AMT first to confirm the tax benefit.
There is not much time to act. While this example and these opportunities are based on proposals that could change, we may not have a law passed before year-end. UPDATE 12/20/17: House and Senate have passed the tax bill.
Two simple actions taken by the Browns will yield an extra $7,750 in tax savings! Paying the property taxes and donating to charity are two things they would have done anyway; it’s just accelerating the two deductions to reap tax benefits.
Each Taxpayer’s Situation is Unique