2017 Year-End Tax Planning for Individuals (Includes Links to Year-End Client Letters)

(Parker Tax Publishing November 2017)

The first installment of Parker's annual two-part series on year-end tax planning recaps 2017's major changes affecting individual taxpayers, and strategies clients can use to minimize their 2017 tax bill. The online version of the article includes links to sample year-end client letters for individuals and businesses.

Introduction

To say that year-end tax planning this year may be a little more challenging than usual would be an understatement. Tax reform will be on the mind of tax practitioners and their clients alike. Given that Republicans control Congress and the White House, and that taxes have become their number one legislative priority, it's likely that reform (or tax cuts) of some kind will pass late this year or early next. But the end result remains anyone's guess. Uncertainty about whether tax reform will happen and when changes would be effective will limit practitioners' ability to recommend year-end tax moves based on the proposed legislation. Because so much remains up in the air, for now, it will make sense to rely on existing rules for most year-end tax planning decisions.

CLIENT LETTERS for both individuals and businesses are available online now -

Practice Aid: See Parker's 2017 Year-End Tax Planning for INDIVIDUALS. Also, see our 2017 Year-End Tax Planning for BUSINESSES.

As with every year, the tax brackets have increased slightly as they are adjusted for inflation. For 2017, the top tax rate of 39.6 percent will apply to incomes over $418,400 (single), $470,700 (married filing jointly and surviving spouse), $235,350 (married filing separately), and $444,550 (heads of households). However, high-income taxpayers are also subject to the 3.8 percent net investment income tax and/or the .9 percent Medicare surtax. For taxpayers subject to one or both of these additional taxes, there are certain actions (discussed below) that can be taken which may mitigate the damage of these additional taxes.

The due date for filing 2017 tax returns is Tuesday, April 17, 2018, because April 15 is a Sunday, and Monday April 16 is Emancipation Day in Washington, D.C. Thus, the tax deadline is extended to the next business day.

Finally, as with last year, the IRS is prohibited from issuing any refunds before February 15 for returns claiming the earned income tax credit (EITC) and/or the additional child tax credit (ACTC). The refund delay is aimed at allowing the IRS additional time to process such returns and prevent revenue loss due to identity theft and refund fraud relating to fabricated wages and withholdings. The IRS will therefore hold the entire refund, even if only part of it is due to the EITC and/or the ACTC.

I. Changes for 2017 Returns

Healthcare Coverage Must Be Indicated on Return

New this year, tax returns must indicate whether or not an individual and his or her family had healthcare coverage during the year. While this had been a requirement last year, the IRS said it would not enforce it and would process returns that did not include this information. However, the IRS intends to enforce the rule for 2017 tax returns and has said it will not process returns if this information is omitted.

Changes for Personal Exemptions and Standard Deduction

Due to low inflation, the personal exemption amount for 2017 is the same as it was for 2016 -- $4,050. However, the amount at which the deduction is phased out for higher income taxpayers did increase slightly. The amount of the exemption is reduced by 2 percent for each $2,500 ($1,250 for married filing separately), or fraction thereof, by which the taxpayer's adjusted gross income (AGI) exceeds a certain threshold. The threshold amounts for 2017 are (1) $261,500 in the case of a single individual; (2) $287,650 in the case of a head of household; (3) $313,800 in the case of a joint return or a surviving spouse; and (4) $156,900 in the case of a married individual filing a separate return. See Parker Tax ¶10,705 and ¶82,105.

For 2017, there were slight increases to the standard deduction. For married and surviving spouse individuals, head of household individuals, unmarried individuals (other than surviving spouses and heads of households), and married individuals filing separately, the standard deduction amounts are $12,700, $9,300, $6,350, and $6,350, respectively. See Parker Tax ¶10,705.

Alternative Minimum Tax Exemption Increased

The alternative minimum tax (AMT) exemption for 2017 has been increased in varying amounts between $200 and $700, depending on a taxpayer's filing status. The exemptions for 2017 are (1) in the case of a joint return or a surviving spouse, $84,500; (2) in the case of an individual who is unmarried and not a surviving spouse, $54,300; (3) in the case of a married individual filing a separate return, $42,250; and (4) in the case of an estate or trust, $24,100. See Parker Tax ¶12,120.

Increase in Phase-out Thresholds for Itemized Deductions

The threshold at which itemized deductions are phased out increased for 2017 to (1) $313,800 in the case of a joint return or a surviving spouse; (2) $287,650 in the case of a head of household; (3) $261,500 in the case of an individual who is not married and who is not a surviving spouse or head of household; and (4) $156,900 in the case of a married individual filing a separate return. See Parker Tax ¶82,125.

II. Tax Planning Options

Life Events

Life events can significantly impact taxes. For example, if a client will be getting married in 2018 and both spouses have significant income, consideration should be given to accelerating income into 2017 or deferring deductions into 2018. This is because combined incomes can lead to higher tax brackets. For example, in 2017, a single taxpayer is not subject to the 28 percent tax rate until his or her taxable income exceeds $91,900. However, for a married couple, the 28 percent rate kicks in when the couple's taxable income exceeds $153,100.

Similarly, if a taxpayer is eligible to use head of household or surviving spouse filing status for 2017, but will change to a filing tax status of single for 2018, the client's tax rate will go up. Thus, accelerating income into 2017 and pushing deductions into 2018 may yield tax savings.

Clients who have recently married or divorced and changed their name need to notify the Social Security Administration (SSA). Similarly, the SSA should be notified if a dependent's name has been changed. The notification is important so that when these individuals file returns next year, the new name on the tax return matches. A mismatch between the name shown on the tax return and the SSA records can cause problems in the processing of tax returns and may even delay tax refunds.

Other life events, such as a birth or death in the family, the loss of a job or a change in jobs, or a retirement during the year, can impact a client's tax situation. Practitioners should discuss the tax implications of these events with their clients.

Retirement Plan Considerations

Fully funding a company 401(k) with pre-tax dollars will reduce current year taxes, as well as increase retirement nest eggs. For 2017, the maximum 401(k) contribution that can be made with pre-tax earnings is $18,000. For taxpayers 50 or older, that amount increases to $24,000.

For individuals with a SIMPLE 401(k), the maximum pre-tax contribution for 2017 is $12,500. That amount increases to $15,500 for taxpayers age 50 or older.

If certain requirements are met, contributions to an individual retirement account (IRA) may be deductible. For individuals under 50, the maximum contribution amount for 2017 is $5,500. For individuals 50 or older but less than age 70 1/2, the maximum contribution amount is $6,500. Contributions exceeding the maximum amount are subject to a 6 percent excise tax. Even if an individual is not eligible to deduct contributions to an IRA, contributing after-tax money to an IRA may still be advantageous if that individual subsequently converts that traditional IRA to a Roth IRA. Qualified withdrawals from a Roth IRA, including earnings, are free of tax, while earnings on a traditional IRA are taxable when withdrawn.

If a taxpayer already has a traditional IRA, practitioners should evaluate whether it may be appropriate to convert it to a Roth IRA in 2017. The client will have to pay tax on the amount converted (to the extent of pre-tax contributions and earnings), but subsequent earnings will be free of tax. And, for a traditional 401(k), 403(b), or 457 plan that includes after-tax contributions, these after-tax amounts can generally be rolled over to a Roth IRA with no tax consequences. A rollover of a SIMPLE 401(k) into a Roth IRA may also be available. As with all tax rules, there are qualifications that apply to these rollovers that practitioners should discuss before their clients take any actions.

The U.S. Department of the Treasury has decided to phase out the myRA retirement savings program and the program is no longer accepting new enrollments. This program was introduced by the Treasury Department several years ago as a starter retirement account program into which taxpayers could deposit tax refunds. Because the accounts offered through the program were Roth IRAs, they had the same tax treatment and followed the same rules as Roth IRAs. Funded accounts remain open and accessible and the funds in myRA accounts remain in an investment issued by the U.S. Department of the Treasury. However, deposits will no longer be accepted beginning December 4, 2017.

Finally, self-directed IRAs allow an IRA owner to have more control over the type of investments that will be held in the IRA. However, the large amount of money held in self-directed IRAs makes them attractive targets for fraud promoters. Thus, self-directed IRA can be costly if not properly managed. In addition, because of the types of investments taxpayers with self-directed IRAs are able to make, taxpayers have a greater risk of running afoul of the prohibited transaction rules. The prohibited transaction rules impose an excise tax on certain transactions - such as sales of property, the lending of money or extension of credit, or the furnishing of goods, services, or facilities - between an IRA and a disqualified person. If a client has a self-directed IRA, practitioners need to review the specifics of the arrangement.

Avoiding the Net Investment Income Tax

While Congress had talked about doing away with Obamacare and its related taxes, that didn't happen. Thus, the 3.8 percent Net Investment Income Tax (NIIT) is still with us. The NIIT applies to certain net investment income of individuals with income above a threshold amount. The threshold amounts are $250,000 (married filing jointly and qualifying widow(er) with dependent child), $200,000 (single and head of household), and $125,000 (married filing separately). In general, investment income includes, but is not limited to: interest, dividends, capital gains, rental and royalty income, non-qualified annuities, and income from businesses involved in trading of financial instruments or commodities. Thus, while the top tax rate for qualified dividend income is generally 20%, the top rate on such income increases to 23.8% for a taxpayer subject to the NIIT.

If it appears that a client will be subject to the NIIT, practitioners can look at the following strategies to help their clients avoid the tax.

(1) Donate or gift appreciated property. By donating property to a charity, taxpayers avoid recognizing the appreciation for income tax purposes and for NIIT purposes. If gifting property, taxpayers should gift the property to individuals that have income below the $200,000 (single) or $250,000 (couples) thresholds and let them sell it.

(2) Replace stocks with state and local bonds. Interest on tax-exempt state and local bonds are exempt from the NIIT. In addition, because such interest income is not included in adjusted gross income, it can help keep a taxpayer below the threshold for which the NIIT applies.

(3) If the client is involved in real estate, review the criteria for qualifying as a real estate professional with the client to see if additional steps can be taken to ensure that the client qualifies. As a real estate professional, rental income will be nonpassive and thus escape the NIIT.

(4) Determine if the sale of an appreciated asset would be better structured as an installment sale.

(5) Since capital losses can offset capital gains for NIIT purposes, determine if it makes sense to sell any losing stock, but keeping in mind the transaction costs associated with selling stocks.

(6) If the client will be selling property but doesn't qualify as a real estate professional, consider a like-kind exchange under Code Sec. 1031 to avoid recognizing income subject to the NIIT.

Because the NIIT does not apply to a trade or business unless (1) the trade or business is a passive activity with respect to the taxpayer, or (2) the trade or business consists of trading financial instruments or commodities, taxpayers may strive for classifying an enterprise as a trade or business. However, such classification could have unintended consequences. For example, Form 1099 reporting requirements apply to payments made in the course of the taxpayer's trade or business whereas personal payments are not reportable.

Reducing AMT Impact

A large increase in the income of a taxpayer that lives in a high-tax state could indicate a potential AMT problem since state and local taxes are not deductible in calculating AMT. The same is true with a large increase in personal exemptions which are also not deductible for AMT purposes.

If it looks like a client may be subject to the AMT this year, practitioners should discuss what actions can be taken to reduce the client's exposure. Since the calculation of the AMT begins with adjusted gross income, lowering a clients adjusted gross income by maximizing contributions to a tax-deferred retirement plan (e.g., 401(k)) or tax-deferred health savings account may be appropriate. Additionally, if a client uses his or her home for business, related expenses (e.g., a portion of the property taxes, mortgage interest, etc.) allocable to Schedule C will also reduce adjusted gross income.

Gifting Appreciated Stock

Depending on a client's financial situation, practitioners may want to recommend the gifting of appreciated assets, such as stock, to a charity. Generally, the higher the appreciated value of an asset, the bigger the potential value of the tax benefit. Donating appreciated assets will not only entitle your client to a charitable contribution deduction but can also help avoid the capital gains tax that would otherwise be due if the stock was sold. However, it should be noted that a tax deduction for appreciated property is limited to 50 percent of the client's adjusted gross income.

Additionally, if a client has children, particularly college age children, practitioners should look at whether it makes sense to shift some of a client's income to the child so that the tax on the income is paid at the child's tax rate. One strategy is gifting appreciated stock to the child. Where a child has earned income and is taxed at the bottom two income brackets, capital gains generated on the stock sale are taxed at 0 percent, instead of the 15 percent or more that the parent would pay. However, if the child has little or no earned income, the kiddie tax could be a factor. In this case, the child's unearned income should be limited to $2,100 or less for 2017 in order to avoid having the parent's top tax rate apply to the child's income.

Capital Gains and Losses

While most of the stock market has been soaring to new heights in 2017, there are some stocks, such as those invested in brick and mortar businesses, which have lost value during the year. If a client's stock portfolio includes such stocks and the client wants to sell off those investments, selling appreciated stocks to absorb long-term losses, the deduction of which is limited, may make sense.

Penalty for Failing to Carry Health Insurance

For now at least, Obamacare is still here and so is the penalty, known as the "shared responsibility payment," for not having health insurance coverage. Clients may be liable for this penalty if they or any of their dependents didn't have health insurance for any month in 2017. The penalty is 2.5 percent of the 2017 household income exceeding the filing threshold or $695 per adult, whichever is higher, and $347.50 per uninsured dependent under 18, up to $2,085 total per family. However, an exemption from the penalty may apply if certain conditions apply.

Charitable Donations from an IRA for Taxpayers 70 1/2 Years or Older

Taxpayers 70 1/2 years old and older who own an IRA are required to take minimum distributions from that account each year and include those amounts in taxable income. For practitioners with clients in this category, it may be prudent to recommend making a charitable contribution directly from the client's IRA to a charity. This has several benefits. For example, it benefits clients who take the standard deduction since charitable contributions deductions are usually only available to individuals who itemize. By making the contribution directly to a charity, it counts towards your client's required minimum distribution but that amount is not included in income. This reduces taxable income as well as the client's adjusted gross income (AGI). A lower AGI is advantageous because it increases the client's ability to take deductions that he or she might not otherwise be able to take. For example, medical expenses are only deductible to the extent those expenses exceed 10 percent of the client's AGI, miscellaneous itemized deductions are limited to the excess of 2 percent of AGI, personal exemptions are phased out once AGI exceeds a certain threshold, and, as AGI increases, more of the client's social security income is subject to tax. Finally, the 3.8 percent net investment income tax, as discussed below, applies to the extent the client's AGI exceeds a certain level.

Liability for the 0.9 Percent Medicare Tax

An additional Medicare tax of 0.9 percent is imposed on wages, compensation, and self-employment income in excess of a threshold amount. The threshold amounts are $250,000 (joint return or surviving spouse), $125,000 (married individual filing a separate return), and $200,000 (all others). However, the threshold amount is reduced (but not below zero) by the amount of the taxpayer's wages. Thus, a single individual who has $145,000 in self-employment income and $130,000 of wages is subject to the .9 percent additional tax on $75,000 of self-employment income ($145,000 - $70,000 (the $200,000 threshold - $130,000 in wages)). No tax deduction is allowed for the additional Medicare tax.

For married couples, employers do not take a spouse's self-employment income or wages into account when calculating Medicare tax withholding for an employee. Thus, if a client and his or her spouse has income that will exceed the $250,000 threshold in 2017 and they have not had enough withheld or made enough estimated tax payments to cover the additional .9 percent tax, a Form W-4 should be filed with the IRS before year end to have an additional amount deducted from the client's paycheck to cover the additional .9 percent tax. Alternatively, estimated payments can be made to cover the additional tax.

Accelerating Income into 2017

Depending on the client's projected income for 2018, it may make sense to accelerate income into 2017 if the client expects 2018 income to be significantly higher. Options for accelerating income include: (1) harvesting gains from the client's investment portfolio, keeping in mind the 3.8% NIIT; (2) converting a retirement account into a Roth IRA and recognizing the conversion income this year; (3) taking IRA distributions this year rather than next year; (4) for self-employed clients with receivables on hand, trying to get clients or customers to pay before year end; and (6) settling lawsuits or insurance claims that will generate income this year.

Deferring Income into 2018

If it looks like the client may have a significant decrease in income next year, it may make sense to defer income into 2018 or later years. Some options for deferring income include: (1) if a client is due a year-end bonus, having the employer to pay the bonus in January 2018; (2) if a client is considering selling assets that will generate a gain, postponing the sale until 2018; (3) delaying the exercise of any stock options; (4) if a client is selling property, considering an installment sale with larger payments being received in 2018; and (5) parking investments in deferred annuities.

Deferring Deductions into 2018

If a client anticipates a substantial increase in taxable income, practitioners may want to explore pushing deductions into 2018 by looking at the following: (1) postponing year-end charitable contributions, property tax payments, and medical and dental expense payments, to the extent deductions are available for such payments, until next year; and (2) postponing the sale of any loss-generating property.

Accelerating Deductions into 2017

If a client expects his or her income to decrease next year, accelerating deductions into the current year can offset the higher income this year. Some options include: (1) prepaying property taxes in December; (2) making January mortgage payment in December; (3) if a client owes state income taxes, making up any shortfall in December rather than waiting until the return is due; (4) since medical expenses are deductible only to the extent they exceed 10 percent of adjusted gross income, bunching large medical bills not covered by insurance into one year to help overcome this threshold; (5) making any large charitable contributions in 2017, rather than 2018; (6) selling some or all loss stocks; and (7) if a client qualifies for a health savings account, setting one up and making the maximum contribution allowable.

Tax Reform

As mentioned previously, the President and the Republican leadership in Congress have now elevated tax reform to be their highest legislative priority. So far, most of the proposals relating to individuals have dealt with lowering tax rates and reducing the number of tax brackets, doubling the standard deduction, getting rid of the personal exemptions as well as almost all personal deductions except for the charitable contribution deduction and home mortgage interest deduction (which would stay on the books, but become unavailable to most taxpayers), and reducing the maximum deduction for 401(k) contributions. Eliminating the AMT and estate taxes have also been proposed.

It's difficult to say what the tax impact of tax reform may be since there are so many proposals floating around and many of the proposed changes do not lend themselves to year-end planning opportunities. The one big exception, for now, is the potential repeal of itemized deductions, which does create a stronger than usual incentive to accelerate deductions into the current year. Whether that's a smart move for a given client will depend on factors such as whether the client will be subject to AMT in 2016, and what direction the client sees his or her income heading in the next year. In many cases there will be little downside in accelerating deductions that are on the chopping block.

Other Miscellaneous Items

Other miscellaneous items to consider are the following:

(1) The IRS has been actively pursuing individuals who fail to report their holdings in foreign accounts. A Report of Foreign Bank and Financial Accounts (FBAR) is due for any client that: (1) is a U.S. resident or a person doing business in the United States; (2) has one or more financial accounts that exceeded $10,000 during the calendar year; (3) the financial account was in a foreign country; and (4) had a financial interest in the account or signatory or other authority over the foreign financial account. The deadline for filing a FBAR is April 15. However, a six-month extension is available. The due date for a taxpayer who is abroad is automatically extended until June 15, with an additional four-month extension available until October 15.

(2) Encourage clients that have a health flexible spending account with a balance to spend it before year end (unless their employer allows them to go until March 15, 2017, in which case they'll have until then). Clients may want to check with their employer to see if they give the optional grace period to March 15.

(3) If a client owns a vacation home that he or she rented out, practitioners should look at the number of days it was used for business versus pleasure to see if there are ways to maximize tax savings with respect to that property. For example, if the client spent less than 14 days at the home, it may make sense to spend a few more days and have the house qualify as a second residence, with the interest being deductible. For a rental home, rental expenses, including interest, are limited to rental income.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

Parker Tax Pro Library - An Affordable Professional Tax Research Solution. www.parkertaxpublishing.com

We hope you find our professional tax research articles comprehensive and informative. Parker Tax Pro Library gives you unlimited online access all of our past Biweekly Tax Bulletins, 22 volumes of expert analysis, 250 Client Letters, Bob Jennings Practice Aids, time saving election statements and our comprehensive, fully updated primary source library.

Try Our Easy, Powerful Search Engine

A Professional Tax Research Solution that gives you instant access to 22 volumes of expert analysis and 185,000 authoritative source documents. But having access won’t help if you can’t quickly and easily find the materials that answer your questions. That’s where Parker’s search engine – and it’s uncanny knack for finding the right documents – comes into play

Things that take half a dozen steps in other products take two steps in ours. Search results come up instantly and browsing them is a cinch. So is linking from Parker’s analysis to practice aids and cited primary source documents. Parker’s powerful, user-friendly search engine ensures that you quickly find what you need every time you visit Our Tax Research Library.

Dear Tax Professional,

My name is James Levey, and a few years back I founded a company named Kleinrock Publishing. I started Kleinrock out of frustration with the prohibitively high prices and difficult search engines of BNA, CCH, and RIA tax research products ... kind of reminiscent of the situation practitioners face today.

Now that Kleinrock has disappeared into CCH, prices are soaring again and ease-of-use has fallen by the wayside. The needs of smaller firms and sole practitioners are simply not being met.

To address the problem, I’ve partnered with a group of highly talented tax writers to create Parker Tax Publishing ... a company dedicated to the idea that comprehensive, authoritative tax information service can be both easy-to-use and highly affordable.

Our product, the Parker Tax Pro Library, is breathtaking in its scope. Check out the contents listing to the left to get a sense of all the valuable material you'll have access to when you subscribe.

Or better yet, take a minute to sign yourself up for a free trial, so you can experience first-hand just how easy it is to get results with the Pro Library!

Sincerely,

James Levey

Parker Tax Pro Library - An Affordable Professional Tax Research Solution. www.parkertaxpublishing.com