Tax planning for next year: Expect the unexpected
While tax professionals will be able to make use of some of their tried and true tax strategies when advising tax clients in the upcoming tax season, they will need to get ready next year for tax changes under the incoming Trump administration and Congress.
“The news is obviously what might be coming in the not too distant future, but for ’16 there are not a lot of changes for people from prior years,” said Greg Rosica, a tax partner at Ernst & Young and contributing author to the EY Tax Guide 2017. “As in 2015, there were some items that were made permanent by the PATH Act of 2015, but permanent only means as long as those tax laws are around. All those things could certainly change next year as well, but they’re permanent through 2016.”
One of the tax-planning strategies he recommends is the IRA charitable transfer, which allows taxpayers to exclude money donated to a charity from an IRA if they’re over the age of 70 ½. “It’s a way to utilize your IRA and help a charity at the same time,” said Rosica. “That continues to be there for 2016 for those who are in that fairly specific fact pattern of having an IRA, wanting to give to charity, and being over 70 ½. That can make a lot of sense for them.”
Another tax break that’s still available for next year is the qualified small business stock exclusion, but again it’s only appropriate for taxpayers who fit a specific fact pattern. Those who have invested in a C corporation and held their shares for more than five years may be able to pay a reduced capital gain on the sale of that stock, usually of a private company, but not always, Rosica pointed out.
Schoolteachers will be able to continue to use a tax break that lets them deduct $250 above the line for school supplies they buy for their students, and they don’t need to itemize to take advantage of it, he noted.
More generally, taxpayers will be able to continue to take a deduction for sales tax instead of state income taxes if it’s a bigger number for them. “For those folks who live in low or no state income tax residences, that can be a deduction for them that’s beneficial as well,” said Rosica.
Even though Congress finally put in place a permanent patch for the alternative minimum tax at the beginning of 2013, Republicans have proposed eliminating the AMT as part of their tax reform plans. But Rosica warns against getting too far ahead in counting on the AMT to go away.
“It’s important to recognize that it’s not known what’s going to happen yet,” he said. “We have some direction and some general guidance as to what direction things may go in ’17 and ’18. We do know with certainty what the 2016 rules are. Let’s say AMT is potentially going away. We know if someone is in AMT for 2016, there are some planning items to be focused on. If you’re in AMT, what that says generally is your tax rate is at a high rate of 28 percent, so the next several dollars that you earn get taxed at 28 percent. There’s a sweet spot, a window at which you’ll be taxed there, and at some point you will have enough income where you will no longer be in AMT. But if you look at what that sweet spot is, for your own situation, you’ve got some income where if you were to accelerate it this year it can be paid at a 28 percent rate. There is a certain kind of generic planning this year that says if rates are going down, therefore I should defer income and accelerate deductions. But there are several examples where that’s probably not the case, and you should do the opposite, and I think this is one of them. If you’re in AMT and you’re basically paying a 28 percent rate on income, and you think that ordinary rates are going to go down from 39.6 to 33 percent, well, 33 percent is higher than 28 percent. So it might make more sense to bring some income into 2016 if you’re in AMT and you’re paying tax at 28 percent, if you expect to be in the 33 percent bracket under the new administration.”
There are several ways to do that, such as by selling stock for short-term gains this year before they become long-term gains next year, or by doing an IRA rollover. “If you’re contemplating doing an IRA rollover, looking at what the sweet spot is, where you’re continuing to pay that tax at 28 percent might make sense to do this year,” said Rosica. “The added benefit you get of doing that kind of rollover is you get the recharacterization option next year. You can undo it up until you file your tax return, which could be as late as October of 2017, at which point we’ll probably know more about what the new tax rules that are being proposed will be. To me, that’s a situation again where somebody is in AMT and they’re considering doing a Roth IRA rollover. They’ve got a 28 percent bracket and they can utilize at least the rollover part of it, and they have the ability next year to undo what they did. You don’t get a lot of situations where you can use hindsight to figure all that out, and this is one of them.”
Taxpayers and tax practitioners can still do planning around the gift tax, although the estate tax might be eliminated if tax reform occurs.
“That’s within your annual exclusion amount,” said Rosica. “You have $14,000 per person that can be given away. It still makes sense to do. I would not suggest you do things in most cases that would involve paying any kind of gift tax, because if in fact the estate tax does go away, then that may not be money that needed to be spent, so I would wait and see on that piece. But there’s a lot of reasons why we do that type of planning, estate tax planning and gift tax planning, that aren’t about the tax piece of it. They might be about putting things in trust to help protect it for future generations and create family harmony. There are good reasons that aren’t tax reasons. Those things still are items that make sense and there is still plenty of planning that can be done in the estate and wealth transfer area that don’t require paying taxes.”
But it’s too early to do planning around many of the other tax reform proposals that have been floated. “We have very limited details of proposals that are out there,” said Rosica. “We have President-elect Trump’s proposal as well as the House GOP’s that have many similarities, with some differences as well. It’s time to keep your eye on those and help advise clients on what’s coming, as we get more information. But really what we’re focused on is taking the certainty that we have for 2016 and implementing actions today where we know the result, where we know that we might be getting the benefit of deductions at 39.6 percent, the top rate today, where we know that if we defer the income out of this year, that it’s potentially to a lower rate so we’re not going to have regrets from doing something like that. We’re really focused on this kind of no-regret planning so the items that you do are positive to your situation today, and are not going to be negative to your situation, depending on what happens with the upcoming administration’s tax changes.”
The traditional kinds of tax planning strategies could still be useful for the foreseeable future then.
“Once we know what the new landscape will be, we’ll understand how income is going to be taxed, how items from flow-through entities will get taxed, and how deductions are going to be allowable,” said Rosica. “And then obviously we’ll be able to start to implement planning under those rules as well.”