There is a whole array of cosmic shifts in process from the election, but one that looks fairly likely is a change in individual income taxes in 2017. President-elect Trump has pretty much adopted the GOP House’s tax proposals, and with a Republican controlled House and Senate, tax change is likely. When we say change, we mean pretty significant changes.
What will likely change for individuals, if the proposal is adopted in its entirety:
- Brackets: There will be three instead of seven: 12%, 25% and 33%.
- Reduced taxes: Most individuals will pay less in taxes. The higher your income, the greater the cut. The Net Investment Income Tax (NIIT) and Alternative Minimum Tax (AMT) will be eliminated.
- Deductions: Parents with childcare expenses will be able to deduct childcare from their income, with income limitations. The standard deductions will increase to $15,000 for single taxpayers and $30,000 for joint taxpayers. Itemized deductions are anticipated to be limited to mortgage interest and charitable contributions, and would be capped at $100,000 for single and $200,000 for joint filers.
- Exemptions: Personal exemptions will be eliminated.
We always advise doing year-end tax planning, but given the climate, you can find some opportunities in your 2016 return. Here are some basic ideas, but note that taxes are complicated. Plan carefully and talk this over with your CPA or tax advisor, but do it before the end of the year.
- Harvest the losses in taxable accounts. We usually advise tax-loss harvesting (taking a loss on a stock or fund before year-end), but if taxes go down next year and the NIIT is eliminated, you may save more by using the losses in 2016 and recognizing the gains in 2017.
- Don’t buy a gain. Be careful about purchasing a mutual fund in a taxable account before its distribution date. Mutual funds can build up taxable gains, including short-term capital gains that are taxed as ordinary income. If your tax rate goes down next year, the last thing you want to do is buy income at a higher tax rate this year. Check the fund before you buy into any taxable account. This doesn’t apply to mutual funds purchased in a traditional or Roth IRA.
- Hit the charitable contributions. If your income will stay the same for 2016 and 2017, and you itemize deductions, it’s likely you’d receive more tax benefit bang for the buck from charitable contributions in 2016. If you have regular contributions, consider a Donor Advised Fund (DAF) where you could make a large contribution now, and use it over time. If you have appreciated property, like stocks or mutual funds in a taxable account, contributing those instead of cash will provide the double benefit of giving you a full fair market value deduction (within some limits) while also avoiding the capital gain tax if you sold the investment and donated the cash. If you know someone age 70 ½ or over with an IRA, they can make a Qualified Charitable Distribution (QCD) of their Required Minimum Distribution (told you it’s complicated), and eliminate that from their income. Most retirees with RMDs will have increasing income, so this strategy works well.
- Save taxes by paying taxes. If you itemize deductions and the new tax laws limit itemized deductions to mortgage interest and charity (we’ll believe that when we see it), then a big itemized deduction will disappear forever: taxes paid. Currently you deduct property taxes and state income taxes paid if you itemize. So for 2016, if you get a winter tax bill due on 02/15/17, it would make sense to pay it by 12/31/16. Likewise, it would make sense to make sure all of your state income taxes are paid before year end, even if it means making a state estimated income tax payment before 12/31/16. Pay too much in state taxes and you get a refund that is taxable the following year. But if that refund is taxable your tax rate is anticipated to be lower. Watch out, though, for the ugly Alternative Minimum Tax (AMT), which actually adds back your state and local taxes paid. If you pay AMT, skip this idea and move on.
- Medical expenses. We hope you don’t have to pay medical expenses, since you have to have a lot of expenses to receive a benefit (for people under age 65, the minimum is 10% of Adjusted Gross Income). It appears that the medical expense deduction will go away, so if you are able to deduct medical expenses (like if you have had an expensive medical procedure this year), see if you can ‘lump’ any more deductions into this year. Glasses, contacts, dental work… anything deductible. Note that you have to pay for it, so you can use a credit card and get the deduction. We hope you don’t need medical expenses, but if you have a lot of them, take advantage.
- Miscellaneous itemized deductions. There’s a wide array here, but most fall into the category of either job-related expenses or investment expenses. These are generally limited to expenses in excess of 2% of Adjusted Gross Income, and might include travel for a job, investment management fees, fees for tax prep, safe deposit boxes and so on. There are also some specific itemized deductions for police and fire fighters, and some for educators. Check with your preparer.
- Tuition and College. We don’t know where these will fall on the new plan, but taking advantage of the deductions now makes sense if tax rates do go down and your income stays the same. Subject to income limits, you can deduct student loan interest and tuition for yourself and dependents.
- 401(k). We normally suggest maximizing your 401(k), but this potential opportunity really makes it worthwhile. When you contribute to the pre-tax portion of the 401(k), you are taking it off your income at today’s rates. You might be deferring today at 15%, when next year your rate might be 12%. With higher incomes the difference is more dramatic. If you are in the top tax bracket (congrats), your earned income is taxed at 40.5%. If the law changes, you may be taxed at 33%. That’s a saving of 7.5% on every extra dollar. Max it out.
- HSA: A Heck of a Saving Account. A Health Saving Account is a tax-deductible way to put money away for medical expenses. You deduct the money as you deposit it in the HSA, and pay no tax if you use a withdrawal for qualified medical expenses. We don’t know what will happen to medical insurance, but the HSA is a top-line deduction that allows tax-free growth.
- Defer income. If your income is a paycheck, this doesn’t work. So not cashing your last paycheck doesn’t pass the income into 2017: your wages are taxed based on your W-2. However, if you own your business, receive commissions or are self-employed, you do have some control over billing and receipts. Monitor your income for FICA and self-employment; you could goof this up and pay a lot of FICA taxes.
We have more, but 10 ideas is a good start.
Check out the free, interactive tool here to see exactly how these proposed reforms to the tax code might affect you.
One final note is the potential elimination of the estate tax. If you are married and have over $10.9 million in assets (or single and $5.45 million), your estate over that amount is taxed at 40%. This is a huge saving to a family with lots of money. If you had a $4 billion estate, repealing the estate tax would save the family over $1.5 billion dollars. But until the law changes, the rules stay. So here’s our advice if you’re rich: Don’t die in 2016.
May we live in interesting times (Chinese curse),