2017 year-end tax planning – a year of uncertainty (updated)

(as also seen online at IRIS)

The Republican Congress is in the process of passing the Tax Cut and Jobs Act, a new tax law. President Trump is expected to sign it by Christmas.

The law was created and passed hastily and affects many aspects of the federal tax code, so many details are still not clear. Furthermore, regulations have yet to be issued. Also, while the provisions affecting corporations are permanent, most affecting individuals expire in 2026. Thus, tax planning is complicated.

How do you plan? Very carefully – you need to augment your traditional year-end planning by anticipating the impact of the many changes.

Note: many proposed changes did not make the final law, so be sure you are referring to the final version when making your planning decisions!

Planning steps

First, be practical:

  • Determine what income and deductions you can move from 2017 to 2018 or vice versa.

Second, review the impact:

  • What happens if you shift any of these amounts of income and deductions to the other year?

Finally, watch for the impact of the Alternative Minimum Tax (“AMT”):

  • The exemption for the AMT and the threshold above which that exemption gets phased out both rise next year, so some deductions lost to the AMT in 2017 could have value in 2018. Others simply vanish next year, so you need to plan carefully!


The new law lowers the tax brackets, so income will be generally subject to less tax in 2018.

Conclusion: You probably want to move income to next year if you can.

Exemptions and standard deduction

The new law eliminates personal exemptions and raises standard deductions to $12,000 for single filers and to $24,000 for married couples. These amounts will be indexed for inflation. The increased standard deduction may offset deductions that you lose, as discussed below. If you have children and others who are dependents, those tax credits are increased, which may help as well.

Conclusion: You probably want to move itemized deductions to 2017.

Itemized Deductions and Credits

The deduction for property taxes and for state and local income taxes is capped at $10,000.

Mortgage interest on new home purchases is deductible only for loans of up to $750,000 used to purchase your primary residence. Interest on home equity loans will not be deductible. (It is not clear if converting any part of home equity indebtedness that was used to purchase or improve your primary residence to a mortgage would make that interest deductible, subject to the cap.)

All miscellaneous deductions are eliminated. This includes investment and tax preparation fees, safe deposit box charges and unreimbursed employee expenses.

The casualty loss deduction is also eliminated and the bike to work exclusion ends.

Moving expenses will no longer be allowed (except for military personnel in certain cases).

The deduction of alimony will be eliminated for divorces occurring after 2018.

What survived? The deduction of student loan interest and medical expenses survived. The latter is subject to a 7.5% rather than a 10% floor. And, the new law repeals the reduction applied to itemized deductions for high-income taxpayers, which may help with some deductions.

Here are several items that were considered for limitation or elimination that remain unchanged:

Dependent care accounts, adoption expenses, tuition waivers and employer paid tuition, capital gains on the sale of your personal residence, the teacher deduction, electric car credit, Archer medical accounts and designating shares of stock or mutual funds sold.

Conclusion: you will want to move any of the eliminated deductions that you can prepay into 2017.

Note: a last-minute provision added to the new law makes prepaying 2018 income taxes in 2017 non-deductible.

Pass-through businesses

If you have income from a sole proprietorship, LLC, partnership or S Corporation, you may be able to deduct 20% of that income, subject to certain rules on wages and a phaseout beginning at $157,500 for singles and $315,000 for married taxpayers. These rules are designed to avoid abuse seen when Kansas enacted a similar law.  (Watch for a post on this soon.)

Conclusion: read the fine print (e.g. rules for personal service firms) to see if there are any opportunities you can exploit.

Estate taxes

The credit before estate or gift taxes are due is doubled to $10,000,000, indexed for inflation.

Conclusion: you may want to postpone your year-end gift planning.


Carefully review any income and deductions that you can still shift to see if moving will lessen the total taxes you pay for 2017 and 2018.

Good luck and best wishes for the holidays!

If you have any questions, please contact me.

Tax Law change under the new Trump Administration? Maybe, but too soon for planning

Enacting Major Changes Will Take Time

(as also appeared online in IRIS.xyz)

President Trump made tax reform a key issue in his campaign. He is now president and Republicans are in charge of the House and Senate, so the likelihood of overhauling the federal tax system is better than they have been for decades.

However, President Trump and Congress are trying to enact changes to the Affordable Care Act as well as addressing budget issues and foreign relations. Also, dealing with all the recent hearings involving the FBI have diverted attention. Finally, there are many details that need to be worked out, making it unlikely that major changes will happen until 2018.

Change in IRS Regulations

President Trump has already made changes in IRS regulations. On his first day in office, he temporarily froze tax regulations and then shortly thereafter, ordered that two existing regulations had to be removed for each one that was added. What is the impact?

  • The Trump administration has stated that the two-for-one exchange rule only applies to significant regulatory actions. The rule may not affect the many IRS regulations that are procedural in nature or are needed by taxpayers.
  • One new regulation that has been threatened is the Department of Labor’s new fiduciary rules for retirement advisers. This updated regulation requires retirement advisers to act in their clients’ best interests, which is a stricter standard than was previously required.
  • Also affected are the new partnership audit procedure. A 2015 law streamlined the exam process of large partnerships. The IRS released proposed regulations which implemented the regime on January 18. However, it later pulled the regulations in response to the freeze.

Possible Tax Law Changes – Lower Corporate Tax Rate

Currently, the corporate tax rate tops out at 35%. House Republicans want to lower it to 20% with 25% for businesses that pass income through their owners and for those that are self-employed. President Trump is calling for a 15% corporate tax. In 2014, nearly 25 million Americans filed taxes as sole proprietors (Schedule C), so the change affects many taxpayers.

Tax strategy: Under this change, individuals who are high-earning could become independent contractors or set up LLCs to shift income and advantage of the lower corporate tax rate. Additionally, those who own pass-through businesses could reduce their salaries and take higher profits.

This is how residents of Kansas responded to a similar state law. The state is now working to repeal a law passed in 2012 that exempted pass-through firms from state income tax. The result was that many individuals and businesses in the state restructured their business as pass-through entities or created new businesses to take advantage of the tax break. In just a few years, the number of pass-throughs in the state almost doubled. The state is now facing a large budget deficit as a result because the pass-through exemption is estimated to have cost the state $472 million in 2014 alone. The cost for 2015 was even higher.

The impact of this tax strategy on the 15% tax at the federal level would be expensive. It is estimated to cost up to $1.95 trillion in lost tax revenues over the next ten years. The Trump administration is considering ways to prevent abuse of this low tax rate but any attempt to prevent gaming the system will likely add more complexity to the tax code. Tax-savvy practitioners will likely still be able to find loopholes.

Tax only on Income Earned inside the US

Worldwide income is taxed presently, with credits for foreign taxes paid. The proposed law would generally tax only income that is earned within U.S.

Multinational Tax: A new, low tax on multinationals is part of the proposed tax, added to raise revenue to fund other rate reductions.

Estate Tax Repeal

Republicans would like to repeal the estate tax. President Trump would impose a tax on pre-death appreciation of assets, with a $10 million per couple exemption. There would be no step up in basis at death. And it is likely that gift tax rules would be retained.

Even if the federal estate tax law is repealed, many states will continue to impost a tax. Massachusetts only exempts $1 million of assets passing to someone other than a spouse, such as a trust. New York and other states have higher exemptions. Thus, planning is still important for most people.

Planning Opportunities

With the uncertainty of any change being enacted, this is not an easy year for planning. For example, this may not be the year for a Roth conversion, if tax rates will go down next year. It may not be the time for complex estate planning techniques involving irrevocable transfers, if the estate tax is eliminated in 2018.

We will keep monitoring this to assess any moves that do make sense and update this post when the likelihood of real changes becomes clear.

Update on estate planning – what should you gift now?

Estate planning remains stuck in limbo. That is, after 2012, the $5 million credit for gift and estate taxes goes away and we could be back at a $1 million credit. Also, the generation skipping tax limit now at $5 million would decrease. Finally, the portability of estate tax exemptions between spouses expires, meaning that the survivor can no longer use any credit amount not used by the first spouse, which would allow more to pass on estate tax free.
So far, Congress has taken no action. Many expect the 35% rate and a credit of at least $3 million to be the law for 2013 on. However, Congress failed to fix the estate tax for 2010 so nothing is certain.

Planning: This means you need to review your estate plan, especially your gifting strategies, and act now to take advantage of the higher gift tax credit. You can gift up to $5 million of assets free of gift tax now, or $10 million for married couples. The benefit is that all future income and appreciation on these gifts is removed from your estate. The downside is that the gifts are irrevocable, so you must be certain that what you pass on now you will not need later.
You always want to select assets that you expect will grow in value. If the assets decline, the strategy is frustrated. An example of what could go wrong is gift of a home at peak values that is now worth far less.

Remember that you have the annual gift tax exclusion allowing you and your spouse can each give $13,000 per year to any individual without eating away at your gift and estate tax credit. And note: any payments made to colleges or hospitals for the benefit of another person are not counted at all. (No gift tax return is required for these excluded amounts.)

How do you effectively structure the gift? Here are some examples:
• Family limited liability company (FLLC): With real estate or business assets, you can transfer minority interests in the FLLC to children or grandchildren. You retain control and the amount you gift is discounted because the minority interests lack control and lack marketability. You will need an appraisal for the value and the discount.
• Dynasty trust: This type of trust is designed to pass assets on multiple generations. Distributions can be made to the first generations, but they never actually receive a final amount – they rely on the trustee for any amounts to be distributed to them.
• Grantor retained annuity trust (GRAT): This trust transfers assets to children after a specified term while retaining a fixed annuity. The amount you gift is discounted, because children do not receive it until the end of the term. If the amount transfers, you succeed in transferring a discounted amount that becomes worth much more to the next generation.
• Qualified Personal Residence Trust (QPRT) Like the GRAT, your children receive your house in the future, so the value of the gift made now is discounted. You can even stay in the house after that term, but you have to pay rent, which is in effect another gift.

One note of caution: some have expressed the concern that if Congress does not act, the IRS could try to take back the excess in some fashion. Be sure to consult with your estate tax advisor before taking any moves.
We added gifting as a “to do” on the Finance Health Day page .

Estate Planning – Techniques for Reducing Taxes in Large Estates

The change in the tax law from the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 gives us a two year window for significant estate tax planning, ending December 31, 2012.

Instead of a $1 million lifetime cap, you can now gift up to $5 million. When your spouse joins in, a major amount of wealth can be transferred. This makes it important to act now, because the law could change in for 2013.

Leveraged Gifting – you can use a defective irrevocable trust (the defective grantor trust is discussed below) to fund an installment purchase of assets from you to the trust over time. The trust is “defective” so that there is no taxable transaction and no gain; it is as if you are selling to yourself. With the installment sale, a note is used and has to bear interest at the IRS mandated rates, the lowest rate of interest allowed. The goal is to repay the note using appreciated assets, where the transfer back to you is also not taxed, and complete the repayment before you die. If it is not completed, the note is an asset taxable in your estate.

Dynasty Trust – you can use the increased generation skipping transfer tax (GST) to pass more to grandchildren and future generations. Again, the new limits allow you to pass far more on to future generations.

Life Insurance Trust – an irrevocable trust that holds insurance for whatever purpose you design, while be excluded from your taxable estate. Your trustee would purchase insurance on your life. The risks of this alternative are that it is irrevocable and that the cost of the permanent insurance is very high.

Second-to-die Life Insurance – a trust that purchases second-to-die life insurance crates a source to pay estate taxes while not increasing the taxable estate.

GRAT – Another alternative is the grantor retained annuity trust (“GRAT”), which uses some portion of your unified credit as a window through which to pass assets at a discount created by the IRS tables that tell us what the asset gifted will be worth at the end of the term of the trust. You receive annuity payments during the term and the principal passes to your children at the end of the term. (This is why it must be funded with “excess” wealth – if you give the trust a term of 20 years but live many years thereafter, there will be many years during which you have foregone the benefit of the assets gifted). The expectation is that the principal will actually be worth more than the amount you gift to the trust, with such increased value escaping estate taxes. Under the new law, there are no GRAT or value limitations.

Cautions: First, the securities laws will treat you as the owner of trust assets for any restrictions on dealing with publicly traded stock. Second, if you die before the end of the term, assets revert to your estate and the structure collapses to look as if nothing was done. Last, a twist: if you stipulate that the trust will not terminate at your death, you substantially reduce the amount that gets thrown back to your estate, reducing the risk of not living through the term of the trust.

Tax inclusive and exclusive – the Sam Walton strategy can used when you want to transfer more than your unified credit alone will allow. If you make a taxable gift, it is tax exclusive (the tax comes from other assets). Thus, the tax is calculated as a percent of the gift. If you die owning the asset and it then passes to your children, it is tax inclusive as the tax is calculated as the total amount, so less of the assets pass to your children. QPRT – The qualified personal residence trust (“QPRT”) uses the unified credit and discount of a future value like the GRAT but applies it to your residence. Thus, both the benefits and risks are similar; it is the asset that differs.

“Defective” grantor trust – The “defective” grantor trust is effective for gift tax purposes and “defective” for income tax purposes so that assets are not included in your estate and yet you pay the tax on their appreciation. Paying the income taxes without any gift tax cost effectively gives away additional wealth. Again, you can leverage this with an installment sale.

Family Limited Partnership – the family limited partnership (“FLP”) is a partnership that you form, acting as the general partners and the limited partners. You transfer assets into the FLP such as any commercial real estate or your shares in your company. When this is complete, you can gift limited partnership interests to your children. Because only the general partners have any say in the management of the FLP, the IRS allows for a discount to the value of the limited partners interest. This discount is 35 to 40%, so more is passed to children without using up your unified credit. Unlike the other alternatives delineated below, when you transfer limited partner interests, your children receive the benefit now. In addition, you have the burden of tax returns for the FLP, as well as tax liability for children who may not receive distributions from the FLP to cover the taxes.

Charitable Remainder Trust – This charitable remainder trust (“CRT”) is a trust that pays a fixed annuity to you and then distributes the remaining principal to charities. You get a gift charitable deduction for the net present value of the future distribution to charities.

Charitable Lead Annuity Trust – This reverses the CRT, where a trust that pays a fixed annuity to charities selected by its trustees and then returns the remaining principal to you or to your estate. You get a gift tax deduction for the actuarial value of the annuity payments to charities or an estate tax charitable deduction.

Caution – you have an investment risk in each vehicle, where failing to generate the larger principal value in the future that you count on to use the strategy will frustrate its purposes. This is the risk of selecting assets that are expected to soar in value but instead collapse. Therefore, none of these alternatives should be considered until you are comfortable that you have “excess” wealth to pass to your children or to a charity and comfortable that you can make a commitment to do so that cannot be reversed. If you say “no” out of lack of comfort or confidence in any strategy, then you will want to stick to a basic plan for now.

What about the Future? Most observers expect the $5 million exemption to stay, along with the 35% estate tax rate. The exemption could be lower, or the rate increased. All of this is reason to review the ideas below and then update your estate plan.

Please see Estate Planning.

Estate tax update

As anticipated, Congress lifted the estate tax credit for 2011 from $1 million to $5 million, lowering the rate from 55% to 35%. Also, the date-of-death value again serves as the basis for estate assets. Also, the exemption is portable, viz. the un-used portion can be carried cover gifts by or the estate of the surviving spouse. Finally, the exemption will be indexed for inflation. (Estates can elect to use the 2010 rules for $1.3 million carry over basis for heirs).

There are some special rules: up to $1,020,000 of real property used for farming or business can get a discounted valuation; and when a closely held business comprises more than 35% of an estate, then as much as $476,000 of estate taxes can be deferred at a cost of 2% (charged by theirs).

In 2013, the exemption again falls back to $1 million and the rate goes back up to 55%, unless Congress again takes action.

For any 2010 estates, the retroactive action provides requires estates with a date-of-death valuation in excess of $1.3 million to file informational returns to report the carry over basis to the IRS and to heirs (as well as the $3 million for assets passing to a surviving spouse).

See more at Estate Planning.

(or contact us with your questions at Contact Us.)