As we move closer to year-end, we start to focus on what we can do to minimize our clients’ taxable income. Marginal tax rates have risen sharply over the past three decades from a 28% marginal federal tax rate in the late 1980s to a 44.6% top marginal rate in 2017 (52.6% for California residents). As a result, tax planning has become an even more important part of how we assist clients in building and preserving wealth.
As of October 2017, certain tax proposals that might impact 2018 tax law for individuals include the following:
In light of these potential tax changes, we wanted to highlight the following tax planning techniques to consider, noting as always, each taxpayer’s tax situation is different, so we strongly recommend you talk to your tax advisor before making any planning moves:
Defer business net income from 2017 to 2018. Current tax proposals suggest federal tax rates on business income (possibly including business income from partnerships and limited liability companies) could drop to as low as 20%–25% in 2018. This could provide an opportunity to defer business revenues and accelerate expenses into 2018 when tax rates will likely be lower.
Consider prepaying property taxes and state income taxes. If you can deduct your property tax or state income tax payments (some people cannot due to AMT restrictions), consider prepaying or even overpaying these taxes in 2017. At a minimum, you will receive a federal tax deduction a year early and if state and local tax deductions are eliminated in 2018, you may receive a deduction in 2017 that you would not be able to receive in 2018. Also, there is a chance that itemized deductions could be capped in 2018 (an old Trump proposal that could be revived) so locking in the deduction seems prudent.
If you are considering making large charitable donations over the next few years, consider making them this year. If tax rates drop in 2018 from 39.6% to 35%, you would receive a larger tax benefit for your contribution in 2017 versus in 2018. Additionally, there is a chance that an itemized deduction cap proposed by Trump during the election cycle could resurface, so taking deductions in 2017 when the deductibility is known is wise.
If you are considering large wealth transfers in 2017, consult with your attorney about possibly delaying them to 2018. The tax proposals on the table include eliminating the estate tax in 2018, so delaying large wealth transfers could be prudent.
If you are retired or retiring soon, consider retirement locations with low or no state income tax rates. States with no state income tax include: Nevada, Texas, Florida, Washington, South Dakota, Alaska, and Wyoming. Current proposals call for the elimination of the deduction for state income taxes starting in 2018. A California couple with $1 million of income and an 11% average income tax rate would pay $110,000 in state income taxes. If their marginal federal tax rate is around 40%, under current law the federal government subsidizes their state income tax to the tune of $44,000 ($110,000 tax deduction x 40% tax rate). If state income taxes are no longer tax deductible, it could make it materially more expensive to live in a high-income tax state.
There is still a lot of uncertainty about the proposed 2018 tax changes as House and Senate committees start the process of putting tax proposals into actual bills, so it is hard to predict what the outcome might be. However, lower tax rates in 2018 and a more generous estate tax exclusion are possibilities, and even if a bill does not pass in 2017, there is a chance a bill will pass in 2018 with tax changes retroactive to January 1, 2018. While the uncertainty makes it difficult to plan, some techniques (such as those outlined above) will likely make sense even without a change in tax law.
While a tax rate cut may be in limbo, it does not appear likely a tax rate increase would occur in 2018, so certain traditional year-end planning techniques seem relatively safe to implement. Here are some tax planning techniques you may wish to consider regardless of potential tax law changes:
Note: A portion of the investment income for children under the age of 25 may be taxed at their parents’ marginal tax rate, so consider sheltering gifts that will be used to pay for college expenses in a College Savings Plan (AKA “529 Plan”). Income earned inside a college savings plan is exempt from income tax if used to pay qualified educational expenses. (Tax proposals include some mention of additional incentives for college savings for 2018, but few details have been provided.)
In addition to working with our clients’ tax advisors to implement saving strategies, we regularly look for opportunities to maximize clients’ after-tax returns and build their long-term wealth. We utilize these techniques in our client portfolios and you may wish to consider using some of them with the money you manage for yourself and your family:
We welcome the opportunity to discuss these topics with you. As with all tax planning, every person’s tax situation is different. We suggest consulting with your tax advisor before implementing any of these tax planning techniques.
Commentary from Our CIO—Second Quarter 2021
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Advisor Q&A: Tax Planning and the American Families Plan with Senior Advisor Chris Wheaton
The American Families Plan was recently released by President Joe Biden and includes many of the provisions outlined during his campaign. We asked Litman Gregory Senior Advisor, Chris Wheaton, to answer some questions about key proposed tax law changes, and related tax planning ideas for our clients to consider in 2021 and beyond.