This week, the Tax Cuts and Jobs Act (the “Act”) gained final approval from the House and the Senate, and President Trump signed the bill into law today. The effects of this bill are far-reaching and significant, and you’ll hear more from us in the coming year about the new opportunities and challenges stemming from this bill. But in the short term, here is a highlight of some actions you may want to take and some areas for you to consider before the year is over.
Roth IRA Recharacterizations are Going Away. Taxpayers may convert funds in their pretax IRA to a post-tax Roth IRA in a taxable conversion, which results in payment of income tax on the portion of the IRA that is converted to a Roth IRA. Before the Act, taxpayers were allowed a period of time until October 15 of the following year to “undo” the conversion for any reason. To “undo” the conversion, a taxpayer would “recharacterize” the assets and return them to an IRA, and would no longer owe the income tax on the conversion. Beginning on January 1, 2018, the ability to recharacterize a Roth IRA conversion disappears under the Act. This change probably applies retroactively to 2017 Roth IRA conversions, although there is some debate on this point among commentators. As a practical matter, taxpayers who made Roth IRA conversions in 2017 should allow that the deadline for recharacterization has probably been accelerated to December 31, 2017 (instead of the previous deadline of October 15, 2018). Financial institutions may also need some lead time before December 31, 2017 to process recharacterizations. If you made a Roth IRA conversion in 2017, we encourage you to reach out to us and your CPA to discuss the impact of these new rules and what actions, if any, you should take before the year is over.
Year-End Income Tax Planning. Tax rates, alternative minimum tax rules, rules for deductions, and other important rules will change significantly in 2018. To the extent you have the ability to shift the timing of income or deductions at year end, you may benefit from a year-end tax planning review with your CPA. The rules are so complicated that your CPA will probably need to prepare computerized projections to help determine the best strategy for you. The following sections summarize some of the most significant changes that affect year-end tax planning.
State and Local Tax Deductions are Capped at $10,000. One important change for California taxpayers is the new $10,000 deduction cap for state and local income, property, and sales taxes. At first glance, it may seem logical to prepay any of these taxes that you can in 2017, but it’s not that simple. Certain prepayments of tax may not be recognized under the new law. And there are other tax rules that could prevent you from receiving a benefit from your 2017 prepayment (such as the alternative minimum tax). You should check with your CPA to make sure that such a prepayment would benefit you given the nature of your overall tax plan for 2018, but your window for taking action here will close on December 31, 2017.
Mortgage Interest Deduction Reduced. Currently, a homeowner can deduct interest paid on mortgages up to $1 million on a first and second home, as well as the interest on some home equity lines of credit up to $100,000. Under the new bill, if a home is purchased after December 15, 2017 a lower limit of $750,000 applies to mortgages and extra deductions for a home equity line of credit will disappear. If you purchased your house before this cutoff, you get to continue using the current law – up to $1 million in mortgage loan interest deductions (but not home equity loan interest). You may also be able to refinance without losing this more favorable limitation if you do not increase your borrowings, but be sure to consult with us or your CPA before proceeding.
Certain Miscellaneous Itemized Deductions Disallowed. Prior to the Act, certain miscellaneous itemized deductions were deductible to the extent that they exceeded a “floor” equal to 2% of adjusted gross income. Perhaps the most important is the deduction for tax and financial advice such as CPA and attorney fees, but there are several others on the list. Starting in 2018, these expenses are no longer deductible. Prepaying these expenses in 2017 may produce a benefit for some taxpayers, but not others. You would need to consult with your CPA to confirm whether you might benefit from prepayment. We are available to help any of our clients who would like to bring their account with our firm as current as possible before year-end. Just give us a call.
Higher Standard Deduction. The standard deduction is doubling in 2018, from $6,350 to $12,000 for individuals and from $12,700 to $24,000 for couples. This means that some taxpayers with modest deductions (perhaps your children or other family members) will no longer have to itemize deductions because the standard deduction is so much larger. For those taxpayers, there may be a benefit to accelerating some of their 2018 deductions into 2017 if they will be itemizing in 2017. Again, check with your CPA to confirm whether this might be the case.
California Income Tax Rules. California’s income tax conforms to most, but not all, federal provisions. When a new federal law such as the Act is signed into law, California can take anywhere from months to years to decide whether to conform or not conform to the new federal provisions. This will be an important area to watch in 2018.
Doubling of Estate Tax Exemption and 2017 Gifts. The exemption for federal estate, gift, and generation-skipping transfer taxes is doubling at the start of 2018, up to a little over $11 million per person, but only for a temporary period ending December 31, 2025. This increased exemption will open up many new opportunities for wealth transfer and tax efficiency transactions for people that have never made gifts before and for people who have already used their current $5.5 million exemption. You’ll hear more from us about these opportunities in 2018, but if you are planning to make any gifts before the end of this year (other than the $14,000 annual exclusion gifts), you should connect with us first to see if you’d be able to avoid unnecessary taxes by waiting until January 1, 2018, to make the intended gifts. By the way, the annual exclusion will increase to $15,000 starting in 2018. This increase is a result of inflation indexing, and not the Act.
We’ll be unpacking all of the details of the Act bill over the coming weeks, and we’ll be paying very close attention to how your estate and tax plans are impacted. In the meantime, we’ll be standing by to answer any question you may have about this new bill and the actions you may want to take in the last few days of 2017. If we do not hear from you before the year is out, please accept our best wishes for health, happiness, and continued success for the coming year.