Whether you agree or disagree with the new tax reform bill (or believe that really the only people winning are the really wealthy and tax professionals), it will be beneficial to do some tax planning before the old tax rules go away in just a few more days.
Most Americans expect to have noticeably lower tax bills starting in January, partially because of lower tax rates. Because of this, most people will benefit from accelerating deductions into the current year. Income should be deferred where possible to be taxed at a lower rate.
Of course, just as with all things relating to personal finance and tax, it all depends on your own specific personal situation. With that being said, I’m sharing a few things to check that may save you an extra few dollars by managing your income and deductions now.
Defer Income to 2018
If you’re a freelancer or self-employed, you may want to try to defer some income into next year, if possible. Of course, most employees (unless you work for a very small business or are also the owner) don’t have much control over when and how they receive their wages.
Even if you perform the services during the current year, as long as you report your income on a cash basis (I’m sure most of you!), you can still defer the income as long as you haven’t yet received it as of December 31st. Request that those who owe you money wait until the new year to issue payments owed to you.
Note that simply not cashing a check that you already received is not enough to defer the income. The tax law requires you to count any income that you are constructively in receipt of during the current year.
Contribute to Your HSA (and IRA!)
The deadline for contributing to your HSA account is December 31st. If you have a high deductible plan and have been considering opening one or simply just haven’t been contributing this year, it’s time to reconsider. The tax rate changes make this year’s contributions worth more than they will next year. That saves you more money that you can then invest…in your HSA (okay, or something else!).
Even if you don’t have major medical expenses, an HSA can still be a great tool to invest money for the future. Once you reach 65, it can actually be used just exactly like a Traditional IRA for retirement. The limit for HSA contributions is $6,750 for families and $3,400 for individuals for 2017. The catch-up contribution for those 55 and older allows an additional $1,000.
While the deadline for Traditional IRA contributions isn’t until April 15th to still be able to deduct them on the 2017 tax return, make sure you’re prioritizing setting aside this money. The earlier you contribute, the more time your money has to grow.
And, while you’re completing that new year’s budget, be sure to allocate some funds each month to an HSA and IRA.
Fund a 529 Plan
If you have kids, you may already be contributing to a 529 college savings plan. The new tax law expanded the ability to use 529 plans for private school tuition in addition to college. Therefore, if you’re already paying private school tuition, contributing to a 529 plan may be an obvious choice.
Here’s where tax planning comes in. If you contribute to your state’s plan, you may be able to get a deduction or credit on your state tax return. In Michigan, we can subtract up to $10,000 of 529 contributions made to our state’s plan each year. There is no federal deduction for the contributions, but your money goes tax-free and everything you withdraw, including earnings, aren’t taxed as long as you use them for qualified education expenses.
If you wait until next year to begin or contribute to a 529 plan and your state offers tax benefits for doing so, you may miss out on an entire year’s deduction.
Just make sure to research whether there is a holding period in the 529 to avoid having to add back the deduction in the following year if you need to spend the money soon (only a few states have this requirement).
The new tax reform bill limits property and state taxes to a $10,000 combined total. In many parts of the country, but especially in high-income tax states, this is a significant limitation.
If you’ll be itemizing your deductions in 2017 and own a home, paying as much in property taxes as possible before the end of the year will ensure that less of your deduction will be limited in 2018. To determine whether this applies to you, look at Schedule A of your tax return. If one or both of the following apply, you’ll probably benefit from paying as much of your property taxes as possible in 2017:
- The total on line 9 of Schedule A is over $10,000, and
- Total itemized deductions (line 29 of Schedule A) are over the new standard deduction amounts ($12,000 for individuals, $24,000 for married couples and $18,000 for head of household)
Alternately, you will also benefit from this if your total itemized deductions are currently between the current standard deduction threshold ($6,350 for single individuals, $12,700 for married couples and $9,350 for heads of household) and the new standard deductions listed above. Since you’ll no longer be itemizing deductions in the future, there will longer be any incremental benefit.
Not all states allow 2018 property taxes to be paid in advance, so check with your individual state and locality. In my local township in Michigan and many others, we have the option of paying our Winter taxes either at the end of the current year or at the beginning of the next year. This provides a great opportunity to be able to optimize which year will provide the best tax deduction.
Note that this planning opportunity will only apply if you’re not subject to Alternative Minimum Tax in 2017.
In addition to property taxes, there is also an opportunity to accelerate state taxes, although this option is more limited. Since you’ve just checked your total taxes from your Schedule A, you’ll already know whether you should accelerate your state tax deductions as well (the same rules from above apply).
State taxes prepaid for 2018 are specifically not allowed to be deducted under the new tax laws. However, if you still owe a state tax estimate for the 2017 tax year, paying it by December 31st, 2017 rather than the standard January 15th due date is likely a good idea to maximize your tax savings.
State tax deductions will also apply only if you’re not subject to Alternative Minimum Tax in 2017.
If you’ll no longer be itemizing your deductions starting in 2018 (because the standard deduction amount will be higher and therefore more beneficial), pay your January mortgage payment before year end.
In addition, you should also do this with any home equity loans you have as well as second homes.
The percentage of people that will itemize their deductions, and are therefore eligible to get an incremental tax benefit of donating to charity will decrease from 30% currently to only 6% starting in 2018. The impact on charitable giving is expected to be sizable because that will result in many people no longer being able to deduct these contributions.
So, if you expect that your allowable itemized deductions will be less than the new standard deduction amounts ($12,000 for individuals, $24,000 for married couples and $18,000 for heads of household), contributing more by the end of the year will result in a tax benefit. Going forward, if you’re close to being able to itemize, you can lump several years worth of charitable contributions together in one year.
If you’re charitably inclined and have extra money available, consider setting up a donor-advised fund. It will allow you to get the deduction in the current year and be able to distribute the funds throughout the future years.
Noncash charitable donations are another way to reduce your taxable income if you itemize your deductions. Because tax rates are going down across the board, you’ll get a bigger benefit from donating physical goods before the end of the year than you will if you wait until the new year. As another bonus, you’ll start the year with less clutter!
Pay As Many Deductions Subject to 2% Floor as Possible
The opportunity to take miscellaneous deductions is being completely eliminated starting in the new year. This includes unreimbursed employee business expenses such as a home office, vehicle costs, and other similar expenses. It also includes tax preparation, job search expenses, investment management and tax planning fees.
So, pay as many of these expenses as possible before the year end, otherwise, you will not get any further tax benefit.
Optimizing your miscellaneous 2% deductions will only provide a tax benefit for you if you’re not subject to Alternative Minimum Tax in 2017.
Consider Starting a Business
Although many individuals will see a noticeable tax decrease, businesses are really the ones that really come out ahead. Pass-through businesses will be eligible to receive a 20% deduction under the new law. Corporation rates have decreased to a maximum of 21%.
This may make it more advantageous to go out on your own rather than working for someone else. Or, even starting a side hustle and structuring it advantageously can provide a great benefit. The earlier you start, the more tax you’ll save.
If you already own a business, consult your tax professional to see if you can benefit from having it structured in a different way to reduce your overall taxes.
Bonus: Plan to Have a Child in 2018
Now, I certainly don’t advocate for the integration of family planning and tax planning necessarily. But, if you’re planning on having a child soon anyway, you just might want to consider that you’ll get an extra $2,000 back. If you’re in the (new) 22% tax bracket, it’s like sheltering $9,000 of income from federal taxes.
But, you’ll obviously also be spending that extra $9,000 because kids aren’t cheap! Now, I’m not personally going to take advantage of this tax planning opportunity, but I’m just throwing it out there.
There are still a few days left to implement a few tax planning strategies before the new year begins, the very basic of which is to defer your income and accelerate your deductions.
What are you doing to prepare for the new tax laws in 2018?