2017 Year-End Planning for Individuals
As 2017 draws to a close, there is still time to reduce your 2017 tax bill and plan ahead for 2018. This letter highlights several potential tax-saving opportunities for you to consider. As you may know, the government is aiming to significantly alter the tax code. The information below is the current law. A few areas of potential tax savings opportunities and some areas of possible concern are listed below.
IRA, Retirement Savings Rules
Tax-saving opportunities continue for retirement planning due to the availability of traditional and Roth IRAs and other retirement savings incentives.
Traditional IRAs: Individuals who are not active participants in an employer pension plan may make deductible contributions to an IRA. The annual deductible contribution limit for an IRA for 2017 is $5,500. For 2017, a $1,000 “catch-up” contribution is allowed for taxpayers age 50 or older by the close of the taxable year, making the total limit $6,500 for these individuals. Individuals who are active participants in an employer pension plan also may make deductible contributions to an IRA, but their contributions are limited in amount depending on their AGI. For 2017, the AGI phase-out range for deductibility of IRA contributions is between $62,000 and $72,000 of modified AGI for single persons (including heads of households), and between $99,000 and $119,000 of modified AGI for married filing jointly. Above these ranges, no deduction is allowed.
In addition, an individual will not be considered an “active participant” in an employer plan simply because the individual’s spouse is an active participant for part of a plan year. Thus, you may be able to take the full deduction for an IRA contribution regardless of whether your spouse is covered by a plan at work, subject to a phase-out if your joint modified AGI is $186,000 to $196,000 ($0 – $10,000 if married filing separately) for 2017. Above this range, no deduction is allowed.
IRA Rollovers: For 2017, taxpayers may make only one IRA-to-IRA rollover per year. (Direct rollovers from trustee to trustee are not affected.) An attempted rollover after the first will be treated as a withdrawal and taxed at regular rates, plus a possible 10% early withdrawal penalty.
Spousal IRA: If an individual files a joint return and has less compensation than his or her spouse, the IRA contribution is limited to the lesser of $5,500 for 2017 plus age 50 catch-up contributions ($1,000 for 2017), or the total compensation of both spouses reduced by the other spouse’s IRA contributions (traditional and Roth).
Roth IRA: This type of IRA permits nondeductible contributions of up to $5,500 ($6,500 if making catch-up contribution) for 2017, but no more than an individual’s compensation. Earnings grow tax-free, and distributions are tax-free provided no distributions are made until more than five years after the first contribution and the individual has reached age 591/2. Distributions may be made earlier on account of the individual’s disability or death. The maximum contribution is phased out in 2017 for persons with an AGI above certain amounts: $186,000 to $196,000 for married filing jointly, and $118,000 to $133,000 for single taxpayers (including heads of households); and between $0 and $10,000 for married filing separately who lived with the spouse during the year.
Roth IRA Conversion Rule: Funds in a traditional IRA (including SEPs and SIMPLE IRAs), §401(a) qualified retirement plan, §403(b) tax-sheltered annuity or §457 government plan may be rolled over into a Roth IRA. Such a rollover, however, is treated as a taxable event, and you will pay tax on the amount converted. No penalties will apply if all the requirements for such a transfer are satisfied.
Individual Deductions
Deduction timing is also an important element of year-end tax planning. Deduction planning is complex, however, due to factors such as AGI levels, AMT, and filing status. If you are a cash-method taxpayer, keep the following in mind:
Deduction in Year Paid: An expense is only deductible in the year in which it is actually paid. Under this rule, if your tax rate is going to increase in 2018, it is a smart strategy to postpone spending until after year end to take the deduction in 2018.
AGI Limits: The overall limitation on itemized deductions (“Pease” limitation) applies to taxpayers whose AGI exceeds an “applicable amount.” For 2017, the applicable amount is $313,800 for a married couple filing a joint return or a surviving spouse, $287,650 for a head of household, $261,500 for an unmarried individual, and $156,900 for a married individual filing a separate return. In addition, certain deductions may be claimed only if they exceed a percentage of AGI: 10% for medical expenses, 2% for miscellaneous itemized deductions, and 10% for casualty losses (except in the case of a casualty loss due to the recent hurricanes).
Standard Deduction Planning: Deduction planning is also affected by the standard deduction. For 2017 returns, unless changed by tax reform legislation, the standard deduction is $12,700 for married taxpayers filing jointly, $6,350 for single taxpayers, $9,350 for heads of households, and $6,350 for married taxpayers filing separately. As you can see from the numbers, for 2017, the standard deduction for married taxpayers is twice the amount as that for single taxpayers. If your itemized deductions are relatively constant and are close to the standard deduction amount, you will obtain little or no benefit from itemizing your deductions each year. But simply taking the standard deduction each year means you lose the benefit of your itemized deductions. To maximize the benefits of both the standard deduction and itemized deductions, consider adjusting the timing of your deductible expenses so that they are higher in one year and lower in the following year. You can do this by paying in 2017 deductible expenses, such as mortgage interest due in January 2018, state estimated tax payments due in early 2018, or doubling up on your charitable contributions every other year.
Medical Expenses: For 2017, medical expenses, including amounts paid as health insurance premiums, are deductible only to the extent that they exceed 10% of AGI for all taxpayers. Unless extended by Congress, 2016 was the last year the special 7.5% limitation applied for taxpayers age 65 or older.
State and Local Income Taxes and General Sales Taxes: If you anticipate a state income tax liability for 2018 and plan to make an estimated payment most likely due in January, consider making the payment before the end of 2017. Or, you may elect to itemize and deduct state and local general sales taxes in lieu of the itemized deduction for state and local income taxes on your 2017 return. Note that there are discussions in Congress on whether the state and local tax deduction will be eliminated during tax reform efforts. It’s uncertain when this elimination, if it occurs, will be effective. If an elimination becomes effective for 2018, you will want to accelerate your deductions into 2017.
Charitable Contributions: Consider making your charitable contributions at the end of the year. This will give you use of the money during the year and simultaneously permit you to claim a deduction for that year. You can use a credit card to charge donations in 2017 even though you will not pay the bill until 2018. A mere pledge to make a donation is not deductible, however, unless it is paid by the end of the year. Note, however, for claimed donations of cars, boats and airplanes of more than $500, the amount available as a deduction will significantly depend on what the charity does with the donated property, not just the fair market value of the donated property. If the organization sells the property without any significant intervening use or material improvement to the property, the amount of the charitable contribution deduction cannot exceed the gross proceeds received from the sale.
If you make a qualifying charitable contribution targeted for hurricane relief efforts by December 31, 2017, you are allowed to elect to suspend the percentage limitations and certain other rules relating to the income tax deduction.
To avoid capital gains, you may want to consider giving appreciated property to charity.
Regarding charitable contributions please remember the following rules: (1) no deduction is allowed for charitable contributions of clothing and household items if such items are not in good used condition or better; (2) the IRS may deny a deduction for any item with minimal monetary value; and (3) the restrictions in (1) and (2) do not apply to the contribution of any single clothing or household item for which a deduction of $500 or more is claimed if the taxpayer includes a qualified appraisal with his or her return. Charitable contributions of money, regardless of the amount, will be denied a deduction, unless the donor maintains a cancelled check, bank record, or receipt from the donee organization showing the name of the donee organization, and the date and amount of the contribution.
Education and Child Tax Benefits
Education Credits: The American Opportunity Tax Credit is available for qualified tuition and fees paid on behalf of a student (i.e., the taxpayer, the taxpayer’s spouse, or a dependent) who is enrolled on at least a half-time basis. The maximum credit is $2,500 (100% on the first $2,000, plus 25% of the next $2,000). The credit is available for the first four years of the student’s post-secondary education. The credit is phased out at modified AGI levels between $160,000 and $180,000 for joint filers, and between $80,000 and $90,000 for other taxpayers. Forty percent of the credit is refundable, which means that you can receive up to $1,000 even if you owe no taxes. The term “qualified tuition and related expenses” includes expenditures for “course materials” (books, supplies, and equipment needed for a course of study whether or not the materials are purchased from the educational institution as a condition of enrollment or attendance). One way to take advantage of the credit for 2017 is to prepay spring 2018 tuition. In addition, if you know what books your student will need for the spring 2018 semester, those can be bought in 2017 and the costs qualify for the credit for 2017.
The Lifetime Learning credit maximum in 2017 is $2,000 (20% of qualified tuition and fees up to $10,000). A student need not be enrolled on at least a half-time basis so long as he or she is taking post-secondary classes to acquire or improve job skills. As with the American Opportunity Tax Credit, eligible students include the taxpayer, the taxpayer’s spouse, or a dependent. For 2017, the Lifetime Learning credit is phased out at modified AGI levels between $112,000 and $132,000 for joint filers, and between $56,000 and $66,000 for single taxpayers.
Student Loan Interest: You may be eligible for an above-the-line deduction for student loan interest paid on any “qualified education loan.” The maximum deduction is $2,500. The deduction for 2017 is phased out at a modified AGI level between $130,000 and $160,000 for joint filers, and between $65,000 and $80,000 for individual taxpayers.
Kiddie Tax: The kiddie tax applies to: (1) children under 18 who do not file a joint return; (2) 18-year-old children who have unearned income in excess of the threshold amount, do not file a joint return, and who have earned income, if any, that does not exceed one-half of the amount of the child’s support; and (3) children between the ages of 19 and 23 if, in addition to the above rules, they are full-time students. A parent may elect to include a child’s gross income in the parent’s gross income and to calculate the “kiddie tax.” One of the requirements for the parental election is that a child’s gross income is more than $1,050 but less than $10,500 for 2017. If a child has more than $2,100 for 2017 in interest, dividends, and other unearned income, and the income is not or cannot be reported on a parent’s return by filing Form 8814, part of that income may be taxed to the child at the parent’s tax rate instead of the child’s tax rate.
Please call Melton & Melton, LLP if you would like to address any questions you may have on the above items or to discuss options available for tax planning before year end.