The likelihood exists that federal tax-cut legislation will become law sometime in 2017. Nevertheless, the possibility also remains that comprehensive tax legislation may be delayed until 2018 either because of difficult negotiations or intervening events, or it could eventually even get tabled indefinitely, except for a few provisions, if momentum turns to other matters. The contents of a tax bill, too, can vary – from a compromise between the House GOP’s “Better Way” blueprint and President-elect Trump’s tax plan as set forth during his campaign—to a significantly rewritten version if Senate Democrats and fiscally conservative House and Senate members are able to gain seats at the negotiating table.
What should a taxpayer do now, before the 2016 tax year ends, to take advantage of possible tax reduction in 2017 and beyond, without painting him or herself into a corner if tax changes of the type anticipated are not realized either retroactively to January 1, 2017, or not at all in the magnitude now being discussed? The first assumption that needs to be made in such a year-end strategy is whether any legislation in 2017 will be retroactive to January 1, 2017, thus providing more of an incentive to deferring taxable income into 2017 and beyond and accelerating deductions into 2016. If 2017 tax legislation only provides a mid-year tax cut, or is approved close enough to 2018 to delay any benefit until 2018, efforts at the end of 2016 to lower 2016 taxable income at the expense of raising 2017 taxable income disproportionately to 2016, can end up costing the taxpayer overall tax dollars.
As with prior years, 2016 year-end planning should start with data collection and a review of prior year returns. This includes losses or other carryovers, estimated tax installments, and items that were unusual. Conversations about next year should include review of any plans for significant purchases or dispositions, as well as any possible life cycle plans. If the general goal for year-end planning has been to balance taxable income between the current and upcoming year to the extent tax bracket rates are equal, planning at year-end 2016 presents a choice between using the new Trump/House Blueprint rates as a target or a more conservative approach that moves more taxable income beyond an ideal balance into 2017, but not necessarily counting on a final tax bill arriving at a 15, 28 and 33 percent rate structure for individuals; and a 15 or 25 percent rate level for businesses, depending upon the Trump or House blueprint versions. Within those goals, use of traditional techniques to delay income recognition into 2017 and beyond or to accelerate deductions into 2016 have particular relevance at year end 2016.
The following income deferral techniques, among others, might be considered:
Installment contracts. Income on a sale reported under the installment method is realized pro-rata over the years in which the installment payments are made, under the tax laws applicable during those future years. This technique is particularly valuable if tax cuts are not made effective immediately in 2017 since installment payments in 2018 and beyond are all the more likely to be subject to lower tax rates.
Bonuses. If an employer can be persuaded to delay paying out a bonus at year end until up to 2 ½ months into 2017, the employee will be taxed in 2017. For this strategy to work, however, the deferral must be made before the bonus is due and payable; and, generally, the bonus must be paid within the first 2 ½ months in 2017 to avoid tripping over the nonqualified deferred compensation rules.
Billing for services. Cash-basis taxpayers in the business of providing services might consider delaying the recognition of service income at year end by billing out late in the year or even into early 2017 for those services performed in late 2016.
U.S. Savings Bonds. For cash-basis taxpayers, interest on series E, EE and I bonds is generally taxed at the earliest of disposition, redemption or final maturity of the bond (however, the taxpayer can elect to report the interest as it accrues).
Debt forgiveness income. Determination of the time of debt forgiveness requires a practical assessment of the facts and circumstances relating to the likelihood of payment. Convincing the lender to postpone issuing a Form 1099-C, Cancellation of Debt, until the 2017 tax year, might form part of the process. Note that IRS final regulations in early November (T.D. 9793) removed the rule under which a deemed discharge of indebtedness, reportable on Form 1099-C, occurs at the expiration of a 36-month nonpayment testing period.
Like-kind exchanges. Taxpayers who want to delay recognition of income on the sale of business or investment property should consider a like-kind exchange conforming to Code Sec. 1031. Proposals to limit to use of like-kind deferral to $1 million, and exclude art and collectibles from like-kind treatment, may be under consideration in the future, but are not applicable at the very least to 2016.
First-year required minimum distributions. Individuals who first reached age 70 ½ in 2016 can delay taking required minimum distributions (RMDs) from qualified retirement plans otherwise due in 2016 until 2017. Of course, they will then be required to double-up in 2017 and take distributions for 2016 and 2017 in 2017.
Roth IRA conversions. Conversions from traditional IRAs to Roth IRAs are taxable in the year of conversion. Individuals therefore should consider delaying conversions into 2017. Individuals who already converted to Roth IRAs in 2016 can reconvert back into a traditional IRA by year-end 2016 and avoid any 2016 income recognition. A follow up conversion, however, would then generally not be permitted for at least 30 days.
The following deduction acceleration techniques, among others, might also be considered:
Bunch itemized deductions into 2016. This traditional technique designed to maximize both itemized deductions and the standard deduction may have even greater benefits since Trump has proposed a significant increase in the standard deduction to $15,000 for single taxpayers and $30,000 for joint filers. In addition, it may be more difficult for higher-income taxpayers to claim itemized deductions under a Trump proposal that would impose a dollar cap itemized deductions.
Don’t delay deductible payments until 2017. Paying medical bills (and accelerating elective medical treatment), making charitable contributions, paying the last state estimated tax installment, are among time-tested techniques now elevated in importance to maximize itemized deductions. Taxpayers can write a check or can charge an item by credit card and treat these actions as payments.