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Practice Management

The uncertain tax and legislative environment means that year-end tax planning is more important than usual. To help clients and businesses prepare for filing season, here are helpful tips.

This Practice Management article is intended for financial advisors only (registered representatives of broker/dealers or associated persons of Registered Investment Advisors).
 

An uncertain tax and legislative environment means that year-end tax planning is more important than usual. The possibility of major tax reform opens up powerful planning opportunities that can save clients on taxes if completed before year’s end.

“The potential for tax reform makes year-end tax planning more important than ever for individuals and public and private companies,” says Dustin Stamper, director in Grant Thornton’s Washington National Tax Office. “Tax filers should look for ways to accelerate deductions into 2017 while rates are high, and defer income into future years when rates might be lower.” He also stressed that the potential to lose deductions or tax incentives as part of tax reform also should factor into year-end planning. “It’s important to remember that good tax planning goes beyond what has happened. You also have to account for what may happen in the months to come.”

To help individuals and businesses prepare for filing season, Grant Thornton LLP has released a collection of Year-End Tax Guides for 2017. What follows are nine of the most important tips when guiding clients.

1. Take a closer look at state residency status.
For individuals who split their time in two different states throughout the year, now is an excellent time to consider where they may be taxed as a resident for 2017. To make it more likely that the high-tax jurisdiction will respect the move and not continue to tax them as a resident, they should track the number of days they are spending in each jurisdiction. Generally, if they reside in a state for 183 days or more, that state will assert residency and the ability to tax all of their income. Furthermore, if they move to a new state, but maintain significant contacts with the old state (including driver’s license, residences, bank accounts and the like), they could run the risk of being taxed as a resident in the old state.

2. Use itemized deductions before they’re gone.
Tax reform threatens many itemized deductions, including the deductions for state and local taxes and medical expenses. If possible, taxpayers should consider paying expenses now while they can still use the deduction. They can often prepay 2017 state taxes even if they aren’t due until next year. Taxpayers also can often control the timing of costly non-urgent medical procedures. But remember that some expenses can’t be deducted unless they exceed a certain percentage of the taxpayer's adjusted gross income. Medical expenses generally can’t be deducted unless they exceed 10% of adjusted gross income (7.5% for taxpayers age 65 and older).

3. Tread carefully with estate planning.
Normally, taxpayers want to make sure they don’t waste their annual gift exclusion of $14,000. This means making gifts to heirs before the year ends. The possibility of estate-tax repeal makes planning a little more complicated this year. It still makes sense for taxpayers to use their exclusion amounts because the estate tax may not be repealed after all, and there is no tax cost to using the exclusion even if it is. But taxpayers may want to avoid using giving strategies that actually involve paying gift tax until after the legislative outlook is resolved.

4. Make up a tax shortfall with increased withholding.
Don’t forget that taxes are due throughout the year. Taxpayers should check their withholding and estimated tax payments now while they have time to fix a problem. If they’re in danger of an underpayment penalty, they should try to make up the shortfall by increasing withholding on their salary or bonuses. A bigger estimated tax payment can leave them exposed to penalties for previous quarters, while withholding is considered to have been paid ratably throughout the year.

5. Leverage state and local sales tax deduction.
If a taxpayer is deducting state and local taxes, he or she needs to remember that they can elect to deduct state and local sales tax instead of state income taxes. This is valuable if they live in a state without an income tax, but it also can provide a bigger deduction in other states if they made big purchases subject to sales tax (e.g., car, boat, home, or all three). The IRS has a table allowing them to claim a standard sales tax deduction so they don’t have to save all of their receipts during the year. This table is based on their income, family size, and the local sales tax rate, and they can add the tax from large purchases on top of the standard amount. If they already know they will make this election for 2017, they should consider making any planned large purchases before the end of the year, in case the election is unavailable or doesn’t make sense next year.

6. Accelerate deductions and defer income.
Deferring tax is usually a good strategy, simply for the time value of money. This year, it’s even more important. Taxpayers want to use deductions now while rates are higher and defer income into future years when rates might be lower. There are plenty of income items and expenses they may be able to control. They should consider deferring bonuses, consulting income, or self-employment income. On the deduction side, they may be able to accelerate state and local income taxes, interest payments, and real estate taxes.

7. Leverage retirement account tax savings.
It’s not too late to increase contributions to a retirement account. Traditional retirement accounts like a 401(k) or individual retirement accounts still offer some of the best tax savings. Contributions reduce taxable income at the time that they are made, and taxpayers don’t pay taxes until they take the money out at retirement. The 2017 contribution limits are $18,000 for a 401(k) and $5,500 for an IRA (not including catch-up contributions for those 50 years of age and older).

8. Document key business activities.
Taxpayers may not need to pay a 3.8% Medicare tax on their business income if they participate enough in the business so that they are not considered a “passive investor.” Participation is defined as any work performed in a business as an owner, manager, or employee, as long as it is not an investor activity. Even so, they must document their activities, and the IRS will not let them make ballpark estimates after the fact. Make sure they document the hours they're spending with calendar and appointment books, e-mails, and narrative summaries.

9. Consider charitable deductions now.
The charitable deduction deserves special consideration, because taxpayers have complete control over its timing. Lawmakers have promised to retain it as part of proposed tax reform, but they could still apply limits. Even if it remains untouched, it might not be valuable next year for many taxpayers. Lawmakers are proposing to double the standard deduction, meaning fewer taxpayers will itemize deductions in the future. If they don’t itemize deductions, they can’t deduct charitable gifts. They should consider accelerating gifts into this year. Also, the deduction may be more valuable against today’s higher rates; however, they must be careful, because there are adjusted gross income limits on deductions.

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