Good tax planning is something that happens year-round, with an eye on the future. But when there has been a political shift as major as the one represented by our recent national elections, taxpayers may find the idea of looking forward unusually daunting.
No one can know exactly what President-elect Donald Trump and Congress will do after Inauguration Day. Campaign promises do not always translate into policy, though given that the executive and legislative branches will both be in the hands of the Republican party, it is reasonable to expect less political gridlock than we have seen in recent years. Taxpayers and tax preparers would be wise to consider the potential for major changes in 2017 and beyond.
Potential Upcoming Tax Changes
Based on Trump’s campaign, his stated goals regarding tax policy are to simplify our current system and to reduce individual and corporate tax burdens. He has suggested a few methods for going about this, though of course it is Congress, rather than the president, who will actually decide on any changes to the tax code.
Trump’s plan would reduce the number of income tax brackets from seven to three, taxed at 12, 25 and 33 percent. If implemented, this proposal would either preserve or lower the rates for everyone but the very lowest bracket under our current system. His reforms mirror those proposed by House Republicans earlier in 2016, suggesting legislators may have an appetite for following this plan or a similar one in the near future.
Given the likelihood of lower tax on ordinary income, taxpayers may want to defer 2016 income to 2017 where possible. Even if tax reform is not Congress’ first priority, they could always make changes later in the year retroactive to the beginning of 2017. Similarly, taxpayers may wish to accelerate any plans for charitable giving, either of cash or appreciated stock, in order to take advantage of deductions while tax rates are still higher.
These plans to change the overall taxation structure would also lower taxes on investment income in some cases. While the long-term capital gains rates are not slated to change, as part of his pledge to scrap the Affordable Care Act, Trump has pledged to repeal the net investment income (NII) surtax, potentially eliminating the 3.8 percent tax for high-income taxpayers altogether. The president-elect also intends to adjust the way that Pease Limitations and Personal Exemptions Phaseouts apply. If he is successful, all of this will mean capital losses will be effectively worth less in the future than in 2016. Taxpayers may want to sell losing assets soon in order to capture the maximum benefit of the loss.
Estate planners have long advised clients to consider paying gift taxes in the present in order to reduce future estate taxes. This advice, however, is likely to fall by the wayside, as it seems probable that the estate tax’s days are numbered. In his campaign, Trump expressed enthusiasm for repealing transfer taxes outright, and replacing them with a tax on capital gains over $10 million on assets held until death and a ban on contributions of appreciated assets to private charities. Whether the estate tax is replaced with this, with something else or with nothing, it seems unlikely to remain in its present form. Taxpayers may find it prudent to hold off on major gifts designed to reduce estate tax obligations, at least until Congress makes up its mind.
Trump expressed a variety of other opinions on the campaign trail that may affect tax planning should Congress decide to take them up. These include eliminating the alternative minimum tax (AMT) for individual taxpayers; limiting itemized deductions; eliminating all personal exemptions, as well as the head-of-household filing status; and increasing the standard deduction. He has called on legislators to cut the corporate tax rate from 35 percent to 15 percent, including for “pass-through” income, which is currently taxed at the owners’ rate instead. Repeal of the Affordable Care Act, in whole or in part, is also bound to create a variety of tax consequences.
Additionally, Trump has asked Congress to create Dependent Care Savings Accounts, which would allow for tax-favored saving to pay for the care of children and elderly dependents. He has said individuals should be able to deduct childcare and elder care expenses and that lawmakers should create incentives for businesses to provide on-site childcare. Trump has also encouraged Congress to create tax incentives to favor infrastructure investment.
The details of such programs, if they come to pass, remain to be hashed out by lawmakers. As with any incoming administration, taxpayers cannot assume any promised change will happen right away, or at all, in the form it was first described. In our current situation, though, the downside risk of assuming individual tax rates will drop or that transfer taxes will decrease or disappear is minimal.
There is always the potential for lame-duck legislation, though it seems unlikely to include any massive tax changes this time around. We may see the outgoing Congress renew a few expiring tax extenders, especially the popular above-the-line deduction for tuition and education fees that is slated to expire at the end of 2016. But taxpayers will mainly need to wait and see what next year brings.
Changes From 2016
While the recent election results will obviously shape tax planning for years to come, taxpayers should not forget some notable tax changes that took effect in 2016.
For instance, amid the uncertainty of upcoming tax reform, it is worth remembering that the Protecting Americans from Tax Hikes (PATH) Act passed in December 2015. The PATH Act made permanent a variety of temporary tax benefits, including the election to deduct state and local sales taxes, a variety of education-related incentives and the American opportunity tax credit. Notably, it also made permanent a provision that allows taxpayers age 70 1/2 or older to make tax-free charitable distributions directly from an IRA, lowering their adjusted gross income (AGI) in the process. Though many of these benefits have been around for some years, 2016 was the first year that taxpayers could take advantage of the certainty they will be available in the future.
Unmarried couples who jointly own property also won a victory when the Internal Revenue Service acquiesced to an appeals court decision in the case of a California couple who each deducted interest on $1.1 million of mortgage debt secured by a property they jointly owned. Now cohabiting couples who own their home, whether domestic partners or simply long-term roommates, will not run the risk that the IRS will argue that they are effectively married for purposes of the limits on mortgage debt deduction.
The IRS also instituted a mechanism to help taxpayers who inadvertently miss the 60-day window to roll over retirement account assets. Taxpayers who miss the window for one of 11 fairly wide-ranging reasons, including misplaced checks or family bereavement, will be able to submit a form letter to the retirement account custodian explaining the delay. This will keep many taxpayers from paying significant costs associated with what is often a “foot fault,” one that Congress clearly did not mean to wipe out retirement savings for the average taxpayer.
One potential upcoming change could have a big impact or very little, depending on whether gift and estate taxes go away: the new regulations relating to family limited partnerships and family limited liability companies. The proposed regulations, which were slated for enactment in early 2017, would limit the use of valuation discounts on interests in such entities for the purpose of transfer taxes. The rules may be scrapped by the new administration or, if the estate tax is repealed, they may simply become irrelevant. Those who hold interests in family entities should pay attention to the state of this rule for the time being.
While tax planning involves keeping an eye on the future, that does not mean it requires clairvoyance. The basic principles of good tax planning, such as keeping good records, taking maximum advantage of deductions to which you are entitled and considering the timing of income you can accelerate or delay, will always remain relevant, regardless of who occupies the Capitol or the White House.
Big changes are probably coming. But that does not mean most taxpayers will need to make radical changes of their own.