Generate a Do-It-Yourself 2017 Tax Cut
Taxpayers can benefit by maximizing itemized deductions this year.
Alert: This year could be your last chance to itemize deductions on your federal income tax return. If you see itemizing as a pain, that might make you smile. If you view it as a way to slash your tax bill, you might panic. Either way, the possibility should intensify your efforts to make the most of year-end tax-saving maneuvers over the next few weeks.
The opportunity to save by itemizing is in jeopardy for millions of taxpayers because lawmakers are seriously considering doubling the standard deduction amounts as part of the effort to reform and simplify the nation’s tax laws. President Trump and leading Republican tax writers in Congress are all for it. This year, for example, a married couple gets a standard deduction of $12,700 on a joint return. Under the Republican plan, that would rise to $24,000.
Of course, there’s some sleight of hand in the figures. The scheme would also eliminate the two personal exemptions a couple now gets, cutting the apparent $11,300 boost to just $3,200. And, in the name of simplicity, the proposal would also ax the $1,250 add-on to the standard deduction awarded to each spouse age 65 or older. That reduces the advertised near-doubling of the standard deduction to an effective hike of just $700 (5.5%) for a married 65-plus couple.
Still, blending the breaks into an enhanced standard deduction fully strikes at the power of itemizing, because it only makes sense when the total of your qualifying expenses exceeds the standard deduction amount. According to one estimate, nearly 38 million of the 45 million taxpayers who now itemize would be better off with the higher standard deduction.
Beat the Clock
While the outcome of the tax-reform debate remains uncertain, it is certain that taxpayers can benefit by maximizing itemized deductions this year. Even if you’re still itemizing on your 2018 return, you’re almost sure to come out ahead by claiming write-offs sooner rather than later. (The one exception is if you wind up in a higher tax bracket next year, making write-offs more valuable, but that’s unlikely since Congress is also talking about cutting tax rates.)
Consider paying your January mortgage payment and any state income or local property tax bills due next January by December 31. That would lock in the interest and tax write-offs for 2017. This could be particularly important when it comes to tax bills, including fourth-quarter estimated state income tax payments, because there’s a major push to eliminate the right to deduct those expenses.
If you plan to buy a new car and are among the taxpayers who write off state sales tax rather than state income tax, making your purchase by New Year’s Eve will let you deduct the sales tax on your 2017 return.
If you’re in the 25% bracket, that effectively means Uncle Sam will pick up 25% of the tax. Tax on major purchases such as an automobile can be added to the deductible amounts the IRS approves for residents of different states at various income levels. (Prepaying tax bills won’t pay off if you are subject to the alternative minimum tax, though, since state and local tax deductions are among those denied by the AMT.)
Be Generous to Yourself, Too
President Trump and congressional leaders promise that the cherished opportunity to deduct charitable contributions will survive. But that won’t matter to you if you find yourself claiming the standard deduction in the future. More than ever before, then, you may want to speed up into 2017 contributions planned for next year or even further in the future.
Remember that gifting appreciated stock or mutual fund shares supercharges the benefit you receive. For property you have owned for more than a year, you can deduct the full market value on the date of the gift, and neither you nor the charity has to pay tax on the appreciation during the time you owned the asset.
Appreciated assets are a prime source for funding donor-advised funds through a brokerage firm, mutual fund company or community foundation. Cash and securities contributed before the end of the year can be deducted in full on your 2017 tax return, even if you don’t select the charities that will benefit from your generosity until well into the future. This is a way to pack many years’ worth of charitable contributions into an up-front tax deduction.
Taxpayers age 70½ and older can contribute up to $100,000 from an IRA directly to charity, a move that for years has given those who don’t itemize deductions a way to earn a tax benefit for their charitable gifts. Such direct contributions can count toward your required minimum distribution. But they are not reported as adjusted gross income, so they not only save on income taxes but can hold down the amount of your Social Security benefits that are taxed or limit the impact of high-income surcharges on Medicare premiums and the 3.8% Medicare tax on investment income.
0% Tax on Profits
Beyond beefing up write-offs, now’s the time to scour your investment portfolio for tax-saving jewels. One of the most valuable is the chance for investors in the 10% or 15% tax brackets to apply a 0% tax rate to long-term capital gains, which are profits from assets you have owned for more than a year. The key to exploiting this break is to get a firm estimate of what your taxable income will be for this year. If there’s room between that amount and the top of your 15% bracket, you can cash in some gains tax-free.
For 2017, the 15% bracket ends at $37,950 on an individual return and $75,900 for married couples filing a joint return. It’s important to note that the caps are on taxable income. The tax-free portion of Social Security doesn’t count, for example, and taxable income is after you subtract exemptions (worth $4,050 each this year) and either the standard deduction or your itemized deductions. A married couple, with each spouse age 65 or older, can still be in the 15% bracket if they have an adjusted gross income (before subtracting exemptions and deductions) of $99,200—or even more if they itemize deductions.
Let’s say a married couple’s taxable income for the year is likely to be $60,000. The $15,900 between that number and the top of the 15% bracket is your window for 0% gains. Look for paper gains on stocks or mutual fund investments and sell shares to realize the gains to take advantage of the 0% rule. This can pay off even if you don’t want to part with the securities. It’s perfectly legal to immediately buy them back. The transaction simply wipes out the federal tax bill on the appreciation. If you overshoot the top of the 15% bracket, any gain that falls in the 25% bracket will be taxed at 15%.
Although it might seem counterintuitive, there is a difference between tax-free income and income that’s taxed at 0%. The amount taxed at 0% still shows up in adjusted gross income, which could affect how much of your Social Security benefits are taxed. And if your state has an income tax, the profit might be clipped.
If you plan to take more money out of a retirement account than required by the minimum distribution rules, consider holding off if you can. For one thing, not adding the amount to your 2017 income could open the window wider for 0% capital gains. For another, it is increasingly likely that tax rates may fall next year, at least for most taxpayers. That would let you share less of your payout with Uncle Sam.