2017 Tax Planning Opportunities

2017 Year-End Tax Planning Opportunities

Tax Reform Uncertainty

Norm Miller, Senior Wealth Counselor

The end of the year is fast approaching and it will be filled with holiday celebrations with family and friends. Time will be a valuable commodity at year-end, but this is also the time to address the important elements of year-end tax planning. Most of the planning ideas are constrained by December 31, so it is imperative to start now before the holidays take over.

Proposed Tax Reform Legislation

The U.S House of Representatives passed H.R. 1 (the Tax Cuts and Job Acts) on November 16. The Senate also introduced its version of tax reform in early November and further complicated the process by adding repeal of the Affordable Care Act’s individual mandate. Highlights of the proposed legislation include:

Individual

  • Reduction of tax brackets
  • Increases standard deduction and repeals personal exemption
  • Sets maximum tax rate at 25% for flow-through income (S-corp, LLC, etc., this only applies to a portion of the income [30 percent], and currently does not apply to professional service businesses)
  • Repeals many itemized deductions (medical, state income tax, personal property tax)
  • Limits mortgage interest deduction to mortgages up to $500,000 (currently $1,000,000)
  • Eliminates the high-cost, basis tax law closing method, and makes first-in first-out (FIFO) the only closing method
  • Repeals the Alternative Minimum Tax (AMT)
  • Repeals Roth Characterization strategy
  • Repeals the estate and generation-skipping transfer taxes in six years

 

Business

  • Reduces corporate tax rate from a maximum of 35% to 20%
  • Limits the deductibility of net interest expenses to 30% of the business’ adjusted taxable income
  • Repeals the work opportunity tax credit

 

Versant Capital Management is closely monitoring the developments of this potential tax legislation. At this point, there is nothing that we would recommend from a planning perspective, as there is uncertainty of passage and content changes. Versant will issue a timely communication once (and if) a tax bill is passed.

Charitable Gifting of Low-Basis Securities

If you have planned charitable gifting before year-end, the most tax-efficient technique is to gift low basis securities. For example, say you hold $25,000 of an ETF (exchange-traded fund) that has a cost basis of $10,000. Your gifting intention is to donate $10,000 to the charity of your choice. You can gift with cash (after-tax dollars or sell the ETF to raise the cash) and get an itemized deduction, where you may save 35% on your tax liability, depending on your marginal tax bracket. So, the net cost to you is $6,500.

If you instead gift $10,000 of shares of your ETF directly to charity, there is no tax consequence to you since charities do not pay income tax. You will then get an itemized deduction (as long as the ETF position was held for more than one year), that yields the same itemized deduction as cash. But you’ve now removed the embedded long-term capital gains. In our example, the realized gains would be $6,000 and the tax liability would be in the $900 to $1,200 range. This tax is completely eliminated with the gifting strategy. One could even take the $10,000 cash not used in making the donation and buy $10,000 of the same ETF thereby increasing the cost basis.

NOTE: Schwab has an internal deadline of gifting ETF securities by December 16.

Qualified Charitable Distributions (aka Charitable IRA Rollover)

Once you hit age 70½, a taxpayer must make required minimum distributions (RMDs) out of their IRAs (and other retirement plans). The RMD in your first year is just under 4% of the market value of the account at the end of the prior year. Distributions are, of course, taxed at ordinary income tax rates. The taxpayer can instead make a Qualified Charitable Distribution (QCD) by raising cash in the IRA (a non-taxable event) and have the custodian cut a check made payable to the charity. The check is mailed to the account owner who then forwards onto the charity.

Thus, two birds killed with one stone. The RMD is satisfied and the distribution is not taxed. This works well if you do not need the cash. The QCDs are simply reported as a non-taxable distribution on the income tax return. This is not as tax-efficient as gifting of low basis securities but is does meet multiple criteria.

Harvest Capital Losses (or Gains)

Versant continuously monitors opportunities to harvest losses. Tax loss harvesting is the strategy of selling securities at an unrealized loss position and substitute with a similar security to maintain proper market exposure. This loss can be used to offset future gains in the portfolio.

Conversely, taxpayers in the lowest tax brackets should consider harvesting capital gains. The long-term capital gains rate for the 10% and 15% ordinary income tax brackets is 0%. This strategy is to sell a security with embedded gains, incur no tax liability, and repurchase the same security, which effectively resets the cost basis for that security.

Paying Estimated Taxes from IRA RMD

Some taxpayers do not like having to remember to pay quarterly taxes. A lesser known tax strategy is to have all of the RMD go to federal and state estimated taxes at year-end. The federal government deems this payment as if it was made throughout the year. So, if ones RMD is approximately your estimated tax payments you could get extra deferral in your portfolio and not make your quarterly tax payment until December. This won’t work for this year, but you could explore with your tax preparer and Versant advisor for next year.

Arizona Tax Credits

We wish to acknowledge CPA Tom Joynt for the following comprehensive section for our Arizona residents.

When to Make Contributions

Contributions should be generally made prior to December 31. For Arizona purposes, however, contributions can be made for a tax year through April 15 of the following year.

CAUTION: If you make a contribution from January 1 through April 15 to claim an Arizona tax credit for the prior year’s tax return, you will not qualify for a federal tax deduction until the following year.

For example, a contribution made to a qualifying charitable organization on March 1, 2018 can be claimed as a credit on a taxpayer’s 2017 Arizona tax return, but the deduction for federal purposes cannot be claimed until their 2018 Federal tax return is filed.

Qualifying Charitable Organizations Credit

Credit for cash contributions made to certain charities

  • Donation may also qualify as charitable contribution deduction on federal return
  • Maximum credit in 2017:
    • $400 for single taxpayers
    • $800 for married taxpayers filing a joint return
  • Credit can offset Arizona tax liability dollar for dollar but is not refundable
  • Unused credit can be carried forward 5 years
  • Contributions can be made from January 1 to April 15 of following calendar year
  • Tax form used to claim credit: Form 321

Click for 2017 qualifying charitable organizations.

Qualifying Foster Care Charitable Organizations Credit

Credit for cash contributions made to certain foster care charities

  • Donation may also qualify as charitable contribution deduction on federal return
  • Maximum credit in 2017:
    • $500 for single taxpayers
    • $1,000 for married taxpayers filing a joint return
  • Credit can offset Arizona tax liability dollar for dollar but is not refundable
  • Unused credit can be carried forward 5 years
  • Contributions can be made from January 1 to April 15 of following calendar year
  • Tax form used to claim credit: Form 352

Click for 2017 qualifying foster care charitable organizations.

Public Schools

Credit for cash donations made or fees contributed to public schools for extracurricular activities or character education programs

  • Donation may also qualify as charitable contribution deduction on federal return
  • Maximum credit in 2017:
    • $200 for single taxpayers
    • $400 for married taxpayers filing a joint return
  • Credit can offset Arizona tax liability dollar for dollar but is not refundable
  • Unused credit can be carried forward 5 years
  • Contributions can be made from January 1 to April 15 of following calendar year
  • Tax form used to claim credit: Form 322

Click for qualified public and charter schools.

Private School Tuition Organizations

Two credits available for contributions made to qualified Private School Tuition Organizations

First credit

Credit for cash donations to a Private School Tuition Program for scholarships to qualified private schools

  • Donation may also qualify as charitable contribution deduction on federal return
  • Maximum credit in 2017:
    • $546 for single taxpayers
    • $1,092 for married taxpayers filing a joint return
  • Credit can offset Arizona tax liability dollar for dollar but is not refundable
  • Unused credit can be carried forward 5 years
  • Contributions can be made from January 1 to April 15 of following calendar year
  • Tax form used to claim credit: Form 323

Click for a list of School Tuition Organizations certified to receive donations.

Second credit (Switcher Credit):

Credit for cash donations made to a Certified School Tuition Organization for scholarships to qualified private schools

  • Donation may also qualify as charitable contribution deduction on federal return
  • Maximum credit in 2017:
    • $543 for single taxpayers
    • $1,085 for married taxpayers filing a joint return
  • Credit can offset Arizona tax liability dollar for dollar but is not refundable
  • Unused credit can be carried forward 5 years
  • Contributions can be made from January 1 to April 15 of following calendar year
  • Tax form used to claim credit: Form 348

Click for a list of School Tuition Organizations certified to receive donations.

Note: First credit (claimed on Form 323) must be maxed out before any credit can be claimed under the second credit (claimed on Form 348).

For further information on both the Public Schools and the Private School Tuition Organizations credits please see Brochure #707.

There are many worthy charities seeking contributions. I would like suggest two that Versant supports. Liz Shabaker is Board President for Free Arts for Abused Children of Arizona, a non-profit organization that provides healing to abused and homeless children through artistic expression. Free Arts falls under the Qualifying Foster Care Charitable Organizations credit.

Norm Miller serves on the Board for Duet: Partners in Health and Aging, a non-profit that promotes health and well-being through a broad range of services to older adults who need one-on-one support. Duet falls under the Qualifying Charitable Organizations credit.

These are just a few examples of year-end tax planning strategies to consider. Your Versant team is here to assist in lowering your tax liability before the ball drops in Times Square on New Year’s Eve.

Disclosure: Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by Versant Capital Management, Inc.), or any non-investment related content, made reference to directly or indirectly in this newsletter will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this newsletter serves as the receipt of, or as a substitute for, personalized investment advice from Versant Capital Management, Inc. To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing. Versant Capital Management, Inc. is neither a law firm nor a certified public accounting firm and no portion of the newsletter content should be construed as legal or accounting advice. If you are a Versant Capital Management, Inc. client, please remember to contact Versant Capital Management, Inc., in writing, if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/evaluating/revising our previous recommendations and/or services. A copy of the Versant Capital Management, Inc.’s current written disclosure statement discussing our advisory services and fees is available upon request.