Year end tax planning moves (preparing for massive tax law change)

As of today, it’s looking like the tax code will change drastically on Jan 1, representing the largest change to the tax code in 30 years.

A huge impact of the tax change is the reduction of the corporate income tax from 35% to 21%. While important to shareholders of firms (i.e. any investor), this change is not actionable for many of us. Small business owners, however, will have an interesting decision to make come Jan 1. It’s looking like the math is making C-Corps an attractive alternative to S-Corps and Sole Proprietorships going forward.

With that rant aside, there are several actionable steps that normal Joe Schmoes like you and me should consider doing by Dec 31. These changes are governed by most of us losing the ability to itemize. 30% of taxpayers itemize today. 5% will itemize going forward. And those that itemize will have incomes much higher than me. If you fall into my camp (itemize now, not in future), here’s what you should consider doing over the next 2 weeks:

  • Make accelerated charitable contribution payments by Dec 31.
    • Doing so will effectively give you a discount on your charitable contributions of (federal marginal tax rate + state marginal tax rate). For me, this represents a 40% discount on charitable contributions made by Jan 1.
    • If I donate $1 today, it ends up costing me $0.60. If I donate $1 on Jan 1, it ends up costing me $1.
    • If you want the tax deduction today but you want the ability to make distributions at a later date, utilize a Donor Advised Fund. Such funds allow you to get the full tax break today, invest the money in stocks/bonds, and distribute to charities at any time in the future. https://www.fidelitycharitable.org/
      • If you somehow made a fortune in Bitcoin, Fidelity accepts donations in Bitcoins. It would be a brilliant way of offloading your Bitcoin without realizing any tax penalty.
  • Prepay your 2017 property taxes (usually due mid 2018) by Jan 1.
    • The same logic from above applies.
    • Unfortunately if you pay AMT, this strategy will not work for you.
      • Why? If you hit AMT, you get zero benefit from property taxes anyway. Doubling your property taxes does nothing.

You can easily see how these actions will effect your 2017 taxes (paid in 2018) by playing around with TaxCaster or my spreadsheet (which got a new face lift a 2 days ago to work better with AMT).

If you have the cash, the above moves are absolute no brainers. Doing these simple moves will benefit you roughly $0.20-$0.40 per dollar spent. I can think of few instances in life where I get an immediate 40% return per dollar spent.

Going forward in 2018, the new tax law will change the calculus of prepaying my mortgage early. Why? My mortgage rate is 2.875%, but after considering taxes my effective interest rate paid goes to 1.73%. As of today I’ve been comfortable with the prospect of beating a 1.73% return with my own investments. Going forward, the new after-tax benchmark for me to beat in my investment accounts will be 2.875%.

 

Disclaimer: consult a tax professional before doing anything crazy. I’m just a spreadsheet monkey typing stuff into a computer. You’d have to be crazy to believe anything I say.

4 thoughts on “Year end tax planning moves (preparing for massive tax law change)

  1. Are you sure about the effect on the cost of your mortgage? A pretty healthy mortgage interest deduction is sticking around, right? For me, even though the standard deduction is higher, I still expect to break out of it (10k state tax + >14k charitable). Are you figuring that you are not going to get out of the standard deduction at all, or are you just accounting for a now lower emtr?

    • Going forward, your deductions will be min($10k, prop tax + state tax). For you and me we’ll both hit $10k easy.

      The remaining commonly itemized deductions are mortgage interest and charitable contributions. You only get an economic benefit to either if you exceed the remaining $14k to exceed the standard deduction. Most people won’t exceed this number, so it’s as if they have $0 deductions (renting, $0 charitable contributions, $0 mortgage interest, $0 prop taxes). The new code drastically moves away from favoring home ownership.

      Let’s say you and I max out the $10k for state + prop tax. Let’s say we pay $8k in charitable contributions every year and $8k in mortgage interest every year. The two of these sum $16k, which means all deductions sum to $26k now. For the first $14k of charitable contributions + mortgage interest we paid, we get $0 economic benefit. We only get $2k of incremental benefit. This can be framed two different ways: 1.) Only the last $2k of our mortgage interest we pay each year is tax deductible, or 2.) Only the last $2k of charitable contributions we pay each year is tax deductible.

      The reason to accelerate charitable contributions to this year is that 1.) EVERY dollar of charitable contributions is deductible, and 2.) your effective marginal rate on charitable contributions is likely higher this year. The two combined make it much more advantageous to donate this year. The Fidelity DAF is a great vehicle if you don’t want to dump multiple years of contributions into your charity’s lap right now.

      • Also, my effective federal rate with respect to charitable deductions is 32.5% now, but in the future it will be 24%, so in addition to the above reasons to accelerate donations I get a 8.5% discount for doing so now.

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