Originally published by Michael Cohen.
Although potential tax reform laws are far from settled, taxpayers could consider certain actions now to maximize tax savings including the following:
- Establish a business entity (if the business owner’s income tax rate is greater than the proposed rate) that the income or losses flow through to the individual at the proposed tax rate of 15% instead of individual’s higher tax rate. The highest current income tax rate is presently 39.6%. Small family businesses, law firms, accounting firms, etc. often operate either as a S corporation or as a limited liability company (LLC) to give some creditor protection and privacy while being taxed at the individual tax rate. If businesses are taxed at a lower rate (15%) to encourage more jobs and economic growth (a “trickle down), it might behoove small business owners to incorporate as a LLC or S corporation now since the final rules may say that this benefit will only be permitted to businesses incorporated, etc. at the time the law is passed.
- Estate planning if favorable capital gains tax law benefits are reduced or eliminated. Although this author finds it hard to believe that there would be an elimination of the step-up in basis rules (which permits no tax on appreciated assets from the date of acquisition to the date of death), some taxpayers may be less inclined to hold property until death if the “step-up” is eliminated. As an example of the step-up in basis rules, if a taxpayer bought real estate or stock for $50,000 which was held until death when it had a value of $300,000 and if the heirs subsequently sold the property for $325,000, then the capital gains taxes would be the heir’s capital gains tax rate (generally 15% -20%) on the $25,000 increase in value from the date of death to the date of sale. There is no capital gains tax on the “step-up” from $50,000 to $300,000. The elimination of the “step-up” seems far-fetched to this author since it would be an accounting nightmare, if not impossible, to determine the original purchase price or cost of an asset purchased by a parent or grandparent decades earlier. Therefore, although some might be more inclined to sell appreciated assets prior to death due to this proposal, it is the author’s opinion that this would certainly be premature if the asset could be held until death.
- Deferral of income until next year could be considered since there is a proposal to reduce the income tax brackets and the income tax rates would be lower. Furthermore, it has been proposed to eliminate the present 3.8% surtax on net investment income.
- Accelerate charitable gifts to year 2017 since the standard reduction may be doubled reducing the amount of taxpayers to itemize their deductions. So, if a taxpayer thinks that they would only use the proposed higher standard deduction and not itemize as a result thereof, then such taxpayer should consider accelerating their charitable gifts into year 2017 to take advantage of the present permissible itemized charitable deduction rules.
- Contribute to your 401(k) (if you are an employee that allows a participatory match) in 2017 since the tax deduction presently given to employees may be eliminated to offset other tax cuts. Another possibility is capping the maximum 401(k) contributions so that employees won’t take advantage of future deductions or tax deferral. Unless there are cuts in spending or there is additional tax revenue, tax cuts will not be able to be made.
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