With passage of the new tax reform bill, a number of tried-and-true year-end tax planning strategies have suddenly taken on added significance. Due to the change in the law as we enter 2018, many filers are looking for opportunities to defer income until next year to take advantage of the lower 2018 tax rates, while accelerating 2017 deductions to save more taxes based on this year’s higher rates.
One standard approach has always been to consider paying deductible tax obligations early. This year, some taxpayers may even be considering prepaying much of their estimated 2018 state and local tax obligations – both income and property taxes – by December 31, given the impending significant reduction in the ability to deduct all of those taxes in the future under the new rule’s $10,000 limitation. Unfortunately, this tactic may not work.
The strategy to openly prepay projected 2018 state and local income tax liabilities by the end of 2017 will likely be disallowed, since the new bill contains terminology under Section 164(b)(6) that provides for “Limitations on Individual Deductions for Taxable Years 2018 through 2025.” The language requires that an income tax paid for “an amount paid in a taxable year beginning before January 1, 2018, with respect to a State or local income tax” (emphasis added) “imposed for a taxable year beginning after December 31, 2017, shall be treated as paid on the last day of the taxable year for which such tax is so imposed.” In effect, it means that a tax paid for 2018, regardless if it was paid in 2017, will be treated under the tax law as if it was paid on December 31, 2018.
There has always been guidance indicating that prepayments of income taxes must be based upon reasonable estimates. Further, deductions of prepaid real estate taxes have been disallowed in the year paid in those instances when a cash basis taxpayer failed to establish that the prepayment represented an actual assessed tax obligation rather than an estimate of a future obligation.
So what can be done now? The law still allows reasonable estimates of 2017 state and local income taxes based upon projected liabilities to be deductible in 2017 if paid by December 31, 2017. As for real estate taxes, it’s best to review property tax rules for the local jurisdiction to determine if a tax that’s been assessed or levied in 2017, but is not yet due, could be paid by December 31.
Clearly, payment of certain tax obligations by December 31 to obtain a current-year deduction is still a viable strategy. Individual facts and circumstances coupled with appropriate supporting documentation may be necessary to uphold those deductions if challenged.
Please do not hesitate to contact Schneider Downs if you have any questions.