I am glad that I am a retired CPA because year-end tax planning this year is especially tricky. Taxpayers won’t know if they employed the optimal tax planning strategies until after Congress passes tax legislation next year.
What makes this year especially difficult are the political uncertainties surrounding legislative changes to the tax laws. President Trump and congressional Republicans want to lower individual and corporate tax rates. It appears likely that some sort of rate reduction will be enacted.
However, there has been considerable debate as to what changes can be passed by a simple majority of senators and which changes will need an affirmative vote by 60 senators to become law.
To the extent 60 Senate votes are needed, the Democrats will have to go along with the Republican proposals for them to pass. Democrats are likely to require some changes of their own to get their vote.
Here’s what we know: Rates are likely to be lower next year. Thus conventional wisdom dictates that accelerating deductions and deferring income probably make the most sense. However, this year it is more complicated than that.
While rates overall are expected to decline, different types of income could be subject to tax at varying rates.
For example, investment income may be taxed at rates significantly lower than income derived from performing personal services. Employees may be taxed at higher rates than self-employed individuals.
Historically, whenever tax rates have been lowered, the base on which those taxes is applied has been expanded. This year, several base-broadening proposals have been made.
Some them will diminish or eliminate itemized deductions. Another proposal would eliminate the deductibility of interest expense. The Republicans have even considered the imposition of a 15 percent tax on the gross margin of businesses.
In other words, the profit on selling merchandise or performing services would be subject to a 15 percent tax in addition to the existing income tax.
Therefore, it is hard to say whether income should be deferred. Indeed, tax practitioners have expressed differing views about the benefits of deferring income.
Dealing with deductions is also equally perplexing. From what I read, many tax advisers suggest that taxpayers who itemize their deductions consider whether it is beneficial to accelerate charitable contributions and/or to prepay their January mortgage payment.
Whether it makes sense to prepay any other deductions is highly dependent on an individual taxpayer’s situation.
When I looked online to find year-end tax planning materials, most of what I found was written before the election and is somewhat dated inasmuch as the materials anticipate a Hillary Clinton presidency with potential Democratic control of the Senate.
Consequently, many taxpayers will find that, especially this year, it probably makes sense to discuss year-end tax planning with a tax professional who has up-to-date knowledge about the potential impact of proposed tax law changes.
Even then, any year-end steps recommended by tax professionals are, at best, an educated guess about optimal tax planning strategies.
Once we get into 2017, when the new Congress and administration are in place, we need to prepare for some massive changes to the workings of our tax system.
Historically, the Internal Revenue Code has been overhauled three times. The first was 1939, when the code was first created.
The second was 1954, when the code was restructured and modified to deal with a post-World War II economy.
The last was 1986, when rates were lowered, individual tax shelters were eliminated and many accounting methods were changed.
Each time it was revised, the Internal Revenue Code became more complex. Without computer technology, the Internal Revenue Code would be impossible to administer.
Donald Trump and the Congressional Republicans tell us that their tax proposals will be even more transformative than the previous overhauls. The rules are going to be complex and it is currently uncertain which taxpayers will benefit from the resulting disruption.
My guess is that the primary beneficiaries will be corporations and investors. If a gross margin tax is imposed on business, the impact will be similar to that of a value-added tax or VAT.
A VAT is a consumption tax imposed on goods and services that is similar to a sales tax except that it is embedded in the price of those goods and services.
The Republicans are careful not to call a gross margin tax a VAT because in other countries where a VAT has been imposed, the political party responsible for the tax was voted out of office. A VAT is generally an extremely regressive tax.
I hope that you have found this discussion enlightening. I am sure that I will write more on this topic in 2017 as the situation evolves.
Jim de Bree is a retired CPA who resides in Valencia.