This week, the Senate will consider tax reform in the wake of its passage in the House. Washington watchers of all stripes are showing legislative forecasting fatigue. Congress has been embroiled in debate on tax reform, the future of the Affordable Care Act and other topics. Little substantive legislation has been passed.
With tax reform set to be considered at least into December, we may be dealing with a new tax regime for a year that is almost complete. While there are usually some uncertainties when Congress considers an issue, our current political climate seems particularly inscrutable.
So what are tax planners to do? We need to be prepared to “adjust our income” to fit the enacted tax scheme. Our methods of adjusting taxable income do not involve any offshore corporate tax havens or conveniently forgotten cash transactions. There are legal, easily executed methods that can be used to manipulate your taxable income up or down. If tax rates head up (which seems unlikely) then be prepared to increase your income. If tax rates go down as predicted, take the reverse tack.
If the President signs a bill lowering your taxes for 2018, look at these ways to reduce your taxable income for this year:
We featured charitable donor-advised funds in previous columns. Offered by Schwab, Fidelity, and local community foundations, they allow you to donate cash (or, even better, appreciated investments) into a charitable fund under your control. You get the tax benefit for the donation right away, but you can determine the timing of when your favored charities will receive the funds. Give two or three years’ worth of donations to your fund in 2017 if you have the cash or investments to fund it.
If you have a business in which you are the only full-time employee, you can open up a so-called solo 401(k) plan. This includes a contracted software engineer and an Uber driver. Unlike their close cousins that cover multiple employers, solo 401(k) plans are cheap or free to administer. They allow you to deduct up to $18,000 a year, plus about 18 percent of your net profit up to a combined total $54,000 for 2017. If you’re 50 or older, you can kick in an extra $6,000.
So if you net $80,000 from your business in 2017 and are aged 55, you could deposit over $38,000 that reduces your taxable income. Even better, under many 401(k) plans, you don’t have to contribute until your tax filing date. This means you could decide to reduce your taxable income for 2017 well into next year. But you do need to open your 401(k) plan account by the end of the year for it to reduce this year’s income.
A smaller lever that some moderate- to lower-income earners can use — or those without a work retirement plan — is a traditional IRA contribution. You can put aside $5,500 ($6,500 for those at least 50 years old) for your spouse and yourself, subject to qualifications. The deadline for lowering your taxable income for 2017 with an IRA contribution is April 17, 2018. Again, you can lower your taxes for this year even though we will be over three months into next year.
Other options for lowering taxable income include prepaying state income tax and property tax in 2017 that are due next year, but these strategies will only work if you’re not paying the Alternative Minimum Tax. You could also sell investments in your taxable account in 2017 that have gone down in value, but most investors don’t have significant losses to “harvest.”
If you’re unlucky enough to face higher tax rates for 2018, the most straightforward method of increasing your taxable income for this year is a Roth conversion. Simply convert all or part of your traditional IRA into a Roth IRA by the end of the year. This will add directly to your taxable income, which may make sense to do this year if you’re taxes are headed up for next year. Anyone with a traditional IRA can do this, regardless of age, income or worker status.
The key with these strategies to raise or lower your taxable income is that you don’t want to carry them out until you know what will happen with tax rates. Be ready to set these plans in motion once a bill is signed and you’ll be far ahead of the rest of us in keeping your tax bill low.