2017 Year-End Tax Planning Summary

An old Chinese curse provides “may you live in interesting times”.  Regardless of your political persuasion, most people would agree that the last 12 months have certainly been interesting. 

Few people expected Donald Trump to win the presidency and fewer expected the Republican party to take control of both the House and the Senate.  The President and Congress have encountered various challenges attempting to implement their policies during the past year, and now pressure in mounting on them to deliver on tax reform.

While both the House and the Senate have each passed a draft of tax legislation, there are still significant obstacles on the road to tax reform.  Whether a unified version of the tax reform passes and what provisions will be included in any final reform package are still questions to be answered.  Until we have been provided with additional clarity, we believe the best course of action is to continue to operate with the structure that is in place but to monitor the situation for developments.  If tax reform is enacted, we will follow-up with a detailed summary of the legislation.  In the interim, our message at year-end is much the same as it has been in prior years. 

Review Current Tax Situation

First, conduct a thorough assessment of your current tax situation, including a review of current year income and deductions (including capital gains and losses); an estimate of income and deductions for future years; a review of any carryover items (e.g., net operating loss or charitable contribution carryover); and identification of taxable items for which you can control the timing.

Once you have a full understanding of your current tax position, you will be able to make more informed decisions about what steps should be taken to minimize your tax exposure going forward. 

Defer Income

If you have the ability to do so, consider deferring some income until 2018.  You will reduce your 2017 tax liability.  Also, if tax reform is enacted, lower tax rates may be effective in 2018.  As a result, you may be able to not only defer the payment of taxes but also reduce your total tax liability.

Accelerate deductions

Each year, we discuss the possibility of accelerating certain itemized deductions.  This year, that advice is even more timely.  While we do not know what will happen with tax reform, both the House and the Senate tax proposals would eliminate many deductions.  Chief among the items that may be eliminated is the deduction for state and local income taxes.  4^th quarter estimated tax payments are due on January 15, 2018.  By making these 4^th quarter state estimated tax payments on or before December 31^st, taxpayers are allowed to claim the deduction on their 2017 tax returns.  By waiting to make these state tax payments until 2018, taxpayers run the risk of having the deductions disallowed altogether.

Review Capital Gains and Losses

The stock market has performed very well over the past year.  If you expect to recognize a capital gain this year, you should review your portfolio for possible capital losses that can be used to offset the gains. If you have any capital loss carryforwards, you should review your portfolio for capital gain opportunities to make use of such carryforwards. In general, net capital losses are deductible dollar-for-dollar against net capital gains. Excess losses are allowed to offset up to $3,000 ($1,500 for individuals filing married filing separate tax returns) of ordinary income per year. Losses over and above the limit may be carried forward indefinitely. 

Maximize Contributions to Retirement Accounts

Maximize contributions to tax-deferred retirement account, such as Individual Retirement Accounts or a company 401(k) plan.  The 401(k) contribution limit for 2017 is $18,000.  In addition, individuals who will be at least 50 years of age by the end of 2017 may make an additional “catch-up” contribution of $6,000.  The limit for contributions to IRA accounts for 2017 is $5,500.  Individuals who will be at least 50 years of age by the end of 2017 may make an additional “catch-up” contribution to their IRA account of $1,000. 

Self-employed individuals may consider establishing a simplified employee pension (SEP) plan.  By utilizing a SEP, self-employed individuals may be able to contribute up to $54,000 to a tax-deferred retirement account.  Further, contributions for 2017 need not be funded until the extended due date for filing the individual’s 2017 tax return.

If you have a high deductible health plan (“HDHP”), consider fully funding a health savings account (“HSA”).  For 2017, an individual with family coverage through a HDHP is allowed to contribute up to $6,750 to an HSA.  If the individual is age 55 or older, they are allowed to make an additional “catch-up” contribution of $1,000 to their HSA (for individual coverage under a HDHP, the contribution limit is $3,400 along with a “catch-up” contribution of $1,000 for individuals age 55 or older).

2018 Illinois Planning Opportunities

While we wait for additional guidance on tax reform at the federal level, there are opportunities you may begin to consider at the state level as we move into 2018. 

Illinois Invest in Kids Act

As part of the comprehensive education legislation enacted in August 2017, Illinois created a program to provide financial scholarships to low-income children to attend private and parochial schools.  Under the legislation, individuals would contribute funds to the program and would be able to designate the school(s) they would like to benefit.  Those funds would then be awarded to eligible students at the applicable schools to offset the cost of tuition and fees.  Donors would be allowed a credit of 75 cents for every dollar contributed to the program (i.e., a gift of $10,000 under the program would result in an Illinois tax credit of $7,500).  While donors are permitted to specify a particular school they would like to benefit, they are not permitted to designate a particular student to receive funds under the program.

Contributions under the plan are limited and individuals wishing to participate in the program will be required to apply with the Illinois Department of Revenue.  Applications will begin to be accepted on January 2, 2018.  It is anticipated that the credits available under this program will be quickly filled.  Individuals interested in the program should plan to apply on January 2, 2018.  Please contact their attorney at BWM&S for additional information.

Illinois Angel Investment Tax Credit

In August 2017, Illinois renewed its Angel Investment Tax Credit program.  Under the program (which previously expired at the end of 2016), individual investors are allowed a credit of 25% of funds invested in a qualified new business venture.  Generally, a qualified new business venture is defined to be a small business that is involved in innovation, employs fewer than 100 people, is headquartered in Illinois, has been in existence for fewer than 10 years and has the potential to create jobs or capital investments in Illinois.  Companies seeking recognition as a qualified new business venture must apply with the state.  Illinois is still drafting rules for the new program and additional guidance is expected in early 2018.  However, individuals considering an investment in an early stage innovation company should consider whether the business entity may qualify under the program and consider having the business apply for recognition under the program prior to completing an investment.

Estate & Gift Taxes

As is true with income taxes, we are in a holding pattern with estate and gift taxes.  While the House bill has proposed a termination of the estate tax (beginning in 2023), the Senate bill would keep the estate tax intact.  Both the House and the Senate propose to increase the exemption amount to approximately $11 million per person (or $22 million for a married couple).  However, there is still a great deal of uncertainty as to whether any significant change to the estate and gift tax will be enacted.  Again, we will follow-up with a detailed analysis of any gift and estate tax legislation that may be enacted.

Current Exemption Amount

For 2017, the estate and gift exemption amount is $5.49 million ($10.98 million for married couples).  The exemption amount is indexed for inflation and will increase in 2017 to $5.60 million ($11.20 million for married couples).  The top tax rate for estate and gift tax purposes has been set at 40%.

The generation-skipping transfer (“GST”) tax is still in place.  Generally, the tax applies to lifetime and death-time transfers to or for the benefit of grandchildren or more remote descendants.  For 2017, the rate is a flat 40 percent.  The tax is in addition to any gift or estate tax otherwise payable.  As with the gift and estate tax, each taxpayer is allowed a $5.49 million GST tax exemption for 2017. 

Consider Lifetime Gifts that take Advantage of both the Gift Tax Exemption and GST Exemption

Many clients utilize a portion or all of their $5.49 million gift tax exemption ($10.98 million for a married couple) by structuring long-term GST exempt trusts benefiting multiple generations.  Such trusts will remain exempt from all gift and estate tax as long as the trust remains in existence.  Under Illinois law, such trusts can last in perpetuity, thereby allowing you to create a family "endowment fund" for your children, grandchildren and future descendants. 

If you already have taken advantage of the current $5.49 million exemption amount or you are not in a position where it makes sense to gift a large amount, you should still continue a gifting strategy going forward. 

Annual Exclusion Gifts

In 2017, you may make a gift of $14,000 to any individual and certain trusts without any gift tax consequences.  Married individuals may make gifts of up to $28,000.  Gifts may be made outright or in trust and may be in the form of cash, securities, real estate, artwork, jewelry or other property.  Giving property that you expect to appreciate in the future is an excellent way of utilizing your annual exclusion gifts because any post-gift appreciation is no longer subject to gift or estate tax.  To take advantage of your annual exclusions for 2017, gifts must be made by December 31.  Gifts over $14,000 or gifts that will be “split” between spouses must be reported on a gift tax return, which must be filed in April 2018.  The annual exclusion amount will increase to $15,000 in 2018, $30,000 for married couples.

Payment of Tuition and Medical Expenses

In addition to annual exclusion gifts, you may pay tuition and medical expenses for the benefit of another person without incurring any gift or generation-skipping transfer ("GST") tax or using any of your estate or GST tax exemption.  These payments must be made directly to the educational institution or medical facility.  There is no dollar limit for these types of payments and you are not required to file a gift tax return to report the payments. 

Take Advantage of Today’s Low Interest Rates

Interest rates remain at historically low levels.  Low interest rates enhance the benefits of several gift and estate planning strategies.  One such strategy is the “grantor retained annuity trust” or GRAT.  A GRAT is an irrevocable trust to which a donor transfers property and retains the right to receive a fixed annuity for a specified term.  At the expiration of the term, the property usually passes outright or in trust for the benefit of descendants or other named beneficiaries.  The amount of the gift resulting from the transfer of the property to the GRAT is the present value of the remainder interest that passes to the beneficiaries at the end of the term.  Under the valuation methods adopted by the IRS, the lower the interest rate at the time of the gift, the lower the present value of the remainder interest and the smaller the amount of the gift that must be reported to the IRS.  Interests in closely held family businesses or marketable securities with high growth prospects are often ideal properties to transfer to a GRAT.  While there has been considerable discussion about disallowing “zeroed-out” GRAT’s and requiring a minimum GRAT term of 10 years, Congress has not taken any action in this respect.  As a result, GRAT’s remain a very attractive planning opportunity.

Low interest rates also make sales to “defective” grantor trusts more attractive.  Under this strategy, a taxpayer creates a trust, typically for his or her spouse and descendants.  The taxpayer then sells assets to the trust taking back a note requiring the trust to repay the taxpayer in installments.  The trust is structured so that it is ignored for income tax purposes, resulting in no income tax consequences upon the sale.  The interest paid on the note is typically at the applicable federal rate in effect at the time of the sale.  The lower the interest rate on the note, the greater the amount of assets that will accumulate in the trust free of estate, gift and GST taxes.

For more information, please contact Greg Winters at 312/840-7059 or gwinters@burkelaw.com.