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November 13, 2017

Tax Planning In an Uncertain World

By Charles Rotblut, CFA, AAII

It is admittedly difficult to write a tax guide when tax rates are uncertain. It is even harder to make tax planning decisions when future tax rates are uncertain. Yet with just a little over seven weeks left in 2017, this is the world we live in.

As the horse trading is occurring in Washington, D.C., I am moving forward with publishing our annual Individual Investor’s Guide to Personal Tax Planning in the next month’s AAII Journal (the link goes to our 2016 guide which contains 2017 information). I do this while being fully cognizant of the possibility of a massive update being required. Postponing the guide risks waiting on legislation that may or may not pass and getting year-end 2017 information out after it’s too late to act upon the numbers. So, as an editor, I’m damned if I do and damned if I don’t.

Taxpayers—both individual and business entities—face the same conundrum: make plans based on current tax law, or wait to see what happens? The correct decision won’t be known until after the fact. We do have an idea of the possible outcomes, however. If no significant changes are made to the tax code, inflation-adjusted deductions, exemptions and credits subject to inflation adjustments will increase by an approximate average of 2% next year. If significant legislation is passed, it will likely reduce the headline tax rates and alter or eliminate many credits, exemptions and deductions. Based on this, there are some steps individuals can take now, without trying to place odds on what will or will not be the eventual outcome for tax legislation.

Capital gains distributions from a sizeable minority of mutual funds are skewing to the high side for this calendar year. According to CapGainsValet, 222 mutual funds so far have announced distributions exceeding 10% of their underlying net asset value. If you have losses you were planning to realize and you have capital gains that are either already realized or will be realized (from funds or other investments), it may make sense to use those losses to offset your gains in the current calendar year. (As of right now, the tax rates on long-term capital gains do not look like they will change, though the income bracket at which the 0% rate applies would be raised to $77,200 for married couples filing joint returns by the House bill.)

If you were intending to do or undo a Roth IRA conversion, you will want to watch how the current tax legislation progresses. Section 1501 of the November 6, 2017, version of the Tax Cuts and Jobs Act (TCJA) contains a section entitled, “Repeal of special rule permitting recharacterization of Roth IRA contributions as traditional IRA contributions.” Wolters Kluwer’s tax and accounting division (CCH) interprets the House bill as not only repealing the ability to undo a Roth IRA conversion, but also “the rule allowing conversion of a traditional IRA to a Roth IRA.” If you are considering making a Roth IRA conversion this year, make sure you run the numbers on whether or not doing so will unintentionally bump you into a higher tax bracket. If, on the other hand, you are considering undoing a Roth IRA conversion, the clock is ticking. Even if the current tax law remains in effect, you must make the recharacterization no later than the due date (including extensions) of when you must file the tax return for the year of the conversion.

It may make sense to accelerate charitable donations and medical expenses into this calendar year if possible. The increased standard deduction included in the House of Representatives’ proposed tax legislation may limit your ability to deduct charitable donations. The deduction for qualified medical deductions is also among the deductions eliminated by the pending House legislation. Right now, medical expenses in excess of 10% of your adjusted gross income are deductible.

Be aware of the possible change in the tax treatment of private activity bonds. The pending legislation repeals the tax-exempt treatment of the interest paid by these bonds. Under current law, the interest is tax-free except in cases where the taxpayer is subject to the alternative minimum taxes (AMT). (The AMT itself would be repealed by the pending House bill.)

Keep in mind the possibility of significant changes being made to tax legislation between now and whenever a “final” version comes up for a vote. (I wrote this week's commentary before the Senate’s version of the tax bill was released.) Nothing attracts special interest groups, lobbyists and donors like comprehensive tax legislation. As such, avoid making big changes you would not otherwise make based on what you think may or may not happen in Washington. The reality is that we simply do not know what the actual outcome of tax reform legislation will be.

The Week Ahead

The number of earnings reports will decline, but next week will still be an active week in terms of quarterly releases. The calendar lists 17 S&P 500 companies, including Dow Jones industrial average components Home Depot Inc. (HD) on Tuesday, Cisco Systems Inc. (CSCO) on Wednesday and Wal-Mart Stores Inc. (WMT) on Thursday.

The week’s first economic report will be the October Producer Price Index (PPI), released on Tuesday. Wednesday will feature the October Consumer Price Index (CPI), October retail sales, the November Empire State Manufacturing Survey and September business inventories. On Thursday, the November Philadelphia Fed Business Outlook Survey, October import and export prices, October industrial production and capacity utilization and the November housing market index will be released. October housing starts and building permits will be released on Friday.

Five Federal Reserve officials will make public appearances: Chicago president Charles Evans on Tuesday and Wednesday; St. Louis president James Bullard on Tuesday; Governor Lael Brainard, Cleveland president Loretta Mester and Dallas president Robert Kaplan on Thursday; and Governor Lael Brainard will speak again on Friday.

The Treasury Department will auction $11 billion of 10-year treasury inflation-indexed securities (TIPS) on Thursday.

About The Author - Charles Rotblut, CFA is the VP and Editor for American Association of Individual Investors (AAII). Charles is also the author of Better Good than Lucky. (EconMatters author archive here

The views and opinions expressed herein are the author's own, and do not necessarily reflect those of EconMatters.

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