It May Not Be a Good Idea to Prepay Your State Taxes This Week, But Maybe You Should Increase Your Giving
Congressional leaders and Donald Trump haven’t told you about this, but under the new tax law you may be in for a nasty surprise instead of some last chance tax savings on your property taxes. On the other hand, the charitably inclined have a chance to do good and save money if they act fast.
Residents of high tax states like New York, New Jersey and California who plan to prepay their 2018 property taxes should be careful.
The new tax bill limits SALT—state and local tax deductions—to $10,000 per year for a married couple, half that for singles starting in 2018. The law also denies tax savings for anyone who tries to prepay their 2018 state or local income tax.
However, people can prepay their 2018 property tax and deduct it in 2017 if they get their payments postmarked in time this year (more on that below). Some local officials are rushing to make tax bills available online this year so people can pay their property tax in advance and deduct it on their 2017 income tax returns.
The problem is that prepaying any or all of your next year’s property taxes may trigger the Alternative Minimum Tax or AMT.
If your extra payment makes you subject to AMT for 2017, then you lose all of your state or local tax deductions on your federal income tax return. Worse, you will also lose your personal exemptions and the standard deduction if you are subject to the 2017 AMT.
The AMT exemption amount is $84,500 for married couples ($54,300 for singles) and begins to phase out at $120,700 and runs to $498,900 ($84,500 to $337,900 for singles).
If you are in the phase-out zone, your marginal tax rate is 35%.
The complexity of this is such that you need to either consult the person who prepares your taxes, or, if you use software, do a test tax return.
On the plus side is an opportunity for the charitably inclined, especially renters and those who have paid off their mortgages.
If you itemize in 2017, then you can deduct charitable gifts. Next year a married couple will have a $24,000 standard deduction ($12,000 for singles). Since only $10,000 of SALT will be deductible you would need $14,000 more ($7,000 for singles) in deductions to equal the exemption amount. Miscellaneous deductions are eliminated starting in 2018, as we reported earlier.
For most people, the only way to itemize will be by deducting $10,000 in SALT and deducting $14,000 in mortgage interest. A $350,000 mortgage at 4% interest costs $14,000 in interest, which would exactly equal the standard deduction and provide no savings. If you owe $15,000 in interest your itemizing would save you the taxes on $1,000.
So, a smart move if you can swing it would be to give several years of gifts to charities this year when you can deduct the money on your 2017 income tax return.
If you would usually give $1,000 to charity this year, and you itemize, you save the taxes on $1,000 of income. If you give $5,000 covering 2017 through 2021, you will save five times as much on your taxes.
If you give $1,000 in each of the next four years you won’t get any tax savings unless you have SALT, mortgage interest and other deductions of more than $24,000.
If you give much more than this it would be smart this year to create or add to a donor-advised fund at your local community foundation. That way you get to deduct the gift this year and then distribute money to charities over future years.
My wife, who heads a community foundation, and I will do exactly that this week, donating money today for a 2017 tax deduction we would not get in 2018 because we don’t have a mortgage.
If you decide this week to send two or more years of gifts to charities you regularly support so you get the most tax benefits, be sure to tell the charities so they don’t think you are upping your annual gift and will be sending the same amount or more next year.