Like all elected politicians at all times everywhere, President-elect Trump has made sweeping promises that will be difficult to deliver in practice. Tax cuts ain't one of them. With both houses of Congress in the Republican slot, this item on his Christmas list should be an easy win.
Trump wants to lower our top marginal tax rate from the current 39.6% to 33%. Stepping back from the whiteboard, let’s tease out the trends in the big data:
39.6% = Higher
33% = Lower
Does it have implications for our tax planning today? You bet.
1) Defer income from 2016 to 2017
The usual gang of suspects here includes:
- Defer compensation and bonuses
- Postpone dividends from your C-corp
- Hang on to incentive stock options
- Use installment sales
- Pay 4th quarter state taxes in December 2016
- Prepay next-year’s property taxes in December 2016
The deep thinking here is that it is better to pay taxes at lower rates tomorrow than at higher rates today, while deductions have more value today when applied against higher rates than they will tomorrow when applied against lower rates.
2) Harvest capital gains losses
The oxymoron "capital gains losses" refers to selling losers where you paid more for a security than it is presently worth. Trump plans to lower our capital gains taxes. This has several parts: scrapping the Obamacare 3.8% Net Investment Income Tax for couples earning more than $250,000, and adjusting how the Pease Limitations and Personal Exemptions Phaseouts apply. If successful, your capitals gains tax losses are worth more under today's higher tax regime, which means you should harvest them now. The difference for high earners could be 4% - 5% (and more if you pay state income taxes). At least harvest enough to offset your capital gains this year (including year-end gains distributions from your mutual funds) plus $3,000 in losses to apply against ordinary income.
3) Accelerate charitable giving
Because 501(c)3 charitable donations are typically tax-deductible, high earners who itemize deductions will find that the dollar they fork over to charity in 2016 delivers a tax saving equal to their marginal rate, or 39.6 cents.
But what if you give that same dollar to charity in the post-Trump tax Woodstock of 2017? Your lower marginal rate means you will only receive 33 cents of tax relief for it.
Many high income earners also live in high tax states. In the worst case, the high bracket taxpayer in California can pay an all-in marginal tax rate of 52% today. We call that one the "widow maker." This means a dollar donated to charity saves 52 cents on taxes. We don’t know what the post-Trump all-in rate will be, but 42% might be an educated guess, which translates into a savings of 42 cents per charity dollar in Beverly Hills or Atherton.
P.S. While you are at it, don’t give cash to your charity. Donate appreciated stock instead.
Today’s high bracket investor pays 25% in capital gains taxes. That means if you paid $100 for stock that’s now worth $200, you save $25 by donating the stock straight to charity rather than selling it and giving them cash instead. In California you would save $33. Take off the rubber band, open the wallet, and let the moths out. Sell your losers (for the tax loss, #2 above), and donate your winners.
4) Avoid Dying in 2016
I heard some disgruntled Hillary supporters saying, "Kill me now!" in the wake of the election. This is not smart. Trump has promised to eliminate the death tax. If your expiration date is getting near, your heirs will thank you if you can possibly hold off until Jan. 1, 2017.
Beware of Darkness
One thing that we have discovered about predictions recently is that they don't always come true. Maybe the Republicans will drop the ball on taxes. In that case, the downside risk from these strategies seems minimal. But play it safe and be guided by your own tax advisors.
