Tax reform is finally done, and Congressional Republicans and the White House are happy to have turned their new tax legislation into a final law. With the measure, a host of new tax rates will take effect in 2018, along with changes to credits, deductions, and other tax provisions in existing law.
However, 2017 isn't over yet, and smart taxpayers are trying to take advantage of whatever benefits they can before they disappear. For many taxpayers in high-tax states, the $10,000 limitation for deductions for state and local property, income, and sales taxes will represent a substantial tax cost in 2018 and beyond. Prepaying such taxes before the end of the year is a smart move, but only if you understand what you can and can't prepay. Below, you'll find a guide to help you with your tax planning.
Property tax strategies
Many jurisdictions charge property taxes in multiple installments, with payment due dates often straddling two calendar years. For instance, where I live, half of the year's property tax is due at the beginning of November, with the rest due in May of the following year.
One common strategy that many homeowners used even before tax reform discussions began was to prepay their second-half property tax payment in the same calendar year that they made their first payment. By doing so, taxpayers could boost one year's tax payments while reducing the next, and that sometimes allowed them to itemize in one year and then take a standard deduction the next to produce overall long-term tax savings.
This strategy looks like it's still available under tax reform, with no mention prohibiting such tax prepayments. What's likely not deductible, however, is trying to make property tax payments for the 2018 tax year that haven't even been determined or billed yet. One complication is that many homeowners have property taxes paid out of escrow, so you might have to coordinate with your mortgage servicing company to arrange for early payment of taxes.
Strategies for income taxes
Congress anticipated that some taxpayers affected by the tax reform limitations would seek to prepay as much of their future tax liability as possible. They therefore explicitly included in the tax reform legislation provisions that prohibit you from prepaying 2018 state and local income taxes during 2017 and claiming them as an itemized deduction this year.
To be clear, though, the measure refers to taxes for the 2018 tax year. That means that you can still make payments toward your 2017 taxes that would otherwise be due in 2018 and deduct them on your federal tax return. Examples include prepaying fourth-quarter estimated state income tax payments that you'd typically wait to pay in mid-January, as well as any tax you expect to owe when you file your tax return in April.
Strategies for sales taxes
Relatively few people claim the sales tax deduction. The state income tax deduction tends to be higher, and current law forces you to pick one or the other, not both. Moreover, for those in states without an income tax, the vast majority of taxpayers use a calculated formula provided by the IRS to determine their deduction rather than actually tracking their spending throughout the year.
The only way to boost sales tax-related deductions in 2017 is to buy goods and services subject to the tax earlier than you otherwise would have. That could potentially make a sizable impact if you need to make high-priced purchases like a motor vehicle. For most people, focusing on the other types of state and local tax makes more sense.
One last caveat
Finally, before you use any of these strategies, make sure to check whether you'll be subject to the alternative minimum tax in 2017. State and local taxes are already disallowed under the AMT, so even if making early payments would reduce your regular tax, your AMT liability might rise to offset that savings.
Most taxpayers can still potentially benefit from looking at prepaying their state and local taxes. By focusing on the biggest-ticket items, you can make the most of the last year you'll be able to claim an unlimited deduction and possibly find tax savings that you'd otherwise have missed out on.