I hope everyone had a nice holiday and is looking forward to their New Year’s parties in just a few more days. Before that ball drops on Times Square and the confetti rains down, there is one last possibility for some federal tax savings on the 2017 return that I’ve already received a lot of calls and emails about.
One of the changes to federal tax deductions that was solidified into the Tax Cuts and Jobs Act of 2017, signed on December 20 and effective for your 2018 return, is a limitation on the total amount of state income and local property taxes that can be deducted on your Schedule A, Itemized Deductions. No more than $ 10,000 in total state income and local property taxes will be deductible for those who itemize their deductions on their federal returns. Just about all my clientele that file a Schedule A to itemize their deductions on the federal return will “max out” on the amount of state income and local property taxes they can deduct in 2018 and going forward. As a result, there have been a lot of questions over whether these state income and local property taxes normally due in 2018 could be paid early in 2017 to take advantage of an extra deduction on the 2017 return that will likely not be available on the 2018 return.
First, the answer to the question about prepayment of 2018 state income taxes is a definite no. The law Congress passed specifically addresses that issue and has stated that you cannot deduct any prepaid 2018 state income taxes on your 2017 federal return. But Congress did not address the issue of whether prepaid 2018 property taxes could be deducted on the 2017 federal return, so it is ultimately up to the Executive agency that enforces the law to determine the answer to that question. Naturally, after the law was passed on December 20, the IRS was deluged with questions on this issue by practitioners and individual taxpayers alike. Many people have chosen to prepay their 2018 property taxes already, in hopes that the IRS would permit it, either by officially addressing it or remaining silent on the topic. Just yesterday, the IRS issued directive IR-2017-210, which states, with a couple of caveats, that this will be permitted. But between the guidance issued by the IRS and other existing regulations that already determine your taxable income on your return, there are some points you need to consider before writing that extra check for any 2018 property taxes.
First, if your total itemized deductions – for most people, that’s mortgage interest, charitable donations, state income taxes and local property taxes (both 2017 and 2018 prepaid taxes) – are less than the standard deduction ($ 6350 for individuals, $ 12,700 for married couples), then there will be no advantage to prepaying your 2018 property taxes. This is a most common situation with my retired clients who own their typically smaller homes free and clear with a senior citizen reduction on the normal property tax assessments, and whose retirement incomes are often taxed at lower state rates.
Second, the IRS directive states that property taxes for 2018 must be formally assessed on the property owners in order to deduct them. Typically, municipalities set their tax rolls on mid-year cycle that starts in July and ends in June. One half of the property taxes are being assessed either six months ahead or six months behind. So if a municipality has set their tax rolls starting in July 1, 2017 and ending June 30, 2018, you may pay those taxes that cover the period ending June 30, 2018. But if a municipality hasn’t yet set any portion of its tax rolls for 2018 during the 2017 tax year, i.e. works on a cycle going from January 1 to December 31, 2017, you will not be able to deduct any portion of prepaid property taxes. Simply sending in a payment in speculation to cover all or part of your 2018 property taxes and having it credited later will not result in an extra deduction on the 2017 tax return. Your town clerk’s office can tell you whether or not property tax rolls have been set for any part of 2018 yet.
Finally, if you typically pay the Alternative Minimum Tax (AMT) on your return, property tax deductions are disallowed. Estimates vary and change from year to year, but about 60% of AMT taxpayers are in the $ 200,000 to $ 500,000 total income range, with smaller shares of taxpayers below and above this range also paying the AMT. If you normally pay the AMT and you don’t expect your income to change radically from 2017 to 2018, then there will be no benefit to prepaying local property taxes in before December 31, 2017.
If you’ve managed to clear all three of these hurdles and are all set to make an extra property tax payment before the new year, remember one more thing. Most people pay property tax on a monthly basis with their mortgage, which the bank then puts into an escrow and then makes a quarterly property tax payment for you. You need to contact your bank and inform them about the extra property tax you paid as soon as possible so they are not collecting too much from you during the year and over-funding the escrow account. Then you’ll need to call the bank at some point mid-year and request them to increase your mortgage payment again so the escrow will build up sufficient funds to make the property tax payments for later in the year. I predict a lot of problems with this, as banks will be sending extra bills toward the end of the year to people who forgot to call them, in order to sufficiently fund the escrow account and pay the final property tax payments of the year.
Our tax code is changing dramatically for 2018, and just like any other tax law changes, some taxpayers will benefit while others will pay more, but I have not seen as many people affected as I have with other tax law changes. This is one last chance to squeeze a benefit out of the old 2017 tax law rules. Have a Happy New Year!