State tax deduction

[Ds2660]

It seems like the state tax deduction from federal income tax will be gone in 2018, assuming the tax reform passes.  I'm thinking about paying extra state taxes this year before 12/31, deducting the full amount of state taxes paid on my federal return, and then on state taxes, applying my overpayment to 2018 taxes rather than receive a refund.  Then in 2018, I won't have state taxes withdrawn from my paycheck.  The goal would be to get the state tax deduction for 2017 and 2018 this year, as it will likely be gone next year.  Anyone think this won't work or is a bad idea?  Would probably make a 16k overpayment from an upcoming year end bonus.

I am in a small PP so very easy to deal with the accountant, make extra payments to state, etc.

[The White Coat Investor]

I'm doing it. I think this is the fourth thread I've seen on this topic though.

My only decision left at this point is whether to prepay 2019 and 2020 too. But I'll certainly be able to deduct 2016 (paid in April), 2017 (paid today) and 2018 (paid as soon as Trump signs the bill if I have enough time before the end of the year).

[jfoxcpacfp]

The White Coat Investor wrote:

My only decision left at this point is whether to prepay 2019 and 2020 too. But I’ll certainly be able to deduct 2016 (paid in April), 2017 (paid today) and 2018 (paid as soon as Trump signs the bill if I have enough time before the end of the year).

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You're aware they won't hold the money for 2 or 3 years for you, right? You'll get a refund in 2018 which will be taxable income. May work out ok, may not, but I wouldn't (personally) try to figure that out so far ahead of time unless you believe your taxable income will drop next year.

And you still risk throwing yourself into AMT this year, even though it's not showing on your tax software yet.

[jfoxcpacfp]

Ds2660 wrote:

It seems like the state tax deduction from federal income tax will be gone in 2018, assuming the tax reform passes.  I’m thinking about paying extra state taxes this year before 12/31, deducting the full amount of state taxes paid on my federal return, and then on state taxes, applying my overpayment to 2018 taxes rather than receive a refund.  Then in 2018, I won’t have state taxes withdrawn from my paycheck.  The goal would be to get the state tax deduction for 2017 and 2018 this year, as it will likely be gone next year.  Anyone think this won’t work or is a bad idea?  Would probably make a 16k overpayment from an upcoming year end bonus.

I am in a small PP so very easy to deal with the accountant, make extra payments to state, etc.

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Get your accountant to run a tax projection to see if AMT will change your plan. As I posted (on yet another thread   ), AMT is tripping up most of our physician clients when we run the projections. So you increase the deduction, then you get hit with AMT and it's a wash. Should take your tax preparer < 30 minutes to run the numbers for you.

[The White Coat Investor]

jfoxcpacfp wrote:

The White Coat Investor wrote:

My only decision left at this point is whether to prepay 2019 and 2020 too. But I’ll certainly be able to deduct 2016 (paid in April), 2017 (paid today) and 2018 (paid as soon as Trump signs the bill if I have enough time before the end of the year). 

Click to expand…

You’re aware they won’t hold the money for 2 or 3 years for you, right? You’ll get a refund in 2018 which will be taxable income. May work out ok, may not, but I wouldn’t (personally) try to figure that out so far ahead of time unless you believe your taxable income will drop next year.

And you still risk throwing yourself into AMT this year, even though it’s not showing on your tax software yet.

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I don't think either of those are true. The Utah state tax commission clearly told me that I could put a check toward my 2020 taxes. Why would they send that back to me as a refund in 2018?

I would love to be able to get my tax burden low enough to have to pay AMT, but I just don't see it happening. What's the highest income level you've seen someone get hit with the AMT at? But even if I did get hit by the AMT, no harm, no foul. All I lost was the interest on that money for a year or two. That's nothing compared to the potential tax deduction.

[jfoxcpacfp]

The overpayment is shown on a 1099G as income in the following year. At the same time, I suppose if you keep rolling it forward, that could work. I hate to admit it, but I think you have a point.

As for AMT, I'm trying to make the point for those who are not as, shall we say, "flush" with cash, that scrounging up money to throw at income taxes by 12/31 may not work out as they had expected. I know many readers try not to give the government a "free loan" but that would be the result. Just seems silly not to figure it out in advance, when it is so easy to do.

[SwanSong]

It looks like the compromised bill closes this loophole and will now allow prepayment of taxes for 2018 to be used in the 2017.  It's one of the few times you'll ever find me going through the New York Times, but here you go:

"In a pre-emptive move against accounting maneuvers in high-tax states such as New York and California, the bill prohibits taxpayers from prepaying next year’s state and local income or property taxes, in order to deduct them from 2018 taxes. That form of tax planning would have allowed taxpayers to benefit more from the full state and local deduction this year before it is capped next year."

https://www.nytimes.com/2017/12/15/us/politics/republican-tax-bill.html?hp&action=click&pgtype=Homepage&clickSource=story-heading&module=first-column-region&region=top-news&WT.nav=top-news

 

Though I think it should read that it prevents you from prepaying 2018 taxes and deducting them from 2017 taxes.

[The White Coat Investor]

SwanSong wrote:

It looks like the compromised bill closes this loophole and will now allow prepayment of taxes for 2018 to be used in the 2017.  It’s one of the few times you’ll ever find me going through the New York Times, but here you go:

“In a pre-emptive move against accounting maneuvers in high-tax states such as New York and California, the bill prohibits taxpayers from prepaying next year’s state and local income or property taxes, in order to deduct them from 2018 taxes. That form of tax planning would have allowed taxpayers to benefit more from the full state and local deduction this year before it is capped next year.”

https://www.nytimes.com/2017/12/15/us/politics/republican-tax-bill.html?hp&action=click&pgtype=Homepage&clickSource=story-heading&module=first-column-region&region=top-news&WT.nav=top-news

 

Though I think it should read that it prevents you from prepaying 2018 taxes and deducting them from 2017 taxes.

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Oh, that's a problem. That's why you wait for the final bill though. I'm still going to pay my 2017 taxes this month instead of in April though.

[jfoxcpacfp]

SwanSong wrote:

“In a pre-emptive move against accounting maneuvers in high-tax states such as New York and California, the bill prohibits taxpayers from prepaying next year’s state and local income or property taxes, in order to deduct them from 2018 taxes. That form of tax planning would have allowed taxpayers to benefit more from the full state and local deduction this year before it is capped next year.”

Click to expand...

Note that what the writer says is they won't be deductible against 2018 taxes. If that is not a typo, that means you can still pay 2018 taxes to deduct against 2017 income. You just can't pay 2019, 2020, etc. I think it m/b an error, though, as it doesn't make sense as written.

[VagabondMD]

Hmm, it would be really good to get some clarification on this. I guess we have a couple weeks to get it figured out.

I was about $45k under my AMT threshold last year, and with similar income numbers and deductions this year, could probably fill a good bit of that space with future state tax payments.

[jfoxcpacfp]

Here is all 1097 pages of it. I'm waiting for the Cliff Notes.

[Hatton]

If you overpay your 2017 state income tax will that be counted as income for 2018?  How will your state know to credit this for 2018 taxes?

[Hatton]

My accountant sent this article from the Journal of Accountancy

This article from the Journal of Accountancy addresses your question on pre-paying the 2018 taxes before 12/31/17.

• NEWS


• TAX

A 2017 federal tax deduction for prepaying anticipated 2018 state income taxes? Not likely!

By Kip Dellinger, CPA, and Christopher W. Hesse, CPA

December 14, 2017

In anticipation of enactment of the House and Senate proposed federal tax legislation, some commentators and tax practitioners are suggesting that — in view of the likely elimination of the state income tax deduction for 2018 and subsequent years — individual taxpayers prepay their 2018 state income tax liability and claim the deduction on their 2017 federal income tax returns. Aside from the problem that many high-income taxpayers will find benefits significantly limited because they will face the alternative minimum tax, we believe there is scant authority, if any, in federal tax law to support the position of deductibility of a prepayment of tax for a year that has not yet arrived.

Prior revenue rulings

Commentators have cited Rev. Rul. 71-190 and Rev. Rul. 82-208 as the basis for claiming a 2017 deduction for payments made in 2017 to be applied to a tax liability in 2018 — notably, a year that has not even arrived at the time of payment, let alone produced any income, deductions, credits, or other items to support a tax calculation. Any payment might be in the form of an estimated tax — to be credited against the 2018 tax liability when it is determined. Some states (e.g., Wisconsin) have a form for receiving a payment in advance. However, neither of those rulings addresses this type of situation. They both address a payment of taxes very late in a given tax year — for example in 2017 — with respect to that tax year (i.e., 2017 in this example). In fact, the latter ruling was adverse to the taxpayer (the payment was held not deductible) because the taxpayer had no reasonable basis to believe he owed additional state taxes and was apparently only attempting to reduce his federal tax for the year at issue.

Other tax professionals have cited the capitalization regulations — Regs. Sec. 1.263(a)-4(f) — as authority, as the regulations allow the deduction of expenses paid in advance where the tax benefit does not extend beyond 12 months. This is an exception to those regulations’ general requirement at Regs. Sec. 1.263(a)-4(d)(3) that prepaid expenses must be capitalized. However, not only is there no direct reference or example of a deduction for taxes paid in advance for a year that has not yet arrived, but the purpose of the regulations is to govern business-related expenditures “paid to acquire or create intangibles,” a very different situation from an advance payment of personal income taxes for a subsequent year. In fact, we believe the regulations have no applicability to the issue discussed here.

In addition, Regs. Sec. 1.263(a)-4(f)(4) provides that Regs. Sec. 1.263(a)-4(f)(1) does not apply to amounts paid to create (or facilitate the creation of) an intangible of indefinite duration. Where there is no liability yet in existence, the payment of an excessive 2017 estimated tax payment would apply against a future liability that is not limited in duration. There is no certainty, for example, as to whether the taxpayer would exist in order to recognize the income. The taxpayer may die in an accident early in 2018 before recognizing any income. It cannot be said that there is a liability for state income tax beyond Dec. 31, 2017.

Professional standards

Any deduction in 2017 for a payment of anticipated 2018 state income taxes is clearly a tax position that requires the CPA adviser-tax preparer to comply with AICPA Statements on Standards for Tax Services (SSTS) No. 1, Tax Return Positions, for preparation of a return and SSTS No. 7, Form and Content of Advice to Taxpayers, for advising on the position. In addition, tax preparers must comply with the preparer penalty provisions of Sec. 6694 (and the regulations thereunder) and Circular 230, Section 10.34, standards with respect to tax returns and documents, affidavits, and other papers, and Section 10.37 if the advice is provided in writing.

Basically, these professional standards with regard to taking and advising on a tax position are quite similar and consistent in that they require a tax preparer or tax adviser to identify substantial authority for any non-tax shelter position that he or she recommends or takes on a tax return that is not disclosed in some fashion. Lacking substantial authority, the tax preparer or tax adviser may recommend a tax position for which he or she believes there is a reasonable basis, provided disclosure is made in the return.

Disclosure is generally made by the taxpayer on either a Form 8275, Disclosure Statement, or Form 8275-R, Regulation Disclosure Statement (where the taxpayer takes a position contrary to a regulation). Substantial authority has often been described by respected commentators as a 40% to 45% chance of prevailing administratively or judicially on the merits if challenged by the government. Reasonable basis has been similarly described as a 25% chance of prevailing. Both confidence thresholds are based on authorities set forth in Regs. Sec. 1.6662-4.

In interpreting authorities, the IRS and the courts have given significant weight to direct reference with respect to the tax treatment of an item in a return, and far less weight is given when a taxpayer argues the tax treatment should be based on analogous authority applicable to tax treatment of another item, however arguably similar. This would be particularly true with regard to attempting to assert analogous treatment of an item if Congress did not intend for the item to be in fact treated in a similar manner.

It is noted that Rev. Proc. 2016-13 does provide that the reasonable-basis and disclosure standard is satisfied for certain items entered on a tax return if the item is reflected on the proper line in the return and is entered in accordance with the form’s instructions. Among those items are state income taxes entered on Schedule A, Itemized Deductions. However, the procedure specifically states that it does not reflect law changes after Dec. 31, 2015. It does not insulate a taxpayer from penalties for claiming a deduction for which there is no liability. Therefore, we believe that the procedure would not insulate a taxpayer (and preparer or adviser) from the disclosure requirements with regard to a 2017 payment of 2018 taxes if the tax reform legislation is enacted. We believe this is particularly true as it would appear to attempt to secure a tax deduction for an amount that Congress does not intend to allow as a deduction.

Consequently, CPAs should advise clients that payments in 2017 of state tax liabilities projected for 2018 are not deductible on their 2017 federal income tax returns. There is simply no authority for that position, and Rev. Rul. 82-208 is authority against that position. The payment sent to a state or local government before 2018 to apply against 2018 tax liability is a mere deposit. Tax deductions are not available for deposits (Rev. Rul. 79-229).

—Kip Dellinger ([email protected]) is senior tax partner with Cooper, Moss, Resnick, Klein & Co. LLP in Van Nuys, Calif. Christopher W. Hesse([email protected]) is a principal in the National Tax Office of CliftonLarsonAllen LLP in Minneapolis.

Opinions expressed in the Journal of Accountancy are those of the individual writers and may differ from policies of the American Institute of Certified Public Accountants, the Tax Division, or its other divisions and committee

[jfoxcpacfp]

Actually knew Kip in an earlier life and he is smart as a whip, but very much a stickler and often goes way too far into analytical territory. Not once in my career have I known this to be the case in filing personal tax returns - except perhaps in Kip's high profile firm. Trying to sort prepayments from overpayments would be like separating cooked spaghetti - or worse. Taxpayers are considered to be "cash basis" and can deduct prepayments of up to a year in advance, anyway, such as for prepaid insurance. This is not advice we will be following - the IRS cannot have it both ways.