With the Republican sweep of the presidency, the house and the senate, some tax advisers and political writers are forecasting the Republicans will swiftly execute their agenda, including repeal of Obamacare taxes and passing tax reform with tax cuts.
I am not sure this will happen as fast as early 2017 as tax reforms are usually very difficult to execute, even with a majority in the house and senate. In any case, it’s probably wise to do some preemptive tax planning just in case we do see major tax reform in 2017. For some, these tax reforms could be a welcomed change.
Tax Planning Steps to Take Before the New Year
President elect Trump’s tax reform plans are similar in many ways to those of the House of Representatives. Though Trump’s tax cut plan is more aggressive than the House by lowering the business tax rate to 15% vs. the House capped rate of 25%.
Reflecting on this, if there’s going to be tax reform in 2017, then it’s probably wise to defer income and accelerate deductions for year-end 2016. Consider a simple strategy such as “tax loss selling” of investments (close out losing positions to offset gains realized earlier in 2016). Also, try to defer other types of revenue until 2017.
However, if you are in a low tax bracket for 2016 and expect to be in a higher bracket in 2017, then you need to book more income now and defer your expenses to 2017.
Trading Businesses Could Reduce Tax Liability From Tax Reform
Trump’s and House tax plans provide meaningful tax-rate reduction for businesses, including those operating in a pass-through entity including an LLC, partnership, and S-Corp.
The president-elect’s plan mentions the 15% business tax rate is for “all businesses, both small and large, that want to retain profits within the business.” A trading business could qualify for Trump’s 15% business tax rate or the House’s 25% capped rate.
- Does the 15% rate for undistributed profit only apply in a pass-through entity?
- Will schedule C sole proprietor businesses be treated differently than pass-through entities?
Trader Tax Status
To qualify for the proposed preferential business tax rate, taxpayers will need to trade in a pass-through entity, and the entity must qualify for trader tax status. Trader tax status allows traders to treat their trading activity as a business and write off various business deductions such as home office, auto, travel, education and more. Furthermore, the company may need to elect Section 475 MTM ordinary income or loss treatment, as capital gains in the entity may not qualify for the preferential business tax rate.
If the entity trades Section 1256 contracts, it may be attractive to file an election for Section 475 ordinary gain or loss treatment, forgoing the lower 60/40 capital gains rates, to qualify for the preferential business tax rate. This decision depends largely on your individual income tax bracket and requires you to consult with your tax advisor.
The tax cuts may exclude capital gains in pass-through entities from using the business rate. Conversely, if the business rate is higher than 15%, some traders may fare better with Section 1256 60/40 capital gains, considering the lower capital gains rates.
If the tax cuts preclude a trading business entity from the new business rate, then you will need to consider more elaborate structures.
Some traders use an S-Corp to create earned income (officer compensation) to allow them to contribute money into their retirement accounts and enjoy other employee benefit programs like health insurance. This strategy may not be sensible if all income is subject to the lower business rate, as paying salary converts business income to ordinary income which for most traders will be much higher than the 15%.
However, if the business rate applies to undistributed income only, and the owner needs a salary to cover living expenses, then it may be wise for the S-Corp to continue with officer compensation and employee benefit plans.
Employees May Want to Become Independent Contractors
There may be huge movement of employees to qualify as independent contractors. This will allow taxpayers to save big on taxes as they could benefit from the preferential business tax rate vs. the higher ordinary rate on wages.
This is a critical time to have a tax professional on your side to help you navigate through upcoming tax changes. Reach out to us for your personal tax planning strategy session.
Happy Holiday Season!