Time is short–really short–so I’ll keep this as quick as I can. If you make a decent amount of money, own real estate, and live in one of America’s higher tax states, the sweeping tax law that President Trump signed on the Friday before Christmas could contain a giant lump of coal for you.
That’s because, while a majority of Americans should see at least a short-term tax break from the new law, it also contains a provision that could well result in a big net tax increase for thousands or even potentially millions of U.S. taxpayers. And if it affects you and you want to try to offset it, you have only until December 31–or maybe really only until December 29–to act.
Below, we’ll explain the new tax law’s land mine and what to do about it, along with (unfortunately) an explanation of why no matter what you do, you’re going to find yourself at risk. In fact, even as I was writing this article on Wednesday evening, the IRS issued new “guidance” that only created more angst and confusion.
The $10,000 cap
The new tax law’s land mine is that it contains a $10,000 cap on the combined amount anyone can deduct from federal taxable income for paying state and local taxes. (Up until now, there’s been no cap.)
For people in high-tax states who make more than $150,000 or $200,000 a year, that’s a big deal. As an example, the average taxpayer who makes more than $200,000 a year in Minnesota takes a $46,591 state and local tax deduction–or at least, they used to. Now, they’ll be limited to $10,000.
It’s even worse for people in New York and California, where the average deductions in this profile are $84,964 and $64,771 respectively. (This data analysis comes from The New York Times.)
Taxpayers and tax professionals have been rushing to find ways to limit their clients’ exposure.
But the whole situation is complicated greatly by the fact that Congress was in a rush to get the tax law done before the end of the year, and that it went into effect with literally only four business days left in 2017–at a time when, let’s face it, half or more of the United States is on vacation.
The potential 1-year trick
You’ll notice that the states whose taxpayers are most affected by this are the ones that tend to vote overwhelmingly for Democrats. (The tax bill was passed with only Republican votes in Congress).
That means that the whole thing is likely a giant political football, and it raises the possibility that if Democrats recapture the White House and Congress in 2020, the $10,000 cap could be eliminated.
Meantime, however, tax professionals have been urging potentially affected clients to consider prepaying as much as they can of their 2018 state and local taxes now, before the end of the year–while the old rules still apply.
Republicans in Congress anticipated this strategy, at least in part, as Michael E Williams, a partner in the New York firm of Schulman, Lobel, Zand, Katzen, Williams & Blackman, LLP pointed out to me: a Congressional committee report “states that one cannot prepay 2018 personal income tax in 2017 and expect a tax deduction.”
However, that report didn’t mention the idea of prepaying local property taxes. As a result, there has been a deluge of people all around the country (or at least in higher tax states) trying to prepay their local property taxes.
Prepaying property taxes
So, should you prepay your property taxes, too?
It seems like a good idea in the abstract, but there are at least two wrinkles involved. The unfortunate net result is that you’ll almost certainly have to make a decision based on incomplete information.
Here are the two wrinkles: First, there’s a potential that by prepaying your 2018 property taxes during 2017, you might accidentally wipe out your entire expected windfall as a result of the alternative minimum tax.
Second, there’s the IRS guidance that came out with literally less than 72 hours left during the last business days of 2017–literally while I was writing this article tonight. In short, it says you can only prepay property taxes and take a deduction in 2017, to the extent that your city or town has actually assessed next year’s taxes already.
Truly, we’d be in much better shape if this bill had been enacted back in September, for example, to give people more time to plan, and talk with tax advisers. Congress didn’t give us that option, however, so we have to make due with what we have.
Putting my money where my mouth is
Ideally, you’d want to be able to estimate what your total 2017 income will be, and what your taxes would be this year and next, with or without taking the extra property deduction, before making this prepayment decision.
But you probably won’t have all that information until January 2018–by which time it would obviously be too late to make a payment in 2017.
Additionally, a lot of municipalities had no idea this was coming down the pike–and so they didn’t assess 2018 property taxes yet. Now, if this is the first you’re thinking about this, do you even know whether your city or town has assessed yet? Could you even find out before the end of the year?
This all means that nobody can give you a 100 percent solid answer on what to do.
But rather than use that lack of certainty as a cop out, I’ll at least share what I’m doing, since I happen to live in one of these high-tax states, and I am one of the people who would face a potential big tax increase next year.
I spent a few hours this afternoon trying to war game what my 2017 taxes are going to look like. It’s difficult, of course, since I don’t have all of the information yet–and because I was using 2016 tax software (all I had available), on the hope and a prayer that there isn’t some other hiccup in tax law between 2016 and 2017 that might significantly affect me.
That said, by prepaying half of my 2018 local property taxes (which is all that’s been assessed in my community ), I think I’m likely to come out ahead.
As of Wednesday evening, I haven’t decided 100 percent for sure what to do, but I am leaning strongly toward prepaying, so as to take a larger deduction in 2017, since it won’t be allowed in 2018.
I’ll probably make a final decision on Friday afternoon. Technically that’s only December 29–less than 48 hours after I wrote this article. Technically, a payment made on Sunday December 31 should count as being made in 2017. Or at least it might count. But given all the chaotic drama involved here, I wouldn’t want to risk the IRS deciding otherwise.
So Friday afternoon it will be. I figure that if Congress and the president waited until almost the last minute to enact the most impactful tax law in 30 years, and if the IRS is going to be issuing last-minute guidance like this–then I can wait until the bitter end to decide as well.
