I promised yesterday to say more about the short-run implications of the tax bill for me. I’m not giving advice but some of you might find this helpful.
The first major point is that the increase in the standard deduction to $24,000 changes things a lot for my wife and me. We have been itemizers ever since buying a house in 1986. But our mortgage interest is now down to about $3,000 a year, we give somewhere between $2,000 and $2,500 to charities annually, our property taxes are about $4,000 a year, and our state income taxes (we live in high-tax California) are about $10,000 a year. That totals about $19,000. With the limit on deductibility of state and local taxes (SALT) of $10,000 a year, we would have itemized deductions next year, not of $19,000, but of $15,000. It’s clearcut that we should not itemize next year. We will probably never itemize again.
Now notice how the tax bill will drive my behavior this month. I give almost half of the charitable deductions in mid-December. I just did so. But I give to the same 4 or 5 charities every year, and usually about the same amount plussed up a little (about 10%) each year.
So here’s one clearcut implication: I will take the 4 charities that I know I’m going to give money to and give them again, this month, what I gave them for 2017. Then in 2018 I will give them almost nothing. That way I get the tax deduction this year. I won’t, obviously, get it next year. Beyond 2018? I’m not sure. I’m guessing that my demand for charitable giving is relatively inelastic.
Interestingly, though, there is one charity I give to where the tax bill has caused a major change in relative prices. I give annually (actually I missed a few years but am back on board) to the Marijuana Policy Project. There are two ways to give: (1) to a fund for political action where your donation is not tax-deductible, and (2) to a fund whose activities can’t include political action where your donation is tax-deductible. I accidentally gave to the non-tax-deductible fund this year by clicking the wrong button. Water under the bridge: it was only $250. But I figure they will use the money more effectively if unconstrained. So from 2019 on, I will give to the one that is not tax-deductible. I’ll go on line in the next couple of days and give another $250 to the one that is tax-deductible; that way I get a deduction this year. Then I’ll give nothing in 2018.
Now to the big one: prepayment of taxes. I’ve run this by my accountant and he is not convinced I can do this. So I’m waiting on his hearing more. But if I get the green light, I will prepay this month about $9,000 of my 2018 California income taxes. He worries that the California state government will regard this as overpayment of 2017 taxes and simply give a refund in April which, of course, is taxable in 2018. I could still gain from arbitrage between tax rates–I think I’m barely into the 28% bracket this year and will clearly be in the 24% bracket next year. But that’s chicken feed, especially since I would have to borrow on my credit line to do this. I figure, though, that I can do it and have it counted as 2018 income taxes by using this form.
My accountant did tell me that I can go to the county tax office next week and prepay my 2018-2019 property taxes that are due in December 2018 and April 2019. That’s $4,000. That’s big.
READER COMMENTS
Kevin Fisher
Dec 22 2017 at 3:50pm
Can’t deduct prepaid property taxes.
The Tax Court has addressed this question, and ruled that the prepayment isn’t deductible.
In California, real estate taxes become a lien upon the property on January 1. See R&TC §117. The taxes are then assessed on the following July 1, bills are sent out before October 1 (usually, mid-September), the first installment is due on November 1 (may be paid by December 10 without penalty), and the second installment is due on the following February 1 (may be paid by April 10 without penalty).
So, real estate taxes for the 2018/2019 year become a lien on the property on 1/1/2018, are assessed on 7/1/2018, billed to the owner not later than 10/1/2018, and are due on 11/1/2018 (one-half) and 2/1/2019 (one-half).
In Estate of Hoffman et al. v. Commissioner, T.C. Memo 1999-395, the taxpayers prepaid $5,520 of their 1997 real estate taxes and deducted the prepayment on their 1996 return. The IRS disallowed the deduction, and the Tax Court said:
“Section 164(a)(1) allows a deduction for real property taxes. Deduction of prepaid real property taxes has been disallowed where a cash basis taxpayer failed to establish that the prepayment represented assessed, rather than estimated, taxes, and that such taxes were due in the year they were paid. See Hradesky v. Commissioner, 540 F.2d 821 (5th Cir. 1976), affg. per curiam 65 T.C. 87 (1975). Petitioners have not established that their $5,520 prepayment represented assessed, rather than estimated, taxes. In addition, they have conceded that the $5,520 was not due in 1996. Accordingly, petitioners may not deduct the $5,520 from their 1996 income.”
As a result, I think it’s pretty clear that prepaying 2018/2019 real estate taxes in 2017 won’t be deductible because the 2018/2019 taxes aren’t assessed until 2018, and don’t become a lien on the property until 2018.
Justin White
Dec 22 2017 at 4:04pm
California certainly may not let your prepay your taxes, but Texas schedules property tax due as of January 31. That provides an opportunity to itemize every other year by paying the previous year’s taxes in January and the current year in December of the same year.
And there’s no income taxes either. 🙂
David R Henderson
Dec 22 2017 at 4:06pm
@Kevin Fisher,
Thank you very much. You saved me a trip to the county tax office in Salinas. 🙂
Do you think I can prepay my 2018 Calif state income taxes?
Zc
Dec 22 2017 at 6:16pm
Nope, you can’t deduct prepaid 2018 state income tax this year. It’s explicitly disallowed in the tax bill.
Looks like it’s time for a new accountant. Suprising someone as intelligent and economically literate as you doesn’t do their own, especially given that it sounds like your tax situation is simple.
Thaomas
Dec 23 2017 at 7:34am
Several good works thank you for this prompt. 🙂
I trust that the small addition to the deficit occasioned in 2018 will soon be made up with higher taxes (ideally progressive consumption taxes) on high income/consumption/wealth folks.
Joe Williams
Dec 23 2017 at 8:01am
I ran my numbers for 2018 under the new tax law, and like you, Prof Henderson, I won’t have enough to itemize going forward. One tax-related action I took recently was to purchase a new car now instead of early in 2018 so that I could include the sales tax in my 2017 deductions for SALT.
Alan Goldhammer
Dec 23 2017 at 8:04am
The only SALT deduction that can be taken on the 2017 return is to make sure you make your January estimated state tax payment by the end of this year. that is not a prepayment on future taxes but a payment on present tax.
David, you are fortunate that your property tax is ‘artificially’ low because of the Proposition 13 cap. If you move to a new California house you will see that tax go up significantly.
Some of us have more complicated tax situations because we have to take mandatory IRA withdrawals and depending on how one has done with such investments, these can be quite substantial. For such individuals the increase in the standard deduction really doesn’t do anything and AMT will still be triggered.
Finally, Ron Lieber has a good column in the New York Times today on how the very wealth can ‘game’ the Section 529 account to pay for private schools across the board. States might be able to take some action against this loopholw.
Michael
Dec 23 2017 at 8:14am
Re: property taxes: In my state, we’re sent two bills…one to pay in June, the second in January. Not sure how it works in California, but if it’s similar, you might pay the January one this week (in 2017)…accelerate it by one month to get the deduction in the higher rate year.
WalterB
Dec 23 2017 at 10:12am
I will keep giving to charity in the same amounts as before. I’ve never given in order to get a deduction. Maybe that’s “virtue signaling”, but I’m not claiming to be any more virtuous than I was before the tax bill passed. However, I do get the point that charitable giving will be greatly affected overall.
Edward Silicani
Dec 23 2017 at 10:57pm
The above comment is correct – you cannot prepay any 2018 state income tax.
The conference report states “The conference agreement also provides that, in the case of an amount paid in a taxable year beginning before January 1, 2018, with respect to a State or local income tax imposed for a taxable year beginning after December 31, 2017, the payment shall be treated as paid on the last day of the taxable year for which such tax is so imposed for purposes of applying the provision limiting the dollar amount of the deduction. Thus, under the provision, an individual may not claim an itemized deduction in 2017 on a pre-payment of income tax for a future taxable year in order to avoid the dollar limitation applicable for taxable years beginning after 2017.”
The IRS also issued a revenue ruling on this topic in 1982 whent the 1981 law was passed and the ruling took the same position.
So, no way.
David R Henderson
Dec 24 2017 at 12:46am
Thanks, Edward.
Hazel Meade
Dec 26 2017 at 10:53am
My one concern is that fewer people itemizing deduction will lead to a drop in housing prices, since there no longer a tax incentive to buy. I just bought a house and would hate to lose money on it right away.
Nick Ronalds
Dec 26 2017 at 12:32pm
Thanks for the tip David. Here in Illinois prepayment of the first installment of the Cook County property tax is indeed allowed, and somewhat to my amazement, Cook Country even put up a website to facilitate such payments. What is not clear to me is why they will accept prepayment only on the first installment. Not sure what would happen if I pre-paid an estimate of the second installment, but don’t think I’ll take the risk of triggering a bureaucratic muddle.
David R Henderson
Dec 26 2017 at 12:34pm
@Hazel Meade,
My one concern is that fewer people itemizing deduction will lead to a drop in housing prices, since there no longer a tax incentive to buy. I just bought a house and would hate to lose money on it right away.
It absolutely will reduce house prices, ceteris paribus. Moreover, even for those who itemize, the SALT limit will reduce the value of the property tax deduction. Finally, the reduction in marginal tax rates for most people will reduce the value of the mortgage and property tax deduction.
So it’s a triple whammy and I haven’t even counted the limit on the mortgage interest deduction, which I posted about earlier.
Nick Ronalds
Dec 27 2017 at 11:25am
Hazel Meade, two comments to add to David’s: Your reaction to the impact of the tax law change–one any homeowner can identify with–illustrates exactly why tax reform, and reform of almost any sort, is so difficult. Existing rules create vested interests, no matter how perverse or counterproductive the rules themselves might be. The deductibility of mortgage interest, for example, incentivizes more debt and more housing than would otherwise be the case. The net economic benefits of the tax law changes may well be significant. But they will be diffused throughout the economy, though it may also be true that the net benefit to you and your family will be positive. Still, in all likelihood many homeowners and others (e.g. the real estate industry) who lost out from the tax reform will be lobbying to restore the status quo ante.
Hazel Meade
Dec 29 2017 at 8:47am
Yes. I think the tax bill is overall a good thing for the country. We might worry about the short run effects that a drop in housing prices will have on the economy though. Hopefully the effect of the tax cut will cancel out the effects of the drop in home prices.
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