I wanted to comment (and ask opinions) on the SALT deduction in the tax reform bill, and suggest a method of maximizing 2017 deductions if you believe your state/local taxes will exceed the SALT limit in 2018.
Starting in tax year 2018, we can only deduct up to $10,000 in combined property and income taxes. You may have heard that pre-paying your 2018 property taxes in 2017 to maximize your tax year 2017 deduction - this advice is widespread, so I'm not addressing it here. The focus of this post is on state and local income tax.
You may have heard that a provision in the bill prevents you from pre-paying 2018 taxes by making 2018 estimated tax payments in 2017 and deducting those payments on your 2017 return.
However, this limitation does not apply to state income taxes paid in 2017 for tax year 2017. Therefore, I believe we have two legal methods of maximizing the 2017 SALT deduction by maximizing state income tax paid in 2017 (and thus maximizing the 2017 deduction).
The first, and most obvious, would be to make a large Q4 2017 estimated tax payment to your state or local government by December 31st.
However, there are limitations to this - see page 151 of IRS Publication 17:
So if you choose to do this, make sure it's reasonable and is done in good faith. Here's my plan, that I believe will lawfully minimize my income tax liability:Estimated tax payments. You can deduct estimated tax payments you made during the year to a state or local government. However, you must have a reasonable basis for making the estimated tax payments. Any estimated state or local tax payments that aren’t made in good faith at the time of payment aren’t deductible.
I am going to perform a basic calculation of my 2017 state income tax liability, document it (save the paper I use to make the estimate - this is important), do it contemporaneously (e.g., now, before making the payment), and make it relatively simple (roughly, take higher-end estimate of total income, subtract a conservative estimate of total 401k contributions and mortgage interest, then multiply by state income tax rate). Then I'm going to add a reasonable margin of safety, let's say 5%. Then I'll calculate the difference between that and the tax I've already paid, and make the 2017 ETP by December 31st.
By making a documented, good faith, but conservative/high-end payment of my estimated 2017 state income tax liability in 2017, I'm both maximizing my 2017 federal SALT deduction AND making sure I don't get hit with state underpayment penalties when I file. I believe it's a prudent approach.
The second method I'm about to suggest is one that I believe is beyond reproach and completely legal even if it results in you significantly overpaying your 2017 state income taxes.
If you have an additional paycheck coming in by December 31st, you can update your state's equivalent of the federal W-4 (in Massachusetts, this is Form M-4) with your employer to remove all exemptions. This could be huge if you have a big bonus check coming in.
Publication 17 addresses withheld state and local taxes thusly:
As you can see, there is no "good faith" or "reasonable basis" provision for deducting withheld taxes. I believe eliminating all exemptions would be well within the realm of legality here, even if you were MFJ with four kids.Withheld taxes. You can deduct state and local income taxes withheld from your salary in the year they are withheld. Your Form(s) W-2 will show these amounts. Forms W-2G, 1099-G, 1099-R, and 1099-MISC may also show state and local income taxes withheld.
Massachusetts (and presumably other states with income tax withholding) allows you to specify on Form M-4 an "additional amount" to withhold from each paycheck. You could probably get into some trouble here if you had a $30,000 bonus coming and you filed an M4 with an additional $20,000 withholding.
Even without the "reasonableness/good-faith" provisions of Pub 17, you'd be sticking out like a sore thumb to the IRS, and they could probably make an argument for tax evasion of some kind under a more generic law. So I would not recommend going nuts with this. But I believe you could probably do a back-of-the envelope calculation that would estimate additional state tax liability, and have a reasonable basis to add $3000 in state withholding or something similar based on a $30,000 bonus. That could save you $1000+ in federal tax liability, depending on your bracket.
All of the above is based on my relatively educated understanding of how the tax system works. I have some experience with tax preparation but I am not a tax attorney. You should seek the advice of a professional before acting on something like this.
That said, any thoughts or advice on this strategy are welcome.