How financial advisers can take advantage of tax reform uncertainty

All eyes are on the prospect of tax reform as congressional Republicans push hard to deliver on one of their most coveted policy goals. While their ability to achieve tax reform is far from certain, there are strategies financial advisers can use this year to plan on the individual tax front.

“Obviously, we don’t know what’s going to happen on the individual-income-tax side,” said John Voltaggio, managing director of wealth management at Northern Trust Co. “But, if we look at some of the proposals, we can say, ‘We don’t expect income-tax rates to rise. We expect them to stay steady where they are now, or decline into 2018.’”

Advisers can use these expectations to their clients’ advantage. Primarily, clients can accelerate their timeline for a tax deduction, such as one from a charitable contribution, by using any planned deductions this year rather than next. Clients can also defer income into next year, if possible.

Using a tax deduction this year, when an individual’s tax rate may be higher than next, would offer clients a greater benefit than taking that deduction in 2018. And, deferring income to 2018 could mean paying lower taxes on that income.

President Donald Trump has proposed condensing the existing seven income-tax rates to just three, and cutting the individual top tax rate to 35% from 39.6%. The lowest rate would remain at 10% and the middle rate would be 25%.

“They’re no worse off if nothing happens [with taxes], but if rates go down you might have gotten more bang for your buck,” Mr. Voltaggio said.

Charitable deductions are where the strategy makes the most sense, advisers said. And, given there’s been a market run-up this year, using highly appreciated stock to make a contribution via a donor advised fund would offer a dual benefit.

The S&P 500 index has returned more than 9% since the beginning of the year.

A donor advised fund would offer investors a tax break for a large charitable donation made in 2017, but they could subsequently spread out payments from that asset over several years to accomplish their annual charitable goals.

“The donor advised fund to me is kind of a no-brainer,” said Charlie Douglas, director of wealth planning at Cedar Rowe Partners. “Maybe front-load those donations [into this year].”

“Trump was never clear before about his tax plan. It’s still so murky, and who knows with any degree of certainty where we’re going to end up with taxes,” Mr. Douglas added. “There’s nothing else [aside from donor advised funds] I’m recommending, except for accelerating deductions.”

Accelerating other deductions, such as the one for state and local taxes, could make sense, too.

Tim Steffen, director of advanced planning in Robert W. Baird & Co.’s private wealth management group, normally tells clients not to pay taxes until it’s necessary; so, if they can wait to pay taxes until filing a tax return and without a penalty, that’s likely best.

But, Mr. Steffen recommends clients do a projection for state tax liability this year. If clients are on pace to pay any such taxes on a 2017 return, they can pay that tax this year to get a deduction that may not be available to them if they were to wait until next April to pay the tax.

An Aug. 22 Politico report said the president’s top aides and congressional leaders have made “significant strides in shaping a tax overhaul,” and they see the deduction for state and local taxes as one of the best options to help pay for tax cuts.

One caveat: A client subject to the alternative minimum tax doesn’t get a tax benefit for deducting state income taxes, Mr. Steffen said. These clients are likely better off waiting to pay state taxes due to the time value of money. (The AMT helps ensure taxpayers, primarily high-income earners, pay a minimum amount of tax.)

There’s often not much leeway to defer income, though. Deferring capital gains (or, holding off on selling an asset) and taking a distribution from a retirement account are the strategies over which clients have the most control, Mr. Steffen said.

Self-employed clients and those who work on commission can also try pushing recognition of any income into next year, he said.