During the lead-up to federal tax reform, there has been much discussion about the fate of the existing state and local tax deduction, set forth in I.R.C. § 164(b). The House version of H.R. 1, The Tax Cuts and Jobs Act, proposed the repeal of the deduction for state and local income taxes while capping the deduction for state and local real property taxes at $10,000. The Senate version of the bill proposed the suspension of the deduction for state and local income taxes for tax years 2018 through 2025 while also capping the deduction for state and local real property taxes at $10,000.
Practitioners immediately began to consider the prepayment of state and local taxes as a tax planning tool to lessen the immediate impact of the tax reform propositions, specifically with respect to property taxes. At Bloomberg Tax SALT Talk, Stephanie Cangialosi and Katie Devinney blogged on the result of their research into whether prepayment of property taxes was even permitted, finding that six states allow prepayment, 11 states do not allow prepayment, and 34 states do not provide guidance and rather yield to local tax collectors.
The possibility of prepaying state income taxes was even more speculative, as practitioners were generally unsure whether this would be permissible. Some, as set forth in a Journal of Accountancy article, expected that such prepayments would not be permissible, citing a lack of authority to support the deductibility in 2017 of payments towards state income tax liabilities for 2018 and the difficulty a CPA advisor would have in complying with professional standards upon advising a client to take a tax position that appears to be in direct conflict with the intentions of Congress.
While numerous states, including Connecticut, Massachusetts, and Virginia, have indicated that taxpayers can prepay 2018 estimated income tax in 2017, the Conference Reconciliation Report for H.R. 1 states “an amount paid in a taxable year beginning before Jan. 1, 2018, with respect to a state or local income tax imposed for a taxable year beginning after Dec. 31, 2017, shall be treated as paid on the last day of the taxable year for which such tax is so imposed.”
This provides a clear answer of no to the question of the permissibility of prepaying 2018 income taxes in 2017 and deducting such prepayments in 2017 to take advantage of the current unlimited deduction, ahead of the deductibility restrictions expected to take effect in the 2018 tax year.
While it is plausible that the public brainstorming of tax planning possibilities surrounding the proposed changes to the state and local tax deduction compelled the conference committee to add the clarifying language, getting the IRS to accept the contemplated tax treatment likely would have been an uphill battle.
Continue the discussion on Bloomberg BNA’s State Tax Group on LinkedIn: What are some other strategies taxpayers can employ in 2017 to offset lost deductions in 2018 and beyond?
To learn more about Congress’s tax proposals, download Bloomberg Tax’s Roadmap to House and Senate Tax Reform Plans, available here.
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