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The IRS has issued an advisory that is causing massive confusion among taxpayers in high-tax states who were planning to prepay some or all of their 2018 property taxes during the final days of 2017 because the tax bill Congress just passed sets a $10,000 limit on deductions for state and local property and income taxes combined.
The bill explicitly disallows any prepayment of state and local income taxes but implicitly allows for prepayment of local property taxes, although that is not spelled out clearly. As a result, the IRS reported it has received “questions from the tax community concerning the deductibity of prepaid real property taxes,” which is why it issued its advisory.
(Related: 4 Last-Minute Tax Strategies for Clients in High-Tax States)
The advisory states that “a prepayment of anticipated real property taxes that have not been assessed prior to 2018 are not deductible in 2017.”
In other words, taxpayers can only prepay 2018 property taxes that have already been billed — the IRS uses the words “assessed prior to 2018” — not taxes that they estimate themselves.
“What would not be deductible is calculating your property tax liability independently and remitting that,” says Nicole M. Kaeding, an economist with the Center for State Tax Policy at the Tax Foundation.
Even if the payment were based on a calculation using the official assessment of a taxpayer’s home multiplied by the official local tax rate it would not be allowed, explained Kaeding. Tax liabilities posted online would suffice as a tax bill.
The confusion for many taxpayers is due in part to the IRS’ use of the word “assessed,” since assessments usually refer to property values, not tax liabilities.
“Asessments relate to the value of a property and then the tax rate is applied to that,” says, Howard Gleckman, senior fellow at the Urban-Brookings Tax Policy Center, a nonpartisan think tank based in Washington. “That language is not even in the tax bill.”
Given the confusion, should taxpayers in high-tax states prepay their local property taxes?
ThinkAdvisor spoke with a number of experts on tax policy and tax planning to develop a basic checklist on whether taxpayers should prepay their property tax repayments before year end, taking into account the latest IRS advisory.
1. “Taxpayers should talk to their tax professional,” says Megan Gorman, a founding partner of Chequers Financial Management in San Francisco.
2. Do they have the cash to prepay and are not subject to the Alternative Minimum Tax?
“The first step is to consider is if they are in the AMT,” says Gorman. “If they are not, they should see what property taxes they are currently assessed and able to pay. Most tax professionals will be able to give guidance on this. Finally, taxpayers need to decide from a cash flow standpoint if prepaying makes sense.”
3. Do they know for sure the amount of property taxes owed for 2018, whether it be for one quarter, the first half or the full year? A tax bill or official posting on the tax collection site of a local government provides that information and taxpayers can contact their local tax authority to confirm that prepayments will be accepted and for what period of time.
“When we called the Tax Collector of Orange County, California, they explicity told us what taxes we could pay — only those taxes that would be due by April 10, 2018,” says Gorman. “They would not accept anything beyond that.” She is advising California clients who are not subject to the AMT to prepay the second half of the current tax bill due April 10, 2018 and checking to see what property taxes are already assessed for clients in other states.
Even if a taxpayer isn’t certain that prepayments will be accepted by the IRS he or she may want to prepay anyway. Even if the IRS eventually decides not to allow the tax deduction for the prepayment, it will only mean that the taxpayer gave an interest-free loan to its local tax authorty. There is no mention of a penalty in the IRS advisory.
“You can take a shot and see what happens,” says Gleckman. Taxpayers don’t actually have to decide now whether to claim the deduction for the prepaid taxes until they file their 2017 tax return, which isn’t due until April 2018.
“Hopefully by then it will all be sorted out.”
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