Thinking of Pre-Paying State and Local Taxes? Some Guidance from the IRS

Should I pre-pay 2018 state and local taxes in 2017? The new tax law, signed into law just before the holidays, did make it seem like that might be a good idea for many people. That’s because the new tax law limits the deductibility of state and local taxes beginning in 2018. For those who will still itemize deductions in 2018 and beyond (although many will not due to the expansion of the standard deduction), the allowed deduction for state and local taxes – income or sales tax, and property taxes  – is limited to $10,000 for all except married people who file separate returns. (They only get $5,000 each.)

Here’s what you need to know if you’re thinking about pre-paying: 

Prepaying INCOME TAX in 2017 for a year beginning after 12/31/17 will NOT generate an allowable  2017 deduction. That’s a special provision of the new law. However, prepaying PROPERTY TAXES  – even for a year that begins after 12/31/17 – could under certain circumstances generate a 2017 deduction.

Yesterday, the IRS issued guidance on pre-paying 2018 property taxes. The IRS says that you can pay and deduct in 2017 property taxes that are due in a subsequent year IF those taxes have been assessed before 2018. The IRS says that even if the local taxing authority will accept prepaid taxes, the taxes won’t be deductible in 2017 UNLESS the taxing authority assesses those taxes before 2018. For example, Philadelphia sends its 2018 property tax bills out in December 2017. Those taxes if prepaid in 2017, would be deductible in 2017.

Some tax experts disagree with the IRS position but the IRS writes the rules and you should not ignore them, unless you would be comfortable fighting about it later.

More importantly, someone should only prepay taxes if they think they will actually benefit from the prepayment – and that means being pretty certain that the Alternative Minimum Tax (AMT) will not deprive them of the tax benefit in 2017. We recommend that you check with your tax advisor about exposure to the AMT.

Isn’t tax law just wonderful?