WHAT IS CONSIDERED PREPAID INCOME TAXES?

I am sure you have been, and will be, getting emails and phone calls from 1040 clients asking if they can prepay their 2018 taxes to claim a 2017 deduction, considering the potential $10,000 limitation on the deduction for 2018.

The conference bill specifically states that "an individual may not claim an itemized deduction in 2017 on a pre-payment of income tax for a future taxable year in order to avoid the dollar limitation applicable for taxable years beginning after 2017."

So, it appears you can deduct prepaid real estate taxes, but not prepaid income tax. 

What exactly is prepaid state income tax? 

The actual amount of state income tax liability is based on the information on the final 2017 tax return – and will not be known until 2018.  The amount of state income tax withheld is based on the state withholding tax tables and a person’s W-2 wage income. 

And for the most part quarterly state estimated tax payments are based on either the prior year’s liability or the current year’s anticipated income.  The 4^th quarter 2017 payment is not due until mid-January of 2018; is making this payment in December of 2017 considered to be a “prepayment”, even though the tax payment is being made for 2017 income?

Obviously, if your normal 4^th quarter payment would be $2,000 but you send a payment of $10,000 in December you are making a prepayment of 2018 taxes.  But what about the normal $2,000 payment.  And if you do not make quarterly estimated state tax payments, having your anticipated state tax liability covered in full by withholding, but you make a 4^th quarter 2017 estimated tax payment of $5,000 in December, this $5,000 is clearly a prepayment.

What about a person who can control his state tax withholding in real time, like a sub-S business owner who pays himself a year-end bonus in December?  He or she can have an excessive amount of state income tax withheld from the bonus paycheck, which would, to me, clearly be a prepayment.  But what if that person anticipates excessive year-end dividends and capital gain distributions?  This could also apply to the person making only a 4^th quarter state payment.  These amounts are often not known until January when the December brokerage statements arrive.  As with anything, specific facts and circumstances would, or should, apply.    

Of course, if a person substantially overpays his or her state income tax for 2017 by whatever method he or she is only temporarily postponing paying federal income tax.  The resulting refund of excessive withholding or estimated payments would be included in taxable income on the 2018 return – although this money would be taxed at a slightly lower tax rate, and the taxpayer would get the potential benefit of the money earned on the deferred taxes if properly invested.

Any thoughts on the question?

TAFN