Taxes

Prepaid Property Tax Perplexity Highlights the Tax Code's Confounding Complexity

Even the experts do not know what the law requires.

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John Greim/Newscom

Although the tax bill that Congress enacted last week was sold as a simplification measure, it created a bunch of new wrinkles for Americans trying to figure out how much they owe the federal government and why. This week's confusion over prepayment of property taxes shows how even a step in the right direction—in this case, limiting a deduction that favors the wealthiest taxpayers in the most expensive parts of the country—can make the tax code even more complicated.

The tax bill imposed a $10,000 limit on the deduction for state and local taxes (SALT), effective this Monday. The change does not affect most Americans, because most Americans do not pay more than $10,000 in state income taxes, local property taxes, or the two combined. The change does not affect my family, for example, because we live in Texas, which has no income tax, and rent our home, so we have no property taxes to deduct. It would be a different story if we still lived in Virginia, which has an income tax, and still owned a house in Fairfax County, where the median property tax bill is about $5,000. When you add state income tax, a middle-class family can easily pay more than $10,000 total.

In parts of the country with higher home prices and/or higher property tax rates, such as New York City and Los Angeles, the SALT deduction is worth even more. And the bigger and more expensive your house, the more you can expect to save on your federal income taxes (especially when you take into account the deduction for mortgage interest, which the tax bill also limits). The new SALT ceiling therefore makes the tax code less favorable to rich people with mansions (as well as politicians who overtax their constituents). But it also introduces new complications, especially during the transition period.

This week homeowners in places such as Fairfax County, Chicago, Washington, D.C., and Hempstead, Long Island, lined up to prepay their 2018 property taxes before the new limit takes effect. New York Gov. Andrew Cuomo and New Jersey Gov. Chris Christie, who see the SALT limit as an affront to residents of expensive, high-tax states like theirs, encouraged advance payments, while officials in Connecticut said they do not have the legal authority to accept them. The tax office in Simsbury warned that prepayment "could be considered an effort to evade federal income tax liability." Compounding the confusion, the IRS on Wednesday issued an advisory saying prepayments are deductible only if the property tax was officially assessed before the end of this year.

The tax bill specifically precludes deductions under the old rules for prepaid state taxes on 2018 income, but it does not address prepaid property taxes. The IRS did not explain the legal rationale for distinguishing between payments and assessments, which is bound to be the subject of litigation. The upshot is that people who have shelled out thousands of dollars in lump-sum property tax payments may get no benefit from paying early and may not know for sure whether their deductions are valid for months or years. "It's fun if you're a tax lawyer," David Herzig, a professor of tax law at Valparaiso University, told The New York Times. "I'm not sure it's fun if you're a person going through it."

Beyond the economic distortion caused by the tax code's myriad deductions, credits, and exemptions, there is something fundamentally wrong with a system of revenue collection that can be navigated only with the help of experts—and in many cases (like this one) not even then. When it comes to figuring out what the tax code requires, the experts may disagree. People are expected to comply with the law but have no way of determining what that means.

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  1. If the tax code is as complex as that headline, we’re in deep shit.

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  2. The new SALT ceiling therefore makes the tax code less favorable to rich people with mansions (as well as politicians who overtax their constituents).

    Diane Feinstein hardest hit

      1. And not in a place where maximum pain results.

        1. Pretty sure Marin estate-owners + Silicon valley bazillionaires are her dearest donor-constituency.

          perhaps their pain will translate into ever more donations for her; perhaps not.

          But its still amusing watching the prog-erati trying to translate “people will million dollar homes not being able to deduct as much” into “we are champions of the poor and downtrodden”

          1. Pretty sure Marin estate-owners + Silicon valley bazillionaires are her dearest donor-constituency.

            Don’t forget highly-litigious public contractors!

            There was a hilarious segment the other night, I think it was on a local Bay Area ABC affiliate, where they showed a scenario where someone earning $75k a year would be trying to calculate how much they could save if they paid some of their $20k annual property tax bill in advance.

            My wife and I blurted out at pretty much the same moment “why don’t you consider selling that $2M house you obviously can’t afford?”

            It’s amazing how quickly the rich become poor victims when there’s a Republican tax plan to smear.

      2. I’m sure Dianne has been dealing with “Not hard enough” for most of her life.

  3. Look what republicans did to us, man: changed shut.

  4. Beyond the economic distortion caused by the tax code’s myriad deductions, credits, and exemptions, there is something fundamentally wrong with a system of revenue collection that can be navigated only with the help of experts?and in many cases (like this one) not even then. When it comes to figuring out what the tax code requires, the experts may disagree. People are expected to comply with the law but have no way of determining what that means.

    Now THAT’S a powerful set of laws.

    1. “Did you really think we want those laws observed?” said Dr. Ferris. “We want them to be broken. You’d better get it straight that it’s not a bunch of boy scouts you’re up against… We’re after power and we mean it… There’s no way to rule innocent men. The only power any government has is the power to crack down on criminals. Well, when there aren’t enough criminals one makes them. One declares so many things to be a crime that it becomes impossible for men to live without breaking laws. Who wants a nation of law-abiding citizens? What’s there in that for anyone? But just pass the kind of laws that can neither be observed nor enforced or objectively interpreted ? and you create a nation of law-breakers ? and then you cash in on guilt. Now that’s the system, Mr. Reardon, that’s the game, and once you understand it, you’ll be much easier to deal with.”

  5. All of the tax attorneys at my firm had to give up vacations to help clients through this, so they’re all extra cranky around the office. THANKS, TRUMP.

    1. Attorneys got screwed? Thanks Trump, indeed!

  6. there is something fundamentally wrong with a system of revenue collection that can be navigated only with the help of experts?and in many cases (like this one) not even then.

    Provide two random congresscreatures with a random taxpaypayer’s information. Give them, say, four hours to independently and properly complete the forms. If the forms are not *exactly* the same, both forfeit their jobs and their pensions. Repeat until this mess is fixed.

  7. Lolz. Rich Liberals who claim the rich should pay their fair share go out and prepay to avoid paying taxes.

    1. Every lefty turd believes that

      1) They should get to pay less.
      2) Everyone else besides themselves should have to pay more.

      1. 3) We’re not that well off, not really.

    2. One of my sisters is a die-hard liberal, a Bernie Sanders supporter, and an unapologetic socialist. But by golly, she pays a CPA to reduce her taxes whenever possible.

    3. Well-to-do Marxists: the ultimate hypocrites.

      1. Is there any other kind? You can’t afford to be a Marxist if you’re not well off.

  8. Not sure what the moral of the story is. I think it might be: don’t reform the tax system, because no matter how much better the reformed system is, the current system is so complex that things will be confusing for people trying to wring every last bit of benefit out of the complexities of the current system during the transition.

    1. Obviously the solution is a moratorium on federal income taxes until — what was the expression? — we figure out what’s going on.

      1. WRONG. Moratorium on income.

      2. Even that wouldn’t help address the problem Mr. Sullum is complaining about. People are trying to figure out how to minimize their 2017 taxes under 2017 law by prepaying 2018 taxes. The tax reform bill really has nothing to do with it other than providing the incentive for people to try to find loopholes in pre-reform law before they’re totally gone. So even if we had a moratorium on income taxes starting today, people would think “well, I can’t get any tax benefit out of this expense going forward, so I need to find a way I can claim it against the taxes I have already had withheld so far this year so I can get a bigger refund.”

  9. Many (even most?) people with SALT > standard deduction were already in AMT, which means they already couldn’t deduct SALT.

    This is a significant and largely unreported fact. Many people in high-tax, high-mortgage states will still be getting tax cuts because SALT is irrelevant for them.

    1. Exactly. And the AMT trip level is going up.

    2. AMT is going to pwn these people. I discovered this the hard way when I paid one year in January and the following year’s tax that December. That meant I paid 2 years of property tax in a single calendar year. AMT disallowed most of the “second” year property tax deduction.

      In other words, they might routinely deduct $15 in SALT from their regular taxes, but when they try to deduct $25k, AMT will kick in.

      So it’s slightly more complicated than “they already couldn’t deduct SALT.” It’s more accurate to say “they already couldn’t deduct $25k in SALT, but they don’t know that yet.”

  10. I thought liberals liked big government and cared about the deficit? So why are they rushing out to prepay 2018 local property taxes and dodge paying their fare share of federal income taxes in 2017?

  11. ” it created a bunch of new wrinkles for Americans trying to figure out how much they owe the federal government”

    Just to clarify. I don’t “owe” the federal government jack shit. That would imply that I had a voluntary contractual obligation, instead of an SS number assigned to me at age 5. I accept that, under threat of violence, I am destined to feed parasites at all levels of government. But I don’t owe them anything.

  12. If I understand correctly, these people are trying to prepay their 2018 property tax liability. A liability for which their property values have not yet been assessed and their taxes not yet specified? They won’t get an actual bill until October of 2018?

    And if they sell their house by December 31 (unlikely) they will not owe even a prorated portion?

    LOL. Fuck that. The IRS should disallow every bit of that.

    However, in reality the 1040 form doesn’t ask such details. It just asks for a single number of how much you paid during the calendar year. So, unless you are audited, there’s no real way for the IRS to flag you. For example, they don’t know if you are paying both 2017 and 2016 property taxes in calendar year 2017, at different times.

    There is a calculation for state income tax refunds received in 2017 for taxes owed/paid in 2016. But no such thing for property taxes. I think.

    IANAL

    TLDR: People will get away with this unless they are audited and then they will owe a small penalty.

    1. I was writing my post below, refreshed and saw yours making the same point. This doesn’t seem like a particularly complicated or onerous rule and I’m not sure what litigation would follow. As stated above it “could be considered an effort to evade federal income tax liability.” Not that there’s anything wrong with that.

    2. They won’t get an actual bill until October of 2018?

      Depends on the state. My 2018 property taxes are past-due, and I’d be assessed a penalty, on Feb. 1.

      Not that they’ll be anywhere near $10K.

  13. “The IRS did not explain the legal rationale for distinguishing between payments and assessments, which is bound to be the subject of litigation.” Seems to me they’re simply saying that if the property was assessed in 2017 and the tax amount payable in 2018 is known, then the deduction can be used. If on the other hand people are simply making a payment to avoid the cap the deduction cannot be claimed. I don’t think there is any way to prepay taxes in Illinois because we pay in arrears and don’t get a bill til spring but other states may differ. Maybe one of you CPAs can clarify.

  14. OK. Checked my 2016 return. My SALT deduction was 11,674. I live in Texas, so I have no state income tax, but I can deduct a couple thousand in sales tax.

    For me, property taxes plus mortgage interest plus charitable donations > $24k so that doesn’t help me unless I stop giving away money.

    And my wife is a Schedule C so fuck my life. I am getting no tax simplification.

  15. Rather than screeching about a one-time change in the tax code that is arbitrary at best and petty partisan politics at worst, wouldn’t the more relevant libertarian question and concern be why any tax benefits for homeownership exist in the first place? (Stated reciprocally: Why shouldn’t rent also be deductible in whole or in part?)

    1. Theoretically the landlord is deducting the interest against his rents which means he can charge lower rents which means hell if I know.

  16. Ignorance of tax law is no excuse!

  17. Really?
    Anyone who cannot understand “if you got a property tax bill in 2017 and aid it 2017 you can deduct it; otherwise you cannot deduct it” should not be allowed to own property or vote. They should be institutionalized.

    1. maybe even ‘paid it in 2017’

  18. Not difficult. IRS did not “compound” the issue. In order to deduct a qualified expense must be incurred at time of payment. In order for the expense to be incurred, in this instance, a real estate tax bill, it must be assessed and issued by the taxing authority. You cannot deduct a generic prepayment. Its not that hard to understand.

  19. Easy fix – PAY YOUR TAXES!

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