March 8, 2018
The Tax Cuts and Jobs Act did not fundamentally reform the individual income tax system, but it did tweak enough provisions to alter the tax planning landscape beginning in 2018. The good news is that many taxpayers will see their federal taxes go down this year. But not everyone will see their tax bill drop because limitations or wholesale elimination of certain deductions may offset the benefit of slightly lower tax rates.
One thing remains unchanged: Year-round holistic tax planning and a sound understanding of the character and timing of income and deductions can help identify opportunities and strategies to achieve a more efficient tax result.
Here are 10 pointers and tax tips to help you plan for 2018.
1. Know your tax bracket
Having a good estimate of where your income might fall can help you to strategize on areas such as how and when to receive income, and maybe even whether to tie the knot.
The law modestly lowers individual income tax rates across the board and sets the top marginal tax rate at 37%. Worth noting is the narrow gap between the thresholds where the top 37% tax bracket kicks in for individuals ($500,000) and for married couples ($600,000), the so-called “marriage penalty.” For high-income singles, late December weddings just became less popular.
Because of the new tax rates, you may also want to update the tax withholdings from your paycheck. The IRS just released a new calculator to help you figure out if you need to file a new W-4 form with your employer.
But the ordinary income rate should not be the only thing you look at. If you have any investments or a house, you should also consider capital gains. The new law preserves the tax treatment of capital gains and qualified dividends. The table below is helpful when planning around these income items.
|Capital Gain Tax||Income Thresholds|
|Single||Heads of Household||Married Filing Jointly|
|Zero||Below $38,600||Below $51,700||Below $77,200|
|15%||$38,600 ‒ $425,800||$51,700 ‒ $452,400||$77,200 ‒ $479,000|
|Additional 3.8% ACA surtax||MAGI* over $200,000||MAGI* over $200,000||MAGI* over $200,000|
|20%||Over $425,800||Over $452,400||Over $479,000|
*Modified Adjusted Gross Income
There are also changes to the AMT, which will now apply to fewer taxpayers, and a new Qualified Business Income deduction. So, it’s important to understand all the ramifications of bringing income into this year and plan accordingly.
2. Determine if you’re better off taking the standard deduction
Many taxpayers, particularly those without mortgage debt, may discover that taking the standard deduction ($12,000 for individuals and $24,000 for married filing jointly) is better than itemizing. Taking the standard deduction means streamlined tax preparation and less record keeping. The Tax Policy Center estimates that barely 10% of households will itemize deductions in the future.
3. Hold on to home equity acquisition debt
The elimination of deductibility of home equity loan interest effectively increases the after-tax cost of that debt, thereby making it more attractive to pay off home equity loans. One exception is home equity debt taken out before December 15, 2017, that qualifies as acquisition debt. It’s still deductible up to the $1 million grandfather limit.
4. Pull forward foreseeable medical expenses into 2018
If you’re considering elective surgery in the near future, the law provides a slight incentive to have the procedure done in 2018 as the hurdle to achieve deductibility is 7.5% of adjusted gross income (AGI) versus 10% of AGI in following years. But first check that total medical expenses would exceed the AGI threshold.
5. Bunch up itemized deductions
The law severely curtailed the deduction for state and local income and property tax and eliminated other miscellaneous itemized deductions. On the other hand, it increased room for charitable contributions by making cash contributions to public charities deductible up to 60% (rather than the current 50%) of the donor’s AGI.
Taxpayers with little or no mortgage debt whose combined itemized deductions (primarily state and local taxes, and charitable contributions) are close to exceeding the standard deduction should consider bunching them by shifting the timing of a deduction. For example, pull forward a charitable contribution into one tax year to boost itemized deductions and obtain a greater tax benefit, and then revert to using the standard deduction in other years. This strategy may be particularly appealing for those who have charitable intent and appreciated assets to fund a donor advised fund.
6. Use your IRA for charitable donations
If you’re older, and especially if you’re not going to itemize, consider using your IRA for charitable donations. The law preserves the ability of taxpayers over age 70½ to make qualified charitable contributions from their IRAs. Taxpayers can give up to $100,000 directly from their IRAs to charity and avoid including the distribution in their income. The contribution also satisfies the minimum distribution requirement. Excluding the distribution from income also helps manage exposure to other taxes and phase-outs, such as the 3.8% surtax on investment income.
7. Postpone Roth conversion decisions
The law eliminated the ability to unwind conversion distributions from a traditional IRA to a Roth IRA. As a result, taxpayers must be confident in the conversion decision because they can’t hit the undo button anymore if you want to capture investment losses. Therefore, for many taxpayers, it’s better to wait on conversions until later in the year when you’ll have more insight into your total income and deductions.
The law left untouched the ability to recharacterize regular, annual IRA contributions made to one type of IRA (either traditional or Roth) as if it were a contribution to the other type. So, you can still clean up contributions made in error to either a traditional or Roth IRA.
8. Review your divorce settlement
Alimony payments are no longer taxable to the recipient or deductible by the payer for divorce agreements executed or modified after December 31, 2018. This change effectively eliminates the ability to achieve a tax advantage when the deduction value for the individual paying the alimony (usually higher income) is greater than the tax cost borne by the alimony recipient (usually lower income). So if you’re divorced or going through a divorce now, make sure your divorce attorney keeps these new rules in mind.
9. Bulk up 529 plans
The new law provides added flexibility to tap into 529 college saving plans to the tune of $10,000 per year to cover tuition costs at public, private, or religious elementary or secondary schools.
If you have young children or grandchildren, consider funding those accounts at a higher level to grow tax-free and cover a portion of the cost of elementary and secondary schools. Taxpayers with large 529 plans can use this added flexibility to better manage cash flow or help prevent a 529 plan from becoming overfunded.
10. Examine your children’s income
The so-called “Kiddie tax” has changed, so like tip No. 1 above, know your kid’s tax bracket as well.
Previously, children under age 19 or full-time students under age 24 were taxed at their own individual rates for any earned income (from wages), but their unearned income (i.e., portfolio income) above a threshold ($2,100 in 2017) was effectively taxed at their parent’s marginal tax rate.
|Unearned Income||Tax Rate|
|$0 – $2,550||10%|
|$2,551 ‒ $9,150||$255 + 24% of more than $2,550|
|$9,151 ‒ $12,500||$1,839 + 35% of more than $9,150|
|$12,501 +||$3,011.50 + 37% of above more than $12,500|
The new law changes this arrangement by subjecting children’s unearned income to trust tax brackets, which are compressed and top out at 37% on income over $12,500. This change won’t mean much for high-income families paying a 37% marginal federal rate, but it could boost the Kiddie tax for taxpayers in lower marginal rates whose children’s portfolios produce more than $12,500 of unearned income. On the flip side, children with modest amounts of unearned income may see some benefit from moving through the lower 10% and 24% trust tax versus their parent’s marginal federal tax rate.
These are just some of the changes, which underscore the benefits of performing tax projections throughout the year. The tax law has many moving parts, and they often interact in surprising ways, such as impacts on Medicare Part B premiums and phase-out rules for the new Qualified Business Income deduction. A projection can help you make informed decisions about how various decisions (realizing capital gains, reconsidering business income, purchasing a rental property, etc.) influence your overall tax result.
Regardless of how specific tax provisions may impact you, it’s always best to meet with your wealth planner to make sure your financial plan, including tax planning strategies, is positioned to meet your goals in 2018 and beyond.
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