April 6, 2018
As the April 17 tax filing deadline fast approaches, we find ourselves rushing to finish our 2017 income tax returns while strategizing around the new Tax Cuts and Jobs Act, which takes effect for tax year 2018. As a result, it’s easy to be misled by tax myths and misconceptions. Below, several of our wealth management experts have set out to debunk some of the more common myths regarding income and estate taxes to help you save time and money.
A common misconception is that taxpayers need to provide a lot of detail to their accountants about their itemized deductions. The most time-consuming records to organize are for Miscellaneous Itemized Deductions. These include tax preparer fees, investment fees, unreimbursed job expenses (including unreimbursed travel, dues and subscriptions), and safe deposit box rental, to name only a few. For 2017, if you were subject to Alternative Minimum Tax (AMT), these deductions were disallowed rendering your upfront preparation worthless in the end. Under the new tax law, it gets worse. These expenses are now disallowed for everyone, not just for those subject to AMT.
We recommend speaking with your wealth manager or personal tax preparer now about what allowable deductions remain and if there are other strategies for deducting these costs. As the new tax law resulted in significant changes in this regard, it may save you disappointment when you review your 2018 tax return and find all your hard work on the cutting room floor.
— Michael Glowacki, Director in Wealth Management, Principal
The benefits of charitable giving with appreciated stock are considerable. Before you make plans to do so, we recommend that you make sure you have the charitable intent necessary to make such a gift. In the appropriate situation, the true “cost” to you may be as little as 19¢ for every $1 gifted, but it’s not zero.
For example, if you bought 63 shares of Amazon stock in 2010 for $7,000 and subsequently gifted those shares to a charity in 2018, you would be forgoing the chance to sell those same shares for proceeds of $100,000. In California, you could avoid state and federal taxes in the amount of $31,000 on that sell transaction (33% x long-term capital gain of $93,000). You also would receive a charitable deduction based on the $100,000 fair market value at time of donation, which if you had sufficient other income could give you a tax deduction worth as much as $50,000. Therefore, your net after-tax cost of the gift is $19,000. The key is making the charitable gifts in high-income years when you can get the most “bang for your buck” on the charitable deduction.
— Clay Stevens, Director in Strategic Planning, Principal
Most homeowners have the ultimate goal of paying off their home loan, whether it be for emotional reasons or simply to improve their monthly cash flow position. However, keeping existing loan balances (mortgages and home equity lines) in place could make sense for overall tax and investment optimization. The Tax Cuts and Jobs Act limits the deduction for interest payments to the first $750,000 of mortgage debt used to purchase or substantially improve a principal residence or vacation home, combined. And for existing mortgages, the law grandfathered up to $1 million in debt.
Because of the dramatic changes to allowable itemized deductions noted above, many taxpayers are scrambling to find qualified expenses to deduct. To that end, if your mortgage interest and other deductions exceed the standard deduction amount, it may make sense to keep the liability in place and continue to deduct the interest on Schedule A. And even though home equity interest is generally no longer deductible, if the interest cost is low, you might earn a greater return by maintaining your investments instead of paying down a home equity loan.
For higher-cost debt, ask your wealth manager to figure the after-tax cost of the debt and compare that cost to investment opportunities elsewhere to determine if or when to pay down a loan.
— Tom Tracy, Chief Client Officer, Principal
You now cannot deduct more than $10,000 of the combined total of your state and local income taxes and your local property taxes on your personal federal income tax return (or sales tax plus property taxes in states where there is no income tax). If you have high state income and real estate taxes, you will likely be losing out on the deductibility of any dollars over and above $10,000 going forward. For this very reason, paying state estimated tax early in December (rather than January) does not provide you with any benefit. Keep the money in the bank or invested a little longer.
— Mark Cecchini, Senior Associate in Wealth Management
California certainly has one of the highest state income tax rates, which is now even more burdensome with the loss of the federal deduction for state income taxes. Some residents, therefore, are leaving the Golden State for other states where there is little or no state income tax, like Nevada, Oregon and Washington. However, unlike Oregon, Washington and 19 other states, California does not have a state inheritance tax, which can be as high as 20% and imposed on all your assets — not just the income earned from those assets.
For example, if a Californian with a net worth of $20 million and $1 million in taxable income moves to Washington to take advantage of the 0% state income tax rate, they may save $130,000 a year in state income taxes, but they could pay over $3.5 million in state inheritance taxes at death.
So, it makes sense to have your wealth manager weigh your income versus estate tax liabilities before you move. One of our clients just relocated to California to save taxes — and the warmer weather was just a bonus!
— Clay Stevens, Director in Strategic Planning, Principal
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