The Tax Cuts and Jobs Act was signed into legislation last December, and this upcoming 2018 tax filing will be our introduction to how the changes affect us personally. As Q3 comes to a close, we have been thinking about what steps can be taken over the remaining 70 days with the goal of reducing tax liability, improving cash flow, or saving time.
Many of the recommendations are familiar and repeated annually, but each year almost always contains a twist that requires us to consider our strategy anew. This year is no different, with changed tax brackets and reduced Schedule A deductions in particular.
1) Determine if you are going to file a Schedule A or take the standard deduction. In 2017, approximately 30% of all tax filers itemized. Given the extremely restricted allowable deductions (e.g.: no more unreimbursed business expenses, accounting or portfolio management fees, moving expenses, personal casualty lossesi), and considering the increased standard deduction amounts, it is estimated that only 10% of filers will now itemize deductions on a Schedule A. This year, the maximum amount that can be deducted for state and property tax combined is $10,000. Add to that the amount of applicable mortgage or HELOC (Home Equity Line of Credit) acquisition interest paid (with limitations, see below), and you will have your base deductions. On top of this number, the addition of medical expenses in excess of 7.5% of AGI, and charitable donation amounts will either bring you over the standard deduction floor – or not.
2) Review your charitable gifting. If you are under the standard deduction floor even when including deductible charitable gifting, there are still ways to enhance gifting financially as well as emotionally:
- If possible, use highly appreciated stock to make charitable donations. The charity receives the shares at current market value, but you do not have to pay tax on the capital gain, and the capital gain does not add to your AGI (adjusted gross income), or impact calculations that use your AGI.
- You could set up a Donor Advised Fund and donate a few years’ worth of donations all at once to increase the current year itemized deduction, then take the standard deduction in the following years.
- If you are 70.5 or more years old, deliver all or part of the IRA RMD (Required Minimum Distribution) directly to a qualified charitable institution (up to $100,000). RMD amounts donated directly to a charity are not included in your taxable income, therefore reducing your AGI, which favorably impacts other calculations that use your AGI number. This is commonly referred to as a Qualified Charitable Distribution.
- Forego the tax deduction, and in doing so leave behind the need to keep track of the value of the dinner, or the gift, or the silent auction item vs the charitable donation.
3) Arrange for investment management fees of IRA and other tax-deferred accounts to be paid from the tax-deferred account directly with pre-tax dollars. This is an allowable expense.
4) Review mortgage and HELOC deductibility. Interest on a HELOCs is still tax-deductible provided it was used to buy, construct, or improve the residence. If the interest expense is insufficient to itemize, calculate the tax, portfolio and cash-flow ramifications of paying off the mortgage and/or HELOC debt.
5) As always, it is useful to review portfolios for any meaningful tax-loss harvesting to improve a tax position. The $3,000 capital loss deduction is still allowed. However, it is equally important to review capital gain positions, to ascertain whether there is room in the tax bracket to take some capital gains at favorable tax rates. This is especially useful in lower income years, such as those after retirement, and before Social Security and IRA withdrawals add to taxable income. The lower tax brackets of the Tax Cuts and Jobs Act legislation may have opened up some cost basis step-up opportunities.
6) If you are a member of an employer sponsored retirement plan (401(k), 403(b), 457, Simple IRA), verify that you will reach the maximum contribution ($18,500 + age 50 and over catch-up amount of $6,000; or $12,500 + age 50 and over catch-up of $3,000 for a Simple IRA) by the end of the year. If not, consider increasing your remaining deferral amounts to reach the maximum and supplementing your cash flow from other investments.
7) Check that wage withholdings and any estimated tax payments made to date in 2018 reflect the new tax regime with the lower tax brackets and increased standard deductions. It may be that your withholdings can be reduced, or that a fourth installment of estimated taxes will not be required. The IRS released an updated calculator that can be used. https://www.irs.gov/individuals/irs-withholding-calculator
8) Don’t forget that now is open enrollment for many health insurance plans, including Medicare. Make full use of the tax deduction and tax deferred growth of a HSA account if the insurance coverage is appropriate, and make maximum use of the ability to pay certain medical, child care, and transportation expenses using pre-tax FSA money if possible.
9) If you have vested Incentive Stock Options (ISOs), request a tax projection to determine whether some of the ISOs can be exercised without adverse AMT consequences. The expanded AMT tax exemption amounts combined with the limited Schedule A deductions could create a favorable ISO exercise environment.
10) Fund 529 Education Plans using all or part of your individual annual gift tax exclusion amount of $15,000.
11) Review withdrawals from Survivor and Bypass trusts. The increase in the Estate Tax Exemption amount to $11.2 million per person has switched the focus from estate tax avoidance to the protection of cost basis step-up. It may now be more efficacious to spend down accounts that will not receive a step-up of assets on death.
The new tax legislation also contained significant changes for business entities, sole proprietorships, partnerships, LLCs, S and C Corps, but for reasons of complexity we did not include any recommendations pertaining to those. As always, please consult with your tax advisor for specific tax related questions.
We would be happy to talk with you about these tips and other last-quarter strategies that can be employed to enhance your overall financial situation, and look forward to working together.
i Moving expenses are allowed as a deduction for active-duty members of the U.S. Armed Forces whose moves relate to a military-ordered permanent change of station. Also, to the loss of personal casualty losses, The Act did retain a deduction for qualified disaster-related personal casualty losses if the loss occurs in a presidentially declared disaster area and is a result of the disaster.