Falling Into Tax Planning Season

With the end of the year approaching, tax and financial planners have some important issues to consider before their clients come calling. By MARK J. GILBERT, CPA/PFS, MBA | Fall 2018



The Tax Cuts and Jobs Act of 2017 (TCJA), enacted into law in late 2017, has held the attention of tax and financial planners all year. As 2018 is nearing its end, however, some of the most useful tools available to aid us in confidently interpreting the law and planning for our clients to effectively reduce their 2018 income taxes (like IRS guidance and tax planning software) are, as of this writing, still inadequate or unavailable. Nevertheless, we must carry on. So, here are some of the most important issues I’ve identified in planning for my individual taxpayer clients.

TAX RATES, STANDARD DEDUCTIONS, EXEMPTIONS, AND CREDITS

A signature feature of the TCJA is that, generally, for a given level of income, the marginal federal income tax rate is lower in 2018. Clients are likely to focus on that aspect of the law, especially if their gross income has changed little between 2017 and 2018. Of course, taxes are computed on income net of deductions and exemptions, or adjusted gross income (AGI), not on gross income.

The standard deduction has increased meaningfully, to $12,000 for single filers and $24,000 for married filing jointly, while the personal exemption for each household filer and dependent has been eliminated (from $4,050 in 2017). The child tax credit has also increased significantly, to $2,000 per qualifying child, and a new family credit of $500 per qualifying dependent has been introduced for 2018.

Since these changes, and others discussed below, are so sweeping and could result in significant increases in or decreases in tax liabilities, I believe most clients will benefit from a review of their 2017 tax liability and some sort of projection of their 2018 liability. At a minimum, I recommend communicating with clients that the impact of this tax law is hard to determine without having a formal discussion and review of their finances before the end of the year.

ITEMIZED DEDUCTIONS

Given the substantial increase in the standard deduction, it’s quite possible that most taxpayers will elect it over itemized deductions. However, there may be opportunities to proactively “bunch” itemized deductions from two years into one year such that the total exceeds the standard deduction for appropriate clients. Consider the following:

• Accelerating qualified medical expense payments into 2018 from 2019 might be beneficial since the medical expense deduction threshold is 7.5 percent of AGI in 2018 vs 10 percent in 2019.

• State and local tax deductions are limited to $10,000 per year.

• The mortgage interest expense deduction is reduced to $750,000 (on post-December 15, 2017 loans) from the prior cap of $1 million, and interest on most home equity loans is no longer deductible beginning in 2018. Consider evaluating whether clients should refinance an existing mortgage to pay off the home equity loan.

• The charitable contribution (cash) limitation increases from 50 percent of AGI to 60 percent in 2018. For charitably minded clients, consider introducing the idea of contributing to a donor advised fund, where a relatively large one-time gift can be deposited in 2018 and distributed over multiple years in the future.

• Miscellaneous itemized deductions have been eliminated. Investment management fees once paid with after-tax funds to secure the tax deduction might now be allocated between IRA and after-tax funds. Consider paying the IRA share of the fee from the IRA, which is also attractive as this might reduce future required minimum distributions.

• The itemized deduction phase-out, for higher income level taxpayers, has been eliminated.

ALTERNATIVE MINIMUM TAX

Exemption amounts have increased by 29 percent for 2018, and the income thresholds at which taxpayers can take at least a partial exemption has increased significantly in 2018 ($781,200 for single filers and $1,437,600 for married filing jointly). As a result, fewer taxpayers are expected to be subject to alternative minimum tax.

NET INVESTMENT INCOME TAX

The net investment income tax, which first landed on taxpayers’ returns for 2013, was created to generate tax revenue to cover a portion of the costs of the Affordable Care Act. While the tax rate and computation methodology were largely unchanged with enactment of the TCJA, the reduction in itemized deductions might cause modified AGI to increase and result in a higher tax. Therefore, I recommend the use of tax-free municipal bonds in client portfolios as the interest on these bonds is excluded from the computation of net investment income for these purposes.

SECTION 529 AND ABLE ACCOUNTS

The TCJA now permits the use of a Section 529 plan account for a child’s elementary and secondary education, in addition to college and other qualified higher education. Therefore, consider recommending clients make contributions to these plans, especially when they are interested in private primary education for children, grandchildren, and other family youngsters.

ABLE accounts, which provide a means for individuals with disabilities and their families to fund the typically higher living costs that disabled individuals face, are funded with after-tax dollars. This provision of the law recognizes that a child, for whom a 529 plan account was established with the expectation that he or she would attend college, may develop a disability and be unable to attend post-secondary school. In this case, 529 plan funds could be used to assist with the child’s disability-related living expenses. I recommend encouraging parents and grandparents of disabled children to set up and fund ABLE accounts.

Whenever we see major tax legislation, it often modifies multiple provisions of the tax code. The TCJA is no different. That’s why this year it’s critical to assess all areas of your clients’ finances to determine the net effect of all TCJA changes on them. It’s far too difficult to predict that what applies to one client might apply to most of your clients. In any event, there’s plenty of tax and financial planning opportunities ahead. Hopefully I’ve presented some ideas that you or your clients can act on to mitigate at least a portion of the negative impacts of the TCJA.