Chances are you are well aware of the recent passage of the Tax Cuts and Jobs Act (TCJA) of 2017 and its reduction in corporate tax rates, changes to itemized deductions/exemptions and individual tax rate changes. You may be too busy organizing your 2017 tax papers to have fully focused on how TCJA will affect your 2018 taxes, so here we highlight some of the areas which may impact you the most.
Standard Deduction Versus Itemizing
Previous changes to the tax code are full of unintended consequences, and this time is no different. While charitable donations, mortgage interest and medical expenses are still deductible, several other deductions are eliminated. It is widely reported that many Americans will no longer be itemizing for two reasons. First, the standard deduction is rising to $12,000 (single) and $24,000 (married). Second, state and local income taxes (SALT) and property tax are limited to a combined total deduction of $10,000 (for both single and marrieds). States are working to convert non-deductible SALT expenses into deductible ones, but it is unclear how this will work. If you hit the SALT maximum of $10,000, then all your other deductions must be greater than $2,000 (single) or $14,000 (married) in order to make itemizing practical.
Lumping and Clumping
If you have little or no mortgage interest and few medical expenses, then you may elect to engage in deduction “lumping” and charitable “clumping,” such as concentrating SALT and charitable donations in certain tax years, in order for your itemized deductions to surpass the standard deduction amount.
With respect to SALT, if you are in a low income tax state and have relatively low annual property taxes, you may want to pay January’s property tax in December so that you lump 3 payments in one year (tax year 1) and one payment in the next year (tax year 2). (Be sure that your tax has been assessed, otherwise the deduction may not count.)
With respect to charitable donations, you have several established options for getting the most out of your donations. The first is to use a Donor Advised Fund (DAF). With as little as a $5,000 starting donation, you can create a DAF in your name, donate two years’ worth of donations into the fund, get the tax deduction in that year (tax year 1) and itemize. Allocate donations from the fund to charities over the next two years (tax years 1+2). In tax year 2, you don’t contribute to the fund and you don’t itemize. For more details on how a DAF works, read our blog Which Charitable Giving Strategy is Right for You?
Qualified Charitable Donations from an IRA
This option only applies to those with IRAs who are over 70 1/2. If you fit this description, you are allowed to donate to charities directly from your IRA. The donation counts towards your required minimum distribution AND it does not result in a taxable distribution. So, while the donation is not deductible, it is made with pre-tax dollars which is equivalent to making a deductible contribution. A big plus is that some financial institutions (Schwab, for example) are allowing IRA owners to simply write a check to a charity from their IRA. Simple and easy.
Mortgage and HELOC Interest
For those with the resources, it may appear attractive to pay off a mortgage if the mortgage is unlikely to generate a deduction. However, given the new rules, caution may be in order. Existing deductible mortgages are grandfathered, but interest on new mortgages will only be deductible if the funds are used to acquire or substantially improve a residence. For example, a HELOC of $50,000 used for a kitchen renovation would qualify, but once it is paid off, using the same HELOC to buy a new car for $50,000 would not be deductible. It is better not to pay off the kitchen HELOC, if you think you’ll want that tax deductible financing in the future.
529 Savings Plans
TCJA also made saving for education a bit more attractive, by allowing $10,000/yr/beneficiary tax-free withdrawals from 529s for elementary and secondary school education in addition to the already allowed college expenses. For more on this, read our blog Expanded Use of 529 Savings Plans Under the New Tax Rules.
Investment Advisor Fees
With the elimination of miscellaneous deductions (subject to 2% income threshold), investment management fees are no longer deductible. Consider having your IRA and other retirement account investment fees deducted from those accounts, so that you are paying with pre-tax dollars.
Sole Proprietors and Business Entities
If you are operating a business as a sole proprietor or as business entity, you should make sure that you are deducting any appropriate state and local taxes against the business since they are not subject to the $10,000 SALT limit.
For many, lower deductions will be offset by lower tax rates as well as a considerably higher threshold for AMT. The impact to you will depend greatly on your mix of deductions and income, making generalizations almost impossible.
Be sure to consult with your accountant and financial advisor on these new tax laws. Can’t wait for the 2018 tax season to begin!