What the Tax Package Means for Your Financial Plan

Much of the tax legislation that's currently on the precipice of passing through Congress centers around reducing tax rates for corporations and small businesses structured as pass-throughs. But plenty of the bill's provisions touch individuals, too. On Friday, a conference version of the bill was released to the public.

Of course, nothing is final until both houses of Congress vote on the bill and the president signs it into law; we'll be providing more updates and guidance as we get new information. But as of this writing, here are some of the key provisions that relate to financial and investment planning for individuals.

Note that if the bill becomes law, most of these provisions would take effect in the 2018 tax year, but nearly all of them would also expire at the end of 2025. As always, check with a tax professional before enacting any changes to your investment or financial plan in anticipation of these changes.

Tax Brackets The proposed legislation retains seven tax brackets, but the tax rates--and the income levels that apply to each--are changing a bit. Notably, the highest tax rate--currently 39.6%--would decline to 37%; it would apply to single taxpayers earning more than $500,000 and married couples filing jointly with taxable incomes of more than $600,000. Baird director of advanced planning Tim Steffen points out that the proposed tax bill would lower marginal tax rates for most taxpayers. A notable exception, Steffen says, is married filers with incomes between $400,000 and $424,950 and single filers with incomes between $200,000 and $424,950; such taxpayers would see their marginal tax rates jump from 33% currently to 35% under the proposed legislation.

Dividend and Capital Gains Tax Note that the three main tax rates that prevail for qualified dividends and long-term capital gains today--0%, 15%, and 20%--would remain, but changes to the ordinary income tax brackets would necessitate a change in the income levels that map to each. The 0% rate would apply to single taxpayers with incomes of less than $38,600 and married filers with incomes below $77,200, while a 15% rate would apply to single taxpayers with income between $38,600 and $425,800 and joint filers with incomes between $77,200 and $479,000. Single taxpayers with incomes over $425,800 and married couples with incomes of more than $479,000 would owe 20% on qualified dividends and long-term capital gains.

First In, First Out Earlier versions of the bill would make first in, first out the only allowable cost-basis election, giving investors less control over their tax bills by forcing them to sell their oldest shares first. The current version of the bill, however, discards that provision, retaining investors' ability to cherry-pick specific lots of securities to sell if using the specific share identification method. This article includes more detail on cost basis elections.

IRA Recharacterizations One of the most generous provisions in the tax code currently gives investors the ability to recharacterize--or undo--previous conversions of traditional IRAs to Roth or vice versa. The current version of the bill, however, would not allow recharacterizations starting in 2018, meaning that an investor who converts must stick with her decision. That means that investors who have their sights set on recharacterizing an IRA conversion should do so before year end 2017. (Given that many investors employ recharacterizations when their accounts have declined in value, however, 2017's roaring stock market doesn't lend itself well to that tactic.)

Moreover, as Michael Kitces points out in his extensive post on the proposed tax law, investors will still be able to recharacterize errant contributions from Roth to traditional or vice versa. For example, if an investor made a Roth IRA contribution but later found that he was over the income thresholds for such a contribution, he would still be able to recharacterize his IRA as a traditional nondeductible IRA.

Standard Deduction The proposed law includes a significant increase in the standard deduction, to $12,000 for individuals and $24,000 for married couples filing jointly. These amounts represent a near-doubling of the current standard deduction amounts. Yet as Kitces points out, the elimination of personal exemptions--currently at $4,050 per family member--takes a big bite out of the benefit of the increased standard deduction amounts; for some families, the current combination of personal exemptions and the standard deduction would actually be higher than the proposed higher standard deduction amount. At the same time, Kitces notes that an expanded child tax credit--to $2,000 per child under 17 from $1,000 currently--will help offset that differential in many cases.

Itemized Deductions For taxpayers who itemize, the proposed legislation caps the combined deduction for state and local taxes, including property taxes, at $10,000 for both single and married couples. Many taxpayers have been mulling prepaying their taxes, especially if the new higher standard deduction makes itemizing less attractive for 2018 or if they still expect to itemize but their state and local tax burden, including property taxes, is significantly higher than $10,000. Notably, however, the proposed law would not allow for the 2017 deductibility of state income taxes related to the 2018 tax year if those taxes were paid in 2017. However, that leaves open the opportunity for taxpayers to prepay their 2017 estimated income taxes--normally due in mid-January 2018--in 2017, as well as to prepay their property taxes related to the 2017 tax year. Here's a good spot to check with a tax professional for guidance before taking action.

Also of interest for itemizers, charitable contributions amounting to up to 60% of the taxpayer's adjusted gross income would be deductible (an increase from the 50% of adjusted gross income deductibility threshold that prevails currently). And while the deductibility of medical expenses was on the chopping block in an earlier draft of the legislation, the current legislation allows for the deductibility of medical expenses in excess of 7.5% of adjusted gross income in both 2017 and 2018. The lowering of the threshold for deductible medical expenses--from its current level of 10% to 7.5%--is one of the few provisions that would affect taxpayers' 2017 tax liabilities, Steffen notes.

Additionally, taxpayers will no longer be able to deduct miscellaneous itemized expenses such as advisor fees and tax preparation fees; under current law, these expenses can be deducted if they exceed 2% of adjusted gross income. Finally, the current law tinkers with the deductibility of mortgage interest. Under current law, interest on mortgage debt of up to $1,000,000 is tax-deductible, but the new law would limit interest deductibility to mortgages of $750,000 or less. (Currently holders of mortgages of $1 million or less would still be able to deduct their interest.) Home equity loan interest would no longer be tax-deductible; that puts a HELOC at a disadvantage relative to a 401(k) loan as a source of emergency funding. (In addition, the 401(k) loan interest gets paid back into the account, whereas the HELOC interest is paid to a bank.)

Estate Tax Earlier drafts of the bill included an outright repeal of the estate tax. The current form of the legislation leaves the estate tax but roughly doubles the exclusion amount, from its 2017 level of $5.49 million per person/$10.98 million for married couples, to $11.2 million per person/$22.4 million per couple.

College Funding The proposed legislation would allow parents to use up to $10,000 of assets in a 529 account to pay for qualified K-12 expenses in a public or private school. (Karen Wallace wrote about using 529 assets for K-12 expenses in this article.) While earlier versions of the legislation banned new contributions to Coverdell Education Savings account, the current tax package does not.