Tackling the New Tax Law in 2018
Although much has changed, “tried and true” planning strategies can still be beneficial.
Our Christmas “gift” from the Republican Congress and administration came in the form of a rushed, complex, far-reaching tax overhaul: The Tax Cuts and Jobs Act. There were numerous articles describing tax-savings moves to make before Dec. 31, 2017, but it’s now 2018. Many analysts provided illustrations of how the new rules will increase a typical individual’s tax liability, while others were certain that the law will decrease the average taxpayer’s tax hit.
Speculation about how the law will affect Americans in general has little to do with ramifications to any particular taxpayer. With that in mind, I will begin with a brief overview of the new provisions, followed by recommendations on what to do.
The law slashes corporate tax rates and cuts individual tax rates—especially for high-income taxpayers. The corporate reductions are permanent, while the individual tax cuts expire after 2025. Over the next decade, these provisions are expected to add about $1.5 trillion to the U.S. deficit.
Reductions for Individuals
Increases for Individuals
What Should You Do?
We are all subject to a new world of tax laws, thanks to the new law. We can’t change the past, so what strategies and moves should we consider? Here are my recommendations:
Watch Your Withholding
New withholding tables will likely reflect lower tax rates under the new law. While taxpayers might feel good about getting a larger check each payday, the tables might not represent their tax picture. In other words, taxpayers should be wary of fast money in their pockets. They might end up owing more come April 2019.
Determine Whether You Will Itemize or Claim the Standard Deduction
Many traditional itemized deductions are no longer allowed, and the standard deduction has been doubled. What this means is that many more taxpayers will be claiming the standard deduction—even if they itemized in the past. As of 2018, allowable itemized deductions will be the total of:
For example, let’s compare a married couple’s allowable itemized deductions for 2017 versus 2018.
Say the couple in 2017 could deduct:
$12,000 in property taxes, $9,000 in state taxes, $8,000 mortgage interest, $4,000 home equity interest, $3,000 charitable contributions, $1,000 tax prep, and $10,000 for investment management minus 2% of adjusted gross income.
The deductions for the same couple in 2018 would be: $10,000 total property and state taxes, $8,000 mortgage interest, and $3,000 charitable contributions.
Assuming they had an adjusted gross income of $150,000, this couple’s 2017 itemized deductions would have totaled $44,000. The same expenses would result in allowable itemized deductions of only $21,000 in 2018. Without deducting home equity interest, miscellaneous itemized deductions and state/local/property taxes above $10,000, this couple will now be forced to claim the standard deduction of $24,000.
It is important to know if clients will be itemizing or claiming the standard deduction because this can have an impact on planning.
Consider Bunching Deductions
Just because taxpayers claim the standard deduction in one year doesn’t mean they can’t qualify to itemize in another year. Remember that if they claim the standard deduction, they will get no tax benefit from paying state/ local/property taxes, mortgage interest, charitable deductions, or medical expenses more than 7.5% of AGI.
How can they get a benefit? Try bunching deductions every other year. In the above example, let’s say that the couple makes their Jan. 1 mortgage payment in December and prepays their 2019 charitable commitment by the end of 2018. Additionally, let’s assume that the couple pays an orthodontist bill by the end of 2018, leaving $2,000 of medical expenses more than 7.5% of AGI. Based on this, the couple’s 2018 total itemized deductions will be $26,600—greater than the $24,000 standard deduction.
Consider a Donor-Advised Fund
A donor-advised fund can provide further opportunity to bunch charitable deductions without immediately distributing funds to specific charities. It’s like a “charitable IRA.” Investors get a tax deduction as soon as they contribute to the fund. The fund invests the money until they decide to make grants to the charities of their choice, and they don’t pay taxes on growth while the funds are invested. Also, investors don’t have to contribute cash—they may get greater tax benefits by contributing appreciated securities. They will get a deduction for the full value of the shares—and they won’t pay tax on the gain. Because they receive a charitable deduction at the time they contribute to their fund, if they establish and contribute to the fund before year-end, they will receive a tax deduction in 2018—no matter when they designate grants in the future.
Pay Attention to Other Tax-Saving Strategies
Be sure to remember other tax-saving strategies, as applicable. These can include:
The new tax rules will have a major impact on taxpayers as well as the U.S. economy. How they will affect you and your clients depends on your specific circumstances.
This article originally appeared in the February/March 2018 issue of Morningstar magazine. To learn more about Morningstar magazine, please visit our corporate website.