WASHINGTON — It’s Halloween and the Grim Tax Reaper lurks in the shadows patiently waiting to collect his due! Beware of the 2018 tax rule changes from the Tax Cuts and Jobs Act of 2017 (TCJA) that may bring unexpected tricks to the unprepared. There’s still time before year-end to utilize a few tricks of your own! There are even ways for you to give treats to your favorite charities that avoid the Grim Tax Reaper’s grasp. Read on … if you dare!
The tricky tale of deductions
The new standard deductions for 2018 are $24,000 (married filing joint), $18,000 (head of household) and $12,000 (single). While this could be a treat, many taxpayers will unknowingly fall into these buckets and lose the value of itemized deductions, even though they have itemized in the past. Due to a couple of unfavorable changes under the TCJA, state and local tax deductions (including state income, excise and real estate taxes) are capped at $10,000; and 2 percent itemized deductions, such as unreimbursed employee expenses and tax prep and investment management fees, are no longer deductible.
The home mortgage deduction is still allowed but now limited to interest on only $750,000 of new debt incurred after Dec. 14, 2017. Home equity interest deductions also got a little devilish starting 2018. If you used your home equity line of credit (capped at $100,000) to buy, build or substantially improve your home, the interest continues to qualify as a deduction. If these loan proceeds were used to purchase a car, pay for college, or consolidate other loans, then beware, the deductibility of this interest is no more.
Another “ghost of tax seasons past” will soon include the ability to deduct qualified medical expenses in excess of 7.5 percent of Adjusted Gross Income (“AGI”) as an itemized deduction which changes after 2018. Starting 2019 through 2025, the AGI limitation increases to 10 percent. Take advantage of short-term bunching of qualified medical expenses before year-end. Starting 2019, taxpayers may want to strongly consider funding health savings accounts (HSAs) as a tax savvy way to pay for medical expenses.
Read 7 Things You Need to Know About Health Savings Accounts.
Speaking of “bunching”, by combining several years’ charitable gifts into one year, you can potentially exceed the new standard deduction limits and lower your overall taxes. Before implementing the bunching strategy, check with your tax preparer and have them analyze the value of bunching deductions given different scenarios. Maybe it makes sense to bunch now because your tax rate is higher than what it’s expected to be next year.
One more skeleton — personal exemptions were eliminated starting 2018.
Treats for you and your charity
As you review your charitable giving strategies, especially if you intend to bunch itemized deductions, remember that giving appreciated stock (i.e., a stock whose value exceeds its cost basis and has been held for over one year) can offer a greater benefit than gifting cash. Donating appreciated stock to a qualified charity or Donor Advised Fund eliminates the capital gain and provides a tax deduction for the value of the stock. Note that donations of appreciated stock are limited to 30 percent of AGI, versus the 60 percent limitation for cash donations. Any excess deduction may be carried forward to the next tax year.
Making qualified charitable distributions (QCD) from an IRA is another great way to fulfill your required minimum distribution (RMD) and lower income taxes by excluding your RMD from your income altogether. There are few tricks to donating all or a portion of your IRA RMD that need to be followed:
- Owner must be 70 ½ or older.
- Charitable distribution must be made from a traditional IRA or ROTH IRA.
- There is a $100,000 annual limit per taxpayer ($200,000 if married filing joint).
- QCD must be made directly from the trustee of your IRA to a qualified public charity. The check cannot be made payable to the IRA owner, private foundation or donor advised fund.
To avoid any gruesome surprises, I recommend that you read How to Use An IRA Giving Strategy To Increase Tax Benefits.
Unleash the magic of your retirement contributions
Maximize your retirement contributions. If you participate in an employer sponsored 401(k) or 403b plan, contribute at least enough to realize any potential “employer match.” Even better, if you are age 50 or older, you can fund your $6,000 catch-up contribution above your maximum annual $18,500 contribution for a total of $24,500 for 2018.
If you are self-employed and have not established a retirement plan, consider opening a solo 401(k) or SEP IRA which allows a maximum tax-deductible contribution of $55,000 to $61,000 for tax year 2018, depending on your age and net income. Specifically, a sole proprietor is allowed to fund 20 percent of their net income (not to exceed $275,000) for a maximum retirement contribution of $55,000. A solo 401(k) allows an additional $6,000 contribution if you are age 50 or older. Keep in mind that a solo 401(k) plan must be in place by Dec. 31, 2018. You have until your 2018 extension filing deadline (Oct. 15, 2019) to establish a SEP IRA plan.
In both cases, actual contributions must be funded in full by your 2018 tax filing deadline, including extensions.
No matter which retirement plan you choose, don’t wait until the very last minute to open and fund it! You can still defer contributions from your last few paychecks of 2018. Making these extra tax-advantaged contributions is like having a magic wand that may have a significant impact on your lifestyle in retirement.
Read Boost Retirement Savings and Reduce Taxes with Catch-up Contributions
Take a lesson from the reaper
Just like Halloween happens each year, so does the opportunity to look for potential capital loss positions in your portfolio to offset any realized capital gains. After netting total realized capital losses against realized capital gains, you can deduct a maximum of $3,000 of capital losses against ordinary income for the same year. But beware of the sneaky wash-sale rule which prohibits taking a capital loss write-off if you purchase substantially identical securities within 30 days before or after a sale. Any excess (unused) capital losses may be carried forward to offset future realized capital gains for an unlimited time period.
While we’re on the subject of capital gains, let’s discuss why you may want to intentionally harvest long-term capital gains based on your taxable income levels. Many people are not aware that there is a zero percent long-term capital gain tax rate that applies to married filers with taxable income up to $77,200 and single filers with taxable income up to $38,600. This zero percent rate also applies to “qualified” dividends if you fall within these same taxable income thresholds.
There may be tax planning opportunities to realize long term capital gains and pay a zero percent tax rate if your taxable income is below these income thresholds, especially if you are retired. The benefits of harvesting gains may vary greatly from year to year, so make sure you have an accurate estimate of your individual tax situation. We strongly recommend consulting with your tax adviser before taking any action.
Potential candy for business owners
Some qualified business owners may now be able to pay taxes on only 80 percent of their income based on the Section 199A deduction of TCJA. If you are a sole proprietor, shareholder or member of an S-corporation, partnership or LLC, you may be able to deduct up to 20 percent of your qualified business income from taxation, subject to certain limitations. However, this deduction may also be limited or disallowed for specific service trades — such as lawyers, doctors and accountants to name a few. This new law is extremely complicated so careful analysis by a tax professional of who is eligible, what is a qualified trade or business, the various phase-in’s and phaseout’s and overall taxable income limitations needs to be done for owners of pass-through businesses.
For a deeper dive, you might want to read How Business Owners Could Reap Big Tax Savings.
Alimony and its new mummy
The year 2018 may be the final year where alimony payments paid to a former spouse are treated as a tax deduction for the payer and taxable income to the recipient. Based on the current law still in effect for 2018, income was often shifted away from the ex-spouse typically in a higher marginal tax rate to the receiving ex-spouse usually in a lower tax bracket. The overall result being lower combined taxes paid. For divorce and separation agreements beginning 2019, the tax deduction for alimony payments is eliminated and recipients will no longer need to report alimony as taxable income. Separating couples who may benefit from the current law have a short timeline to finalize their divorce or separation agreement before year-end to be grandfathered in.
Alternative Minimum Tax (AMT) is less hair-raising
With the elimination of miscellaneous itemized deductions and state tax deduction capped at $10,000, many taxpayers who previously paid AMT will no longer be subject to it. In addition, the new tax law raised both the exemption and exemption phaseout amounts. For years 2018 through 2025, the AMT exemption amount increased to $109,400 for married filing joint and $70,300 for single taxpayers. The exemption phaseout thresholds increased to $1 million for married filing joint and $500,000 for single taxpayers. The result of new AMT rules will significantly decrease the number of individuals required to pay the dreaded AMT tax beginning 2018.
More treats with annual gifting and estate planning
Giving year-end gifts is still a popular way to reduce your taxable estate. The annual gift tax exclusion increased to $15,000 per person starting 2018. Any taxpayer may gift up to $15,000 per person (in cash, securities or property) to multiple family members or other individuals without having to reduce their lifetime gift tax exemption or pay any gift tax. Married couples may gift up to $30,000 jointly per year to each individual.
The IRS also allows taxpayers to gift a lump-sum maximum of $75,000 (i.e., five years advance gifts of $15,000 per year) per beneficiary into a 529 plan. Note that 529s are no longer just for college since tax-free distributions of up to $10,000 per year can now be used to help pay for private or parochial K-12 tuition.
Keep in mind that paying tuition directly to a school or paying medical expenses directly to a service provider on behalf of anyone is also not treated as a gift for purposes of gift and estate tax rules.
Many clients don’t realize that the TCJA expires on Dec. 31, 2025 — thus many of its provisions are temporary and could become a thing of the past (though a new bill proposes making several provisions permanent). This elevates the urgency to have an estate plan in place or to review existing estate plans. Why? Because the enhanced lifetime gift tax exemption amounts of $11,180,000 per taxpayer ($22,360,000 per married couple) indexed annually through 2025 will revert to $5,000,000 on Jan. 1, 2026.
Consider the value of gifting assets, especially assets expected to appreciate, before Dec.31, 2025 and not waiting until death. Yes, you would need to file tax returns to disclose these gifts to the IRS since they count toward reducing your available lifetime gift exemption but presumably, these assets will continue to grow in value and their future appreciation would also be excluded from your estate.
While the portability provisions are favorable and a permanent part of the tax code, another administration could decide to repeal them at any time. Your estate plan should be reviewed and updated with professional assistance every few years to make sure it is maximizing the current tax laws — both Federal and State.
There are still many opportunities to lower your taxes this year so don’t wait until midnight of Dec. 31, 2018 — that may be more terrifying than Halloween!
Nina Mitchell is a principal and senior wealth adviser at The Colony Group. She is also a co-founder of Her Wealth®.
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