SBK Year-End Tax Planning Newsletter: 2018
Navigating the New Tax Environment at Year-End: 2018 and Beyond
By Dean Williams, CPA
Last year’s close was highlighted by the hasty introduction of the Tax Cuts and Jobs Act (TCJA). Further major reform is not expected before the close of this year, however the TCJA has created a considerably different environment for tax year 2018 and beyond. Taxpayers need to reevaluate whether traditional year-end tax planning techniques still make sense.
The new tax law has unequivocally created a lower tax rate environment. However, because itemized deductions have been severely limited for many, lower rates may not necessarily equate to lower taxes for all.
In addition to general commentary on new ways for individuals to reduce their overall tax liabilities before year-end, we wanted to focus on three specific areas where we have seen significant changes to planning as a result of the TCJA: charitable giving, retirement planning and estate planning.
Taxpayers now have to re-think how, and when, to make charitable gifts. Below, we will highlight a variety of strategies for taxpayers to maximize their deduction for federal income tax purposes, yet maintain their annual giving habits and preferences.
The introduction of new tax tables and income thresholds has also created new opportunities for taxpayers to use retirement accounts and other tax-favored accounts to manage taxable income levels.
Lastly, the lifetime estate and gift tax exemption has increased to $11.18 million per person as a result of the TCJA, creating room for individuals to maximize gifts to family members and others. But is additional lifetime giving the right answer for everyone? Or is there value in holding off?
Year-End Planning for Individuals with Regard to the New Tax Law
In reviewing real-time tax projections with our clients throughout the year, we have consistently seen that the new tax law has produced a range of different outcomes for individuals. An effective strategy for one taxpayer may not be advantageous for another. Every family has unique circumstances and tax consequences can vary.
As highlighted below, itemized deductions have been revamped. Taxpayers who have historically itemized deductions may be able to use the new standard deduction as a tax planning tool, intentionally taking the standard deduction in certain years.
With the $10,000 cap on state and local taxes and the elimination of other deductions, charitable contributions become the primary driver of Schedule A and a focal point for year-end planning. (Note: This is even more applicable for clients without a mortgage or margin account – mortgage interest and investment interest expense remain deductible, though new limits apply to home acquisition debt)
New rates mean that there are new targets for optimal taxable income levels. Taxpayers should evaluate accelerating or decelerating income events. Remember to keep AMT in mind – those historically subject to AMT may be able to avoid it in 2018.
Plus, continue to review your overall investment portfolio. Should adjustments be made in December to capture a 2018 tax benefit?
What can you do before year-end?
1) Calculate all year-to-date charitable contributions to determine if it is better to continue making gifts in 2018 or to hold off until 2019.
2) Consider managing taxable income by making contributions to and/or distributions from tax-favored accounts.
3) Prepare a plan for family gifts which can be revisited annually – use December to maximize 2018 annual exclusion amounts.
Notable Changes to Itemized Deductions:
State and Local Taxes*
Old Law: Unlimited, New Law: Limited to $10,000 total
*Includes state income taxes, real estate taxes and personal property taxes
Investment Advisory, Tax Prep and Other Misc. Fees
Old Law: Deductible in excess of 2% of AGI, New Law: Non-deductible
Old Law: 3% reduction of allowable deductions for high-income taxpayers, New Law: Eliminated
New Increased Standard Deduction
Single Taxpayers, Old Law: $6,350, New Law: $12,000
Married Taxpayers, Old Law: $12,700, New Law: $24,000
Plus: Additional Deduction for Age 65+ or Blind: $1,600 or $2,600 (MFJ)
Charitable Giving: Strategies for Consideration
Question: What are the most effective ways to bunch charitable contributions?
- As mentioned above, taxpayers should consider bunching charitable contributions in alternating years; itemizing deductions in the years with charitable contributions and taking the standard deduction in years without
- Gifts to donor-advised funds (DAFs), community foundations or private foundations allow taxpayers to make front-loaded gifts for income tax purposes yet spread out the distribution of those funds to designated charities across multiple years
- For substantial gifts directly to a public charity, taxpayers can ask if their designated charity is supported by state tax credit programs (e.g.: NAP and EISTC programs in Virginia)
- To further increase the tax benefit of any gift to a DAF or directly to a charity, taxpayers should consider donating highly appreciated stock, wherever possible
Question: Should I consider a qualified charitable distribution (QCD) from my retirement account?
- For eligible taxpayers, QCDs are a great option
- QCDs are only available to taxpayers ages 70 ½ and above (required minimum distribution (RMD) age)
- QCDs count towards a taxpayer’s RMD requirement and can be used to satisfy the requirement, in full or partially
- Especially attractive for charitably-inclined taxpayers taking the standard deduction
- Because QCDs directly reduce a taxpayer’s adjusted gross income (AGI), QCDs can also be an effective tool in managing AGI for lower Medicare monthly premiums
- Note: Checks written from IRAs need to be cashed before year-end to count towards an RMD
Maximize Your Charitable Tax Benefit:
Charitable deductions provide more overall tax offset when the donor faces a higher marginal tax rate.
Consider increasing your charitable gifts in years with:
1. Extra ordinary income (such as from a one-time bonus or engagement)
2. Gain from sale of a business or real estate
3. Expectations of lower income in future years
Retriement Planning: New Developments in Managing Tax-Favored Accounts
Question: Is there a target level of taxable income to keep in mind for qualified plan distributions (or contributions)?
- This answer will vary dependent upon individual circumstances, however taxpayers may want to consider recognizing ordinary income up to the highest point of the 24% tax bracket, which is $315,000 for MFJ couples (see table below)
- Others may want to consider different ways to limit their income to this same threshold
- For reference, MFJ taxpayers entered the 33% tax bracket starting at $233,350 under the old 2017 tax brackets
- Paying tax now may prove to be a good deal if rates rise, where future withdrawals would be subject to higher tax
Strategies to consider to increase current taxable income:
- Earlier distributions from IRAs, 401Ks or other qualified accounts for taxpayers ages 59 ½ – 70 ½
- Conversions to Roth accounts; though be careful as re-characterizations are no longer allowed after Dec. 31st
Strategies to consider to decrease current taxable income:
- Using a QCD to reduce taxable portion of an RMD
- Contributions to a Solo 401K or SEP IRA for individuals with self-employment income
- Contributions to HSAs (see below)
2018 Individual Income Tax Brackets
Rate Single MFJ
10% Up to $9,525 Up to $19,050
12% $9,526 – $38,700 $19,051 – $77,400
22% $38,701 – $82,500 $77,401 – $165,000
24% $82,501 – $157,500 $165,001 – $315,000
32% $157,501 – $200,000 $315,001 – $400,000
35% $200,001 – $500,000 $400,001 – $600,000
37% Over $500,000 Over $600,000
Health Savings Accounts (HSAs):
With the rapid rise in health care costs, taxpayers should consider HSAs as a vehicle for funding current and future health care needs. Benefits of HSAs:
Tax-savings – above the line deduction up to annual contribution limits*
Tax-free growth – many HSAs allow for the funds to be invested
No expiration – funds carry over year-to-year
For qualified medical expenses, withdrawals and reimbursements are tax-free at any age. After age 65, account owners may take penalty-free withdrawals for non-qualified use (subject to tax).
*$3,450 or $6,900 (family), plus additional $1,000 if over 55
Estate Planning: Revisiting Your Plan
The TCJA provided a significant increase to the lifetime estate and gift tax exemption. The total exemption amount was effectively doubled, rising to $11.18 million per individual. While currently scheduled to remain in place until 2026, this figure could be a political target prior to then.
With a doubled exemption amount and a potentially limited window of opportunity, now is a key time for taxpayers to consider additional lifetime gifts or other changes to their overall estate plan. Estate tax planning needs to be viewed parallel to income tax planning – as cost basis of assets also takes on increased importance. Taxpayers should weigh whether preserving the ability for their heirs to achieve a step-up in cost basis is more valuable than making a current lifetime gift, which would be tied to carryover cost basis (and a potentially higher future income tax liability). This is an important exercise for low basis or discounted assets.
Don’t ignore portability. Portability is an extremely valuable estate planning tool, for taxable and nontaxable estates. Currently, married couples could have the capability to potentially shield $22.36 million of their assets from federal estate tax.
The annual gift tax exclusion was increased to $15,000 for 2018. Taking full advantage of this exclusion should remain a year-over-year priority for individuals actively focused on reducing their estate.
Taxpayers may also want to consider ways to add flexibility to their current estate plan. Certain documents may need additional language to ensure that there is built-in flexibility with regard to: a future change in the unified exemption amount, successor beneficiaries and trustees, revocation clauses, etc.
Types of documents to revisit:
Wills Beneficiary Designation Forms Trust Documents
Medical Directives Family Partnership Agreements POAs
Using 529 Plans:
New for 2018, taxpayers can now use 529 plans to directly pay for the cost of private elementary, middle and high school expenses for eligible students. Limited to $10,000 per year.
Reminder: Taxpayers over age 70 are not limited to $4,000 per account for purposes of the Virginia state income tax deduction. Additionally, any prior year carryover amount becomes available in the year in which an account owner turns 70.
SBK Financial, Inc.
1001 Haxall Point, Suite 705
Richmond, VA 23219