You have heard a lot from us over the past year throughout the tax reform process that ended in late December when the 2017 Tax Cuts and Jobs Act was passed. Keep in mind there are many unanswered questions on this legislation and we are still awaiting guidance from the IRS on several points. We expect to see more information from Congress and the IRS in the coming months.
We are focusing on a number of areas as we explore how it will impact our clients. Here are some planning aspects that we think will be important for our clients in 2018:
- Pass-Through Entity Deduction – This might be the most complex part of the new law but if you earn income from a pass through entity (Sub S corporation, partnership, LLC, or Schedule C), you may be eligible for a 20% deduction against that income. Unfortunately, there are many limitations to the deduction that I won't try to tackle here. Just know that if you have income from these sources, we should have a discussion to see how the new deduction applies to you.
- Charitable Deductions – As you probably know, the deduction for state and local taxes is now limited to $10,000 per year and miscellaneous itemized deductions are also eliminated. For clients in high tax states, this will have a significant impact on their tax situation going forward. Combined with the increased standard deduction ($24,000 joint, $12,000 single), many people will no longer be able to itemize. This would mean losing the benefit of your charitable deductions if you do not get over the standard deduction. For many clients, it may make sense to “bunch” your deductions in certain years; charitable contributions are a good candidate for this. Rather than give $10,000 to charity each year and still be under the standard deduction, you can double it one year and then skip the next year. You might want to consider using a Donor Advised fund to do this. Keep in mind if you are over 70 ½ you can directly contribute from your IRA to charity. If you don’t need the cash from your required minimum distribution, this is an excellent way to reduce your taxable income.
- Roth conversions – While the new law eliminated the free “look back” period where you could do a Roth conversion and then recharacterize by the extended due date of the return the following year, you are still allowed to do Roth conversions. If you know you have a year where you will be in a lower bracket than in the future, converting some of your IRA to a Roth may make sense, paying less tax and reducing the RMD you are required to take at age 70 ½. Since overall rates have come down and these rate cuts expire in 2025, there may be additional reasons to consider a Roth conversion now.
- Net Investment Income Tax – This 3.8% surtax is still in effect, so you need to factor this into any investment decisions so that you fully understand your rate. All investment income, capital gains, etc. is subject to this tax once your income goes above certain levels. Since we can no longer deduct state income tax or miscellaneous itemized deductions, will these be deductible for this surtax? This is currently an unanswered question in the new tax law. This still makes asset location an important issue. Understanding your tax rate on investment income and which assets to put in retirement accounts vs. hold outside is important.
- 529 Education Funding Changes – The new law permits $10,000 per year to be taken from 529 plans per beneficiary for elementary and high school tuitions. This flexibility might encourage more clients to use 529 plans, but you should make sure you are funding college costs to the level that is appropriate based on your goals.
- Estate Planning Changes – This might be the most significant aspect of Tax Reform for many of our clients. The lifetime exemption has been doubled to $11,200,000 for individuals for estate, gift and GST tax purposes. This higher exemption sunsets on December 31, 2025 and many wonder if it will last that long. (Keep in mind the exemption has never decreased in the past.) As we think about this change, it is clear our clients fall into three categories: under $5 million in assets (did not have to worry about estate tax before), between $5-11.2 million (likely will not have estate tax under current law, but could if the exemption decreases in the future), and over $11.2 million. There are estate planning strategies that should be considered for both of the last two groups and we would be glad to discuss those with you.
We would be glad to help you think about the impact of the Tax Cuts and Jobs Act on your own situation. We have found that it is unique for every client based on your own situation. Our income tax planning software now can do the calculations based on this new law but we will continue to watch developments to understand how it will impact you.
-Lyle K. Benson, Jr., CPA, PFS, CFP
The views expressed represent the opinions of L.K. Benson & Company and are subject to change. These views are not intended as a forecast, a guarantee of future results, investment recommendation, or an offer to buy or sell any securities. The information provided is of a general nature and should not be construed as investment advice or to provide any investment, tax, financial or legal advice or service to any person.Please see Additional Disclosures more information.