Let’s cut to the chase and consider several specific ways that your financial planning will change because of the new Tax Cuts and Jobs Act of 2017 (TCJA) law. Here’s what we are expecting as financial advisors:
Bunching deductions will be the new norm.
The new higher standard deduction ($12,000/person, $24,000/couple) means many more people will take the standard deduction each year and fewer taxpayers will itemize. Those taxpayers with low itemized deductions (from high state and local income taxes, property taxes, mortgage interest, charitable contributions, and medical expenses) will plan when to itemize and when to take the standard deduction. In itemizing years, they will bunch as many deductions as possible into that one year. Now even basic tax planning will depend upon a multi-year time horizon.
Donor advised funds will be even more common.
The best way to keep charitable giving on an even keel while still optimizing tax planning is to use a donor advised fund. Taxpayers with low itemized deductions will make large contributions to their donor advised fund in years when they plan to itemize, preferably using appreciated securities, the ideal funding source for donor advised funds. The higher the personal wealth, the more years of gifts you can likely afford to bunch into one year. The new tax law allows taxpayers to deduct cash gifts to public charities up to 60% (formerly 50%) of their Adjusted Gross income, allowing larger gifts each year and swifter use of charitable deduction carryforwards.
Note: Funding gifts to your favorite charities with distributions from your donor advised fund can make your charitable giving easier and more policy-driven. Instead of sending out random checks throughout the year, you can review what you gave last year through your donor advised fund, edit that list for the current year, and then easily distribute current gifts at one time from the donor advised fund website. (Donor advised funds cannot be used to pay legally-binding pledges. Read the fine-print of pledge cards before signing!)
Older taxpayers will use Qualified Charitable Distributions (QCDs) from their IRAs more.
Especially in years when itemizing does not make sense, taxpayers over the age of 70 ½ will increasingly fund charitable donations with QCDs. Funds diverted this way will not be included in Adjusted Gross Income (AGI), the bottom line of the first page of your tax return. (Minimizing AGI muffles income tax liability, including potentially the 3.8% Medicare Net Investment Income Tax surcharge on unearned income for high income taxpayers, and can also protect against the income-related Medicare premium surcharge.)
Note: For those savvy older taxpayers who have set their IRA required minimum distributions to occur automatically, there is a new annual planning task: To make sure the desired QCDs leave the IRA before the custodian calculates and distributes the annual mandatory withdrawal.
All taxpayers have reason to refresh withholding and estimated tax liability calculations.
Get ready to adjust withholding rates on your salary and the dollar amounts of your estimated tax payments early this year. Most, but not all, taxpayers will pay less in taxes because of the new tax law, and all but a few will have new opportunities to manage tax liability. Adding further planning complexity, most of the new tax rules for individual taxes are scheduled to phase out by 2025. (The most favorable and permanent provisions in the new tax law apply to businesses, not individuals.)
Note: Be kind to your accountant (and to the IRS!). They did not ask for complex, and probably temporary, new tax rules to become applicable just before tax season begins.
Those who can will pay off their home equity indebtedness. (updated 1/8/18)
The interest on loans collateralized by your home is no longer deductible unless used to purchase, build, or improve, a first or second residence, i.e. if it is acquisition debt. This means that interest is no longer deductible for cash take-out mortgages or for any debt collateralized by your home incurred to fund a “non-acquisition” purpose, so called home equity indebtedness incurred, e.g. to pay credit card debt or college tuition expenses, or for a big vacation. This is a big change, with no grand-fathering, applicable to mortgages, home equity loans, and home equity lines of credit. Going forward, the purpose, not the form, of home-related debt, determines if its interest is deductible.
Plus, interest deductions for acquisition debt are capped. If you have large acquisition debt, there is an incentive to pay down the balance to the point where the interest is fully deductible. (See Appendix for details.)
Estate tax planning is now only for the very wealthy—at least until 1/1/2026.
TCJA doubles the amount each person can pass to heirs without estate tax from $5.6 million in 2018 to $11.2 million as of 2018, with portability for couples and post mortem step up in basis still intact –but only for those who die before 1/1/2026.
Note: Don’t neglect estate planning, however. There are many personal, non-tax factors addressed in your estate plan documents regarding who will care for you and your finances, and who will inherit your wealth, under what terms, with what message, and when.
529 plans will be used for qualified pre-college expenses down to the elementary school level, and including apprenticeship expenses, up to $10,000 per student each year.
529 funds can now be used for pre-college expenses. If your family hits a temporary period of tight cash flow, 529 funds could ease the strain if there are children in the home with eligible expenses. If you want to streamline your finances and/ or set up for optimal college aid claiming, you might drain 529s for your pre-college age children, and direct comparable funds to a consolidated college cash reserve. Or perhaps you’ll use 529 funds for pre-college expenses, freeing up cash to pay down the ‘no-longer-deductible’ home equity loan. In any case, 529 planning is even more of a multi-year planning exercise.
Roth conversions will be more exact.
There is no longer the Roth recharacterization ‘do-over’ option. Instead of converting a generous amount of what you think you might want to convert with the chance to trim it back in later months, you’ll want to make a more exact, and perhaps more conservative, calculation of the amount to convert.
Health Savings Accounts will flourish.
Health savings accounts are a triple win: They are funded with pre-tax dollars, grow with no taxes, and come out tax free if used for eligible expenses. If you are exasperated by the increasing complexity of tax planning, health savings accounts offer welcome respite.
Note: Health Savings Accounts can only be funded in years when you have a high deductible health insurance plan, (and not at all if you are enrolled in Medicare). High deductible plans tend to reward staying in network for care. Many people choose a non-high deductible plan to have more choices in health care providers. As with all financial planning, tax efficiency is important but it’s not the only factor to consider.
These initial practical implications of the new tax law illustrate that:
Bottom line: Let your financial advisor and accountant collaborate with you and with each other on your behalf. Integrating tax and cash flow planning with decision-making for college funding, charitable giving, employee benefit elections, and portfolio management is not an intuitive exercise. Don’t go it alone.
Appendix: Additional planning points for individuals from H.R. 1 Tax Cuts and Jobs Act (2017)
Originally published: January 5, 2018