2018 TCJA Tax Law Year-End Planning & Reminder
November 28, 2018
Here are some tax savings ideas for you to possibly take advantage of before the end of 2018. Although we sent notification earlier this year, this is a reminder of the major changes under the new TCJA tax law.
Lower Tax Rates and Investment Gains Under the TCJA
2018 ordinary tax rates are generally lower than those for 2017. For example, the top rate has been reduced from 39.6% to 37%. (The remaining six rates are 10%, 12%, 22%, 24%, 32%, and 35%.) Also, the top rate now applies to joint filers whose taxable income is over $600,000 (as opposed to $470,700 for 2017). Some taxpayers who were taxed at 39.6% in 2017 may now find themselves in the 35% tax bracket.
In other good news, the TCJA didn’t change the capital gains rate structure. Therefore, most categories of long-term capital gain are taxed at 0%, 15%, or 20%. The maximum 20% rate applies to joint filers with 2018 taxable income (including long-term gains) above $479,000.
As you evaluate investments held in your taxable brokerage firm accounts, consider the tax impact of selling appreciated securities (currently worth more than you paid for them) before the end of this year. For most taxpayers, the tax rate on long-term capital gains is still much lower than the rate on short-term gains. Therefore, it often makes sense to hold appreciated securities for at least a year and a day before selling to qualify for the lower long-term gain tax rate.
Also, taxpayers who expect to be subject to a higher capital gain rate after 2018 should consider selling profitable long-term investments in 2018 to take advantage of this year’s rate. The proceeds and tax savings could be used to help fund a traditional IRA (possibly deductible) or Roth IRA to postpone or eliminate future taxes.
New Standard Deduction versus Itemized Deductions
For 2018, joint filers can enjoy a standard deduction of $24,000 (versus $12,700 for 2017). The new standard deduction for head of household taxpayers is $18,000, and single taxpayers (including married taxpayers filing separately) can claim a standard deduction of $12,000. The TCJA suspends the deduction for personal exemptions, increases the child tax credit (see later discussion), and eliminates or limits many of the itemized deductions, which may significantly impact your tax situation.
Home Mortgage Interest Deductions
Before the TCJA, taxpayers could deduct interest paid on up to $1 million ($500,000 if married filing separately) of home acquisition debt (debt used to buy or substantially improve a first or second home). Also, taxpayers could deduct interest paid on up to $100,000 ($50,000 if married filing separately) of home equity debt, regardless of how the proceeds were used. The TCJA cuts those numbers back significantly. For 2018–2025, in general, the TCJA reduces the limit on home acquisition debt to $750,000. For married taxpayers filing separately, the debt limit is halved to $375,000. There are many other details and exceptions with regard to the Mortgage Interest Deduction, which can be found in the full TCJA tax law.
The New Child Tax Credit
Under pre-TCJA law, the child tax credit was $1,000 per qualifying child, subject to phase-out when the Adjusted Gross Income (AGI) exceeded $110,000 for married couples filing jointly (or $55,000 for married couples filing separately and $75,000 for unmarried taxpayers.)
Starting in 2018, the TCJA doubles the child tax credit to $2,000 per qualifying child under age 17. It also allows a new $500 credit (per dependent) for any of your dependents who aren’t qualifying children under 17. There is no age limit for the $500 credit, but the tax tests for dependency must be met. The TCJA also substantially increases the “phase-out” thresholds for the credit. Starting in 2018, the phase-out begins when AGI exceeds $400,000 for married couples filing jointly. The threshold is $200,000 for all other taxpayers. If you were previously prohibited from taking the credit because your AGI was too high, you may now be eligible to claim the credit.
Bunch Charitable Contributions through Donor-advised Funds
The TCJA temporarily increases the limit on cash contributions to public charities and certain private foundations from 50% to 60% of AGI. However, as we mentioned earlier, the standard deduction has almost doubled. Combined with the capping of the state and local tax deduction at $10,000 per year ($5,000 for a married taxpayer filing a separate return), changes to the home mortgage interest deduction, and the elimination of miscellaneous itemized deductions, it’s likely that fewer taxpayers will be itemizing in 2018. One way to combat this is to bunch or increase charitable contributions in alternating years. You may also contact your investment advisor concerning donor advised funds, also known as charitable gift funds, or philanthropic funds. In short, taxpayers can claim the charitable tax deduction in the year they fund the donor-advised fund and schedule grants over the next two years or other multiyear periods.
Qualified Tuition Plans
Although the details of Qualified Tuition Plans (QTPs) can vary widely, they generally allow parents and grandparents to set up college accounts for children and grandchildren before they reach college age. Once established, QTPs qualify for favorable federal (and often state) tax benefits, which can ease the financial burden of paying for college. QTPs may be particularly attractive to higher income parents and grandparents because there are no AGI-based limits on who can contribute to these plans.
Under pre-TCJA law, the earnings on funds in a QTP could be withdrawn tax-free only if used for qualified higher education at eligible schools. Eligible schools included colleges, universities, vocational schools, or other postsecondary schools eligible to participate in a student aid program of the Department of Education. Thanks to the TCJA, qualified higher education expenses now include tuition at an elementary or secondary public, private, or religious school, up to a $10,000 limit per tax year. So, you may want to revisit your QTPs if you have children or grandchildren who attend elementary or secondary schools.
New Alimony Rules Under the TCJA
Certain future alimony payments will no longer be deductible by the payer. Also, alimony will no longer be considered income to the recipient. Therefore, for divorces and legal separations that are executed (that come into legal existence due to a court order) after 2018, the alimony-paying spouse won’t be able to deduct the payments, and the alimony-receiving spouse doesn’t include them in gross income or pay federal income tax on them.
It’s important to emphasize that pre-TCJA rules apply to already-existing divorces and separations, as well as divorces and separations that are executed before 2019. However, under a special rule, if taxpayers have an existing (pre-2019) divorce or separation decree, and they have that agreement legally modified, then the new rules don’t apply to that modified decree unless the modification expressly provides that the TCJA rules are to apply. There may be situations where applying the TCJA rules voluntarily is beneficial for the taxpayers, such as a change in the income levels of the alimony payer or the alimony recipient.
Qualified Opportunity Zones
Tucked away in the TCJA is the creation of Qualified Opportunity Zones (QO Zones). These are low-income communities that meet certain requirements. Investing in QO Zones can result in two major tax breaks: (1) temporary deferral of gain from the sale of property and (2) permanent exclusion of post-acquisition capital gains on the disposition of investments in QO Zones held for ten years.
The IRS has already announced the designation of QO Zones in over 20 states and U.S. possessions. It will make future designations as submissions by states are received and certified. The IRS also plans to issue additional information on QO Zones in the future. If you’re looking to defer taxable gains while revitalizing low-income communities, QO Zones may be the way to go.
State Response to Tax Reform
States react differently to changes to federal tax law. Ohio has incorporated the TCJA changes, however some states pick and choose which federal provisions to adopt. Because of this, your state income tax rules may be drastically different than the federal income tax rules.
Significantly increased Alternative Minimum Tax exemptions
The TCJA significantly increased the AMT exemptions for 2018–2025. The exemption is phased out when your AMT income surpasses the applicable threshold, but the TCJA greatly increased those thresholds for 2018–2025.
Maximize Your Qualified Business Income Deduction
You may have heard a lot of talk in the news about a new deduction for “pass-through” income, but it’s actually available for qualified business income from a sole proprietorship (including a farm), as well as from pass-through entities such as partnerships, LLCs, and S-Corporations. Under the TCJA, individuals may deduct up to 20% of their qualified business income; however, the deduction is subject to various rules and limitations. Although there is some uncertainty surrounding this new deduction, there are some planning strategies to consider.
This year is definitely unique given the numerous tax law changes brought by the TCJA. Please don’t hesitate to contact us if you want more information or clarification. Also, tax projections can still be performed before year-end if you want one.