The Tax Cuts and Jobs Act of 2017, enacted into law in late 2017, has held the attention of tax and financial planners all year. As 2018 is nearing its end, however, some of the most useful tools available to aid us in confidently interpreting the law and planning for our clients to effectively reduce their 2018 income taxes (like IRS guidance and tax planning software) are, as of this writing, still inadequate or unavailable. Nevertheless, we must carry on. So, here are some of the most important issues I've identified in planning for my individual taxpayer clients.
Tax rates, standard deductions
A signature feature of the TCJA is that, generally, for a given level of income, the marginal federal income tax rate is lower in 2018. Clients are likely to focus on that aspect of the law, especially if their gross income has changed little between 2017 and 2018. Taxes are computed on income net of deductions and exemptions, or adjusted gross income (AGI), not on gross income. The standard deduction has increased to $12,000 for single filers and $24,000 for married filing jointly, while the personal exemption for each household filer and dependent has been eliminated (from $4,050 in 2017). The child tax credit has also increased significantly, to $2,000 per qualifying child, and a new family credit of $500 per qualifying dependent has been introduced for 2018.
Since these changes are so sweeping and could result in significant increases in or decreases in tax liabilities, I believe most clients will benefit from a review of their 2017 tax liability and some sort of projection of their 2018 liability. At a minimum, I recommend communicating with clients that the impact of this tax law is hard to determine without having a formal discussion and review of their finances before the end of the year.
Given the substantial increase in the standard deduction, it's quite possible that most taxpayers will elect it over itemized deductions. However, there may be opportunities to proactively "bunch" itemized deductions from two years into one year such that the total exceeds the standard deduction for appropriate clients. Consider the following:
• Accelerating qualified medical expense payments into 2018 from 2019 might be beneficial since the medical expense deduction threshold is 7.5% of AGI in 2018 vs 10% in 2019.
• State and local tax deductions are limited to $10,000 per year.
• The mortgage interest expense deduction is reduced to $750,000 (on post-Dec. 15, 2017 loans) from the prior cap of $1 million, and interest on most home equity loans is no longer deductible beginning in 2018. Evaluate if clients should refinance a mortgage to pay off a home-equity loan.
• The charitable contribution (cash) limitation increases from 50 percent of AGI to 60 percent in 2018. For charitably minded clients, consider introducing the idea of contributing to a donor-advised fund, where a relatively large one-time gift can be deposited in 2018 and distributed over multiple years in the future.
• Miscellaneous itemized deductions have been eliminated. Investment management fees once paid with after-tax funds to secure the tax deduction might now be allocated between IRA and after-tax funds. Consider paying the IRA share of the fee from the IRA, which is also attractive as this might reduce future required minimum distributions.
• The itemized deduction phaseout, for higher income level taxpayers, has been eliminated.
Alternative minimum tax
Exemption amounts have increased by 29 percent for 2018, and the income thresholds at which taxpayers can take at least a partial exemption has increased in 2018 ($781,200 for single filers and $1,437,600 for married filing jointly).