Tax Reform … New Rules, Old Game

Written by: Allie Schmidt, CFP® , CPA, Financial Advisor

Tax reform has been signed into law, leaving most of us asking, how does this affect me and my family?  If you’ve followed the back and forth of the bill, there was initial talk of creating the “postcard tax return”, basically making doing your taxes so easy that you could complete them on a postcard.  For many Americans, that certainly does not seem to be the result of these changes with several moving parts that would likely require at least a deck of postcards.  But, either way, it’s now law and my business partner Steve Higgins and I are tasked with quickly learning how best to navigate the new landscape for our clients to be sure to take advantage of any new opportunities available.  Here are a handful of changes we’ve identified that could affect our clients and likely other investors.

• Roughly doubling the standard deduction: This will likely change how many people do their taxes.  Folks who have always itemized their deductions may now decide to take the standard deduction; basically, eliminating the tax benefit of any of the deductible items such as property taxes, state taxes, medical expenses, and charitable deductions, among others.  Consider if “bunching your deductions” makes sense.  Alternate between the standard deduction and itemized deductions year to year and bunch all of your deductible expenses that are able to be itemized into the one year.

  For example, let’s say you and your spouse give $15k per year to charity, the married filing jointly deduction is now $24k, so you would likely no longer itemize.  However, if you were to set up a Donor Advised Fund, you could make an irrevocable contribution every other year. By doing this, you would be able to contribute $30k (2 years of contributions) in the year you’re itemizing and receive an additional $6k deduction over the $24k that year.   You can initiate distributions from your Donor Advised Fund to qualified charities at any time, therefore, allowing you to still give on your timeline to the organizations of your choice, but receive the entire deduction in one year.

• Small Business Owners: If your business is structured as a pass-through entity (such as a partnership, sole proprietorship, C corp, etc), there are opportunities in the new tax plan. The new tax law gives a 20% deduction on taxable income to qualifying pass throughs.  There are income limitations, but this change, in addition, to the new structure on C corps is a game changer for how business income is taxed.
• Deductible Medical Expenses: There was a temporary reduction to the threshold to deduct unreimbursed medical expenses to those expenses that exceed 7.5% of adjusted gross income (AGI) from 10% of AGI. However, you must act fast, the reduction is limited and reverts back to 10% in 2019.  Think kids braces, IVF, Lasik eye surgery, or home renovations for medical purposes (i.e. widening hallways, installing ramps, etc).  Getting these in before the end of the year will create a larger deduction than in future years.
• Professional fees deduction: There are several investors who deduct investment management fees from their non-qualified accounts.  These are no longer deductible, so consider moving those fee payments back to your retirement accounts, in essence making the fee deductible because the IRA contribution was deductible.
• Roth Conversion “undo”: Until 2018, investors were able to convert a Traditional IRA to a Roth IRA and then undo the conversion if they changed their mind before that tax year’s tax filing deadline. Now, the conversion is a done deal at execution, so make sure you have a good estimate of taxes due and conversion amounts before pulling the trigger, there are no take-backs.*
• 529 plans become more useful: The new tax law allows you to use 529 funds to pay for private elementary and secondary school expenses up to $10k per year.  Since Colorado does offer a state tax deduction (4.63%) for contributions to state-sponsored 529 plans, even if the cash doesn’t sit in the account and benefit from the tax free growth, it may make sense to contribute tuition in the account for a couple of months then distribute to receive the state tax deduction.  Use the 529 as a pass through.

These changes are just the tip of the iceberg, but hopefully a jump start for investors to start planning and strategizing their tax approach with the new rules of the game.  This is certainly an ongoing conversation and one that we intend to discuss thoroughly with our clients.  Please stay tuned to our blog, events, and commentary to make sure you’re doing everything you can to take advantage of new opportunities.  As always, Steve and I are available to sit down and talk about your specific situation.  Everyone’s situation is different and planning needs to be personalized.  Certainly run any strategy by your tax accountant before implementing any plan.

*Traditional IRA account owners should consider the tax ramifications, age, and income restrictions in regards to executing a conversion from a Traditional IRA to a Roth IRA. The converted amount is generally subject to income taxation. The Roth IRA offers tax deferral on any earnings on the account. Withdrawals from the account may be tax free, as long as they are considered qualified. Limitations and restrictions may apply. Withdrawals prior to age 59 or prior to the account being opened for 5 years, whichever is later, may result in a 10% IRS penalty tax. Future tax laws can change at any time and may impact the benefits of Roth IRAs. Their tax treatment may change.

Securities offered through LPL Financial, Member FINRA/SIPC. Investment Advice offered through HD Wealth Strategies, a registered investment advisor and separate entity from LPL Financial. This information is not intended to be a substitute for specific individualized tax or legal advice. We suggest that you discuss your specific tax issues with a qualified tax or legal advisor. Prior to investing in a 529 plan, investors should consider whether the investor’s or designated beneficiary’s home state offers any state tax or other state benefits such as financial aid, scholarship funds, and protection from creditors that are only available for investments in such state’s qualified tuition program. Withdrawals used for qualified expenses are federally tax free. Tax treatment at the state level may vary. Please consult with your tax advisor before investing.