Here's our latest stab at deciphering the new Tax Law. The Top 7 things you need to know:
“Back Door” Roth IRA: The “back door” Roth IRA is a strategy that has been used with fingers crossed because there has never been clear acceptance of it by the IRS. While it was not written into the TCJA, the conference report did confirm that it is acceptable. This strategy is used by workers who have earned income and make too much money to make a Roth contribution. Instead, they make a non-deductible IRA contribution and convert it to a Roth. This strategy does require the help of your CPA in order to document it properly.
Divorces: For divorces after December 31, 2018, alimony will no longer be a tax deduction. Alimony is not required in Texas, so we more commonly see divorces that require child support. Nonetheless, alimony will no longer be deductible as of 2019. The December 31 deadline will likely serve as an incentive for filers who are in the middle of a divorce with an alimony element.
529 Plans: Once a unique and compelling college funding tool, 529 Plans can now be used to cover elementary and secondary schooling up to $10,000 per year. While I like this idea in concept, I struggle with it the same way I struggle with allowing loans from a 401(k) plan. College – like retirement – requires a lot of moneyPhew! You made it. The deadline to file your 2017 taxes has finally passed, and now you can start thinking about all of the new tax breaks your CPA kept talking about. In February we hosted an event with Jon Karp of Whitley Penn to shed some light on the Tax Cuts and Jobs Act (TCJA), and I was taken by two thoughts:
- Jon, a very well-studied CPA, can’t highlight all of the important parts of this tax law in thirty minutes because it’s so extensive.
- Many parts of the new tax law were, at the time, yet to be defined, and the practical application of the law was yet to be understood.
If you read the last sentence and thought, “huh?” - you might need a little refresher on how the tax code works. It’s like this: Congress fights very publicly over the tax code for a few weeks/months - as the deadline draws near, deals are made - aides scramble to put that in writing - there is a vote - voila, Americans have to figure out what just happened. So yes, the tax bill was approved by Congress on December 22, 2017.
Then the experts get involved. CPAs, financial advisors, and other financial geniuses start to dive into the implementation of the new tax legislation and start asking questions. A lot of questions. And then they begin to fashion their answers and strategies as a way of interpreting Congress’ writings.
In light of that background, below are my top seven ideas about changes to the tax code that can affect individuals:
Charitable Giving: Charitable giving basically remains as tax favorable as it used to be, and in some cases more favorable. The standard deduction was almost doubled (now $12,000 for single and $24,000 for joint filers), which means that some filers won’t be able to deduct their charitable giving. However, there is a clever strategy that filers can use to “bunch” deductions into one year to get over the hurdles listed above. This is where a donor-advised fund (DAF) makes abundant sense. Filers who want to donate to a charity can minimize their taxes by funding a DAF in one year, but retain flexibility to send the funds to the charity they choose in a future year. This allows DAF donors to take a deduction in just one tax year for the amount that they would normally contribute over two or more years.
Privately Held Businesses: Based on the new corporate tax rate (a decrease from 35% to 21%), privately held companies may consider becoming a corporation. We work with many small business owners and spend a lot of our time with them strategizing on how they can retain more of their success in the form of after-tax income. CPAs around the country will be analyzing which companies will benefit from this change.
Owners of Pass-Through Businesses: Over 90% of the businesses in the United States are pass-throughs, so if you own a business, this may apply to you. Owners of pass-through companies (sole proprietor, partnership, LLC, and S corporations) can now deduct up to 20% of income. There are nuances around what applies for this type of deduction – including phase-out based on certain types of businesses and income caps - so we recommend using a CPA to implement this one.
Estate Tax and Family Gifting: The TCJA doubles the estate and gift tax exemption to $11.18M. While this seems like a boon for wealthy individuals, the estate limit is scheduled to revert back to $5.5M in eight years. So for those who have every intention of being here in eight years, we can’t use the $11.18M as a final estate planning strategy. We can, however, use the same $11.18M for gifting over the next eight years while the individual is alive. There are many issues to consider in designing this strategy to maximize the benefits with respect to not only taxes but also wealth accumulation and holistic family goals.
One of the ways to accumulate a lot of money is to invest for a long time. If parents see 529 Plans as a savings account for current education expenses, the huge payoff of tax-free growth that the 529 Plan can provide over many years may never be realized. Other than grandparents using 529 assets to pay for pre-college costs, we have not yet seen a case where we recommend using 529s for anything but future educational expenses.
As our CPA friend Jon Karp says, “Don’t let the tax tail wag the dog.” The best practice is to be sure that all of your financial decisions have merit on their own, and are not solely made for tax reasons. It’s important to note that we are not tax advisors, so we recommend that you talk to your own tax advisor to understand how your income profile can benefit from the new law. Here are a few more resources:
www.irs.gov/newsroom/tax-reform
Seriously – irs.gov is a really helpful website. This is the page the IRS will use to provide information and guidance to taxpayers, businesses and the tax community as it becomes available while they do their work of implementing this major tax legislation.
Click on News and Insights for their latest releases about the TCJA.
www.cftexas.org/create-a-charitable-fund
For more information on how to create and use Donor Advised Funds. Full disclosure: I am on the Advisory Council of CFT.
Although the information has been gathered from sources believed to be reliable, it cannot be guaranteed. This material is intended for informational purposes only and should not be construed or acted upon as individualized tax, legal or investment advice. Federal tax laws are complex and subject to change. Neither FSC Securities Corporation, nor its registered representatives, offer tax or legal advice. As with all matters of a tax or legal nature, you should consult with your tax or legal counsel for advice. Jon Karp and Whitley Penn are not affiliated with FSC Securities Corporation. Listed entities are not affiliated with FSC Securities Corporation.