It’s been more than a year since Congress made sweeping changes to the U.S. tax code by passing the Tax Cuts and Jobs Act. For most taxpayers, however, the full impact of the changes won’t be felt until they file their 2018 tax returns by the April 15 deadline.
In January 2018, we wrote an article outlining the most significant changes implemented through tax reform. This year, we’d like to focus on the changes that will likely be of greatest interest to you as you prepare to file your tax returns for the first time in a post-reform world.
Watch for effects of changing tax brackets
The new tax laws kept the seven brackets, but lowered several of the tax rates and changed the income thresholds applicable to these rates. You’ve now had a year to see the result of these changes on your paychecks, but you will get a clearer picture of the net impact once you’ve completed your tax return. Depending on how you adjusted your withholding, the size of your tax return (or required payment) could be different than what you’ve seen in previous years.
Standard deduction or itemize?
Apart from the modified tax brackets, the most significant changes, for many taxpayers, concern the following topics:
* Higher standard deduction – The standard deduction nearly doubled starting in 2018, from $12,700 to $24,000 for married couples and from $6,350 to $12,000 for individuals.
* Elimination of the personal exemption – The personal exemption, which was $4,050 per person in 2017, is eliminated starting in 2018.
* $10,000 SALT limit – In past years, if you itemized deductions, you could deduct an unlimited amount of state and local taxes, including property tax, sales tax, and income tax (as long as you weren’t subject to the alternative minimum tax). Starting in 2018, deductions for these so-called “SALT” taxes are limited to a total of $10,000 per tax return; this limit applies to both individuals and married couples.
Taken together, these three factors may represent a major change in how you file your tax returns—particularly in terms of whether you choose to itemize deductions or take the new, higher standard deduction.
For many taxpayers, the higher standard deduction will make it worthwhile to forego itemizing. But for others, the decision isn’t going to be so clear-cut.
To answer this question, you will need to consider your other possible itemized deductions. Mortgage interest payments are still deductible (with some exceptions, described below), as are charitable gifts, medical expenses above a certain threshold, and a host of other expenses. So, if you determine that your itemized deductions, even with the new SALT limits, are going to be larger than the new, higher standard deductions, you may decide to continue itemizing.
Making the most of your charitable gifts
While charitable gifts are still tax-deductible, the changes described above mean that fewer taxpayers will receive a direct benefit from charitable gifts. In fact, the Tax Policy Center estimated that the new tax laws would reduce the number of households taking itemized deductions for charitable gifts from about 37 million to about 16 million in 2018.
But even if you plan on taking the standard deduction, there are still opportunities to think strategically about ways to maximize the tax benefits of your charitable gifts. One such strategy involves “bunching” your charitable gifts in one year, as opposed to spreading them evenly over multiple years.
Suppose, for example, that you and your spouse typically donate $5,000 annually to charities, so that in 2019 through 2021, you would end up giving a total of $15,000. If your total potential itemized deductions for those years—your $5,000 charitable deduction, plus SALT, mortgage, and other deductions—were less than the $24,000 standard deduction, you’d take the standard deduction. This means that your charitable gift wouldn’t help you tax-wise.
But if you bunched the three years’ worth of charitable gifts into 2019, resulting in a $15,000 gift that year and no gifts in 2020 and 2021, your total itemized deductions could be larger than the standard deduction, assuming your other itemized deductions were more than $9,000 in 2019. In this case, you could itemize your deductions for 2019 and then take the standard deduction in 2020 and 2021. The end result? You’d still average $5,000 per year in charitable gifts for three years, and you’d get the full $15,000 deduction for your charitable gifts.
If you’re 70 ½ or older, you have another option for using your charitable gifts to reduce your tax burden, even if you don’t itemize. As you may know, once you reach 70 ½, you must start taking withdrawals—technically called required minimum distributions (RMDs)—from your traditional IRA. These RMDs are taxable, and could even push you into a higher tax bracket. But you can contribute up to $100,000 each year in RMDs to a qualified charity. By doing so, your distribution will be excluded from taxable income, effectively giving you a significant tax break.
Other changes to consider
The new tax laws may affect you in other ways, too, particularly if you have children, own a business, or are considering leveraging your home equity.
* Expanded use of 529 plans – If you have children (or grandchildren), you may already be familiar with 529 college savings plans. Earnings in a 529 plan can grow on a tax-deferred basis, and withdrawals used for qualified higher education expenses are free from federal taxes. Starting in 2018, up to $10,000 per year of funds in 529 plans can be used for K-12 tuition, in addition to a broader range of college expenses.
* Deductions for “pass-through” income – The new tax law established a new tax deduction for owners of “pass-through” businesses, including sole proprietorships, partnerships, S corporations, limited liability companies (LLCs), and limited liability partnerships (LLPs). If you’re a qualified pass-through owner, you can deduct up to 20% of your net business income. But not all owners of pass-through business will receive this deduction. It can be reduced or fully eliminated depending on your income level and the type of work you do.
* Higher child tax credit – The amount of the Child Tax Credit doubles from $1,000 to $2,000 per qualifying child in 2018. Also, $1,400 of the credit is now refundable; previously, the credit was nonrefundable. (As you may know, a tax credit, unlike a deduction, is a straight dollar-for-dollar reduction in your tax bill. Refundable tax credits can reduce your tax liability below zero and allow you to receive a tax refund.)
* Interest deductibility limits for home equity loans and new “jumbo” mortgages – Interest on home equity loans and lines of credit are no longer deductible, unless the loans are used to improve your current home. Fortunately, the term “home improvement” can cover a variety of projects, such as additions, remodeling, and even the installation of solar panels. Also, for mortgages incurred after December 14, 2017, the interest on only the first $750,000 of mortgage debt is deductible. (After December 31, 2025, though, this interest cap will revert to $1 million.)
Time to look at a Roth conversion?
In the current low-tax environment, you may want to consider converting a traditional IRA to a Roth IRA, so you can take advantage of a Roth IRA’s tax-free earnings and withdrawals and lack of RMDs.
While it may be advantageous to convert a traditional IRA to a Roth IRA, it isn’t cheap. The conversion is treated as taxable income, so it will likely trigger a bigger federal tax bill, and possibly a bigger state income tax bill, too.
It’s impossible to predict what Congress will do, but today’s federal income tax rates might be the lowest you’ll see for many years. This means that now might be your best opportunity to do a Roth conversion. Still, a Roth conversion isn’t appropriate for everyone. In addition to having to pay the upfront tax bill, you’ll want to think about whether you’re likely to be in a higher tax bracket now or when you’re retired.
You can initiate a Roth conversion at any time, but it’s generally beneficial to wait until the end of the year. At that point, you will have more complete information on your income taxes—and this knowledge may help you avoid converting so much money that you’ll be bumped into a higher income tax bracket. So, if you think you might be interested in a Roth conversion, contact The Retirement Network in November or early December of 2019.
Helping you navigate the new landscape
Understanding the impact of all these changes might seem daunting. As you begin the task of filing your taxes, The Retirement Network is here to help. We can guide you in assessing the impact of the changes on your personal situation and navigating these changes in a way that allows you to continue making progress toward your long-term financial goals.
This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.