The first sentence of our early November 2017 Astute Angle post read “It is November 8th, 2017 as this is written and there is no doubt that a lot will happen with the Tax Cuts and Jobs Act before the end of the year.” As expected, a lot did happen to the initial Tax Cuts and Jobs Act (TCJA) including (of all things) a mandatory name change for the legislation to comply with the Byrd Rule. Officially, it’s no longer the Tax Cuts and Jobs Act. Rather, it is now titled “An Act to provide for reconciliation pursuant to titles II and V of the concurrent resolution on the budget for fiscal year 2018.” While this is indeed a catchy name, we take the liberty of using the informal TCJA moniker to follow.
Some of the tax planning strategies in the initial post – like the time sensitive purchase of any electric vehicles – no longer apply because of subsequent changes to the TCJA. Moreover, brand new tax planning strategies have become relevant because of additions to the original bill.
With the updated bill now just a signature away from being the law of the land, this article highlights some of the personal tax planning strategies that become useful or more useful with the passage of this 494 page tax overhaul. Some of the planning strategies apply to the next 10 days while others will continue to apply into 2018 and beyond.
Everyone should fully pay all their 2017 state income taxes and 2017 property taxes before the end of 2017 – even taxpayers who face AMT.
With the state and local income tax deduction capped at $10,000 even for those who itemize starting in 2018, everyone should pay all 2017 state income and property taxes in 2017 to ensure a deduction for these dollars.
This means that anyone who pays quarterly estimated taxes should not wait until January to make their last payment for 2017 – they should pay it before year end. It means that anyone who recognized meaningful capital gains in 2017 should make a tax payment to their state before year-end – not wait until April when taxes are filed.
It also means that even taxpayers who expect to be subject to AMT in 2017 should pay all 2017 state and local property taxes before the end of 2017. Yes, these tax payments are not deductible under AMT so there would seem to be no tax benefit for AMT filers. However, paying the 2017 state and local taxes provides a valuable itemized deduction on the state tax return in most states (including Georgia) which, consequently, reduces the amount of state income tax. Additionally, married taxpayers with over $250,000 of modified adjusted gross income (MAGI) or single taxpayers with over $200,000 of MAGI are subject to the 3.8% Medicare surtax whether in AMT or not. Increasing itemized deductions by paying all state income taxes and property taxes in 2017 reduces the amount of income subject to the 3.8% Medicare surtax – even for those filers who face AMT.
Many families would be well served to accelerate anticipated future year charitable contributions into 2017 and consider establishing a donor advised fund with appreciated investments before year-end.
Under the initial House bill, it was estimated that only 1 in 20 taxpayers would continue to use itemized deductions rather than the increased standard deduction. That percentage of itemizers is expected to be 14% starting in 2018 after changes in the final bill such as the allowance for up to $10,000 of state and local tax deductions and the retention of the medical expense deduction. Still, that reduces the number of itemizers by more than 50% from 2017 and means that more than 85% of households will claim the standard deduction.
One of the biggest impacts for those taxpayers who use the standard deduction starting in 2018 is that charitable contributions made after December 31st will have zero tax benefit. The higher standard deduction also means that even households who itemize will often not get the full tax benefit of their charitable gifts. Given that high income taxpayers currently receive an effective federal and state tax subsidy of approximately $40 for every $100 they give to charities, this lost deduction is a huge deal for both charities and taxpayers.
If you do not have a large mortgage (interest expense that exceeds $14k/year) and/or large medical expenses (that significantly exceed 7.5% of your adjusted gross income), it is likely that you will not receive a full tax benefit from charitable gifts made after 2017. If you’re in such a scenario, then perhaps the most valuable year-end tax planning strategy is to accelerate charitable contributions before the end of 2017. One of the most efficient ways to exploit this strategy is via a donor advised fund where the tax deduction is immediate but the actual timing of the gifts to the targeted charities can be years in the future.
You can read our complete explanation of a donor advised fund here or simply think of the donor advised fund as a bank account that you fund (with cash or, better yet, with appreciated investments) with two important differences. The first key difference is that this bank account can only be “spent” on gifts to 501(c)3 charities. There’s no timetable on how quickly you need to “spend it” but you cannot spend it on a vacation or a new TV – only charitable gifts in the future. The second key difference is that when you fund this bank account, you get an immediate tax deduction – one that will likely be valuable in 2017 and less valuable thereafter.
Short of funding a donor advised fund before year-end, the other technique that will likely be advantageous in future years is to lump several years of charitable contributions into a single calendar year – a technique that is being called “charitable lumping”. Beginning in 2018, there will be a meaningful tax incentive for many, under the proposed tax bill, to give away $50,000 to charity in one calendar year rather than $10,000 per year for five years.
529 Plans become even more flexible which makes an even stronger case for high income taxpayers to aggressively fund them.
This 2016 Astute Angle post explained why 529 College Savings Plans are generally much more flexible than most people realize and why the financial risk of overfunding them is mitigated by this flexibility. The Republican tax bill further broadens the flexible usage of 529 Plan assets – permitting up to $10,000 per student per year to be used for elementary and secondary school expenses. This means that high income parents and grandparents who have the most to gain from the tax benefits of 529 College Savings Plans can aggressively fund these accounts while the children are young and then, to the extent the accounts become overfunded due to better than expected growth, begin using the funds to pay for high school (or even middle school) expenses Consider the case of parents who live in South Carolina and send three children (3rd grade, 5th grade, 9th grade) to private school at a cost of $10,000 per child per year. Rather than pay the $30,000 tuition ($10,000 per child) directly to the school each year, they can open South Carolina 529 Plan accounts for each child and contribute $10,000 to each plan every year. Immediately after funding the accounts, they can distribute the funds from the 529 Plan to the school for the tuition expenses. Because South Carolina offers a state tax deduction on the full amount of the 529 contribution, this relatively simple tactic saves the parents $2,100 of state taxes (7% state tax rate x $30,000) every year. Notably, grandparents who want to help with pre-college expenses or already do so can also exploit this strategy even if they do not live in the same state as their grandchildren. For the many taxpayers who will begin using the higher standard deduction in 2018, mortgage interest payments will no longer provide any tax benefit. This has the impact of significantly increasing the effective mortgage interest rate. Consider the taxpayer who currently itemizes but will begin using the higher standard deduction under the new code. Also assume this taxpayer has a 4.0% mortgage and pays an effective tax rate of 30%. His effective interest rate on the mortgage increases by 30% in 2018 from 2.8% to 4.0% which clearly changes the calculus of the “should I pay off my mortgage or invest” question. Taxpayers who have been considering an aggressive paydown of their mortgage or taxpayers with small mortgage balances who have been considering a mortgage payoff would likely be well-served to do so as the economics of carrying a mortgage will not be as favorable for most people starting in 2018. Additionally, taxpayers who have a home equity line of credit (HELOC) that was initiated after the home purchase should consider paying down the HELOC more aggressively as the interest expense will no longer be deductible after December 31st. This is even true for taxpayers who will continue to itemize which effectively raises the cost of a HELOC by as much as 40% or more for high income earners. The qualified charitable distribution (QCD) is an underutilized tax-saving tool that will see its benefit dramatically expand starting in 2018 under the proposed tax law. The biggest beneficiaries of the QCD now are those taxpayers who claim the standard deduction as they receive a tax benefit from charitable contributions that would otherwise provide no tax benefit. Given that the number of standard deduction filers will significantly increase (and likely approach 99% for retirees over age 70.5 as most will not have any mortgage interest), the tax benefit of the QCD expands to a much larger base and should be a tool that everyone over age 70.5 considers in 2018. The Astute Angle explained the tax saving strategy in this popular 2015 post. Notably, the “kiddie tax” changes under the new tax law but the increased standard deduction of $12,000 for single filers makes this investment gifting strategy more favorable in many instances, especially for high income taxpayers who face the highest 37% bracket. Expect an update to the original post with a more robust explanation of the new math. For now, keep in mind that if you are gifting investments to a child in college and letting him or her claim dependency, the child should realize no more than about $27,000 in gains during a year or the strategy can start to do more harm than good. Once again, these strategies are not intended to be all-encompassing or to cover every unique situation. They are just a few broadly applicable strategies that come to mind for individual and family taxpayers in light of the proposed tax reform. We welcome feedback if you think we have missed anything important or if you have questions about whether these strategies might be useful for your situation. Please feel free to email us or leave comments below if you have any questions, feedback, or additional thoughts. [i] The new law allows these funds to be used tax and penalty free for public, private, and religious elementary and secondary schools. [ii] A full list of states offering a state tax deduction for 529 Plan contributions can be found here.Parents with children in private school who live in states that provide a state tax benefit for 529 Plan contributions (Georgia, Alabama, South Carolina, New York, etc.)[ii] should begin running some or all of the annual tuition costs through a 529 College Savings Plan.
If you are considering an aggressive mortgage or HELOC paydown, it probably makes more sense now.
If you are at least 70.5 years old, utilize the qualified charitable distribution (QCD) starting in 2018 (or just start in 2017 and keep using in 2018).
Gifting appreciated investments to children to cover college expenses can actually become more valuable under the new “kiddie tax” rules but creates a maximum level of gifting for most taxpayers, over which additional gifts do more harm than good.
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