Tax Cuts & Jobs Act: Planning Strategies for Individuals
Apr 02, 2018
The Tax Cuts and Jobs Act (TCJA) was signed into law on December 22, 2017. While many of the provisions in the new legislation for businesses are permanent, others (including most of the tax cuts that apply to individuals) will expire at the end of 2025 unless otherwise noted. Below are several planning ideas to consider under the new law. Before proceeding with any of these techniques, be sure to consult with your tax advisor regarding how a strategy may apply to your individual situation.
Increased Standard Deduction & Changes to Itemized Deductions
The legislation roughly doubled standard deduction amounts to $12,000 for single individuals or married couples filing separately and $24,000 for married couples filing jointly, while it repealed personal exemptions. The overall limit on itemized deductions that applied to higher‐income taxpayers (commonly known as the Pease limitation) was also repealed. Higher standard deduction amounts will generally mean that fewer taxpayers will itemize deductions going forward. The following changes were made to individual deductions:
- State and local taxes: Individuals are only able to claim an itemized deduction of up to $10,000 ($5,000 if married filing separate) for state and local property taxes and state and local income taxes (or sales taxes in lieu of income taxes).
- Home mortgage interest deduction: Individuals can deduct mortgage interest on no more than $750,000 ($375,000 for married individuals filing separately) of qualifying mortgage debt. For mortgage debt incurred prior to December 16, 2017, the prior $1 million limit will continue to apply. No deduction is allowed for interest on home equity indebtedness.
- Medical expenses: The adjusted gross income (AGI) threshold for deducting unreimbursed medical expenses is reduced from 10% to 7.5% for 2018, after which it returns to 10%. The 7.5% AGI threshold applies for purposes of calculating the alternative minimum tax (AMT) for 2018 as well.
- Charitable contributions: The top AGI limitation percentage that applies to deducting cash gifts to public charities is increased from 50% to 60%.
- Casualty and theft losses: The deduction for personal casualty and theft losses is eliminated, except for casualty losses suffered in a federal disaster area.
- Miscellaneous itemized deductions: Miscellaneous itemized deductions that would be subject to the 2% AGI threshold, including tax‐preparation expenses and unreimbursed employee business expenses, are no longer deductible.
Consider the following strategies to maximize your deductions.
- Look for options to bunch itemized deductions so that in combination they exceed the new higher standard deduction. If you are charitably inclined, it could be beneficial to make larger gifts in one year rather than smaller gifts over several years. This could be done via a Donor Advised Fund to get the deduction in a single year and ultimately distribute amounts out to charity over time. For 2018 in particular, you may consider incurring out‐of‐pocket medical expenses for procedures recommended by your doctor that you may have been delaying. Keep in mind that your total out‐of‐ pocket medical expenses would need to exceed 7.5% of AGI before a deduction is permitted. Beginning in 2019, that threshold returns to 10%.
- If you are age 70 ½ or older, consider transferring all or a portion of your Required Minimum Distribution (RMD) from Individual Retirement Accounts (IRAs) and qualified plans directly to charity via a Qualified Charitable Distribution (QCD). If certain requirements are met, this allows the funds to be excluded from income so that you get the tax benefits of giving to charity regardless of whether or not you itemize deductions.
Estate, Gift, and Generation Skipping Transfer (GST) Tax Exemptions
Application of the federal estate, gift, and GST tax is narrowed by doubling of the estate, gift, and GST tax exemption amount under TCJA to $11.18 million in 2018, indexed for inflation in future years. Beginning in 2026, this provisions is scheduled to sunset to levels in place prior to TCJA ($6.56 million projected exemption for 2026). While you may not be subject to estate tax currently, there are still benefits to having estate documents in place, including management of assets in the event of incapacity and asset protection for heirs.
During this window of opportunity, you may consider lifetime gifts to make use of the increased exemption amounts. Keep in mind that gifted property will have a carryover basis, compared to property inherited at death that will get a stepped‐up basis. The higher basis would reduce capital gain taxes when your heirs ultimately sell the assets transferred to them. If you have a relatively short life expectancy, it may therefore be more beneficial to retain assets until your passing. However, it is possible that legislation could change prior to the intended sunset so there is no guarantee of how long the higher exemptions will remain in place.
Your ability to maintain financial independence should be reviewed prior to making lifetime gifts, and provisions for flexibility are advisable. For example, you may consider a dynasty trust to protect assets for future generations but structure it as a Spousal Lifetime Access Trust (SLAT) so that your spouse could have access to trust assets if needed in the future.
529 Plans Expanded
Under TCJA, the definition of a 529 plan qualified education expense was been expanded to include K‐12 expenses. Starting in 2018, annual withdrawals of up to $10,000 per student can be made from a 529 plan for tuition expenses in connection with enrollment at an elementary or secondary public, private, or religious school (excluding home schooling). Such withdrawals are now tax‐free at the federal level.
At the state level, roughly 20 states (including Florida) automatically update their state legislation to align with federal 529 legislation, but the remaining states – including Ohio and Michigan – will need to take legislative action to include K‐12 expenses as a qualified education expense. 529 account owners who are interested in making K‐12 contributions or withdrawals should understand their state's rules regarding how K‐12 funds will be treated for tax purposes.
If your state allows for funds to be used for K‐12 expenses and provides significant state income tax benefits for contributing to a state‐sponsored plan, it may be advantageous to use your resident state’s plan. For example, Pennsylvania permits K‐12 withdrawals to be treated as qualified expenses for state tax purposes and also offers a state income tax deduction of $15,000 per beneficiary per person ($30,000 for a married couple) for Pennsylvania residents contributing to the Pennsylvania plan. Based on a state income tax rate of 3.07%, this equates to tax savings of approximately $920 for a married couple. Florida also permits funds to be used for K‐12 expenses, though there are no specific tax benefits to Florida residents for using a Florida plan since there is no state income tax.
Planning with Roth IRAs
Beginning in 2018, you are no longer able to recharacterize Roth conversions. This is only for conversions, not contributions. If you make a new Roth contribution and later discover that you are over the income threshold to do so, you can still move the excess funds back to a traditional IRA.
Though not part of the law itself, the Conference Committee’s Explanatory Statement of the TCJA explicitly blesses the backdoor Roth contribution technique that some had questioned by saying it might be illegal under the step transaction doctrine. The Explanatory Statement states four times that, “Although an individual with AGI exceeding certain limits is not permitted to make a contribution directly to a Roth IRA, the individual can make a contribution to a traditional IRA and convert the traditional IRAto a Roth IRA.”
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consult with a qualified tax, legal or financial representative prior to making a decision.