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New Tax Rules & Year End Planning
Unlike recent years, in which the tax rules have been relatively stable, 2018 brings extensive changes as a result of a large tax overhaul that passed Congress last December. These changes will affect how your 2018 taxes will be calculated. Here's a quick recap of the new rules, followed by some thoughts on steps we can take to reduce your bill.
For specific instances on how this legislation may impact you, please call or email us directly and we can speak at a more personal level regarding your situation.
I. Tax Rules for 2018
A centerpiece of last year's legislation is the reduction in income tax rates. While the new law keeps the same number of tax brackets for individuals as there were in 2017, many tax rates are two to three percentage points lower than prior years. The top rate is reduced from 39.6 percent to 37 percent and kicks in at higher taxable income levels - $600,000 of taxable income for joint filers, $300,000 for married taxpayers filing separately, and $500,000 for all other individual taxpayers.
The 2018 tax rates are 10%, 12%, 22%, 24%, 32%, 35%, and 37%, compared with the 2017 tax rates of 10%, 15%, 25%, 28%, 33%, 35%, and 39.6%. However, while applicable tax rates at any given level of income have generally gone down by two to three points, some individuals will see an increase in taxes due to the tax brackets at which the rates apply. For example, the tax rate for single taxpayers with taxable income between $200,000 and $400,000 goes from 33 percent to 35 percent (head of household filers face a similar jump, but at a slightly different breakpoint). However, high-income taxpayers are also subject to a 3.8 percent net investment income tax and/or the .9 percent Medicare surtax. There were no changes made to these taxes in last year's tax overhaul. In addition, the maximum tax rates on net capital gain and qualified dividends are the same in 2018 as they were in 2017.
*Chart does not account for the Medicare surtax on high earners. Source: House of Representatives, Tax Cuts and Jobs Act, December 16, 2017.
For 2018 individual tax returns, two of the most significant changes are the repeal of the personal exemption deductions and the increase in the standard deduction amounts. The standard deduction amounts are almost twice what they were in 2017: $24,000 for joint filers and surviving spouses, $18,000 for heads of household, and $12,000 for single individuals and those who are married but filing separately. Additional amounts for the elderly and blind are also available. Because the standard deduction is generally claimed only when it exceeds available itemized deductions, the increase in the standard deduction will not benefit you if you itemize deductions. The repeal of the personal exemption deductions, by contrast, will affect you whether you itemize or not.
To compensate for the repealed exemptions for dependents, the new law increased the child tax credit from the 2017 amount of $1,000 (which was fully refundable) to $2,000 ($1,400 is refundable). The modified adjusted gross income threshold where the credit phases out has been increased to $400,000 for joint filers and $200,000 for all others (up from $230,000 and $115,000, respectively). The maximum age for a child eligible for the credit remains 16 (at the end of the tax year). In addition, a $500 nonrefundable tax credit for dependent children over age 16 and all other dependents is also available beginning in 2018. Most families with non-child dependents will lose some ground here, as the $500 credit will generally be less valuable than the $4,150 exemption deduction it replaces.
Other significant changes as a result of the new tax law, as discussed below, include the elimination of many expenses that were previously deductible and new limitations on other expenses, particularly the $10,000 limitation on the deduction of state and local income and property taxes. While you may have itemized your deductions in prior years, we need to review whether that still makes sense in light of the increased standard deduction and the changes in the deductibility of other expenses.
The following are some key items to review:
State and Local Income and Property Taxes
State and Local Income and Property Taxes
State and Local Income and Property Taxes
New for 2018, there is a $10,000 limit on the deduction for state and local income and property taxes. No deduction is allowed for foreign property taxes.
Child and Dependent Care Expenses
State and Local Income and Property Taxes
State and Local Income and Property Taxes
If you paid someone to take care of your child or a dependent so you can work or look for work, you may be entitled to a tax credit for up to 35 percent of the expenses paid. Various qualifications must be met in order to be eligible for the credit, but if you incurred such expenses, you may qualify.
Casualty and Theft Losses
State and Local Income and Property Taxes
Miscellaneous Itemized Expenses
If you incurred a casualty loss in a presidentially declared disaster area, it may be deductible. Any other casualty loss, along with all theft losses, are not deductible.
Miscellaneous Itemized Expenses
Miscellaneous Itemized Expenses
Miscellaneous Itemized Expenses
If you deducted miscellaneous itemized expenses in prior years, such deductions are no longer available for 2018. The miscellaneous itemized expense deduction has been eliminated for tax years 2018 through 2025.
Adoption Expenses
Miscellaneous Itemized Expenses
Alternative Minimum Tax
If you incurred expenses to adopt a child, you may be eligible for a tax credit of up to $13,810 for some or all of those expenses. The determination of the tax year in which qualified adoption expenses are allowable as a credit depends on whether they were paid before the year in which the adoption became final or whether they were paid during or after the year in which the adoption became final.
Alternative Minimum Tax
Miscellaneous Itemized Expenses
Alternative Minimum Tax
If you were subject to the alternative minimum tax in prior years, you may get a break this year as the result of increases in the alternative minimum tax (AMT) exemption amounts as well as the increases in the income level at which the exemption is phased out.
Charitable Contributions
Whether it makes sense to take an itemized deduction for your charitable contributions depends on whether your total itemized deductions exceed your standard deduction. It's also worth noting that a new change in the law increases the maximum contribution percentage limit from 50 percent of your contribution base to 60 percent for cash contributions to public charities.
Taxpayers 70 1/2 years old and older who own an IRA are required to take minimum distributions from that account each year and include those amounts in taxable income. If you are in this category, a special rule allows you to make a charitable contribution directly from your IRA to a charity. This has several benefits. First, since charitable contributions deductions are usually only available to individuals who itemize, individuals who take the standard deduction instead can benefit from this rule. Second, making the contribution directly to a charity counts towards your required minimum distribution but that amount is not included in income and thus reduces your taxable income and adjusted gross income. A lower AGI is advantageous because it increases your ability to take medical expense deductions that you might not otherwise be able to take. For example, medical expenses are only deductible to the extent those expenses exceed 7.5 percent of your AGI and a lower AGI means you can deduct more medical expenses. In addition, as AGI increases, more of your social security income is subject to tax. Finally, the 3.8 percent net investment income tax applies to the extent your AGI exceeds a certain level.
Mortgage Interest
The mortgage interest deduction on acquisition indebtedness (e.g., mortgages) of more than $750,000 obtained after December 14, 2017, is limited to the portion of the interest allocable to $750,000 ($375,000 in the case of married taxpayers filing separately). In the case of acquisition indebtedness incurred before December 15, 2017, the limitation is the same as it was under prior law: $1,000,000 ($500,000 in the case of married taxpayers filing separately). Additionally, no deduction is allowed for interest paid on home equity indebtedness. However, to the extent the debt is used for certain purposes, the interest on the debt may still be deductible.
Education-Related Expenses
If you have any student loans outstanding, the interest you paid on those loans may be deductible. A deduction of up to $2,500 of interest paid on a qualified student loan is deductible in computing adjusted gross income. The deduction is phased out if your modified adjusted gross income is between $65,000 and $80,000 ($130,000 and $160,000 if filing a joint return).
- If you are an educator and spend your own money on school supplies, up to $250 may be deductible from gross income.
Moving Expense Reimbursement
If you received a reimbursement from your employer for moving expenses incurred in 2018, the reimbursement is taxable income. However, if you receive a reimbursement in 2018 for 2017 moving expenses, that is not taxable income. While taxpayers could previously deduct employment-relating moving expenses, this deduction is no longer available for moves taking place in years 2018-2025, unless the taxpayer is a member of the U.S. Armed Forces on active duty who moves pursuant to a military order to a permanent change of station.
Medical, Dental, and Vision Expenses
For 2018, you can deduct medical, dental, and vision expenses to the extent they exceed 7.5 percent of your adjusted gross income (AGI). In order to take this deduction in following years, such expenses must exceed 10 percent of your AGI. Thus, to the extent you are planning any elective medical, dental, or vision procedures, the expenses of which you can accelerate into 2018, the bunching up of those expenses in 2018 may help reduce your taxable income if you will be itemizing deductions. Such expenses must be primarily to alleviate or prevent a physical or mental defect or illness. They do not include expenses that are merely beneficial to general health, such as vitamins, or the costs of cosmetic surgery, unless the surgery is necessary to ameliorate a deformity resulting from a congenital abnormality, a personal injury, or a disfiguring disease.
Distributions from a 529 Plan
New for 2018, if you have a 529 Plan, you can use up to $10,000 in aggregate 529 distributions per year for elementary and secondary school tuition. Previously, 529 distributions could only be used for higher education expenses.
Individual Healthcare Penalty
While the tax penalty on individuals who fail to carry health insurance, which was enacted as part of the Affordable Care Act, has been eliminated for tax years after 2018, the penalty still applies for 2018 unless a taxpayer is exempt from the penalty because the taxpayer's income falls beneath a certain level.
Pass-through Tax Break
Another change in the law, effective for 2018, allows a 20 percent deduction for qualified business income from sole proprietorships, S corporations, partnerships, and LLCs taxed as partnerships. If you qualify for the deduction, which is available to both itemizers and nonitemizers, it is taken on your individual tax returns as a reduction to taxable income. The new tax break is subject to some complicated restrictions and limitations, but the rules that apply to individuals with taxable income at or below $157,500 ($315,000 for joint filers) are simpler and more permissive than the ones that apply above those thresholds.
- It's worth noting that the effective marginal tax rate on qualified business income for individuals in the top 37-percent tax bracket who are able to fully apply the new deduction will be 29.6 percent - a full 10 points lower than the top rate under prior law.
II. Year-End Tax Planning
Retirement Plans Considerations
Fully funding your company 401(k) with pre-tax dollars will reduce your current year taxes, as well as increase your retirement nest egg. For 2018, the maximum 401(k) contribution you can make with pre-tax earnings is $18,500. For taxpayers 50 or older, that amount increases to $24,500.
If you have a SIMPLE 401(k), the maximum pre-tax contribution for 2018 is $12,500. That amount increases to $15,500 for taxpayers age 50 or older.
If certain requirements are met, contributions to an individual retirement account (IRA) may be deductible. For taxpayers under 50, the maximum contribution amount for 2018 is $5,500. For taxpayers 50 or older but less than age 70 1/2, the maximum contribution amount is $6,500. Contributions exceeding the maximum amount are subject to a 6 percent excise tax. Even if you are not eligible to deduct contributions, contributing after-tax money to an IRA may be advantageous because it will allow you to later convert that traditional IRA to a Roth IRA. Qualified withdrawals from a Roth IRA, including earnings, are free of tax, while earnings on a traditional IRA are taxable when withdrawn.
If you already have a traditional IRA, we should evaluate whether it is appropriate to convert it to a Roth IRA this year. You'll have to pay tax on the amount converted as ordinary income, but subsequent earnings will be free of tax and the decrease in tax rates that are effective this year makes such a conversion less costly than it would have been in previous years. Of course, this option only makes sense if the tax rates when the money is withdrawn from the Roth IRA are anticipated to be higher than the tax rates when the traditional IRA is converted. And if you have a traditional 401(k), 403(b), or 457 plan that includes after-tax contributions, you can generally rollover these after-tax amounts to a Roth IRA with no tax consequences. A rollover of a SIMPLE 401(k) into a Roth IRA may also be available. As with all tax rules, there are qualifications that apply to these rollovers that we should discuss before any actions are taken.
Capital Gains and Losses
If your stock portfolio includes stocks that have lost value since you originally invested and you've decided you want to divest yourself of them, we should evaluate whether you might benefit from selling off appreciated stocks, particularly those that would generate a short-term capital gain, and using the resulting gain to limit your exposure to a long-term capital loss, the deduction of which is limited. And any net capital gain you may reap, will be taxed at the substantially reduced capital gain tax rate.
The tax rate for net capital gain is generally no higher than 15 percent for most taxpayers. Some or all of your net capital gain may be taxed at 0 percent if your income is not above $38,600 (single), $77,200 (joint), or $51,700 (head of household). However, a 20 percent tax rate on net capital gain does apply to the extent that your ordinary taxable income is over $425,800 (single), over $479,000 (joint), $239,500 (married filing separately), or over $452,400 (head of household). There are a few other exceptions where capital gains may be taxed at rates greater than 15 percent: (1) the taxable part of a gain from selling certain qualified small business stock is taxed at a maximum 28 percent rate; (2) net capital gains from selling collectibles (such as coins or art) are taxed at a maximum 28 percent rate; and (3) the portion of certain unrecaptured gain from selling real property is taxed at a maximum 25 percent rate. If you have been involved in any such transactions during the year, we should review your options for reducing the tax on those transactions.
Alternative Minimum Tax
Beginning in 2018, fewer taxpayers will be subject to the alternative minimum tax (AMT) as a result of sharp increases in exemption amounts and higher exemption phaseout levels. Nonetheless, if it looks like you may be subject to the AMT this year, there are certain strategies we should review to see if they may reduce or eliminate the impact of the AMT in your situation. While all taxpayers are eligible for an exemption from the AMT, the amount of the exemption depends on your filing status. For 2018, the exemption amounts for individuals, other than those subject to the kiddie tax, are (1) $109,400 in the case of a joint return or a surviving spouse; (2) $70,300 in the case of an individual who is unmarried and not a surviving spouse; and (3) $54,7000 in the case of a married individual filing a separate return. However, these exemptions are phased out by an amount equal to 25 percent of the amount by which your alternative minimum taxable income (AMTI) exceeds: (1) $1,000,000 in the case of married individuals filing a joint return and surviving spouses and (2) $500,000 in the case of all other individuals.
Foreign Bank Account Reporting
If you have an interest in a foreign bank account, it must be disclosed; failure to do so carries stiff penalties. You must file a Report of Foreign Bank and Financial Accounts (FBAR) if: (1) you are a U.S. resident or a person doing business in the United States; (2) you had one or more financial accounts that exceeded $10,000 during the calendar year; (3) the financial account was in a foreign country; and (4) you had a financial interest in the account or signatory or other authority over the foreign financial account. If you are unclear about the requirements or think they could possibly apply to you, please let me know.
Flex Spending Accounts
Generally, you will lose any amounts remaining in a health flexible spending account at the end of the year unless your employer allows you to use the account until March 15, 2019, in which case you'll have until then. You should check with your employer to see if they give employees the optional grace period to March 15.
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