Fall is typically an opportune time to take stock of one’s finances in preparation for the upcoming income tax preparation season. For many taxpayers, income taxes for the 2018 calendar year may prove to be a much simpler process due to the passage of the Tax Cuts and Jobs Act late last year. However, that doesn’t mean that there aren’t any opportunities to take some strategic steps now to save on income taxes come April 2019. Before we get to these tax savings strategies, let’s quickly review some of the more common changes that were implemented under the new law for the period January 1, 2018 through December 31, 2025:
The standard deduction in 2018 has been increased to $12,000 for single taxpayers, $18,000 for “heads of household” and to $24,000 for those married, filing jointly. Keeping track of myriad receipts for itemized deductions will now apply only to those individuals whose deductions for medical expenses, state and local income and property taxes (“SALT”) up to a maximum of $10,000, interest expense and charitable deductions when aggregated exceed these thresholds, depending upon filing status.
For those able to itemize deductions, medical deductions must exceed a threshold of 7.5% of adjusted gross income (AGI) in 2018; this threshold will increase to 10% of AGI beginning on January 1, 2019. For this reason, annual physicals, eye exams, ordering contact lenses and eyeglasses, prescription refills, and other qualifying medical expenses will produce a greater tax benefit in 2018 than in 2019, assuming one is able to itemize deductions in 2018.
Qualifying mortgage interest remains deductible on residential mortgages and on existing home equity lines of credit (HELOCS) that were in place prior to December 15, 2017. Interest on residential mortgages and HELOCS established after December 14, 2017 will be deductible with a cap on the principal amount borrowed of $750,000.
Miscellaneous itemized deductions have been completely suspended through December 31, 2025.
Personal and dependency exemptions have been repealed.
Charitable contributions remain deductible with several new twists in the calculation method. Cash contributions to public charities and certain types of private operating foundations have been increased from 50% of AGI to 60%. Any excess amounts may be carried forward for up to five years. Contributions of marketable securities that have been held for more than one year are deductible subject to a limitation of 30% of AGI.
For employed taxpayers who may no longer have sufficient deductions to itemize, all is not lost. Contributions to 401(k) and 403(b) plans, as well as IRA contributions are classified as adjustments to gross income and are not itemized deductions. Boosting contributions to the maximum permitted dollar amount (lesser of 100% of earned income or $18,500 for 401(k) and 403(b) plans, plus an additional $6,000 “catch-up” contribution for taxpayers age 50 and over) before calendar year-end can reduce adjusted gross income before applying any standard deduction or itemized deductions. Regular IRA contributions are limited to $5,500 for taxpayers not an active participant in an employer’s qualified retirement plan; this contribution threshold is also increased by $1,000 as “catch-up” contributions for taxpayers age 50 and over. Please note there are phase-outs for Regular IRA contribution amounts based on whether one spouse or both spouses are active participants in an employer’s qualified retirement plan.
Taxpayers who are age 70 ½ or older in 2018 may elect to designate up to $100,000 of their 2018 Required Minimum Distribution (RMD) amount from qualified retirement plans directly to a qualifying charity, without including this sum in gross income. This is a more tax efficient method of making charitable contributions, especially for taxpayers unable to itemize deductions in the current year.
In 2018, the annual gift tax exclusion amount was increased to $15,000 per recipient. Individuals interested in funding education accounts for children or grandchildren may wish to consider establishing and funding a separate 529 Plan account for each child or grandchild with cash up to this level. Individuals seeking to “front-load” or “superfund” 529 Plan accounts per child/grandchild in one calendar year may opt to contribute up to $75,000 per account. While this will not reduce one’s income tax liability in the current year, many states now offer some form of deduction or credit on state income taxes for 529 Plan funding. In addition, transferring sums from a personal account to a 529 Plan account will remove the income produced on these sums from taxable to tax-exempt status.
Prior to Congress’s adjournment on September 28th until the mid-term elections in early November, the House of Representatives passed what is being referred to as “Tax Reform 2.0.” This prospective legislation must be reviewed and passed by the Senate, and signed by the President, before taking effect. However, some of the provisions in this proposal include:
Making provisions of the Tax Cuts and Jobs Act affecting individuals and small businesses permanent. At present, most will sunset at midnight on December 31, 2025.
Expanding the qualifying education use of 529 Plan accounts to homeschooling expenses, apprenticeships and school loan repayments.
Repealing the maximum age (currently age 70 ½) for Regular IRA contributions.
Providing an exemption from Required Minimum Distributions (RMDs) for individuals with certain account balances.
Establishing “Universal Savings Accounts” permitting cash contributions of up to the lesser of $2,500 or earned income, as indexed for inflation. Withdrawals from these accounts would be income tax free.
The future of these proposals is uncertain presently, but bears watching closely as we approach the end of the year.
The above information is presented for educational purposes only. Please consult your personal tax advisor before implementing any technique or idea contained in this quarterly commentary.