Tax Planning Under New Law – What Has Changed?
As year-end approaches, many people tend to revert to the old tax planning adage “defer income, accelerate deductions.” But does that always work? With the new tax law in effect, should taxpayers change the way some planning items are viewed? Here are a few tax planning tips that should be reviewed prior to year-end.
Capital Gain/Loss Planning
Under new tax law, taxpayers in either the 10% or 12% marginal brackets (up to $38,700 of taxable income for single and $77,400 for married filing joint) will enjoy their long-term capital gain and qualified dividend income taxed at 0%. Considering this, taxpayers need to be on the lookout for the opportunity to recognize long-term capital gain income at year-end to the extent this situation presents itself. It should be noted that these gains, despite being taxed at 0% at the Federal level, could still be subject to state income tax (as is the case in Illinois).
Alternatively, for taxpayers that will likely owe tax on capital gains, there can be benefit in recognizing capital losses in the portfolio by way of tax loss harvesting. If a taxpayer has an investment that is currently at a loss, it can be beneficial to sell that security to recognize the tax loss. This tax loss can be used currently if an identical investment is not repurchased within 31 days.
Roth IRA Considerations
Under new tax law, married couples with taxable income of $315,000 stay completely within the 24% income tax bracket. When law reverts to old tax rates in 2026, that same couple will find themselves almost halfway into the 33% tax bracket – a 9% difference! Taxpayers that are comfortable paying some tax now can make these Roth conversions in today’s lower rate environment, then pull these funds (and related investment earnings) out of the Roth IRA tax-free later on when rates are set to climb back up. There also can be a state income tax benefit to Roth IRA conversions – depending on an individual’s state of residence, IRA income may not be subject to state income tax. The states that do not tax IRA income are as follows: Alaska, Florida, Illinois, Mississippi, Nevada, New Hampshire, Pennsylvania, South Dakota, Tennessee, Texas, Washington and Wyoming.
Also, Roth IRA conversions can be a great estate planning tool. If a married couple has a large estate that contains large qualified plan balances, Roth IRA conversions can be a great way to reduce the size of the estate. Not only can this mitigate estate taxes, but the heirs of the estate will inherit the Roth IRA and not owe any income tax on distributions from the account.
New tax law has limited the deduction for real estate and state taxes, when combined, to $10,000 per return. Also, miscellaneous deductions subject to the 2% AGI floor have been eliminated. To compensate for this, the standard deduction was essentially doubled to $12,000 for single filers and $24,000 for married couples filing jointly. The end result? Many taxpayers who were itemizing deductions under old law will now take the standard deduction in 2018. For those that are charitably inclined, it may be beneficial to lump multiple years’ worth of gifting into one year and take the standard deduction in the next year. Consider the following example to articulate this point. Let’s say a married couple filing jointly has state taxes of $10,000, mortgage interest of $4,000 and gifts $15,000 to charity every year. Comparing the two methods of gifting looks like this:
You will see in the above example that if the couple continues their normal gifting schedule of $15,000 per year, their tax deductions over the next four years will total $116,000. However, if that same couple lumps gifts every other year and takes the standard deduction of $24,000 in the years they don’t gift, their total deductions over the same timeframe totals $136,000 – a $20,000 increase! As you can see, being strategic with charitable deductions can result in real tax benefits.
As year-end approaches, being mindful about how the above planning items can prove to be beneficial in many situations. Reach out to your BDF team to discuss tax planning in more detail.
Matt is a wealth manager at BDF. He sits on BDF's Financial Planning Committee and leads many of the firm's tax-related initiatives. Matt has a passion for building strong relationships with his clients and helping them make sound decisions. He also holds the Certified Exit Planning Advisor designation which helps him advise business owners on how to exit their business and prepare for retirement.