Year-end financial planning will be a lot different this year than previous years, largely because it is the first full year after the implementation of the Tax Cuts and Jobs Act (TCJA). The good news is that for millions of Americans, the new code should make filing easier for these two reasons:
- Nearly 90 percent of taxpayers are likely to claim the standard deduction this year, up from 70 percent last year.
- Fewer taxpayers will have to deal with the Alternative Minimum Tax (AMT), which impacted middle- and higher-income taxpayers from states with high income and property taxes.
The new law did not repeal AMT, but it increased the amount of income exempt from the AMT to $109,000 for joint filers (up from $84,500) and $70,300 for singles (from $54,300).
That said, there are plenty of changes to address. “Because the changes are vast, you may want to consider having your CPA/tax preparer do a projection of your 2018 taxes, while he or she has the time,” says Brenna McLouglin,CFP®.
Short of taking a stab at determining your 2018 return, a good place to start is to pull last year’s returns and ask two important questions:
- How will my 2018 and 2019 income compare with 2017? Is it likely to be higher or lower? This estimate will allow you to make important decisions.
- Based on last year’s deductions, am I likely to itemize, or take the new, higher standard deduction ($12,000 Inds/$24,000 MF/$18,000 HOH)? To determine itemized versus standard, you tally up deductions, including: mortgage interest (be mindful of new restrictions, which limit the deductibility of mortgage amounts in excess of $750,000 and home equity interest used for non-home related purposes); state and local income or sales taxes, real estate taxes, and personal property taxes up to $10,000; and charitable contributions.
Whether you choose to itemize or claim the standard deduction, there are considerations to keep in mind for each.
If you itemize deductions:
Many itemized deductions of the past have been scrapped, including those for unreimbursed employee expenses; tax preparation fees; investment and management expenses; employment related educational expenses; job search expenses; theft; and most personal casualty losses (except those that resulted from a federally declared disaster area).
The change in itemized deductions makes the concept of “bunching” or “bundling” deductions much more important. The theory is that if you can bunch future itemized items into one year, you may be able to itemize again. The best opportunity may be with your charitable contributions.
If you claim the standard deduction:
For those who are claiming the standard deduction or have higher income in 2018 than they are likely to have next year, the best way to reduce your tax liability is to maximize your retirement plan contributions. If you have not done so, contact your HR department to see if you can increase your contributions before the end of the year. If you are self-employed or have a side hustle, you may want to establish your own retirement plan. Most plans, with the exception of a SEP-IRA, must be established (though not funded) by December 31.
Don’t despair if your income has stayed the same or dropped this year, because you may have a unique opportunity to execute a full or partial Roth IRA conversion, where you pay taxes at today’s rates, rather than wait until later in life, when you may be in a higher bracket. This may also work well for a retiree, whose tax bracket has dropped. Remember: a conversion only works if you pay the taxes due from money outside of the retirement account.
What this means for charitable contributions:
The tax law is expected to reduce the marginal tax benefit of giving to charity by more than one-quarter in 2018, according to the Tax Policy Center, but if you give one lump sum, which represents your gifts for the next few years, you may be able to feel good while also recapturing the tax benefit. One easy way to accomplish this is by establishing a donor advised fund (DAF), which allows you to make multiple years’ worth of donations up front. An added bonus of DAFs is that you can contribute appreciated securities as well as cash into the account.
As you begin your year-end planning, it’s always a good idea to sit down with your CERTIFIED FINANCIAL PLANNER™ professional to discuss how the new tax law will impact you specifically and how that should be reflected in your strategy to ensure you are set up for success in the year ahead.