Don’t plan your taxes based on last year’s numbers
As we approach the end of the year, there are at least nine items for individuals and five for businesses to be aware of as a result of these changes.
Changes for Individuals
- Check Your Income Tax Withholding
While the new tax law reduced the tax rates applicable to most brackets, it also reduced or removed many deductions or credits, so it is important to check your income tax withholding. If you are under withholding, you may be hit with a big tax bill in April. Conversely, if you have been over withholding, but adjust now, you may get a bump in your take-home pay for the rest of the year. It is important to double-check your withholding and, if appropriate, file a new W-4 with your employer to adjust it before year-end.
The IRS has published a calculator to assist you with determining whether you need to make an adjustment to your withholding amounts.
- Be Aware of Changes to Standard Deduction, Personal Exemption and Child Tax Credit
One of the major changes under the new tax law was an increase in the Standard Deduction:
Married Filing Jointly
Head of Household
Married Filing Separately
This increase will likely reduce the number of individuals itemizing deductions. In addition, changes to the availability of some itemized deductions — such as the new $10,000 limit on the state tax deduction and some of the other limits discussed below—will further reduce the number of individuals itemizing deductions.
The Personal Exemption, on the other hand—which in 2017 was $4,050 for each individual and their dependents—has been revoked. For filers with dependents, this may offset any gain realized due to the increased Standard Deduction.
Last, the Child Tax Credit has been doubled from $1,000 to $2,000 per qualifying child, but now, only children under the age of 17 qualify. There is also a new $500 credit for any other dependent.
- Does the Change to the Mortgage Interest Deduction Affect You?
The new tax law changed the mortgage interest deduction by reducing the cap on the amount of principal that qualifies for the deduction.
For loans that were taken out for the purchase, construction or substantial improvement of a residence and that are secured by that residence, the new law reduced the amount of qualifying principal from $1,000,000 to $750,000 for new loans. These threshold numbers are halved for married couples filing separately—the cap applicable to these individuals was reduced from $500,000 to $375,000. Loans in existence before December 21, 2017 still qualify for the higher principal cap ($1,000,000) and are not affected by the new law.
For any other loan secured by a residence that does not satisfy the requirements above, the principal cap has been reduced from $100,000 to $0. This change applies to all such loans, regardless of when the loan was initiated. As a result, there is no mortgage interest deduction for these loans.
Determining whether the loan qualifies as being used for the purchase, construction, or substantial improvement of a residence will be up to you and your tax or legal advisor.
- Miscellaneous Itemized Deductions Are No Longer Allowed
Any itemized deduction deemed to be a “miscellaneous itemized deduction” is no longer permissible. This includes items such as unreimbursed work expenses, tax preparation fees, legal fees or professional dues. In addition, there is no deduction for investment or asset management fees for advisory or custody accounts.
For certain accounts, such as IRAs, it may be time to consider paying fees inside the account. If a tax deduction was a major reason for paying the fees separately, this lets you effectively deduct 100% of the fees, as fees paid inside are treated as an expense of the account, and not a taxable distribution. Alternatively, if cash flow is an issue, it may be easier to pay fees inside the IRA. There may still be non-tax related reasons to continue to pay these fees separately, but now is a good time to have a look at these options again.
- Alimony Will No Longer Be Deductible
The new law changed the treatment of alimony agreements entered into or modified after January 1, 2019. Under the new law, alimony paid under those agreements will no longer be deductible. Likewise, alimony received under those same agreements will no longer be includible in gross income. Thus, there is a planning opportunity to finalize alimony agreements by the end of the year to maintain their traditional tax aspects or defer them into the next year to take advantage of the new treatment. Consult your legal advisor about whether this end-of-year deadline will impact you.
- Bunching Income or Deductions Can Help Meet Certain Thresholds
In any given year, there are certain tax events that you have direct control over when they occur. For example, you can choose to sell stock and incur capital gain or loss this year or push it into the next year. This is important because capital losses can offset any capital gains for the tax year and up to $3,000 of other income.
This ability to control losses or gains can be important to qualify for certain income-based credits, or avoid certain income-based taxes. For instance, the 3.8% Net Investment Income Tax applies once Adjusted Gross Income (AGI) exceeds $200,000 for a year ($250,000 for married couples filing jointly). By incurring capital losses before the end of the year or delaying capital gains until the next year, you may be able to fall under these threshold amounts and avoid this tax.
In addition, you can choose to bunch charitable contributions for two tax years together, by either making the single contribution before the end of the first year or by pushing the contribution into the next year. Gifting appreciated stock, instead of selling the stock and giving the cash, can give a double tax benefit as you may be able to both deduct the full market value of the stock and avoid taxes on the built-in capital gain.
The new tax law also increased the cap on the amount of cash contributions to public charities that qualify for a deduction. The cap is based on a portion of the donor’s AGI, and was raised from 50% of AGI to 60% of AGI.
For example, if you had $100,000 of AGI in 2018, you could claim a charitable deduction of up to 60% of that—$60,000—for cash contributions made to a public charity.
This timing of tax events, especially deductions, may be important for you to carefully consider if you are on the threshold of itemizing under the new tax law.
- Review Your Estate Plan to Account for Higher Estate Tax Exemption
The new tax law significantly increased the exemption amount for Federal Gift, Estate and Generation-Skipping Transfer (GST) Tax purposes to $11,180,000 (for decedents dying in 2018). This has significantly reduced the number of estates subject to estate tax. However, depending on where you live, state estate or inheritance taxes may still be applicable. For example, if you live in Minnesota, Illinois or New York, your estate may be subject to a separate state estate tax. Consult your tax or legal advisor to find out if your state has either tax.
While not part of the new tax act, the annual gift exclusion increased to $15,000 in 2018. The annual gift exclusion is the amount that you can give each year to any person without triggering gift tax or the need to file a gift tax return. The annual gift exclusion applies on a recipient-by-recipient basis, so you could, for example, give up to $15,000 in 2018 to your sibling and then give up to $15,000 in 2018 to your child.
- Expanded Uses for 529 Plans
The new tax law has expanded what expenses can be paid by a 529 plan. A 529 plan is a tax-advantaged account designed to pay for an individual’s education expenses. Distributions from the 529 plan for education expenses are made tax-free and are not included in the individual’s income. The use of the 529 plan for any other purpose will mean that any distributions will be included in that individual’s income (and may incur an excise tax as well).
Under the prior law, these distributions were limited to college or university expenses, such as tuition, fees, books, etc., but the new law expanded this to cover public, private or parochial elementary or secondary education (K-12)—but only tuition expenses.
A 529 plan can be funded for an individual by using your annual gift exclusion. In fact, it is sometimes possible to utilize future years’ annual gift exclusions and bulk fund a 529 plan in one deposit. Consult your tax or legal advisor if this funding option is something you are interested in.
- Increased Contributions Amount to IRAs and 401(k)s
The IRS just released the inflation adjustments for 2019 for retirement plans. The annual deductible amount for contributions made to an IRA will increase in 2019 from $5,500 per individual to $6,000 with the catch-up limit for those 50 and older increasing to $7,000. The deductible amount for employee contributions to 401(k)s and other plans will increase in 2019 from $18,500 to $19,000. Deductibility ranges and qualifications for retirement savings contributions credit have also been adjusted.
Changes for Businesses
- Reconsider Your Business’s Tax Classification
The new tax law lowered the Corporate Tax Rate from a series of brackets with a top tax rate of 35% to single bracket with a flat 21% tax rate. It may be a good time to see if a change in tax classification to a C Corporation would make sense and potentially save taxes.
- New Deduction for Qualified Business Income for Pass-Through Entities
The new tax law also introduced a new deduction applicable to Partnerships and S Corporations. If you have income from an active trade or business, up to 20% of that income may be deductible. Once an individual’s taxable income exceeds $315,000 for a married couple filing a joint return, or $157,5000 for all other taxpayers, the deduction is further subject to a cap based on the amount of W-2 wages paid by the business and the basis of certain property held by the trade or business, provided that the business is not a specified service trade or business.
Specified service trade or businesses involve the performance of services in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, investing and investment management, trading, dealing in certain assets or any trade or business where the principal asset is the reputation or skill of one or more of its employees.
- Increase to Depreciation Expensing
Consider putting new equipment into service before the end of the year. The new tax law increased bonus depreciation percentage from 50% to 100% for certain property acquired and placed in service between September 27, 2017 and January 1, 2023. In addition, it also increased the maximum deduction for certain tangible, depreciable property or computer software which is acquired by purchase for use in the active conduct of a trade or business (Section 179 Property) from $500,000 to $1,000,000. Section 179 lets a trade or business immediately take a tax deduction of the cost of the property in the year it is bought, rather than capitalize that cost and then depreciate it over time.
If you purchased a new building or did a major renovation, you should consider doing a cost segregation study. This can move some of the items that are part of the project from a 39-year depreciation schedule to 15, 7 or 5-year classes, accelerating deductibility for these items.
- Qualify for the New Family Leave Credit
If you have a plan that provides at least 50% of a qualified employee’s wages during family and medical leave (FMLA), be sure that the plan is in writing. There is a new tax credit for 2018 and 2019 for employers who provide paid FMLA to their employees, but only for leave taken after the written policy is in place. The credit amount is between 12.5% and 25% of eligible wages paid while a qualifying employee is on FMLA. In addition, the plan must be only available for FMLA purposes and cannot be used for reasons other than FMLA purposes.
A written policy will be deemed to be in place as of the effective date so long it is adopted on or before December 31, 2018 and the company brings its leave practices into compliance with the terms of the full period it covers including making any retroactive leave payments no later than the last day of the tax year. In addition, paid leave under a short-term disability program may qualify if it meets all the relevant requirements.
- Denial of Deductions for Work-Related Expenses
Employees can no longer deduct unreimbursed work expenses, as they are classified as Miscellaneous Itemized Deductions. Since the new tax law removed the ability to deduct these, you may want to reexamine your expense reimbursement policies. In addition, entertainment expenses are no longer deductible at a corporate level. As a result, you should track meal reimbursement and entertainment expenses in separate accounts to preserve the remaining deduction.
These fourteen changes brought about by the new tax law are important to consider, so if you think you’ll be impacted, talk them through with your legal or tax advisor. Understanding these new rules now can help reduce the risk of being hit with surprises when it’s time to file in 2019.
This post is informational only and does not constitute legal or tax advice. For all the items discussed in this post, it is best to consult your own legal or tax advisor who knows your specific situation and can advise you accordingly.
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