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Beyond Year-End Tax Planning (Quoted in The Washington Post)

Beyond Year-End Tax Planning (Quoted in The Washington Post)

David recently had the opportunity to share his thoughts on the new tax law with Michelle Singletary of The Washington Post and was quoted in her article titled, "Start 2018 with a new strategy for your taxes." What follows is our expanded perspective on tax planning as we close out 2017 and prepare for 2018 and beyond.

The new tax law is bringing about significant changes in how we engage in strategic planning. Many opportunities are going away for good (e.g. recharacterization of Roth conversions) while some have popped up with only a brief window and need to be implemented before 12/31/17. In the past week and a half, there has been a lot of media attention on these strategies, and if you haven't already, you should consider doing the following right now.

  • Pay your Q4 estimated state income tax before 12/31/17 (if you will itemize for 2017 and will not be subject to AMT)
  • Prepay your property taxes to the extent currently assessed by your local jurisdiction (if you will itemize for 2017 and will not be subject to AMT)
  • Accelerate charitable gifts into 2017 (If you will itemize for 2017)

Thankfully, however, most of the changes in the tax law won't require you to make frantic moves. We are currently in the process of carefully reviewing the new legislation and discussing it with fellow tax professionals to make sure we understand the financial planning implications going forward. We will then contemplate each client's unique situation, evaluate the new opportunities created, and consider what changes should be made in our approach.

With so much current focus on taxes, it’s also important to step back and look at the big picture. While taxes can have a significant impact on financial decisions, the goal is not necessarily to minimize taxes, but rather to maximize after-tax return. Even more, tax planning, like all financial planning, should be done within the context of a broader life plan, so we not only seek to maximize wealth but also our return on life!

How the Proposed Tax Framework Would Affect You

How the Proposed Tax Framework Would Affect You

On September 27th, 2017, the President, along with House and Senate Republicans, released their framework for tax reform. The proposal aims to lower taxes, simply the federal tax code, and create a more competitive business environment. It’s important to note that the nine-page document provides only a broad outline, leaving many of the details to be determined by Congress when writing the potential bill. Here is what we’ve learned so far that we think could impact our clients:

Fewer Tax Brackets

Ordinary income is currently taxed at seven different tax brackets, ranging from 10% to 39.6%. Under the proposed framework, there would be only three—12%, 25%, and 35%. In addition, the framework allows for the possibility of a fourth tax rate that would apply to the highest-income taxpayers. It’s unclear whether this would be a fourth bracket like the current 39.6% rate or might instead resemble something like the Buffet Rule. While the details will have to be worked out by the tax-writing committees in Congress, the stated intention is for the tax system to maintain its progressive nature and not shift the burden from the wealthy to low- and middle-income households. Our initial thought is that while fewer tax brackets give the impression of simplicity, the number of tax brackets isn’t what makes our current tax code so onerous. In fact, having only three brackets means the transition between brackets would be less gradual, which would make hitting the next bracket potentially more painful! Until we know where the cut-offs for each bracket would be and what the potential “fourth-rate” looks like, it’s difficult to evaluate how this would impact specific taxpayers, so nothing to get to excited about yet.

Reduced Top Tax Rate for Small Business

Sole proprietors, partnerships, and S corporations would see business income taxed at a maximum rate of 25%. This is notably lower than the proposed 35% top tax bracket for normal wages, so the framework also discusses the need for measures to prevent wealthy taxpayers from inappropriately recharacterizing personal income into business income in order to take advantage of lower rates. This is potentially exciting news for small businesses, family-owned operations, and entrepreneurs; however until further details emerge regarding what would be classified as personal income versus business income (some have speculated that service professions could be excluded), it’s unclear whether all small business owners would benefit.

Doubling of the Standard Deduction

The standard deduction would roughly double to $24,000 for married couples and $12,000 for single individuals. This is good news for many low to mid-income taxpayers as it creates an effective 0% tax bracket on the first $24,000 of income for married couples. For many, if not most, this would more than offset the increase in the lowest bracket from 10% to 12%. It also means that many taxpayers who currently itemize deductions would instead use the new higher standard deduction, simplifying their tax preparation and record-keeping responsibilities.

Elimination of Most Itemized Deductions

Most itemized deductions would be eliminated, other than mortgage interest and charitable deductions. Therefore, unless one’s annual mortgage interest plus charitable gifts exceed $24,000, a married couple would be better off with the new higher standard deduction. This would mean more taxpayers would take the standard deduction, and therefore simplify the preparation and record-keeping. Perhaps the most significant deduction that would likely be eliminated is itemizing state and local taxes (e.g. state income tax and property taxes). This would most negatively impact those with high incomes living in states with high income taxes, such as California and New York, along with those who own expensive personal real estate.

Expanded Family Tax Credits

Personal exemptions for dependents would be replaced with an increased Child Tax Credit. The amount and details of the New Child Tax Credit were not specified, but would be higher than the current credit of $1,000 with higher income limits on the phaseout. In addition, there would be a new $500 credit for non-child dependents (e.g. aging parents).

Retention of Tax Benefits that Encourage Work, Higher Education, and Retirement Security

While details were not provided, it likely means keeping the earned income tax credit (for low- to moderate-income workers), the American opportunity tax credit (for college expenses), and tax deductions for contributions to retirement plans (such as 401k plans and IRAs).

Repeal of the Alternative Minimum Tax (AMT)

The AMT is a supplemental income tax system that was initially designed to ensure high-income taxpayers weren't able to reduce their effective tax rate “too much” by taking advantage of all the deductions and incentives available under the standard tax system. Under the new proposal where most of these deductions would be eliminated, the AMT arguably becomes unnecessary. Given that the AMT is considered one of the most complex areas of the tax code, this would certainly simplify tax planning and preparation.

Elimination of the Estate and Generation-Skipping Taxes (but likely only for 10 years!)

We currently have an estate and gift tax exemption of $5.49 Million per individual. Estates larger than this are taxed at a rate of up to 40%. Under the proposed framework the estate and generation-skipping transfer tax would disappear. The gift tax (for transfers during one’s life) was not mentioned in the framework so it’s unclear whether it would remain intact or disappear also. However, assuming that the resulting tax bill is unable to receive 60 votes in the Senate and is passed through budget reconciliation instead (requiring only 51 vote, thus subject to the Byrd Rule), it’s likely to come back within 10 years. As a result, unless one is nearly certain they will die within that time frame, wealthy families should likely continue to plan as though there will be an estate tax.


How Should You Plan in the Interim?

Until the details are hammered out and we actually have a bill to review, it’s difficult to assess the impact the proposed changes would have on any specific taxpayer and thus what actions should be taken to minimize one’s tax liabilities. Until we have greater clarity, the almost timeless strategy of deferring income and accelerating deductions likely continues to make sense. For example, it's likely better to pay property taxes at the end of 2017 rather than the beginning of 2018, as they may not be an eligible deduction by then.

Special note for taxpayers who exercised Incentive Stock Options (ISO) - If you exercised ISOs in a prior year and paid AMT as a result, you likely have an AMT credit that you expected to get back when you eventually sell the shares. If the AMT is eliminated, as proposed in the released framework, it’s unclear how your AMT credit would be treated and there is a chance it could become worthless, significantly increasing your expected tax liability. Depending on the magnitude of this risk to your specific situation, you may want to consider selling enough shares before the end of 2017 to claim as much of the AMT credit as possible. Hopefully, we’ll get more clarity on this issue as we approach the end of the year, but we recommend looking at the scenario now so that you can move quickly toward the end of the year if necessary. If you still work for the company and are subject to black-out periods this is even more important as your opportunities to sell are already limited.

Quoted in USA Today on Tax Planning

Quoted in USA Today on Tax Planning

Now that tax season is over (unless you had to extend) you probably want to breathe a sigh of relief and forget about taxes again for another eight months or so. While that feeling is more than understandable, you may want to consider that it is also the perfect time to start exploring tax planning opportunities for the current year. If you take the time to engage in proactive and deliberate planning, your next tax season may not be so painful. Since most tax strategies have to be implemented before December 31st, the best way to minimize your taxes in the long-run is to think about it prior to filing. Last week, an article in USA Today examined this very concept, and featured several CPA financial planners, including yours truly.

It's Not Too Late to Contribute to an IRA for 2016

It's Not Too Late to Contribute to an IRA for 2016

The deadline for making 2016 contributions to an IRA is April 18, 2017. The contribution limit is the lesser of your earned income or $5,500 ($6,500 if you were over age 50 on December 31, 2016). You may also be able to contribute to an IRA for your spouse, even if they didn't have any income for the year.

Traditional IRA

To contribute to a traditional IRA, you must have been under age 70 1/2 by December 31, 2016. If you or your spouse was covered by an employer plan (e.g. 401k) for 2016, your ability to deduct your contribution may be limited depending on your filing status and modified adjusted gross income (MAGI) (see table below). If you won't be able to deduct your traditional IRA contribution, evaluate whether you can make a Roth IRA contribution (see below) as this is almost always better than making a non-deductible traditional IRA contribution.

2016 Income Phaseout Ranges for Traditional IRA
If covered by an employer-sponsored plan and filing as... Your IRA deduction is reduced if your MAGI is: Your IRA deduction is eliminated if your MAGI is:
...Single or Head of Household $61,000 to $71,000 $71,000 or more
...Married Filing Jointly $98,000 to $118,000 $118,000 or more
...Married Filing Separately $0 to $10,000 $10,000 or more
If not covered by an employer-sponsored retirement plan, but filing joint return with a spouse who is covered by a plan $184,000 to $194,000 $194,000 or more

Roth IRA

While there is no tax deduction for Roth IRA contributions, the earnings and eventual distributions are tax-free. For those who expect to be in a higher effective tax bracket when they begin distributions, a Roth IRA may be your best bet. In addition, there is no age limit to contribute to a Roth IRA and no required minimum distributions once reaching age 70 1/2. There are however income limitations that can reduce or eliminate your ability to contribute to a Roth IRA (see table below).

2016 Income Phaseout Ranges for Roth IRA
Your ability to contribute to a Roth IRA is reduced if your MAGI is: Your ability to contribute to a Roth IRA is eliminated if your MAGI is:
Single or Head of Household $117,000 to $132,000 $132,000 or more
Married Filing Jointly $184,000 to $194,000 $194,000 or more
Married Filing Separately $0 to $10,000 $10,000 or more

Make Too Much Money?

If your income is too high to contribute to a Roth IRA and you're unable to deduct a traditional IRA contribution, there are some advanced tax planning techniques that may allow you to make a non-deductible traditional IRA contribution and later convert it a Roth IRA, paying little or no tax in the process. There are a number of considerations that need to be taken into account before attempting a "back-door" Roth IRA strategy to ensure that you don't inadvertently create a large tax bill or run afoul some of the IRS's principle-based doctrines. Contact us if you think you might be a candidate.

2017 Key Financial Planning Numbers

2017 Key Financial Planning Numbers

Individual Retirement Accounts (IRA)

  • Contribution Limit = Lesser of $5,500 or 100% of earned income
  • Additional "Catch-up" Limit (age 50 or older) = $1,000
  • Traditional Deductible IRA Compensation Limits (income phase-out range for deductibility if covered by a employer-sponsored plan)
    • Single = $62,000 - $72,000
    • Married Filing Jointly = $99,000 - $119,000
    • Married Filing Separately = $0 - $10,000
    • Not Covered by Employer Plan, but Filing Jointly with Spouse Who is Covered = $186,000 - $196,000
  • Roth IRA Compensation Limits (income phase-out range for ability to fund)
    • Single = $118,000 - $133,000
    • Married Filing Jointly = $186,000 - $196,000
    • Married Filing Separately = $0 - $10,000

Employer Plans - 401(k), 403(b), 457(b), SAR-SEPs

  • Elective Deferral Limits = Lesser of $18,000 or 100% of earned income
  • Additional "Catch-up" Limit (age 50 or older) = $6,000
  • Annual Limit (employer + employee contributions) = $54,000

Health Savings Accounts (HSA)

  • Annual Contribution Amount for Self-only Coverage = $3,400
  • Annual Contribution Amount for Family Coverage = $6,750
  • Additional "Catch-up" Limit (age 55 or older) = $1,000

Flexible Spending Account (FSA) for Health Care

  • Maximum Salary Reduction Contribution = $2,600

Social Security

  • Cost-of-Living-Adjustment (COLA) = 0.30%
  • Under Full Retirement Age - Annual Earnings Limit to Avoid Temporary Withholding = $16,920
  • Reaching Full Retirement Age in 2017 - Annual Earnings Limit to Avoid Temporary Withholding = $44,880

Estate Planning

  • Annual Gift Exclusion = $14,000
  • Gift & Estate Tax Lifetime Exemption = $5,490,000
  • Generation-skipping Transfer Tax Exemption = $5,490,000

Business Planning

  • Maximum Earnings Subject to Social Security Taxes = $127,200
  • Maximum Section 179 Deduction = $510,000
  • Standard Mileage Rate = 53.5 cents per mile