If you’re like us, visions of sugarplums aren’t the only things dancing through your head this time of year. Major changes in tax policy — the biggest reform in three decades — have given both investors and firms like Silversage Advisors a lot to consider in their financial planning as 2018 comes to a close.
Overall, the tax reform this year provided several ways for investors to reduce their tax bill or increase their refund. The change with the most direct impact has been the decline in tax rates for most income brackets…but there were a number of less-publicized changes as well.
Here’s a brief overview of the most significant tax reform changes:
Higher Standard Deductions
One of the major benefits for many individual taxpayers is the higher standard deduction, which is now $12,000 for individuals — up from $6,350 last year. For married couples filing jointly, that deduction is now $24,000, up from $12,700 in 2017.
With nearly double the standard deduction, taxpayers who typically itemize should revisit whether that strategy is still in their best interest. Of course, if deductions such as charitable donations, interest on student loans, etc. exceed the higher standard deduction, it still pays to itemize.
Limited Mortgage Deductions
Now, homeowners can only deduct interest on mortgages of up to $750,000, down from $1 million allowed by the previous tax policy. This also applies to home equity loans if they are used to purchase a second property. And interest paid on home equity lines of credit is no longer tax deductible.
Business Income Deductions
Tax reform has also brought major changes for the way business income is taxed. For C corporations (where business income is taxed separately from an owners’ income), the tax rate was cut to 21% from 35%.
Other “pass-through” entities — sole proprietorships, LLCs, partnerships and S corps (which have fewer than 100 shareholders and are typically taxed as a partnership) — have also been affected. Many of these business owners will see a new deduction of 20% for qualified “pass-through” business income, a popular form of business income that is not taxed at the corporate level.
For many business owners, the revised deduction will reduce their income and provide the kind of tax savings found in a lower tax bracket. Those in a high tax bracket with a 37% rate could possibly bump down to a tax bracket with the lower rate of 29.6%. This deduction is reduced if the owner’s income is more than $157,500 if filing individually, or $315,000 if married filing jointly.
Limited SALT Deductions
High-income earners in high-tax states like California and New York will likely pay more in federal taxes as a result of the SALT (State And Local Tax) deductions now being limited to $10,000.
For perspective, 33.86% of California returns filed in 2014 included a deduction for state and local taxes according to IRS data. The average California SALT deduction was $17,148.35.
Expanded 529 Education Plans
Traditionally, 529 savings accounts were adopted to help families save for a college education. They allow funds to grow tax-free until withdrawn for qualified education expenses such as tuition, supplies, computers, etc. But for federal tax purposes, the new changes have expanded the use for these plans to include attendance costs for private or religious elementary and secondary school tuition. In many (but not all) states, these new uses have been approved for state tax benefits as well.
For primary education (K-12) expenses, funds in a 529 account can be used to pay for up to $10,000 each year per student (there’s no limit for qualified college expenses). Contribution limits are unchanged at $15,000 per year for individuals and $30,000 for joint filers.
Although tax policy has incurred considerable changes, some policies many thought would be included in the overhaul have remained intact. For example, taxes on capital gains and dividends still start at 15% for taxpayers in the lower brackets and up to 23.8% for those in the highest. And retirement accounts like 401(k)s and IRAs continue to provide the same tax breaks.
For traditional IRAs and employer-offered 401(k) plans, taxpayers can deduct any contributions made to these accounts from their income tax, and delay paying a tax until they withdraw the money in retirement years. For Roth accounts, investors who deposited funds over the years can continue to rely on that money not being taxed when they withdraw it.
It’s always wise to consult your tax adviser and/or CPA when considering year-end tax strategies. We wish you a prosperous new year and are happy to discuss any questions you have regarding the impact this year’s tax reform may have on your wealth planning strategies.