The new federal tax overhaul made major changes starting with your 2018 taxes. And even if you haven’t finished preparing your 2017 tax returns, now is the time to start making some planning moves for 2018. Note that under the new tax law, many of these changes are “temporary” and that for tax years beginning after December 31, 2025, the prior law becomes re-effective…but of course, that might change as well. I want to thank my partner Brian Lovett, CPA, JD, for invaluable contributions to this post—now, read on and start cutting your 2018 taxes…
Planning move: Make your charitable donations deductible. Under the new law, the standard deduction has been increased to $24,000 for a married couple filing jointly or $12,000 for a single taxpayer. Additionally, a $10,000 limitation has been placed on state and local income and real estate taxes, and miscellaneous itemized deductions and unreimbursed employee business expenses have been eliminated. A cap has been placed on interest deductions on new mortgages issued after December 15, 2017, allowing deduction of the interest on no more than $750,000 of acquisition debt. Further, interest is no longer deductible on home equity indebtedness.
What this mean for charitable deductions: Many more people will be using the standard deduction instead of itemizing…so most charitable contributions will not be deductible and will not provide a tax benefit because of the increased benefit of the higher standard deduction.
What to do: While many taxpayers will continue making charitable contributions whether deductible or not, one tax-saving strategy depending upon the amounts to be donated would be to bunch two years’ contributions into one year so the total for that year will bring itemized deductions to more than your standard deduction. This can be done by making your annual contributions in 2018 as you normally would, but then in December 2018, either make next year’s (2019’s) contributions or open a donor-advised fund and pay next year’s contributions to that fund. If you still fall short of surpassing the standard deduction for 2018, then consider making several years’ contributions in 2018 to a donor-advised fund so you get the deduction for 2018…and then you can direct the fund to distribute the money to charities over time as you normally would.
You can also donate appreciated securities to the donor-advised fund and get a deduction for the full value of the shares without having to recognize the capital gain income. Since you are loading up your cash (or stock) contributions, you can also do this with unwanted household items, autos, art, and collectibles – just make sure your total in one category is under $5,000 so you do not need to obtain an official appraisal. In this manner, you might qualify for itemizing this year and for the standard deduction next year…and then continuing to switch between the two in each subsequent two-year span.
Planning move: Make the most (or least) of alimony. People getting divorced starting in 2019 will not be able to deduct alimony paid and will not have to report as income alimony received. This could suggest trying to get a divorce completed by the end of 2018 if you will be making alimony payments…or delaying a divorce until after 2018 if you will be receiving alimony payments. There’s more to divorce than alimony, so consult with your divorce attorney about how this potential strategy might work in your situation. (As far as tax treatment of alimony goes, prior divorce arrangements remain in effect.)
Planning move: Avoid the kiddie tax. The so-called kiddie tax—levied on unearned income that is over $2,100—applies to a child who is age 18 or under on the last day of the year…or 23 or under and a full-time student, with at least one living parent and who does not file a joint return. However, if the child is age 18 or over, the tax does not apply unless the child’s earned income is less than half of that child’s support. Starting in 2018, the unearned income will be taxed at the trusts and estate rate, which jumps up to 37% when unearned income exceeds $12,500. A strategy to mitigate this is for the child to have as little reportable income as possible. Ways of achieving this might include investing in U.S. savings bonds with deferred interest, owning low or no dividend-paying stocks, and/or owning a fixed annuity with a maturity after the child exceeds the age limit. Capital gains will have a zero rate for incomes up to $2,550.
Planning move: Limit your exposure to potentially high tax on interest income. Under the new law, dividends received by taxpayers with taxable income not over $75,200 will not be taxed at all and if over that amount, the tax rate will be 15% until AGI reaches the 37% bracket. In contrast, interest income will be taxed in full at individual tax rates. What to do: Consider reducing your investments in fixed-income instruments and increasing investments in qualifying dividend-paying stocks. Note: This may be a good tax strategy, but it also involves shifting the risk profile of your investment portfolio—as with any significant tax or investment move, be sure to discuss this one with a qualified financial adviser who knows your specific situation.
Planning move: Get rid of mortgage interest. Try to pay down mortgages with excess cash to save the interest expense that will now be nondeductible. If, in contrast, you hold onto this cash and keep it in, say, interest paying CDs or bonds, your cash will generate taxable income. Also, with today’s low CD and bond yields, the interest received would likely be less than the mortgage interest being paid. If you are concerned about depleting your cash resources, consider opening a home equity line of credit to be used solely in the event of an emergency (but understand that the interest on any home equity indebtedness is not deductible).
Planning move: Make excess investment interest deductible. Under the new law, investment interest expense—meaning interest you incur in acquiring an investment, such as margin interest—remains deductible only to the extent of investment income. However, if the investment interest cannot be fully deducted, it can be carried forward until offset by income. But there’s another way to handle this: You can elect to have qualified dividends (dividends that are taxed the same as capital gains) taxed as nonqualified dividends…and then your investment interest expense that is not currently deductible because of insufficient investment income can be applied to the recharacterized “nonqualifying” dividends for a current deduction.
Planning move: keep an unneeded required minimum distribution (RMD) from increasing your taxes. If you are subject to taking a required minimum distribution from an individual retirement account (IRA) but don’t need those funds for living expenses, you can instead make a qualified charitable distribution from an IRA. While you will not get a direct deduction for the charitable distribution, your AGI will be lower (by the amount of the distribution) than it would have been had you taken a regular RMD—providing the tax benefit. This is a way to continue charitable donations and get tax benefits for them. This strategy is limited to $100,000 per year per person (so $200,000 for joint filers), and distributions must be made from traditional IRA plan accounts.
Some of the strategies discussed above could very well reduce your 2018 tax bill. The sooner you start, the better your opportunity for savings.