By BRANDON BUCKINGHAM
It’s been more than a year since the Tax Cuts and Jobs Act (TCJA) was passed, but with tax season now upon us, we will first learn how the new legislation will affect us and our tax bill. Financial professionals have an opportunity to add value to clients during this confusing time—and it’s not too late to help your clients minimize tax impacts and maximize deductions. Here are a few quick tips you can bring to clients to help them get the best outcomes under the new tax regime.
Last-Minute Moves to Reduce Tax Liability
In general, marginal tax rates fell at nearly all income levels under the TCJA, and tax bracket adjustments mean it generally takes more income to get to the next bracket. That creates opportunities for clients who may be on the edge of a higher tax bracket who can find ways to reduce their taxable income and therefore drop into a lower bracket. Although most tax-saving strategies needed to be implemented before year-end 2018, there may still be time to lower clients’ tax bills by enacting changes before April 15:
- Contribute $5,500 to individual retirement accounts—$6,500 for those 50 and older. Maximizing these kinds of contributions lowers clients’ taxable income. Importantly, non-working spouses can take advantage of this provision as well, further reducing the tax burden for some married couples.
- Establish and fund a Health Savings Account (HSA). To qualify, the taxpayer must participate in a high-deductible health plan, which is a deductible of at least $1,350 for individual coverage and $2,700 for family coverage. HSA contributions max out at $3,450 for individuals and $6,900 for family coverage. The money in these accounts will grow and pay out tax-free if the withdrawals are used for qualified medical expenses.
Make Sure Clients Maximize Key Deductions
Most taxpayers in 2018 will likely take advantage of the higher standard deduction which is now $12,000 for single filers, $18,000 for head of household filers and $24,000 for joint filers. But there are a few areas to watch out for where clients could add on additional savings:
- The child tax credit has doubled to $2,000 for each dependent under age 17, making this a critical tax-savings area for clients who qualify. Also, more people will be able to take advantage of the higher tax credit because it does not phase out until income exceeds $400,000 for joint filers and $200,000 for single filers, up from $110,000 and $75,000, respectively, last year.
- For clients who are philanthropically minded, it’s important to remember that charitable contributions will continue to be deductible under the TCJA. Donations of cash to public charities is deductible up to 60 percent of adjusted gross income, up from a 50 percent limit last year.
- If your clients have faced any medical hardships in the last year, they may qualify for a tax provision that allows medical expenses to be deducted to the extend they exceed 7.5 percent of clients’ adjusted gross income (AGI), down from 10 percent. This is an important change, only in effect for 2017 and 2018, which can be especially important for clients grappling with a chronic illness.
Plan Ahead for Next Year
It’s critical financial professionals start now to prepare their clients for next year’s tax season. Because of changes in the treatment of itemized deductions, some clients, particularly those in higher income brackets, may be able to take advantage of “bunching” by consolidating deductions. For example, clients who regularly give to charities, but who will no longer benefit from charitable gift deductions due to the higher standard deduction, may choose to instead give a larger gift every few years and itemize during those years to maximize the impact. With the repeal of the Pease limitation, higher-income taxpayers no longer have the value of their itemized deductions reduced or phased out, making “bunching” a viable strategy for some clients to achieve greater tax savings.
Finally, financial professionals can add great value to clients by ensuring investments and income streams are tax-efficient from the start. Periodic reviews of an investor’s portfolio may unveil certain tax inefficiencies. Unfortunately, most people don’t think about how taxes affect their investment goals. The tax drag will be greater for portfolios that are actively managed and have a high turnover ratio. This could result in a lot of short-term capital gains being distributed to the investor each year, which can face tax rates as high as 40.8 percent, including the 3.8 percent Medicare surtax. To add insult to injury, especially during periods of high volatility like we have seen over the past year, many investors will receive a taxable distribution even though they experienced a market loss in their overall investment portfolio.
The benefits of tax efficiency, tax diversification and tax deferral could be compelling for certain investors and consideration may be given to the tax benefits of life insurance and tax-deferred annuities. These products allow investors better control over taxes, tax-free portfolio rebalancing and the ability to tap the cash value of an insurance policy tax-free or defer taxation on income from an annuity until the income is needed and at a time the retiree will likely be in a lower tax bracket.
Tax season is a good time to review strategies to reduce taxes and improve the tax efficiency of an investment portfolio.