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02/07/2018

Aspects of the 2018 Tax Cuts and Jobs Act

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The new tax plan will impact investors in many new ways. We will cover some of the more important aspects of the act and opportunities for 2018 tax year.

Rates, Exemptions and Standard Deductions

The new tax brackets for 2018 vs. 2017 are as follows:

2017

2018

10%

10%

15%

12%

25%

22%

28%

24%

33%

32%

35%

35%

39.60%

37%

There has been some rate savings at the top 6 brackets and the income ranges that correspond with them have gone up which should help lower potential tax liabilities over all income ranges. The $4,050 tax exemptions have been eliminated for the taxpayer, payer’s spouse, children and other dependents. The standard deduction has almost doubled from $6,350 to $12,000 for single filers, $12,700 to $24,000 for joint filers. 90% of the people who will claim the standard deduction will likely see a lower tax bill and complete simpler tax returns. However, their opportunities for tax planning will also be limited to self-employment, fringe benefit and some credit strategies. One example many are talking about is the tax filer with a home in the $200,000 or so range and a mortgage of $160,000 will likely claim the standard deduction now eliminating the need to itemize deductions and reducing the tax incentives of home ownership.

Itemized Deductions

Many itemized deductions have changed.

Deductible medical expenses have a new threshold of 7.5% of taxable income down from 10%. This threshold was lowered for tax years 2017, 2018 and 2019 under the act. This may create and opportunity to schedule discretionary medical procedures to 2018 and 2019 under this new threshold.

State and Local Income, Sales, and Real and Personal Property Tax

The deduction on a filers federal return has been limited to $10,000. For high tax states like California and New York this will impact filers negatively. States such as California are exploring ways to help minimize the impact of the state and local tax deduction cap with restructuring how tax payments are characterized to include the portion that is more than the cap as a charitable contribution.

Mortgage Interest Deduction

Existing mortgages are grandfathered in and subject to the previous cap on interest expense on acquisition indebtedness of up to $1 million dollars. Under the Tax Act new interest indebtedness for up to two homes is capped at $750,000 for loans from December 15, 2017 through 2025. Interest on home equity loans is no longer deductible after 2017 through 2025. This also adversely effects tax filers in high property value states such as California.

Charitable Contributions

The deduction for charitable contributions remains unlimited but the amount deductible in any given year is subject to certain percentages of Adjusted Gross Income (AGI) depending on the type of property contributed. Any excess remaining is carried forward to be used in future years. Charitable cash contribution limitations have increase from 50% to 60% of AGI under the new law.

Tickets and Seating

The deduction for payments connected to the purchase of tickets and preferential seating at athletic events has been repealed.

Casualty and Theft Losses

The deduction allowance for casualty and theft losses is now allowed only for presidentially declared disaster areas.

Miscellaneous Itemized Deductions

Tax preparation fees, investment expenses and unreimbursed employee expenses after 2017 are now disallowed. Filers with significant unreimbursed cost for things such as employee expenses, mileage, internet and phone charges and education expenses are recommended to request an excludable working conditions fringe benefit arrangement or accountable plan from their employer.

Phase-out of Itemized Deductions

The phase out of deductions after higher levels of adjusted gross income levels has been eliminated under the new plan. For filers who are single and married with itemized deductions close to standard amounts a “bunching” strategy with discretionary deductible expenses may provide a tax planning opportunity. Discretionary expenses may include charitable contribution, medical expenses and the state and local taxes below the new $10,000 capped amount.

Alternative Minimum Tax (AMT)

2017’s AMT exemption is $54,300 for unmarried individuals and $84,500 for married individuals filing jointly. This exemption was phased out at $120,700 for unmarried individuals and $160,900 for married individuals filing jointly. The new tax act significantly increases these exemption amounts to $70,300 for unmarried individuals and $109,400 for married individuals filing joint returns. The phaseout thresholds have also been raised significantly. New threshold levels are $500,000 for unmarried individuals and $1,000,0000 for married individuals filing jointly. The effect of this is that many filers who have lost out on deductions, especially due to the state and local tax deduction cap, may pay more regular tax but may pay less total tax because they will now avoid the alternative minimum tax.

Child and Family Credit

The child tax credit increase to $2,000 per qualifying child under the new plan. $1,400 is refundable. It also adds a $500 nonrefundable credit for other qualifying dependents. The phase out ranges for this tax credit have been greatly increased from $110,000 to $400,000 for married filers filing jointly and from $75,000 to $200,000 for all other taxpayers.

The “Kiddie Tax” and Trust and Estate Tax

The new tax act completely changed the tax on unearned income of children. No longer does the parents income or the income of sibling’s factor in. Earned income is taxed at unmarried taxpayer rates. Net unearned income is taxed according to more unfavorable rates that are applicable to trusts and estates. Trust and Estates earning from $0 to $2,550 are tax at 10%, $2,550 to $9,150 at 24%, $9,150 to $12,500 at 35% and more than $12,500 at 37%.

Section 529 Savings Plans

The utility of the funds in these plans has changed to now include the use of up to $10,000 per year for a child’s elementary and secondary education for public, private or religious schooling.

Estate, Gift and Generation-Skipping

Under the new tax act, the exemption for estate, gift and generation-skipping tax has gone from $5.6million to $11.2million per individual. For couples it is now $22.4million. The income tax basis step-up or step-down at death remains.

Roth Conversions

No longer can an individual reverse a Roth conversion by re-characterizing it. A person can continue to contribute to their Roth IRA and re-characterize those contribution to a Traditional IRA if it happens before the due date of their individual tax return for that year.

Alimony

The new law makes alimony and maintenance payments no longer deductible to the payor spouse or includible in the income of the payee spouse. Divorce settlement structures will certainly be impacted going forward.

Moving Expenses

The deduction for moving expenses is suspended under this law except for those in the Armed Forces (and their spouse and dependents) who are on active duty and move due to military order to a permanent change of station.

Before acting on any of the aspects discussed here, tax filers and investors should check with their accountants and advisors to make sure that their situation and needs are evaluated and proper advice specific to them is given.

03/02/2016

Roth IRA vs. Traditional IRA:Distribution Advantage

Roth IRAs have a specific advantage vs. Traditional IRAs when it comes to distributions.

For a Traditional IRA all distributions are deemed to consist of both contributions and earnings. This makes the entire distribution taxable becasue the contributions where made with pretax money.

Roth IRA potential distribution advantages over a Traditional IRA are based off of the order of distributions. There are three types of distributions that occur with Roth IRAs:

1) Return of Contributions: Principle is returned first, and there is no income tax or 10% penalty assessed on this portion.

2) Return of Conversion Amount: If there was a conversion of Traditional IRA money to a Roth IRA this money will not be subject to income tax, since it was taxed when converted. If the individual is under age 59 1/2 it will be subject to the 10% early withdrawal penalty if the funds have not been in the Roth IRA for at least 5 years from date of conversion.

3) Return of Earnings: Earnings come out last. They will not be taxed if it is a qualified distribution. Qualified Distribution is a distribution of money for an individual attaining 59 1/2 and the five year holding requirement has been met. If it is not a qualified distribution, then it will be subject to income tax and the 10% early withdrawal penalty for individuals under 59 1/2 years old.

Being able to distribute contributions first and avoid taxation is a big advantage of Roth IRAs. 

 

05/01/2015

Taxes: Asset Location, Location, Location!

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The old saying “It isn’t what you make, it is what you keep” is at the core of building an effective wealth management plan to achieve goals.

Taking time to get a complete understanding of a family’s total financial picture is key to developing strategies to effectively manage taxes. Taxes are inevitable and after tax returns are crucial to achieving wealth planning goals.

One strategy called Asset Location is a technique that can greatly enhance the amount of return that is kept and not paid out in taxes. Asset Location refers to how an investor distributes their investments over taxable accounts such as a Trust brokerage accounts, tax-deferred accounts such as IRA’s and 401ks, and tax-exempt accounts such as Roth IRA’s and Roth 401k’s. Allocating assets that pay the lower long term capital gains tax rates to your taxable accounts and allocating assets that pay higher income tax rates to tax deferred and tax exempt accounts allows investors to keep more of the return they make.

One simple example: An investor with $1 million in an IRA and $1 million in a Family Trust may have an asset allocation of 50% Equities and 50% Fixed Income. If currently both portfolios are situated with this allocation, shifting the assets that are taxed as ordinary income, 39.6% Federal rate, to the tax-deferred IRA and shifting assets that are taxed at the more favorable long term capital gains rates of up to 20% Federal to the taxable trust account could generate tax savings. The potential shift may be to move the taxable fixed income assets over to the retirement account and move the more tax favorable long term capital gains taxed assets, such as equities and ETFs intended to be held for longer than a year, to the taxable account. This will change the allocation percentages inside of each account; however with proper execution the overall 50% Equities, 50% Fixed Income allocation will remain constant in order to achieve the desired total investment allocation and risk profile.

Shifting assets in this way must be looked at and executed carefully. It may take time to implement in order to keep fees generated low and to minimize the unnecessary triggering of a realized tax liability.

In order for this type of strategy to work requires viewing all investment portfolios through one asset allocation strategy that all the accounts make up. Having the ability to get consolidated performance reporting for all of your accounts from your advisor no matter where they are held is important to monitoring the success of this strategy. 

11/14/2014

Mortgage Interest And Points Paid:Tax Deductible?

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I often get asked questions about how much mortgage interest is deductible and what size loan to use when financing a home purchase. Also it is common to get into a discussion about if paying points to pay down interest make sense and if they are deductible. 

While every situation is different with regard to mortgage size, and I am a fan of getting the largest mortgage that one can possibly afford in most cases but not all, I will tackle the deductible nature of interest and points here to clarify how it works.

Mortgage Interest: Interest paid on a qualified residence is limited to interest on the acquisition indebtedness secured by a principal or secondary residence up to a maximum debt level of $1,000,000, plus home equity indebtedness secured by a principal or secondary residence up to a maximum debt level of $100,000.

Points Paid: Points paid on a loan are really nothing more than prepayments of interest. Generally points must be capitalized and amortized over the life of the loan. However, the points incurred on a loan that is used to buy or improve a principal residence generally are deductible in the year the points are paid. 

Points Paid on Refinance: These points must be deducted ratably over the life of the loan (amortized). If it is a second refinance the un-amortised (not deducted) points from the first refinance are deductible in full when the first refinance loan is paid off.

Choosing to pay down loan interest by paying points can help lower a payment to a level that is more affordable. Often I suggest that not doing so is the better decision. Buyers will have use of the funds used to pay the points and often through investment may be able to generate a better return on those funds than paying down the points would generate over time. However, doing so really is specific to the home purchasers own situation. In many cases, home purchases are as much an emotional decision as they are a financial decision and if paying down points to make a payment more affordable gets a buyer in the home they love and want that may in itself make paying points well worth it.

 

09/23/2014

Managing Tax Liability To Create Wealth

There are 3 methods that can be legally used in tax planning.

  1. Avoiding Taxes-use of exclusions, credits and certain deduction to legitimately reduce taxes.
  2. Deferring Taxes-does not produce a permanent reduction in taxes but reduces current taxes.
  3. Conversion-converting highly taxed income into more favorably taxed income.

Tax planning is fundamental to financial planning. The objective of financial planning is to structure financial affair's so that the result is the greatest accumulation of wealth possible. The less money paid in taxes the more money one has working towards increasing their wealth. Two investments with the same amount of return pre-tax will not necessarily net the same amount of after tax return thus reducing the amount of money working toward wealth accumulation. Using legitimate methods to reduce taxes, defer them or avoid them all together should be discussed with your advisors to make sure the optimal strategy is taken. 

Understanding the tax rules on capital gains, both short and long term, and income such as interest and dividends are key to developing the appropriate strategy. 

 

08/25/2014

Important Tax Aspects of Securities

Capital Gains and Losses and Qualified Dividends

  • Short term capital gains are gains from the sale of securities where the holding period is 12 months or less.
  • Short term capital gains are currently taxed at ordinary income tax rates.
  • Long term capital gains are gains from the sale of securities where the holding period is longer than 12 months.
  • Long term capital gains and qualified dividends are currently taxed according to the following:
    • 0% if taxable income falls in the 10% to 15% marginal tax brackets
    • 15% if taxable income falls in the 25%, 28%, 33% or 35% marginal tax brackets
    • 20% if taxable income falls in the 39.6% marginal tax bracket
    • 25% on Depreciation Recapture
    • 28% on Collectibles (art, gold, etc.)
    • 28% on qualified small business stock after exclusion
  • Capital Loss are deductible in a year up to $3,000 after the netting process is completed. Any loss in excess of $3,000 can be carried over to future years.