In the wake of Congress’s passage of the largest tax overhaul in three decades, we’d like to share some insights on potential tax-planning strategies, keeping in mind that the impacts will vary depending on your circumstances. This list of five to consider for 2018 is by no means exhaustive; however, it is representative of topics we’ve been discussing with our clients.
Since each taxpayer’s situation is different, we suggest consulting with a tax advisor before implementing any of these tax-planning techniques.
1. Evaluate Your Current and Alternate Primary Residence Locations
Taxpayers in high-income-tax states (like California) may be materially impacted by the new $10,000 cap on deductions for state and local taxes (SALT). As an example, a taxpayer with property taxes of $20,000, and state income taxes of $40,000 may lose $50,000 in deductions (because their $60,000 combined SALT will be capped for deductions at $10,000). This translates to an $18,500 tax increase for taxpayers in the top 37% federal tax bracket. For our clients who are close to or in retirement and expect to be significantly impacted by this change in SALT deductibility, reviewing alternate states of primary residence, and possibly selecting one with a lower tax burden, might make sense. Currently, states with no income tax include: Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming, and other states may offer low state income taxes. Along with this residence review, it is also important to consider how other specific circumstances in your tax profile might be affected by more favorable changes in the new tax law, as they may offset the impact of the cap on SALT.
2. Concentrate Charitable Deductions
Thanks to the significant increase in the standard deduction amounts ($12,000 for individuals, $24,000 for married couples filing jointly), and the new $10,000 cap on the deduction for SALT, some of our clients may no longer receive much, if any, tax benefit from their annual charitable contributions. Specifically, if the total amount of their itemized deductions (including charitable gifts) is less than the new standard deduction, then there would be no tax benefit for the charitable gift. One way we are planning to help our clients to still receive a tax benefit from their philanthropic giving is to concentrate multiple years’ worth of gifts into one tax year.
For instance, a married couple that has a standard deduction of $24,000 may take either that standard deduction or itemize, whichever is greater. If they have $19,000 of deductions from mortgage interest and state and local taxes, and make annual donations of $5,000 to charities, under the new tax law, they would not receive a tax benefit from their charitable donations. This is because the total deductions would only match their standard deduction of $24,000. However, if they combine three years’ worth of charitable contributions for a total of $15,000, then their total itemized deductions would be $34,000. They would now receive a tax benefit for the amount over their standard deduction, or $10,000.
Using a donor-advised fund (DAF) account is an easy and effective way to facilitate this larger deduction, because it allows you to group your charitable gifts into a single tax year, but then spread your individual grants to charities over current and successive years. On top of that, gifting appreciated assets held for longer than a year, such as low-cost-basis stocks, instead of cash could result in even greater tax savings. That’s because you can take a tax deduction for the fair market value of your gift in the year you make it and avoid capital gains taxes on the gifted security.
3. Reconsider Your Mortgage Debt
Depending on your personal circumstances, reassessing your debt level could be helpful. For instance, with our clients who have fairly low mortgage debt ($200,000 or less) and/or interest expense that is too low to generate much of a tax benefit, we review whether it might make sense for them to consider paying off their mortgage. For example, say a married couple paying 4% on a $200,000 mortgage has $8,000 in interest expense. Adding in the $10,000 maximum amount for SALT deductions, this would total $18,000 of itemized deductions. Even including a hypothetical $5,000 of charitable gifts, their total itemized deductions would be $23,000, still less than the couple’s $24,000 standard deduction. So they would lose the benefit of the tax deduction on mortgage interest. When reviewing this with our clients, we consider the specifics of their situation, such as the interest rate they are paying and how that compares to the after-tax rate of return we may experience on their portfolio.
4. Consider Taking Advantage of New Flexibility on College Savings (aka Section 529) Plans
For our clients with educational funding needs, we are considering whether they can benefit from changes to the rules on qualified withdrawals from Section 529 plans. Under the old law, withdrawals were limited to funding qualified college expenses. The new tax law allows withdrawals of up to $10,000 per year for “expenses for tuition in connection with enrollment or attendance at an elementary or secondary public, private, or religious school.” In addition to this expansion of the type of allowable expenses, rollovers from 529 accounts into Achieving A Better Life Experience (ABLE) accounts, for individuals with disabilities, are now allowed. Both provisions expire in 2025.
Clearly, we carefully consider the impact making withdrawals might have on the funds our clients may ultimately have available to meet college spending needs. We are also careful to check whether they are using plans from states that may not offer tax-free withdrawals for K-12 expenses. All in all, while the expanded flexibility at the federal level in using funds might be helpful, reviewing it based on your family’s circumstances is important.
5. Manage Your Portfolio with Tax Efficiency in Mind
Although this opportunity hasn’t just appeared with the recent tax law changes, it is always important to keep in mind within your own investing and tax backdrop. For assets that we manage for our clients, taking tax efficiency into account can help us make sure they hold on to more of their after-tax wealth. One way to do this is to, when possible, time asset sales to benefit from the lower capital gains tax rate (maximum combined rate for a California resident of around 33%) which applies to assets held for more than a year versus a much higher marginal income tax rate on gains from sales of short-term assets (maximum combined rate for a California resident of 55%).
Another tax-sensitive portfolio management strategy is to hold assets in a structure that maximizes tax efficiency. For instance, by allocating higher-income-generating investments to tax-deferred retirement accounts that postpone tax payments until you take withdrawals, you might benefit from being in a lower tax bracket at that point. And, you might avoid taxes on the gains and/or income from some investments entirely by placing them in Roth IRAs, where withdrawals are typically free from income taxes.
This is just a sampling of potential tax-planning strategies to consider in light of the new tax law. While the full implications of the legislation have yet to play out, we hope these tips highlight some ideas to discuss with your tax advisor, to ensure your tax planning supports your long-term wealth-planning goals.
If you would like to discuss any of these tax-planning topics in more detail or have questions regarding your individual situation, please contact your Litman Gregory Wealth Advisor.
Research Team Changes
We are pleased to announce that 23-year veteran Jack Chee has taken on the U.S. CIO – Asset Management role.
Insight Newsletter—Summer 2023
Our Insight Newsletter is now available. Included in this edition: Investment Commentary Gauging the Odds of a Recession Wealth Management Team Updates View
Gauging the Odds of a Recession and What it Would Mean for Investors
While the U.S. economy has recently been more resilient than many expected, the question remains whether the Fed’s aggressive series of rate rises will lead to a recession in coming quarters. In this post we consider the relevant economic data to address this question and the potential impact on financial markets.