The 2018 tax return will be the first tax season under the 2017 Tax Act. Below are 8 tax tips to consider as you sift through opportunities to maximize tax savings.
1. To itemize or not to itemize.
That is the question. Tax reform increased the standard deduction considerably; $24,000 for married couples filing jointly, $12,000 for single filers, and $18,000 for head of household filers. The tax act also capped– at $10,000– the amount one can deduct on federal return for property, state and local taxes paid. This means most tax filers will be better off using the standard deduction than itemizing deductions. See #6 below regarding how to maximize charitable deductions under the new tax law.
2. Maximize retirement plan contributions.
Contributing the maximum amount allowable to retirement plans has not changed under the new tax law. This helps clients continue to save for retirement while lowering overall taxable annual income. The amount that can be contributed to a 401(k) or 403(b) is $18,500 and to an IRA is $5,500, for example. Clients who are age 50 or older, however, can take advantage of the annual “catch-up” contributions (an extra $6,000 can be contributed to a 401(k) or 403(b), and an extra $1,000 to an IRA).
3. Consider benefits of converting a traditional IRA to a ROTH IRA.
Distributions from a qualified ROTH IRA are not taxed at the federal level. Therefore, converting an existing pre-tax traditional IRA or other eligible retirement plan (distributions of which are fully taxable) to a ROTH IRA today can help diversify taxes at retirement. However, when converting to a ROTH today, the accounts are fully taxable– subject to federal income taxes on their pre-tax contributions and earnings. If not converted, the distributions from the traditional IRA will be taxable at retirement any way. The question is, should a taxpayer pay taxes now or later? By converting today, taxes are paid at today’s tax rates, which may be lower than what they will be in retirement, depending on what happens with tax law. Taxpayers are eligible to exercise a ROTH conversion provided the account has been in existence for at least five years and the owner is at least age 59 1/2.
Life Insurance Planning Tip:
An alternative to a ROTH IRA is to contribute to an accumulation focused cash value life insurance policy. The cash values grow tax deferred and can be withdrawn on a tax-free basis as non-reportable supplemental retirement income, when structured properly. In addition, the cash values are not reportable for purposes of social security taxation, nor for purposes of determining Medicare Part B premiums, which are based on income. Moreover, the cash value policy can include a rider that allows the insured to accelerate the death benefit during lifetime to pay for long-term care, chronic illness or critical illness expenses, depending on the specific rider. In this way, the life insurance serves to preserve retirement income sources and protects them from the risk of long-term care costs, which are rising at double the rate of regular inflation.
4. Use stock losses to offset capital gains.
If a client has realized capital gains on an investment, an underperforming stock can be sold in order to generate a capital loss to offset the gains. The amount of the loss that can be deducted is $3,000 (for taxpayers who are married filing jointly) in excess of capital gains ($1,500, if married and filing separately). If the losses are above $3,000 (or $1,500), clients can carry over the losses to the following year’s tax return.
5. Make contributions to health care accounts.
Health Care Savings Accounts (HSAs) and ‘Health Care’ Flexible Spending Accounts (FSAs) can go a long way in helping to fund future costs of medical insurance premiums and qualified healthcare costs. The contributions to these accounts are pre-tax so they lower your taxable income. The HSA is appealing because unlike an FSA, the client does not need to spend all the funds by year-end (however, some employers may allow for up to $500 of an FSA-sponsored plan to be rolled-over). Notably, the HSA funds can also be used to fund qualifying long-term care expenses and premiums any time today or in the future.
The maximum annual contribution to an FSA is $2,650, while the maximum annual contribution to an HSA is $3,450 (single filers) and $6,900 (married filing jointly). HSA owners age 55 and older are also eligible for a $1,000 annual catch-up contribution. The HSA funds can continue to rollover until retirement, at which time the funds can be withdrawn throughout retirement on a tax-free basis to fund qualified medical expenses. Funds that are withdrawn for reasons other than qualified medical expenses, are taxable. If HSA funds are withdrawn before 59 1/2 there is also a penalty
Note that unlike an FSA which is sponsored by an employer, an HSA fund can be sponsored by an employer, but does not have to be. The client must have a high deductible health insurance plan in order to contribute to an HSA account.
6. Donate to charity.
Charitable gifts of cash or securities can be deducted provided the taxpayer itemizes deductions. If clients have been long time donors to a charity and the standard deduction amount limits the benefit they receive from making the annual gift, it may make sense to “bunch up” charitable contributions in a given year in order to itemize. The “bunched up” contributions can then be placed in a Donor Advised Fund (DAF) which will distribute the funds to charity over a period of time. Please see the following Highland Capital Brokerage blog articles on: Top 3 Reasons to Meet with Clients NOW, The Skinny on SALT Under Tax Reform, and Overview of Tax Act 2017 Part II.
Life Insurance Planning Tip:
The cash gifts made to the charity can be leveraged with life insurance, either by the donor before the cash gift is made or by the charity, after the cash gift is made, subject to charitable underwriting requirements.
7. The ‘Use It or Lose It’ of tax-free gifts to family.
Individuals can make annual gifts of $15,000 to anyone each year without paying gift tax, and without having to report the gift or use part of their lifetime gift tax exemption amount each year. This offers parents and grandparents an opportunity to make tax free gifts. Therefore, two grandparents together can give up to $30,000 per recipient per year with no reporting requirement. And there’s no limit or reporting requirement for payments made directly to medical and educational institutions for health care expenses and tuition. This means grandparents can make tax-free gifts of tuition payments directly to a college or university to benefit their child or grandchild, in any amount. Moreover, parents and grandparents can fund 529 accounts for each child or grandchild. 529 Plans grow tax deferred and the income and growth are never taxed as long as the funds are used for higher education expenses.
With the new tax bill, parents who send their children to private elementary and high schools will have more options when it comes to saving for tuition. Up until now, the only vehicles that offered tax-free savings for K-12 were Coverdell Education Savings Accounts (ESAs). With tax-free earnings growth and tax-free withdrawals for qualified purchases, Coverdell ESAs operate very similar to a 529 savings plan. However, with ESAs there are earnings eligibility limits, contribution limits of $2,000 and contribution deadline of age 18.
The tax act now permits 529 plans to be used for up to $10,000 per year in K-12 tuition expenses, giving more families an opportunity to save tax-free for private and religious schools. Families who are currently saving with a Coverdell ESA and want to switch to a 529 plan can do a rollover with no tax consequences.
Moreover, with 529 plans, you could be eligible for a state tax break. Currently, over 30 states offer a deduction or credit for contributions to a 529 plan. The amount of the potential benefit varies by state, but deduction limits range from $500 per year (for an individual) to the total amount of the contribution. Some states also allow residents to carry forward any excess contributions above the limit to future tax years. Generally, clients have to use their home state’s plan to qualify for the deduction or credit, but residents of Arizona, Kansas, Minnesota, Missouri, Montana and Pennsylvania may be eligible for a tax deduction for contributions to any state’s 529 plan.
Life Insurance Planning Tip:
Life insurance cash values are considered a non-reportable asset for financial aid purposes.
8. Gifting a qualified conservation easements.
Landowners who place a qualifying conservation easement under IRC 170(h) on their property can benefit from a federal income tax deduction against adjusted gross income (AGI). The deduction is limited to 100% of AGI for farmers and ranchers, and to 50% of AGI for everyone else. A 15-year carryforward for any unusable deduction is available, subject to the same AGI limits annually. There are also potential state tax credits available, local property tax and estate tax benefits. The restriction is based on protecting the land’s conservation attributes and therefore lowers the fair market value of the land relative to its development value. The federal income tax deduction available is based on the value of the property before and after the restriction is placed on the property. In some cases, the deduction can be significant enough to help conservation-minded property owners manage large income tax years.
A conservation easement is a voluntary “use restriction” added to the property deed. This restriction is legally binding and must remain with the land forever. Essentially, the restriction is an agreement to permanently limit the extent to which the land can be developed in the future. The landowner continues to own, use and enjoy the land and can continue to sell, gift or bequest it in the future, as usual. Placing a conservation easement on qualifying land can help a landowner to both protect the land and benefit from significant tax savings.
Life Insurance Planning Tip:
Life insurance can be used to restore the economic value lost from the easement. A portion of the tax deduction can be used to fund the premium. In this way, the life insurance makes heirs whole and converts a portion of the property value to a liquid asset.