We’re over halfway through 2019, and we’ve all filed our taxes (or at least an extension) under the Tax Cuts and Jobs Act (TCJA) of 2017, which took effect January 1, 2018.

TCJA provided a fair number of changes for individual taxpayers. It lowered income tax rates, increased standard deductions, limited or eliminated certain itemized deductions, and repealed personal exemptions, among other provisions.

Effects on 2018 tax year filings

The IRS has released initial data for the 2019 tax-filing season in late May, showing TCJA’s effects.

Key findings include:

  • The Tax Policy Center estimated that around 67% of individual taxpayers experienced a tax cut, while 5% paid more in federal income taxes. (The rest had little to no change in federal income tax liability.)
  • Changes to the alternative minimum tax (AMT)—a parallel tax system previously affecting households with income equal to or greater than $200,000—had the most significant effect on middle- to higher-income individuals. Under TCJA, households making $1 million or more are potentially subject to AMT. Now it’s estimated that the adoption of TCJA rules reduced the number of taxpayers subject to AMT by 95%.
  • The most noteworthy change many taxpayers experienced was the increase in the standard deduction amount, significantly reducing the percentage of itemizing taxpayers to 10%, down from 30% the previous year—this decrease is on target with what Congress intended with these rules.

So, should I still itemize?

The key for taxpayers in deciding whether to itemize is to plan and coordinate between the new limit on state and local tax (SALT) of $10,000, mortgage interest (if any), charitable giving, and deductible medical expenses. So, plan, plan, and then plan.

Many clients ask me about itemized deductions. Here are the questions I answer most often. (I tried to include actionable answers, although my favorite go-to response is always: “It depends on your personal situation!”)

  • How can I continue to give to charities in a tax-smart way, and should I keep my mortgage or pay it off? In many cases, the mortgage interest deduction (if any) is the key to deciding if you’ll itemize deductions, along with the timing and amount of charitable gifts to make in 2019. You have to do the math to see what makes sense for you.

Here’s an example for Jack and Jill Golucki, a professional couple in their 50s who are fellow New Jerseyans. They’re considering paying off their mortgage and researching the impact on their charitable giving plan.

Scenario 1: Deduction for Jack and Jill Golucki Amount in 2019
SALT cap $10,000
Mortgage interest $7,500
Charitable contribution $10,000
Itemized deduction $27,500
Scenario 2: Deduction for Jack and Jill Golucki Amount in 2019
SALT cap $10,000
Mortgage (paid off) $0
Charitable contribution $10,000
Standard deduction $24,400

I’d ask the Goluckis to consider the tax and non-tax ramifications for paying off their mortgage and its impact on their cash flow, financial plan, and tax picture. Absent their mortgage interest, they may consider “bunching” 2 years of their charitable giving as one of the strategies we’ll discuss in my next blog post.

  • How did the $10,000 SALT limit change the tax picture year over year? Running the numbers and comparing the effects revealed that many taxpayers may not have benefited from the SALT deduction pre-TCJA for various reasons, including being subject to AMT and the Pease limitation (which reduced if not eliminated the SALT, charitable contributions, and mortgage interest deductions for high-income households prior to TCJA). Other taxpayers who are impacted by the SALT limit are considering moving to low-tax states if it makes sense from a non-tax perspective. But, remember, don’t let the tax tail wag the dog.
  • With the elimination of miscellaneous deductions, how should I pay my retirement plans’ investment management fees? If you have retirement assets (other than a Roth IRA) managed by financial advisors, consider paying the management fees for the retirement plans from your retirement plans rather than your taxable assets. These fees aren’t considered taxable distributions from the retirement plans, so in effect they’re paid with pre-tax dollars.

What’s new for the 2019 tax year?

The medical deductions floor for 2019 increased to 10% of adjusted gross income, up from 7.5% in 2017 and 2018. In this case, an increase means you may deduct fewer medical expenses. (A recent proposal seeks to keep the floor at 7.5% for 2019, so stay tuned). In the meantime, taxpayers would likely have to start considering “bunching” their medical expenses if and when possible.

What can I do now to prepare for my 2019 tax filing?

It may seem too early, but with the first tax season under the new rules behind you, you know how the new laws impacted your situation. So plan and make adjustments for 2019. Yes, summer is a great time to start your tax planning for the year!

  • Save, save, save in tax-advantaged plans. Now’s a great time to revisit your savings in your employer plans (like 401(k) pre-tax vs. Roth after-tax contributions), Roth IRAs, health savings accounts (HSAs), and 529 plans. Why? You’re probably in a lower tax bracket, and tax rates are at a historical low—and TCJA tax rates are scheduled to sunset after 2025 unless these rates are changed sooner.
  • Long-term capital gains and qualified dividends still enjoy preferred tax rates, ranging from 0%–20%. Because capital gains tax rates are progressive, you can take advantage of tax-gain harvesting when you rebalance your portfolio following recent market performance. (Note that a Medicare surtax of 3.8% applies to investment income above a certain threshold.) In addition, you should consider changing your cost basis method to specific identification (SpecID) rather than average cost in your mutual funds to help liquidate shares in a tax-efficient manner. While it’s not as simple as the average cost method, you’ll take control and have the flexibility to manage your tax outcome. Harvesting your losses* is a good strategy to consider year-round.
  • If you’re in the “sweet-spot age” (between retirement age and under 70), consider converting your IRAs to Roth IRAs to potentially stay in your current or the next marginal tax bracket. Remember, there’s no looking back on Roth conversions, but you may want to work with a tax advisor to determine a Roth conversion amount that will keep you within certain tax brackets to manage your future potential income tax when IRA required minimum distributions (RMDs) and Social Security benefits start. If you don’t convert to a Roth, you could be facing a higher IRA RMD at age 70½. Also, a higher income at that age could mean more of your Social Security payment gets taxed and your Medicare Parts B and D could become subject to premium surcharges—otherwise known as the “tax torpedo.”
  • Plan, plan, plan the timing of your deductions. Review your potential itemized deductions under the federal and state tax rules where you reside. Then plan for whether you may be itemizing your deductions on the federal level to benefit from an overall tax benefit between the federal and the state levels. Coordinate the timing, amounts, and source of your charitable giving accordingly. Many taxpayers set up donor-advised funds and front-load their gifts using appreciated securities to maintain annual philanthropic goals. Others use their IRA RMDs to give, taking advantage of the qualified charitable distribution (QCD) option.
  • Check your tax withholding. Since TCJA lowered tax brackets and the withholding tables, many employees should have updated their 2018 withholding to avoid penalties for tax underpayment, so the IRS issued partial relief from penalties in 2018. Make sure you update your withholding in 2019 to avoid unnecessary penalties.
  • Keep an eye on certain proposals that may affect inherited retirement plans/IRAs and “stretch IRA” rules. We’re paying attention to possible changes from the SECURE Act bill, which passed the House in May. (It’s currently only a proposal and not yet tax law.) However, if enacted, it will eliminate stretch IRA and qualified plan rules for certain beneficiaries and replace them with a 10-year distribution requirement. Consequently, some IRA beneficiaries may have to take the full balance of an inherited IRA by the end of the 10th year after the IRA owner’s death. Certain beneficiaries may be exempt, including surviving spouses, minor children (not grandchildren), and disabled individuals.

Ultimately, if you consider your own personal income tax history, compare it with where you are now, and project where you may be headed to in the future, you’ll get the perspective you need to make your decision.

And while everyone’s situation is different (that’s why my favorite answer is “It depends!”), if you plan early and often (by working with your tax and financial advisors), you can make informed decisions by year end and avoid surprises next April.

 

*Tax-loss harvesting involves certain risks, including, among others, the risk that the new investment could perform worse than the original investment and that transaction costs could offset the tax benefit. There may also be unintended tax implications. We recommend that you consult a tax advisor before taking action.

Notes:

  • All investing is subject to risk, including the possible loss of the money you invest.
  • This information isn’t intended to be tax advice and can’t be used to avoid any tax penalties. We recommend that you consult a tax advisor.