3 Ways to Take Advantage of the New Tax Law
by John Cooney on Jan 29, 2018
The Tax Cuts and Jobs Act (TCJA), passed just at the end of 2017, made some of the most significant changes to the tax code in decades, and you have probably heard numerous takes on how good or bad the legislation is. This is not going to be a discussion of the merits of the bill, but instead, I will highlight three changes that taxpayers can use to their advantage starting as early as 2018. Just one big note, this is for 2018 taxes, due in April 2019. For your 2017 taxes, due in April of 2018, the old tax rules still apply.
You may be familiar with 529 plans, as they have been in existence since 1996, and serve as a tax advantaged way for tax payers to save for future college costs. 529 plans allow taxpayers to deposit money into an investment/savings plan, which then grows tax free, and the money withdrawn is also tax-free if used to pay for qualified education expenses. From 1996 to 2017, distributions from 529 plans could only be used for qualified higher education expenses without incurring an IRS penalty. With the passage of the TCJA, distributions from a 529 plan can now not only be used for college expenses, but can also be used to pay for elementary and secondary school expenses, at both private and public schools. This serves as an excellent opportunity for taxpayers to save now for future education expenses, and allow those savings to grow tax free until they are distributed. This can help reduce some of your out of pocket expenses now, and provide tax efficiency at the same time.
A couple things to keep in mind with the 529s; the distributions for other than higher education expenses are limited to $10,000 per year, per student. Also, the provision allowing 529s to pay for elementary and secondary school expenses is currently scheduled to expire in 2025.
Is a 529 Plan Right For You?
Using a Donor Advised Fund for Charitable Giving
One of the most significant changes in the TCJA was in raising the standard deduction for both individuals and married couples. For a married couple, filing jointly for 2018, their standard deduction has risen from $12,700 to $24,000. This means in practice, many people who donate to charity will not donate enough to push their itemized deductions above the $24,000 standard amount. To continue to get the tax benefit of your charitable giving, you could decide to “lump” your charitable giving into one year, and then in the off years take advantage of the $24,000 standard deduction. One way to accomplish this is through the use of a Donor Advised Fund (DAF). You can establish a DAF at many custodians, and when you make your contribution to the fund, you get to immediately recognize the charitable contribution. Then, over the course of time, you can direct the custodian to make grants out of the DAF to your directed charities. The years after your contribution, you are not claiming a charitable contribution, and instead are using the higher standard deduction amount. If you are already donating to charities, and are worried you will no longer receive a tax benefit for doing so, this may be a strategy for you to explore with your financial planner and or your accountant to see if it is one you can employ.
A third strategy that may be right for you based on the tax law change is to convert a portion of your tax-deferred savings to a Roth IRA. The reasoning behind this strategy is based on the lower tax brackets that are available starting in 2018, which when combined with the higher standard deduction means for most people, their tax liability will be lower in 2018 than it was in 2017. Low tax income years are a great time to take advantage of converting some tax deferred assets like a traditional IRA or a 401K to a Roth asset. You will have to pay income taxes on the converted amount, but by doing so in a low tax year you can recognize some tax savings, and have access to more of your money once it is ultimately withdrawn. This can be a particularly welcome strategy for those retirees who have yet to start taking required minimum distributions. However, the TCJA also added a provision that no longer allows you to re-characterize a Roth Conversion. Prior to the TCJA, a tax payer who converted a tax deferred account to a Roth had up until October 15th of the following year to re-characterize the conversion back to the tax deferred account. That option will no longer exist, and any decision to convert assets to a Roth will be irrevocable, so be aware that this option does have a little bit of an added risk.
Not all of you will be able to benefit from these three strategies, but if you think any could apply to you, make sure you bring them up to your accountant or financial planner, so that you can move forward confidently and tax efficiently!
Do You Have Questions on the TCJA?