Tax law changes could affect your finances this year
We’ve all read the headlines about how the new Tax Cuts and Jobs Act of 2018 (TCJA) will slash the corporate tax rate, reduce individual income taxes, change some treasured tax deductions, and virtually eliminate others. But there are other aspects of our financial lives that it may affect as well.
Here’s a quick overview of how the new Tax Act could influence your income, retirement savings, and lending decisions in the year ahead from Boston Private Managing Director and Wealth Strategist Alyssa Do, JD, LL.M. Please check with your own tax advisor for more details on how these changes may apply to your personal tax situation.
For a bird’s eye view of the other ways the Tax Act could affect you as an individual taxpayer, see our 2018 Tax Cuts and Jobs Act Changes diagram. For ideas to help you take advantage of the Act’s new tax deduction rules, read Three ways to streamline your tax prep in 2019.
Changes that could affect your (AGI) income
While your individual federal income tax rate in 2018 will likely be lower due to the TCJA, your taxable income may also drop as the result of recent tax changes. For example:
- If you receive income from qualified “pass-through” entities such as S corporations, limited partnerships, LLCs, or sole proprietorships, the TCJA’s new 20% deduction could reduce the amount of income that is reflected on your individual return.
- If you are divorced and entitled to alimony, new TCJA rules could mean you won’t need to report these payments as income if you modify your agreement or your divorce is executed after December 31, 2018. (Of course, your ex-spouse must also agree to the modification and the loss of the deduction for alimony paid.)
The Tax Act also left intact another key way to lower your taxable income: contributing to a workplace retirement plan. If you have a 401(k), 403(b), or 457 plan at work, you can lower your income (AGI) even more this year by increasing your tax-deductible contributions to meet the new, higher limit of $18,500 in 2018 ($24,500 if you are age 50 or older).
There are also significant changes to how “unearned” income for children and college students will be reported and taxed under TCJA. In 2017 any investment or dividend income over $2,100 was taxed at the parent’s income tax rate. But starting in 2018 this “Kiddie Tax” will be imposed at the current estate and trust tax rates, ranging from 10% to 37%. (The tax rules for a child or student’s earned income remain the same as before.)
A 'back door' stays open for retirement saving
Although income limits for deducting an IRA contribution will increase in 2018, most high earners still won’t be able to take advantage of deductible IRAs in 2018 unless they have no workplace retirement plans. High income levels will also mean they can’t contribute directly to a Roth IRA. (See the chart below for 2018 IRA deduction and Roth IRA eligibility limits.)
Fortunately, the latest round of tax changes still allows anyone, at any income level, to take advantage of a Traditional to Roth IRA conversion. For high income earners who can’t contribute directly to a Roth IRA, a conversion offers desirable “back door” access to all of the Roth’s benefits.
“When you convert to a Roth IRA, you create a tax-advantaged retirement account that will not be taxed when you withdraw the funds later and isn’t subject to minimum distribution rules,” Do explains. “But you will have to pay current taxes on the amount converted.”
While the new tax law no longer allows you to reverse (or “re-characterize”) a Roth IRA conversion to avoid onerous tax consequences, this takeaway isn’t a problem if you take a measured approach, says Do. “You have to be strategic and understand that it's not an all or nothing proposition. You can cherry pick the positions within your IRA that you convert to limit your taxable gains. You don't have to convert the entire account. You also need to be careful that the amount you convert doesn't push you into a much higher tax bracket—especially between the new 24% and the 32% brackets. That's the biggest jump.”
New sources for borrowing and lending
If you’ve been tapping an existing home equity line of credit (HELOC) to help pay for college, cars, or vacations, you’ll no longer be able to deduct the interest you pay on your income tax return. So now may be a good time to explore using other secured sources of liquidity, such as your investment portfolio at Boston Private, which may offer lower rates.
If you are making intra-family loans to your children for a business start-up or home purchase, be aware that the minimum Applicable Federal Rate (AFR) for these loans increases this year to about 3.5% for longer-term loans. Because this higher interest will be reported as income in 2018, you’ll need to consider this in your financial planning decisions as well, says Do. “You may want to look at other lending options that reduce your personal income but still support your family’s goals.” (Alyssa Do joins the investment team to discuss how rising interest rates can affect your financial planning. Go here to register for the upcoming webinar on April 23, 2018.)
Because the TCJA is complex and wide-ranging, details continue to emerge from the IRS about how certain changes should be implemented. “In many areas, the IRS still hasn’t given us guidance on what the changes mean and how to deal with them,” says Do. That’s why it’s important for individuals and their tax advisors to keep on top of news about the Tax Act and stay tuned for any updates, she says.
It’s also important to enlist the help of your Boston Private advisor if you have any tax questions that affect your financial, investment, or estate planning decisions. Your advisor is prepared to work with you and your tax professional to find the answers you need to keep on track toward your goals.
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