Planning around The Tax Cut and Jobs Act
The Tax Act of 2017 created reform for C corporations. Regarding other parts of the tax code, the portions that affect individuals and pass-through business entities, such as sole proprietorships, partnerships, S corporations and LLCs, are described as tax editing.
What does this mean? We have the same overall tax system as before, but with some changes in the details. Most all of the changes affecting individual taxpayers and pass-through enterprises are under a sunset provision. Unless Congress acts to make all or a portion of the changes permanent, most will be rescinded, effective for tax year 2026.
The focus of this article is to identify areas of opportunity for individuals and pass-through enterprises.
Let’s start with individual taxes. Standard deductions nearly double to $24,000 for couples, $12,000 for singles and $18,000 for head of household. Those age 65 or older and blind people will get $1,300 more per person ($1,600 if married).
The new tax law eliminates the personal exemption.
What this means is the first $24,000 of taxable income for married couples under 65 is not taxed because the standard deduction offsets the amount of taxable income.
For married couples under 65, the next $19,050 is taxed at 10 percent. So, if a married couple had $43,050 of taxable income, their effective tax rate would be 4.4 percent. That is $1,905 divided by the $43,050 of total income.
Continuing, the next $58,350 of taxable income is now taxed at 12 percent, which is $7,002. Last year the rate would have been 15 percent. So, if a married couple has taxable income of $101,400 their effective tax rate under the new law is 8.8 percent. That is $8,907 divided by $101,400.
This is an amazing opportunity to take advantage of historically low tax rates.
Many people ask about moving money from 401Ks and IRAs before retirement. People are also asking about making contributions to 401Ks and IRAs, 402Bs and 457 plans while still working.
Here is an example to consider: A couple has $70,000 per year of taxable income. They could withdraw $30,000 from taxable accounts each year and they would stay in the 12 percent tax bracket with an effective income tax rate of 8.8 percent. The question is, would it benefit to pay an income tax rate of 8.8 percent now or risk paying a much higher rate later?
Consider repositioning money into vehicles that have lower or no future tax liability depending on health and financial circumstances.
A few additional highlights:
Many popular deductions are affected. The home mortgage interest deduction has been nixed and the state and local taxes are being squeezed. Several other write-offs are eliminated: deductions for job-related moves except for the military; all miscellaneous write-offs subject to the two percent of AGI (adjusted gross income) threshold, including employee business expenses; brokerage and IRA fees; hobby expenses; tax preparation expenses; theft losses; and alimony for divorce decrees after 2018 (that is good news for the receiver, who will not be taxed on the alimony they receive).
Key points to consider for your donations: Donate your RMD (required minimum distribution from an IRA) tax-free to charity. A donation counts as your required minimum distribution, but doesn’t increase your adjusted gross income. If you already give, this could be a great tax savings strategy.
Calculate your tax break: The limit for a charitable contribution from your IRA is $100,000; that could save tens of thousands of tax dollars. You do not need to make a huge donation to benefit from this tax break. For a retiree in the 25 percent tax bracket, a $10,000 contribution from your IRA could save $2,500 in taxes or $1,000 could save $250 in taxes.
The new tax law dramatically reforms the taxation of businesses of all sizes. Regular corporations (C corporations) will pay tax at a flat rate of 21 percent.
Many individual owners of pass-throughs will get a new 20 percent deduction. The rules cover sole proprietors and owners of S corporations, partnerships and LLCs. They can generally deduct 20 percent of qualified business income. This is a new and temporary section 199A deduction on qualified business income. These provisions are, however, some of the most complex in the new law. There are a lot of limits and restrictions.
The bottom line is this: individuals and businesses have a spectacular opportunity to take advantage of historically low tax rates, focusing on strategic charitable deductions and the 199A deduction for owners in pass-through entities.
Ken New is the president of Pinnacle Financial Wealth Management serving retirees and business owners in Brevard County for 21 years. To learn more call (321) 454-3623.