Tax planning for next year

Ernst & Young and Fidelity discuss the tax changes and tax planning strategies you may want to consider.

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Key takeaways

  • New tax rules generally lowered tax rates and raised standard deductions.
  • Many deductions were eliminated or limited.
  • It may be a good time to revisit your charitable giving, mortgage debt, and municipal bond investment strategies.

In March, Fidelity and Ernst & Young came together to deliver a webcast that looked at the tax changes and individual tax planning strategies. One take away: It may make sense to review your mortgage, retirement savings strategies, and other tax-related decisions in light of the new rules.

1. New tax rates

With the new tax changes, Congress created a new set of tax rates that were either unchanged or lower than the previous rates. In addition, the taxable income levels within each bracket went up. This means more of your income gets taxed at lower marginal rates.

2. New standard deductions

As in the past, the new law allows taxpayers to reduce their adjusted gross income by the higher of the standard deduction or the sum of itemized deductions. The Act has increased the standard deduction significantly.

For tax years beginning after 2017 and before 2026, the standard deduction has been raised to $12,000 for single and married filing separately, $18,000 for head of household, and $24,000 for married filing jointly and surviving spouse. These new amounts will be adjusted for inflation, for instance in 2019 the standard deduction was raised to $12,200 for single filers and $24,400 for married couples filing jointly. No changes have been made to the pre-Act, additional standard deductions for the elderly and blind.

3. Reduced deductions

Tax reform changed the landscape for many deductions. Under the old law, itemized deductions were limited for higher-income taxpayers.

Under the new law, the limitation on itemized deductions for wealthier taxpayers is suspended.

While the rules for many deductions changed, let's look at a few of the more popular deductions, state and local taxes, mortgage interest, and charitable giving (the webcast covers more).

State and local taxes: Under the old law, taxpayers could deduct several types of taxes paid at the state and local level, including property taxes and either income or sales tax. There was no limit on this deduction, other than the limit on total itemized deductions for wealthier taxpayers and limitations for taxpayers subject to the alternative minimum tax (AMT).

Under the new law, this deduction is subject to a limit. A taxpayer can now generally deduct up to $10,000 for state and local property taxes and either state and local income taxes or state and local sales taxes paid during the tax year. Also, you can't claim an itemized deduction for any prepayment of state or local income tax that was imposed for a tax year after the year for which you're filing a return.

Home mortgage and home equity loan interest: Under the old law, a taxpayer could deduct qualified interest paid on a mortgage or home equity loan on a first or second home. The deduction was limited to interest on up to $1 million of mortgage debt and interest on up to $100,000 of home equity loan debt.

Under the new law, for homes bought after December 15, 2017, but before 2026, you can deduct interest on up to $750,000 of mortgage debt. If you entered into a binding written contract before December 15, 2017, to close on the purchase of a principal residence before January 1, 2018, and you bought this home before April 1, 2018, the interest on your mortgage will be subject to the pre-Act deduction limit. Under the new law, the deduction for home equity loan interest is suspended, except for home equity loans for substantial home improvements that comply with the debt limit. For tax years after 2025, the pre-Act rules on deducting home mortgage and home equity debt will be restored, regardless of when you incurred the debt.

The new rules do not apply to mortgages secured/incurred on or before December 15, 2017, or to refinancing after that date, as long as the amount of new mortgage does not exceed the amount of the mortgage being refinanced.

Charitable contributions: Under the old law, you could deduct up to 50% of your adjusted gross income for charitable contributions of money or property to a qualified organization. In some cases, 20% or 30% limitations applied.

Under the new law, the 50%-of-adjusted-gross-income limit is increased to 60% for certain cash contributions. Also, cash contributions exceeding the 60% limit can generally be carried forward and deducted for up to 5 years.

These changes all took effect January 1, 2018, and most are scheduled to expire December 31, 2025.

Tax planning strategies

Charitable contributions still valuable: Consider bunching deductions. Because of the higher standard deduction, you may want to concentrate your charitable gifts into a single tax year.

Revisit pre-tax versus Roth 401(k) analysis: With lower tax rates now, and the potential for higher tax rates down the road, you may want to reconsider the role of a Roth 401(k) or IRA. All else equal, the benefits of tax-free withdrawals increase if your tax rates are expected to be higher in retirement.

Reconsider tax-free municipal bond income: If your tax situation has changed, you may want to reconsider the role of municipal bonds in your portfolio. Some investors in high tax states who lost deductions may find municipal bonds more appealing, because the income from those investments is typically federally tax-free. For investors whose tax burden has gone down, the yields on muni bonds may have become less compelling.

Review after-tax cost of mortgages on second homes and home equity lines of credit: Anyone carrying significant home equity debt that is impacted by the new caps on the deductions should reconsider the after-tax cost of that debt. You may need to adjust your budget, or reconsider your debt payment plans based on the new rules. 

Revisit state residency: If you pay taxes in a high tax state and are limited by the new cap on deductions, you may want to research the impact of relocating. While decisions about where to live are complex, it makes sense to weigh taxes as one part of the equation.

Next steps to consider

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