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Individual Federal Income Tax Planning

By Miranda L. Aavatsmark
Originally published in The Kentucky CPA Journal.

It’s beginning to look a lot like….tax time! Looking back at all of the tax law changes, interpretations and developments each month, this has been quite an interesting and eventful year. Between changes to the Federal tax code, Kentucky income and sales taxes, and the Wayfair case, accountants have had their hands full for some time. With all of the changes in mind, what can taxpayers do before year-end to be better prepared and maximize their federal tax savings?

Before attempting to answer that question, a review of the changes that were brought about with the Tax Cuts and Jobs Act is necessary. To start, Form 1040 was completely revamped. The new forms and schedules are still in draft form but are available for viewing on the IRS’s website. The most notable change to Form 1040 is the complete makeover (or makeunder) of the size and length. Page 1 of the form consists of lines to enter taxpayer(s) information such as name, address, dependents, etc. Page 2 is used to report taxpayer(s) income and deductions. But here’s the kicker – both pages are half the size of an 8X11 piece of paper with blank white space on the bottom half! I suppose this was created to accommodate the “post-card” filing promise. However, since most returns are filed electronically, typically with additional schedules attached, I am unsure how this format alleviates any headaches related to a form being an entire page long.

Regardless of the format of the new form, the content is of greatest importance to focus on. The most prominent changes to the federal tax code affecting individual taxpayers this upcoming busy season include the following:

  • New tax brackets and lower rates
  • Elimination of personal and dependency exemptions
  • New standard deduction
  • $24,000 for joint filers and surviving spouses;
  • $18,000 for heads of household; and
  • $12,000 for singles and married filing separately
  • Elimination of net operating loss carrybacks; losses limited to 80% of taxable income and carried forward indefinitely
  • Losses from a non-passive trade or business are now limited to $500,000 married filing jointly/$250,000 all others
  • Pass-through deduction for business owners equal to 20% of qualified business income (limitations may apply)
  • Medical expenses limited to 7.5% of adjusted gross income (AGI) for 2017 & 2018; limitation returns to 10% of AGI starting in 2019
  • Schedule A tax deduction limited to $10,000 (real estate, vehicle, state and local)
  • Mortgage interest deduction limited to mortgage loan balances of $750,000 or less for new loans under contract after December 15, 2017
  • Home equity interest deduction eliminated, unless acquisition or improvement debt
  • Charitable contributions limited to 60% of adjusted gross income; 50% limitation previously
  • Athletic event donations are no longer deductible; 80% deductible previously
  • Suspension of miscellaneous itemized deductions (unreimbursed employee business expenses, investment advisor fees and tax preparation fees)
  • Personal casualty and theft losses only deductible in federally declared disaster areas
  • Suspension of overall limitation on itemized deductions
  • Suspension of moving expense deduction (except for members of the Armed Forces)
  • Alternative minimum tax exemption increased to:
  • for married filing jointly/surviving spouses—to $109,400 (from $78,750); and
  • for all others—to $70,300 (from $50,600).
  • Child tax credit doubles to $2,000 per child with phase increased out at $400,000 married filing jointly/$200,000 all others
  • Kiddie tax rates no longer subject to parents’ rate; trust and estate tax rates will now apply to earnings subject to kiddie tax
  • 529 Plans will now allow up to $10,000 per year/student to pay for elementary and secondary school (K-12)
  • Repeal of deductibility and inclusion of income for alimony payments with agreements entered into after December 31, 2018
  • Repeal of The Affordable Care Act’s individual mandate beginning with tax years after December 31, 2018

Individual and Family Issues

For individuals who are non-business owners, year-end planning just became much simpler. Many Americans that itemized in previous years will likely begin taking the standard deduction with the filing of their 2018 income tax return. This change is largely due to the $10,000 limitation of state and local taxes and the elimination of miscellaneous itemized deductions. Nonetheless, if a taxpayer’s deductions are teetering near the standard deduction of $24,000 (if married filing jointly) they may consider accelerating certain deductions before December 31st. For example, increase charitable contributions, plan and pay for a medical procedure that has been delayed, and pay January mortgage payments in December. Subsequently, in 2019, when there are fewer write offs, the taxpayer can take the standard deduction. By “bunching” deductions in one year, instead of spreading them evenly, tax savings will be realized over a two year period.

Although the dependency exemption was eliminated, the child tax credit, dependent care credit, earned income credit and education related credits were not. Divorced individuals with children may need to re-evaluate their agreements and consider how the new tax laws affect their taxes. Higher income earners, who may not have received any benefits from claiming dependents in the past, may want to re-negotiate their terms.

Since changes to the tax treatment of alimony payments are near, couples that are currently going through divorce with alimony on the table will need to consider the timing of their agreement. The payer of alimony may want to speed up signing agreements before year-end for their payments to be deductible. The recipient will probably want to push off signing until 2019 so the payments are not includible in income.

Although the above ideas and examples are meant to be helpful and thought provoking, they are not inclusive of all taxpayer circumstances. Furthermore, the list of tax changes above is a high-level summary and does not include all changes and all relevant details. Each individual taxpayer should consider all the changes to the tax laws and seek advice based on their situation.

Pass-Through Business Owners

The creation of the pass-through deduction has provided a great opportunity for significant tax planning to business owners beginning in 2018. Earlier this year, I wrote an article about the new pass-through deduction and how to maximize the benefits of this deduction and the tax savings. More details about the deduction and planning ideas are included in the article.

To illustrate how large the tax savings could be I will share an example of a calculation I prepared recently for a client. The client is the sole owner of a medical practice that is taxed as an S-Corporation. The client’s projected taxable income for 2018 is $430,000 (married filing jointly). Since a medical practice is a “specified service trade or business” (SSTB) this level of taxable income pushes him out of the qualifications for any amount of pass-through deduction (the deduction is completely phased out for SSTB taxpayers with taxable income over $415,000 MFJ). But if we find a way to reduce his taxable income by $115,000 (taxable income will be $315,000 and not subject to any limitations) he will realize tax savings of around $50,000. The tax savings is a realized percentage of nearly 45%!  If he is not able to reduce his income by the entire $115,000 but is able to reduce it by some other amount, he still may be eligible for a partial deduction. However, additional calculations will need to be performed based on wages paid in the business and property owned.

Tax planning options for business owners have always been flexible and this did not change with tax reform.  In fact, tax reform brought with it additional expensing options for businesses.  For example:

  • Bonus depreciation is now 100% instead of 50% immediate expensing for assets purchased and placed in service after September 27, 2017
  • Section 179 expensing increased allowing businesses to write off up to $1,000,000 of assets purchased and placed in service after December 31, 2017

My client and I are currently considering many ways to decrease income. A few of the ideas we have brainstormed include purchasing a large piece of equipment (that he needs), accelerating payment of expenses, increasing his retirement contributions, and prepaying 2018 local net profits taxes. He would also like to purchase the building he is renting but we doubt this will happen before year-end since real estate transactions are rarely quickly turned around. Therefore, the purchase of the building will probably take place in 2019, providing additional deductions when we are scrambling again this time next year.

The example above is just one of many situations that will arise for business owners in 2018. Non-specified service businesses are not subject to the same limitations as this business owner, but the wage and property limitations may still apply. Each taxpayer circumstances are different and will need to be evaluated on an individual basis. My hope is that creative solutions will be sought after as tax savings like these can be significant.

Be sure to contemplate this deduction and others before it’s too late. Once the clock strikes midnight on December 31st, a potential shiny new tax deduction may turn back into a plain ugly pumpkin.

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