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Strategies to Reduce your Taxes Under the New Tax Law

John J. FureyJanuary 23, 2019

Taxes

A client asked about the ways to lower taxes under the new tax rules?

The Tax Cuts and Jobs Act (Tax Act) passed in December 2017 took effect on January 1, 2018 for individual taxpayers. Individual tax returns for 2018 will be processed using the new rules of the Tax Act. Two of the most significant changes are:

  1. The large increase in the Standard Deduction; and
  2. The elimination or reduction of Itemized Deductions many taxpayers used to reduce their taxes before 2018.

There are some actions that taxpayers can take to reduce their Adjusted Gross Income (AGI) or their Taxable Income even with the significant changes to the Standard Deduction and Itemized Deductions.

Here are the changes.

Increases in the Standard Deduction

Tax Year 2017 Tax Year 2018 Tax Year 2019
Single 6,350 12,000 12,200
Single (age 65 or older) 7,900 13,600 13,850
Married (filing joint) 12,700 24,000 24,400
Married (one person 65 or older) 13,950 25,300 25,700
Married (both 65 or older) 15,200 26,600 27,000
Head of Household 9,350 18,000 18,350
Head of Household (65 or older) 10,900 19,600 20,000

 

Changes to Itemized Deductions:

Tax Year 2017 Tax Year 2018 Tax Year 2019
Medical Expenses Must exceed 7.5% of AGI Exceed 7.5% Exceed 10%
State/ Local Income & Real Estate Taxes No limit on deduction Limited to 10K Limited 10K
Mortgage Interest* Mortgage debt up to 1M Debt up to 750K Debt up to 750K
Charity Cash up to 50% of AGI Up to 60% AGI Up to 60% AGI
Miscellaneous Itemized

  • Employee expenses
  • Tax prep fees
  • Investment fees
  • Attorney fees
  • Safe deposit box
Must exceed 2% of AGI Eliminated Eliminated

*If the mortgage debt was incurred before 12/15/17, interest on such debt up to $1 million is still deductible. In 2018 and 2019 the interest on home equity debt is deductible provided the debt is used to buy, build or substantially improve the home that secures the debt. The interest on home equity debt and mortgage debt incurred after 12/14/17 is only deductible on total debt up to $750,000.

Beginning in tax year 2018 most taxpayers will only be able to deduct the following 4 items:

  1. Medical expenses that exceed the threshold;
  2. State and Local Income Taxes and Real Estate Taxes (SALT) up to 10K;
  3. Mortgage interest; and
  4. Charitable contributions.

If the above 4 deductions do not exceed your Standard Deduction, you do not need to assemble data on itemized deductions to prepare your 2018 federal tax return. It is estimated that for tax year 2017 about 33% of taxpayers itemized their deductions and for tax year 2018 only about 10% will do so.

Strategies to Reduce your Adjusted Gross Income

There are many reasons to try to reduce your AGI. Some of the important items that are determined by your AGI are:

  • Ability to make a tax-deductible IRA contribution
  • Ability to make a Roth IRA contribution
  • Eligibility for education tax credits
  • Ability to deduct student loan interest
  • Eligibility to take the 2K child tax credit- phases out at 200K (single) and 400K (married)
  • The 3.8% Net Investment Income Tax starts at 200K (single) and 250K (married)
  • Medicare monthly premiums start to increase at 85K (single) and 170K (married)

Some ways to reduce your AGI are:

  • Make before-tax contributions to 401(k), flexible spending accounts and Health Savings Accounts
  • Convert taxable interest to tax-exempt interest
  • Do tax-loss harvesting to reduce capital gains income
  • Contribute to an IRA or a SEP-IRA, if eligible
  • Deduct student loan interest
  • Take a distribution from a Roth IRA instead of a Traditional IRA
  • If you are over age 70 ½, use all or a portion of your Required Minimum Distribution (RMD) to make a Qualified Charitable Distribution (OCD)
    • Example: If you make a QCD of 40K out of your RMD of 90K, you only include 50K in your AGI for that year
    • Limited to 100K in any tax year
    • Must be a direct transfer from the IRA custodian to a qualified charity
    • Private foundations and donor advised funds are not qualified charities for QCD purposes
    • You do not have to itemize your deductions to take the OCD deduction
    • You should contact your financial advisor or your IRA custodian to determine how to make a QCD from your IRA

Here is a link to a recent Wall Street Journal article about QCDs 

Strategies to use the higher Standard Deduction and Itemized Deductions to reduce taxes

  • Plan to use the higher Standard Deduction in some years and then group your Itemized Deductions in other years to exceed the Standard Deduction.
  • Example: In tax year 2019 married taxpayers will have the following deductions:
    • Medical expenses above the threshold: $2K
    • SALT: $10K
    • Mortgage interest: $5K
    • Charity: $5K
    • Total: $22K

The taxpayers need to pay a medical bill of 12.4K that they could pay in 2019 or 2020.  They also have stock held for more than 1 year (20K market value with a 5K tax basis) available to prepay their charitable contributions for the next 4 years.

The taxpayers decide to pay the medical bill in 2019 and to contribute the stock to a donor advised fund in 2019. A contribution of stock to a donor advised fund is deductible in the year it is made. The deduction amount is the fair market value of the stock on the date of the contribution. No capital gains tax is due when stock is contributed to charity.

Their total Itemized Deductions in 2019 are now 54.4K (22K +12.4K + 20K). If the taxpayers are in the 24% marginal tax bracket, they would reduce their taxes by 7.2K by grouping their deductions in 2019 (54.4K minus 24.4K standard deduction = 30K times 24%).

In addition, the taxpayers avoided at least 2.2K in capital gains taxes by donating the stock (gain of 15K x 15%).

In the next few tax years the taxpayers plan to use the Standard Deduction to prepare their tax returns.

Information about Donor Advised Funds (DAF)

If you have any questions about tax issues, Qualified Charitable Distributions or Donor Advised Funds, please do not hesitate to call our office (610-651-2777).  We look forward to a productive tax season!  Let us know if we can help.