Broker Check

Planning for Tax Reform

| December 06, 2017
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Sounds hard to do - plan for tax reform - when the news changes daily on different bills and deals that the House and Senate are putting together.  And yet a large part of what we do for our clients is to help you plan for your future – and taxes play a big role in our finances. 

We have been following the bills closely (and I am fortunate to be able to obtain the bills from a lobbyist colleague of mine).  Reading draft bills and listening to the news only gets us so far.

Planning for Tax Reform

What we are paying attention to now relating to tax reform:

  • Changes to the flexibility to back out of a Roth conversion (called a recharacterization) – we might lose the ability to change our minds about a conversion.
  • Whether Health Savings Accounts in Maryland will be deductible in 2018 due to conflicts between Maryland laws and Affordable Care Act (hint: Maryland has a better law).
  • Increase to the maximum contributions for 2018 for 401Ks, 403bs, and the Thrift Savings Plan to $18,500 for the base (the catch up for 50 and older remains at $6000).
  • Ability to select which “lots” we are selling in a large stock or stock fund holding when we are selling only part of an investment and want to keep taxes as low as possible – the requirement to use FIFO (first in, first out) accounting increases taxes in the short term.
  • Changes to the tax brackets, which means that many of us will be paying higher taxes – either next year or within a few years.
  • Limit the mortgage interest deduction – though this was partially reinstated and may later be fully reinstated.
  • Elimination of the estate tax, which means that your beneficiaries won’t pay taxes on the value of your estate when you pass away (in 2018, this amount increases to $5.6M for a single person and $11.2M). Many folks never reach these values.
  • Elimination of the Alternative Minimum Tax (AMT) a parallel tax code that adds to the tax bill of many upper middle class tax payers – this will help most of us.

The loss of deductions is the single biggest concern we have. On the table to be eliminated are:

  • Medical deductions (this is a big concern for folks with large medical bills and/or long-term care and nursing home expenses).
  • Property tax deductions (which in Maryland and other high property value states, this is a large deduction) – though this might be kept in the final bill with a $10,000 cap
  • State and local tax deductions – again in high income/high tax states such was Maryland, DC, New York, and California, this generally is a big deduction against your Federal taxes. 

The loss of the deductions relating to property and income taxes makes the idea of retiring to a state with lower taxes even more appealing (see GFP’s blog post about lower tax states).

The increase to the standard deduction may ameliorate some of the loss of itemized deductions (the items on the 1040 Schedule A such as medical, state and local taxes, property tax, and mortgage interest), though it might have an unintended consequence of not making the typical American’s charitable contributions tax deductible because the contribution didn’t exceed the amount of the standard deduction. Clients would either need to make large contributions in the same year by bunching up their contributions or simply donate for the love of donations.

Keep in mind that the Senate and the House still need to “reconcile” their different bills. What this means is that none of this is set in concrete yet. It won’t be law until the president signs it. 

Ongoing Tax Planning Services

What we pay attention to in a “normal” tax year:

  • Your tax bracket and anticipated income taxes for the year
  • Estimated tax payments
  • Roth versus deductible contributions to your IRAs and employer plans
  • Roth conversions and possibly the “two step” Roth contribution/conversion process
  • Benefits of maximizing your retirement plan and IRA contributions now
  • Future tax rates in retirement compared to today
  • Managing your capital gains and whether to create taxable income this year or next
  • Tax loss “harvesting” if there are any losses
  • State tax deductions to college savings plans
  • Self-employment income benefits and tax reduction strategies
  • Health Savings and Flexible Savings Account benefits
  • Putting high tax generating investments such as REITS, bonds, and dividend paying stocks in your tax deferred accounts and putting tax efficient (low dividend paying stock funds and tax free municipal bond funds in your taxable accounts); and putting the high growth stock funds and REITs in your Roth accounts for even larger tax-free balances long into your retirement years.

Basically, keeping your taxes as low now as appropriate and balancing this against the benefits of keeping taxes low in retirement when you can’t earn your way out of a cash flow deficit.

State Taxes in Retirement:

Taxes are an important factor to consider when selecting a state for retirement. States with lower costs of living and lower income taxes for retirees as described below:

  • Currently, seven states do not tax individual income – retirement or otherwise: Alaska, Florida, Nevada, South Dakota, Texas, Washington and Wyoming. Two other states – New Hampshire and Tennessee – impose income taxes only on dividends and interest (5 percent for New Hampshire and 6 percent for Tennessee)
  • The 10 states with the lowest taxes on retirees are: the ones listed above plus Mississippi, Georgia, Delaware, Arizona, and Louisiana.  All of them exempt Social Security benefits from state taxes. Most exempt at least a portion of other retirement income, such as pensions and withdrawals from tax-deferred retirement plans.
  • In addition to the nine states that lack a broad-based individual income tax, 27 states and the District of Columbia do not tax Social Security: These states in addition to the ones above: are Alabama, Arkansas, California, Hawaii, Idaho, Illinois, Indiana, Kentucky, Maine, Maryland, Massachusetts, Michigan, New Jersey, New York, North Carolina, Ohio, Oklahoma, Oregon, Pennsylvania, South Carolina, Virginia and Wisconsin.
  • One of our neighbors, Delaware, also has no sales tax, and its income tax rates are modest. Social Security benefits are exempt, and seniors can shelter many other forms of retirement income from state income taxes. Taxpayers 60 and older can exclude $12,500 of income from IRAs, 401(k) plans and pensions from state taxes. Delaware has the fourth-lowest property taxes in the U.S.

As part of our planning together, we can model moving to another state in retirement to see how lower taxes can help your money last longer.

Let us know how we can be of assistance.

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