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December 18, 2018

Embrace Changes to Your Tax Strategy (article)

Tax

The term “tax planning” holds more weight in 2018 thanks to the tax law known as the Tax Cuts and Jobs Act (TCJA). The tax reform bill was passed at the end of last year, and most of its modifications became effective in 2018. These changes present a unique opportunity for you to look at your taxes in a new light, explore new benefits, and incorporate these insights into tax savings strategies. The following discussion highlights some key considerations that may require a change in your tax planning and strategies.

Itemized Deduction Planning

The TCJA will almost certainly impact your itemized deduction strategy. It nearly doubled the standard deduction, making it more difficult for taxpayers to tally itemized deductions in excess of that threshold. It also placed restrictions on certain deductions:

  • Property, income, and sales tax deductions are now limited to a total amount of $10,000
  • Mortgage interest deductions from new indebtedness incurred after Dec. 15, 2017 are now limited to $750,000 of indebtedness, down from the previous $1 million limit (certain refinance indebtedness incurred after this date remains eligible for the higher $1 million limitation)
  • Interest on home equity loans is nondeductible; however, such loans ostensibly labelled “home equity” but that are used to acquire, construct, or substantially improve a qualified residence can still generate deductible interest
  • Only the medical expenses that exceed 10 percent of adjusted gross income will be deductible in 2019, compared to 7.5 percent in 2018

Simply put, itemization may no longer be an option for you. At the very least, your strategy will look different. Some taxpayers whose deductible expenses are at or near the standard deduction threshold will choose to “bunch” their expenses every other year. This strategy requires an acceleration of deductions in one year to surpass the threshold, and a deferral of deductions the next year when the standard deduction would be used. The IRS permits this technique, and if your tax position qualifies you for this strategy, it will save you money in the long run. However, be mindful of the $10,000 cap on property taxes (a deduction common to the bunching strategy) when implementing this technique.

Estate & Gift Planning

The TCJA more than doubled the estate tax exemption beginning 2018, but set this enhancement to expire after 2025. Should Congress allow this expiration to occur as scheduled, the exemption will revert back to a pre-TCJA level in 2026. Even so, taxpayers should take note of the exemption trends as they are difficult to ignore. In the last two decades, we have seen a simultaneous increase in the estate tax exemption and a decrease in the maximum tax rate.

Year

Estate Tax Exemption

Maximum Estate Tax Rate

1997

$600,000

55%

2005

$1,500,000

47%

2009

$3,500,000

45%

2018

$11,180,000

40%

 

These pro-taxpayer trends may mean that estate taxes will be less of a concern going forward. Irrespective of this trend, it is always smart to take advantage of annual gift tax exclusions while they are available. In 2018, each taxpayer is permitted to gift up to $15,000 per person while keeping their lifetime exemption of $11.18 million intact.

Aside from annual gifts, you can make tax-advantaged gifts in the following ways:

  • Directly pay educational or medical institutions on behalf of beneficiaries
  • Split gifts with your spouse to maximize your annual exclusions
  • Create a life insurance trust to keep life insurance proceeds out of your estate
  • Gift assets that have high appreciation potential but low income tax basis
  • Utilize a grantor retained annuity trust to shift appreciation away from your estate

Pass-Through Entity Deduction

The Qualified Business Income Deduction (QBI deduction) offsets 20 percent of income allocated to you from your qualifying pass-through business. However, if your taxable income exceeds $415,000 (married filing jointly, or $207,500 for other filers), your deduction will be subject to a limitation that is equal to the greater of:

  • 50 percent of W-2 wages from that trade or business; or,
  • 25 percent of W-2 wages from that trade of business plus 2.5 percent of your allocated share of qualified property.

Certain specified services trades or businesses (SSTB) are ineligible for the deduction. Married filing joint taxpayers who make less than $415,000 but more than $315,000 (for other filers, less than $207,500 but more than $157,500) will not be subject to the full limitation, but must phase it in as their income approaches that upper threshold.

When considering these limitations, you can see insufficient wages in your business may curtail the deduction. To ensure you receive the full 20 percent deduction, consider the amount of your own compensation if you are an S corporation shareholder, as increased shareholder compensation may result in a corresponding increase in the available deduction.

A strategy taxpayers had initially considered was coined the “crack and pack” strategy. The technique involved a split of a single trade or business that would be a disqualified SSTB into separate business activities, where “good” and “bad” businesses would ultimately exist. The “good” businesses would provide services exclusively to the “bad” businesses (i.e., not to external customers), in order to salvage the “good” portion from the SSTB limitations. Unfortunately, an anti-abuse provision in recently proposed regulations bars taxpayers from doing this in the manner described. Nevertheless, it is possible to employ a similar technique when the “good” business provides separate services to external customers, rather than to the “bad” business directly.

Business Owner Tax Opportunities

Aside from the QBI deduction, business owners have a multitude of planning opportunities.

  • Look into the R&D Tax Credit
    This credit can now offset the alternative minimum tax (AMT) as well as regular tax, making it available to more taxpayers than ever before.
  • Fund Your Retirement Plans
    Profit-sharing contributions can be made well into the next tax year, up until your tax filing deadline. Doing so can significantly decrease your current-year tax bill.
  • Clean House
    Dispose of worthless assets, write off uncollectible receivables, and dump any dated inventory. All result in potential tax benefits.
  • Pay Year-End Bonuses
    Your employees and your tax bill will thank you.

Unfortunately, not all of the changes in the TCJA will benefit business owners. There is a new limitation on business interest deductions, and the meals and entertainment deduction has lost some of its appeal. But there is enough wiggle room in other areas that business owners should feel confident that they can make positive changes to their tax position in 2019.

2019 and Beyond

The ripples from the TCJA will touch almost every taxpayer, and there are even more changes on the horizon. The Protecting Family and Small Business Tax Cuts of 2018, the Family Savings Act, and the American Innovation Act were together hailed as “Tax Reform 2.0.” But as Congress nears the takeover of the House of Representatives by Democrats, House Republicans have three time scaled back the provisions of Tax Reform 2.0 in the hopes of getting some legislation passed before year-end. These bills remain questionable as to whether they will pass in the Senate, nevertheless, we should prepare ourselves for possible changes.

If you have questions about your current-year or future-year tax plans, please contact your local CBIZ MHM tax professional.

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Copyright © 2018, CBIZ, Inc. All rights reserved. Contents of this publication may not be reproduced without the express written consent of CBIZ. This publication is distributed with the understanding that CBIZ is not rendering legal, accounting or other professional advice. The reader is advised to contact a tax professional prior to taking any action based upon this information. CBIZ assumes no liability whatsoever in connection with the use of this information and assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect the information contained herein.

CBIZ MHM is the brand name for CBIZ MHM, LLC, a national professional services company providing tax, financial advisory and consulting services to individuals, tax-exempt organizations and a wide range of publicly-traded and privately-held companies. CBIZ MHM, LLC is a fully owned subsidiary of CBIZ, Inc. (NYSE: CBZ).

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