Medical and Dental Expense Tax Benefits Enhanced

checklist_LI Medical and Dental Expense Tax Benefits Enhanced

Many miscellaneous itemized deductions, including unreimbursed employee business expenses, no longer can be used to reduce your income, starting with 2018 tax returns. Some observers predicted a similar demise for medical and dental expenses. As it turned out, these deductions not only were retained, the tax benefit was enhanced.

Playing the Percentages 

Under the law in effect during 2017, unreimbursed medical and dental expenses could be deducted only to the extent they exceeded 10% of adjusted gross income (AGI).

Example: Ivan Larson had $100,000 of AGI in 2017 and $9,100 of unreimbursed medical or dental expenses. Because 10% of his AGI was $10,000, Ivan’s outlays were under the threshold, so he wasn’t expecting a tax deduction for them.

Surprisingly, the TCJA lowered the threshold to 7.5% of AGI, effective for 2017 and 2018. For Ivan, that was $7,500 of expenses (7.5% of his $100,000 AGI), so his deduction for last year was $1,600 (his $9,100 of costs minus the $7,500 threshold).

Under the TCJA, the threshold will move back to 10% of AGI next year. Therefore, you may want to accelerate elective medical expenses, such as prescription sunglasses and tooth implants into 2018.

If you plan to incur such expenses this year, before they may be absolutely necessary, you should be confident that your total of unreimbursed medical and dental costs will exceed 7.5% of AGI in 2018. You also should believe that you won’t be taking the standard deduction: $12,000 this year for Ivan, a single taxpayer.

Unless you itemize deductions and your total of unreimbursed medical and dental costs will top 7.5% of AGI, accelerating elective outlays into 2018 will be a wasted effort. You’ll be better off waiting until 2019 to make such payments when they might be tax deductible under the law that will be in effect then.

Give us a call if you have questions about how to use your medical or dental expenses toward your future tax returns.

 

This post originally appeared in the CPA Client Bulletin Resource Guide, © 2018 Association of International Certified Professional Accountants. Reprinted by permission.

Are state and local taxes a reason to move?

Moving-Truck_LI Are state and local taxes a reason to move?

As many people are all too aware, some states and localities impose higher income and property taxes than others. Residents of high tax areas may have taken some solace by itemizing deductions on their tax returns and reducing federal income tax obligations by deducting the taxes paid.

Example: Jennifer Knight deducted $25,000 worth of state income tax and local property tax on her 2017 tax return. Assuming Jennifer was in a 25% tax bracket, she reduced her net outlay for those taxes with $6,250 in tax savings (her 25% tax rate times the $25,000 tax deductions).

In this scenario, Jennifer’s actual tax cost was $18,750, not $25,000, because she cut her federal tax bill by $6,250.

New Rules

Under the TCJA, there is still an itemized deduction for taxes paid, but it is now capped at $10,000 a year, starting in 2018. Some people refer to this as the SALT deduction for state and local taxes. It mainly covers property and income taxes, although taxpayers can choose to include sales tax instead of income tax towards the $10,000 cap. (The $10,000 limit is the same for single filers and couples filing jointly, so there is a true “marriage penalty” here.)

As might be expected, taxpayers and politicians in high tax states and localities have loudly protested the cutback in the deduction for taxes paid. Is this the final straw? The added burden that will drive people to move to areas where income and property tax (and perhaps estate tax) are less of a burden?

Relocation may make sense, but such a decision should be made with care. Calculate how much extra you’ll be paying in tax now, considering the loss of the taxes paid deduction and all the other features of the TCJA. Don’t forget to include the alternative minimum tax (AMT), which still impacts many individuals. People who owe the AMT get no tax benefit from deducting state or local taxes. Our office can help with this computation.

Then, find out how much you’d owe after a move to a different area. Include income taxes and, assuming you’ll be a homeowner, likely property tax. Find out if sales tax will be meaningful in the new area. Determine the state’s estate tax exemption and estate tax rates, if you expect to leave assets to loved ones.

Typically, you’ll discover that relocating is a puzzle with many different parts of varying sizes. Effectively paying more in state and local tax under the TCJA may be a key piece of that puzzle, but it’s just one thing to consider before calling the movers.

Additional Resources

View our many calculators to help you plan for the big move, or other important life changes.

 

This post originally appeared in the CPA Client Bulletin Resource Guide, © 2018 Association of International Certified Professional Accountants. Reprinted by permission.

Be Cautious About Converting from a Roth to a Traditional IRA

laptop-hands-2_LI Be Cautious About Converting from a Roth to a Traditional IRA

The article “Is your employer’s retirement plan getting less attractive?” explains why the new TCJA devalues putting money into traditional tax-deferred plans and favors Roth versions. Does the same reasoning apply to conversions from Roth to traditional accounts? From a tax viewpoint, the answer may be yes, but other factors indicate you should be cautious about such moves.

Example 1: Fred and Glenda Polk would have had $220,000 in taxable income in 2017 without contributing to their employers’ traditional 401(k) plans. However, they contributed a total of $40,000 to the plan, bringing their income down to $180,000. The couple was in the 28% bracket last year, so the income deferral saved a total of $11,200 in tax: 28% times $40,000.

Assume they kept their $11,200 of tax savings in the bank. If their employers have a 401(k) plan that offers designated Roth accounts, they could convert the $40,000 they contributed in 2017 to the Roth side if the plans allow such moves. Alternatively, depending on the plan terms and the Polks’ circumstances, they might be able to rollover the $40,000 to a Roth IRA. Yet another possibility, the Polks might leave the $40,000 in their 401(k)s but convert $40,000 of pretax money in their traditional IRAs to Roth IRAs.

With any of these strategies, the couple would generate a $9,600 tax bill (24% of $40,000) on the Roth conversion, because their joint income falls into the 24% tax bracket in 2018, in this example. The Polks could pay that $9,600 from their $11,200 of tax savings in 2017 and wind up ahead by $1,600.

Therefore, people who move into a lower tax bracket this year might be able to come out ahead with Roth conversions of income that had been deferred at a higher tax rate. Going forward, the money transferred to the Roth side may generate tax free rather than taxable distributions.

One-Way Street

Nevertheless, there are reasons to be cautious about Roth conversions now. For instance, U.S. stocks are trading at lofty levels. Roth conversions could be highly taxed at today’s equity values.

Example 2: Heidi Morris has $300,000 in her traditional IRA, all of which is pre-tax. Investing heavily in stocks, Heidi has seen her contributions grow sharply over the years. With an estimated $100,000 in taxable income this year, Heidi calculates she can convert $50,000 of her traditional IRA to a Roth IRA in 2018 and still remain in the 24% tax bracket.

However, stocks could fall heavily, as they have in previous bear markets. The $50,000 that Heidi moves to a Roth IRA could drop to $40,000, $30,000, or even $25,000. Heidi would not want to owe tax on a $50,000 Roth conversion if she holds only $25,000 worth of assets in the account.

Under previous law, Heidi had a hedge against such pullbacks, at least for Roth IRA conversions. These conversions could be recharacterized (reversed) to her traditional IRA, in part or in full, until October 15 of the following calendar year. In our example, Heidi could have recharacterized after a market setback, avoided a tax bill, and subsequently re-converted at the lower value. (Timing restrictions applied.)

Such tactics are no longer possible because the TCJA has abolished recharacterizations of Roth IRA conversions. (Conversions to employer-sponsored Roth accounts could never be recharacterized.) Now moving pre-tax money to the Roth side is permanent, so the resulting tax bill is locked in.

In the new environment, it may make sense to take it slowly on Roth conversions in 2018. If stocks rise, boosting the value of your traditional retirement accounts that hold equities, you won’t be sorry about the increase in your net worth; you can convert late in the year at today’s lower tax rate. On the other hand, if periodic corrections occur, they could be an opportunity for executing a Roth conversion at a lower value and a lower tax cost.

If you have questions about your retirement plan, financial planning, or wealth management, our professionals are here to help create a plan that works for you. Give us a call to learn more.

 

This post originally appeared in the CPA Client Bulletin Resource Guide, © 2018 Association of International Certified Professional Accountants. Reprinted by permission.

Is your employer’s retirement plan getting less attractive?

woman-confused_LI Is your employer's retirement plan getting less attractive?

The TCJA generally lowered federal income tax rates, with some exceptions. Among the ways in which lower rates impact tax planning, they make unmatched contributions to traditional employer retirement plans less attractive.

Example 1: Chet Taylor has around $100,000 in taxable income a year. Chet contributed $12,000 to his company’s traditional 401(k) in 2017, reducing his taxable income. He was in the 28% tax bracket last year, so his federal tax savings were $3,360 (28% of $12,000). An identical contribution this year will save Chet only $2,880, because the same income would put him in a lower 24% bracket.

Not everyone will be in this situation.

Example 2: Denise Sawyer has around $200,000 taxable income a year. Denise contributed $12,000 to her company’s traditional 401(k) in 2017, reducing her taxable income. She was in the 33% tax bracket last year, so her federal tax savings were $3,960 (33% of $12,000). An identical contribution this year will save her $4,200 because the same income would put her in a higher 35% bracket.

Planning Pointers

Considering the changes in tax rates, participants in employer sponsored retirement plans should review their contribution plans. If your company offers a match, be sure to contribute at least enough to get the full amount. Otherwise, you’re giving up a portion of your compensation package.

Beyond that level, decide whether you wish to make unmatched tax-deferred contributions to your traditional 401(k) or similar plans. The value here is tax deferral and the ability to compound potential investment earnings without paying current income tax. Deferring tax at, say, 12%, 22%, or 24% in 2018 will be less desirable than similar deferrals were last year, when tax rates were 15%, 25%, or 28%.

On the Roth Side

If you decide to cut back on tax-deferred salary contributions, spending the increased current income won’t help you plan for your future retirement. Other savings tactics may be appealing.

For instance, your employer might offer a designated Roth account in its 401(k) plan. These accounts offer no upfront tax benefit because they’re funded with after-tax dollars. The advantage is all withdrawals, including distributions of investment income, will avoid income tax after age 59½, if you have had the Roth account for at least five years. (Other conditions can also qualify distributions from a Roth account for full tax avoidance.)

Generally, the lower your current tax bracket and the higher your expected tax bracket in retirement, the more attractive Roth contributions can be.

Example 3: Ed Roberts, age 30, expects his taxable income (after deductions) to be around $50,000 this year, putting him in the 22% tax bracket. Ed hopes to have a successful career, so he might face a higher tax rate on distributions in the future. Therefore, Ed contributes $6,000 ($500 a month) to his company’s traditional 401(k) to get some current tax relief, and $6,000 to the Roth 401(k) for tax free distributions after age 59½.

Some advisers suggest going into retirement with funds in a regular taxable account, funds in a tax-deferred traditional retirement account, and funds in a potentially tax-free Roth account. Then, you may have considerable flexibility in choosing tax-efficient ways to draw down retirement cash flow.

Other Options

What if Ed’s employer’s 401(k) plan does not offer designated Roth accounts? A possible solution for Ed would be to contribute to a Roth IRA instead. In 2018, he can contribute up to $5,500 ($6,500 for those 50 and older). Roth IRAs also offer completely tax-free distributions after five years and age 59½.

Example 4: Assume that Ed’s employer will match up to $4,500 of his 401(k) this year and that Ed plans to save $12,000 for his retirement. Ed could contribute $5,500 to a Roth IRA and $6,500 to his traditional 401(k).

With higher incomes ($120,000 or more of modified adjusted gross income for single filers in 2018, $189,000 for couples filing jointly), Roth IRA contributions are limited or prohibited. People facing this barrier may able to fund a nondeductible traditional IRA, up to $5,500 or $6,500 this year, then convert those dollars to a Roth IRA with little or no tax at this year’s tax rates. (IRA contributions for 2017, with slightly different income limits, are possible until April 17, 2018.)

Ultimately, the choice between traditional and Roth retirement accounts will largely depend on expectations of future tax rates. Deferring tax in a traditional plan this year and saving 24% in tax may not turn out to be a good deal if future withdrawals are taxed at 28%, 30%, or 35%. The fact that the TCJA rates are among the Act’s provisions that are due to sunset in 2026, reverting to 2017 rates, may tilt the scales a bit towards the Roth side, where distributions eventually may escape tax altogether.

Retirement Rules

  • Participants in 401(k) and similar employer sponsored retirement plans can contribute up to $18,500 this year, or $24,500 if they’ve reached age 50.
  • If your company’s 401(k) plan offers a designated Roth account, contributions to the plan can be divided in any manner you choose between a pre-tax account and a designated Roth account, but the total can’t exceed the $18,500 or $24,500 ceilings.
  • Any employer match usually goes into the traditional 401(k), even if the contribution is to the Roth version, so income tax on the matching money is deferred.

If you’re in the financial planning or wealth management phase, our professionals are here to help you plan your strategy and to aid you in your success. Give us a call or complete the following for form for a follow up.

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This post originally appeared in the CPA Client Bulletin Resource Guide, © 2018 Association of International Certified Professional Accountants. Reprinted by permission.

New Tax Laws: Savings and Pitfalls

Tax-Reform_LI-1 New Tax Laws: Savings and Pitfalls

The Tax Cuts and Jobs Act (TCJA) of 2017, passed at year end, has been called the most extensive tax legislation in more than 30 years. It’s certainly far reaching, covering individual income taxes, business income taxes, and estate taxes. The new law has many tax saving opportunities, as well as possible pitfalls.

Trying to grasp everything in the TCJA can be overwhelming. Therefore, it’s best not to panic; don’t rush into tax-motivated actions just because of gossip or opinions you hear. There’s no need to act rashly this early in the year.

That said, it is important to understand what’s in the TCJA and what it might mean to you. Subscribe to our CPA Client Bulletin newsletter (using the email form on the sight sidebar) to be in the know all year long.

One issue is not sufficient to cover the new law, so we’ll keep you posted throughout the year as uncertainties are addressed and new strategies emerge.

Of course, if you have questions about the TCJA and possible planning tactics, please call our office for a personalized response, or complete the following form for a follow-up.

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This post originally appeared in the CPA Client Bulletin Resource Guide, © 2018 Association of International Certified Professional Accountants. Reprinted by permission.