Whether they like the new tax laws or not, what do your tax clients need to change for 2018 to take advantage of the new tax law?
The 8 action items below show common decisions that tax clients need to make early in the year to benefit the most from the new laws. Tax professionals could raise some of these issues with their 1040 clients and prospective clients for 2018. Rather than discussing the pros and cons of the new law, the focus of this post is on the action items for tax-payers as a result of the changes in the tax law.
And once the 8 decisions have been made, tax pros can also help clients update their W4 or estimated tax withholding.
Action 1: Invest Savings vs. Pay Off Mortgage
The standard deduction increases from $12000 to $24,000 in 2018. As a result, many tax-payers who had itemized deductions may switch to the standard deduction. Also, the $10,000 cap on state and local tax (SALT) deduction means that even where the itemized deductions were more than $24,000 earlier they may no longer be.
One change this causes is how tax-payers choose between paying down the mortgage or investing, when they have money to save. If the mortgage interest was used as an itemized deduction, than a mortgage rate of 3.5% would have effectively costed 2.62% in the 25% tax bracket (or 2.52% in the 28% tax bracket). When money is that cheap, it makes sense not to pay down the mortgage but invest savings elsewhere.
However, if the standard deduction is used, the loan is costing the full 3.5%. Paying down the loan is equivalent to investing in an investment that gives a guaranteed 3.5% return - very hard to beat. Combined with the emotional appeal of paying off the home, the tax law may change the tax-payer's decision in several cases.
Even for cases where the itemized deduction still applies, say due to a large mortgage, the tax savings will be lower due to reduced tax rates.
Action 2: Recalculate New Home Purchase Budget
Tax-payers who do not have enough itemized deductions to exceed the $24,000 limit, will lose the federal tax benefit on their property tax.
So the cost of paying property tax for a home buyer will be greater. For instance, paying $10,000 in property taxes might have previously costed only $7500 in after-tax money (in the 25% tax bracket) but will now cost the full $10,000. If buying a new home, either as a first time buyer, or moving from an existing home to a new one, it is important to consider this cost correctly and buy accordingly.
High-tax States: In states with high state income tax, even for someone with more than $24,000 in itemized deductions (such as due to high mortgage interest), much of the $10,000 limit will be used up by the state tax. Much of the property tax will thus not be deductible.
Home-hearth exemptions: Many localities have property tax exemptions to safeguard existing home owners from large property tax increases when property prices increase. Buying a new home may mean paying property taxes at the current market price for the new home. Holding on to the old home as a rental property, could mean losing the home-hearth exemption on the old home as well. Again, this means that the budget for any new home purchases and cash-flow projects for rental investments must account for the new tax laws. For more tips on maximizing deductions on rental income, see this article.
High loan amount: Mortgage interest on loans greater than $750,000 is no longer deductible even if deductions are itemized. This may change the price points your clients are buying or how much money down they pay if buying an expensive home.
Action 3: Do Not Ignore the Obamacare Tax Penalty Just Yet
The Affordable Care Act (ACA) penalty for not carrying sufficient health insurance is removed per the new tax law. However, the penalty is still in effect for 2018 and will only go away in 2019. So tax-payers should make sure that their 2018 meets ACA requirements.
Private Health Insurance Scams: A related impact of the tax law change is that some private health insurance salespersons have started quoting the new tax law to fraudulently sell insurance plans that do not provide sufficient coverage to comply with the ACA. In fact, many of these plans are not even health insurance plans but what are called indemnity plans. They claim significantly lower prices than traditional health insurance plans and use the new tax rule change as the excuse for why the rates look too good to be true. For instance, if they know that the buyer does not need psychiatric care, they may claim that the rate is lower because unlike ACA compliant plans, this new plan does not provide pregnancy benefits. Information on certain scams is available from the FTC but the most recent scams are not described yet.
While the new law removes the penalty for not having health insurance, most tax-payers will still need health insurance to be able to pay for medical expenses. Having an insurance plan often gives access to discounted pricing on medical services, including doctor visits, that is not available if paying without a health plan. However, for tax-payers who prefer to use alternative care providers that are often not covered by health plans, such as naturopathic doctors, and are willing to shell out of pocket for emergency room visits, the new law allows not having a health insurance from 2019.
Action 4: Decide personal-use days for vacation home
Does your client own a vacation home? Or are they thinking of getting one, after watching HGTV episodes of Vacation House for Free? Then, they likely rent it out for part of the year using AirBnb or otherwise, and they have rental income to report. While the IRS provides clear rules to classify the property as a second home or an investment property, the classification depends on the number of days of personal use. So your client needs to determine how many days of vacation they will take at the property (less than or more than 2 weeks).
Classifying the property as a home allows deducting mortgage interest and property tax allocated to the personal use of the home and is a good option when property expenses are higher than the rental income. However, if the property tax and state tax cap of $10,000 is largely used up by the state tax, then losing the property tax deduction is less of an issue. Classification as a rental property may allow additional deductions of depreciation and maintenance. The best outcome will depend on total expenses and rental income (see helpful tips and examples here).
Using the new tax rules may change the best classification compared to prior years and is important to know before the client heads over for their vacation in 2018.
The new reduced amount of mortgage for which the interest expense is deductible may also impact certain purchase or refinance situations where the loans on first and second homes add up to exceed the new limit.
Action 5: Moving?
First, moving expenses, whether paid by the tax-payer or their employer, are not tax deductible per new rules. Employer sponsored moves will increase the taxable income.
Second, if moving to a new state, such as for a new job or for retirement, and you have options among multiple choices, the new rules change how the impact of the state tax on net after-tax income is computed. The SALT cap means that states such as California where property prices are and state taxes are high, are relatively even more expensive than other states, compared to 2017 and earlier. While employers in such states may offer higher salaries, the increment may not offset the tax impact. Tax professionals can help compute the effective after tax income to help clients make the right choice.
Retiring in Florida may become even more fashionable, given that the state has no state income tax.
Action 6: Choose Pass-through Entity vs. C-Corp
Clients with income from pass-through entities such as S-corporations and partnerships, as well as self-employed income from sole-proprietorships or freelancing activities may be able to deduct 20% of that income from their taxable income. For service businesses such as doctors, lawyers, and accountants, there is an income cap of $315,000 beyond which the deductions is phased out. Kelly Phillips from Forbes explains the rule in more detail.
For clients who have options to choose between a pass-through entity and a C-corp, the new rules may change the trade-offs depending on the type of business, expected income, and its planned usage (distribution to the owner vs. re-invested into the business). Partners or S-Corp shareholders who do not actively engage in the operations may benefit from not taking up a job at the business entity itself, because the deductible amount may be reduced for such active participants.
Of course, the corporate tax rate reduction from 35% to 20% also directly affects the trade-offs involved. Again, depending on the amount of income expected and its intended usage, the best business structure may change. For instance, a sole-proprietor who wishes to use retained earnings to buy new property or capital equipment for the business, would have to do so after paying income tax at personal income tax rates (up to 37%) on those earnings whereas a C-corp would pay just the corporate tax rate of 20%.
Action 7. Invest in 529 Plans
Savings in tax-advantaged 529 plans could earlier only be used for college. Under new rules, up to $10,000 a year can also be used for elementary and secondary schools.
This can change the decision for clients on whether to invest in such plans, and the amount to invest, especially for those considering private schools for their children. Effectively, private schools are now a little more affordable since part of the fees can be paid through tax-free money.
Remember however that the contributions to the 529 plan are not deductible. The earnings are not taxed at the federal level and often also not at the state level. Clients with 529 plans that have accumulated earnings over several years already would benefit from this immediately. But even those starting out now can hope to save in future years, when they do have earnings accumulated on their savings.
Action 8. Get married, Stay Married
The new tax brackets effectively eliminate the marriage penalty for taxable incomes up to $600,000. Previously marriage penalty kicked in at incomes above $153,000. That is, if the combined income for the married couple was more than $153,000, they were paying more tax (as married filing jointly or married filing separately) than what they would pay if they were not married and filed as singles.
If the marriage penalty was preventing a client from tying the knot, well, this could change their decision.
A related change is that alimony is no longer deductible for the payer (but is not taxed for the receiver). This makes alimony even more expensive for the payer spouse. So if the divorce is not final, the payer spouse may wish to reconsider their position. Or work toward adjusting the alimony amount to account for tax law changes.
Help Clients Find You
Clients need help coping with tax law changes. Even tax-payers who self-prepare using automated software can get the calculations correct but the software does not give much advice on what changes can help them reduce their tax for the coming year with the new laws. Tax professionals can offer additional services to such filers for planning their coming year.
Tax-payers need to calculate the exact tax implications for each of the above items and to make the right choice for their situation. Let your past clients know you are here to help. Need ideas for an effective email subject line or a postcard? Check out these proven ads that attract tax clients, including the ad that got Stephanie Sanders 706 leads in just one week!
Finally, Update Estimated Tax Payments or File a New W4
For tax-payers with one job (entire income on return being based on one W2), the employer will likely update their withholding per the new tax rates automatically.
However, many situations require a correction to the employer calculated withholding, or estimated taxes are required to be paid, such as:
- Single filers with more than one job
- Married, filing jointly with both spouses working
- Filers with a household employee such as a nanny or babysitter, who is paid more than $2000 over the year (to account for the household employee related employment taxes)
- Filers paying estimated taxes or filing 1040ES (due to a second job or freelance activity)
- Self-employed filers or owners of pass-through business entities (S-corporations, LLCs, and partnerships)
In any situation where the employer paid income is not the only taxed income, the employer calculated withholding will not be correct and a new W4 should be filed. For most filers, taxes are going down, and filing a new W4 will mean more money in the pocket now. If they do not file the W4, the overpaid tax does not earn interest and is a lost opportunity for the tax-payer since they cannot invest or spend it until the refund is issued many-many months later. For rare clients where taxes are going up, such as filers losing certain deductions, filers with no children (so the loss of personal exemptions is not made up for by the increased child tax credit), and living in high-state-tax states and having income above certain thresholds, filing a new W4 may be necessary to avoid under-payment penalties.
Similar concerns apply for filing quarterly estimated taxes, where the first quarter estimated payment is due around the same time as the prior year taxes.
Changes Affecting Tax Calculations
Even if the tax-payer does not change anything related to the actions listed previously, the new rules may still change the amount of tax due. The following changes are expected to affect many taxpayers, often resulting in tax savings overall:
Child tax credit raised from $1000 to $2000 per child: Remind your tax client that the credit is not a deduction on the income but a direct reduction on the amount of tax paid - so an increase of $1000 in credit per child is like getting an extra deduction of $4166 on income (for those in the 24% tax bracket). This helps clients make sense of the reduces state and local tax deduction limits in high tax states.
New credit introduced for non-child dependents: A new $500 credit is introduced temporarily for non-child dependents, such as children over 17 and elderly parents needing care (provided they qualify as a dependent).
Child tax credit income limit raised: Previously, married tax-payers filing jointly could not benefit from the full credit if their income exceeded $110,000. That limit has been increased to $400,000 allowing many more filers to take advantage of the full and increased credit. For single filers, the limit has increased from $75000 to $ 200,000.
Tax rates lowered: The new tax brackets are given in the bill and listed below for one of the common cases:
|Tax Rate||Married Filing Jointly||Single|
|10%||up to $19,050||up to $9,525|
|12%||$19,050 to $77,400||$9,525 to $38,700|
|22%||$77,400 to $165,000||$38,700 to $82,500|
|24%||$165,000 to $315,000||$82,500 to $157,500|
|32%||$315,000 to $400,000||$157,500 to $200,000|
|35%||$400,000 to $600,000||$200,000 to $500,000|
|37%||over $600,000||over $500,000|
These are reduced from 10,15,25,28,33,25 and 39.6 percentages. Not only have the tax rates been reduced, but the income limits that fall under lower tax rates have been raised - giving tax payers a double advantage.
- Personal and dependent exemptions gone: Regardless of whether the tax-payer used itemized deductions or the standard deduction, previously a personal exemption of $4050 per person was available to tax-payers with taxable income below certain limits. For instance a married couple with two children had up to $16150 in exemptions if income was below $313,000 for married filing jointly. This is gone, poof! But for most payers, the loss would be made up for by the increase in standard deduction and the child tax credit.
Example: Consider a family of 4 using standard deductions. The total deduction (standard deduction + exemptions) used to be $12,000 + $4050 × 4 = $28,200. The child tax credit was $2000. With the new tax rules, the total deduction becomes: $24000 (standard deduction only). The child tax credit is increased to $4000. The reduced deduction means $4200 in increased income, implying $1008 in extra tax (assuming the worst case tax bracket of 24% applicable, for filers with income below $313k). This is more than offset by the $2000 increase in child tax credit. Total tax savings: $2000-1080=$920.
The table below shows the change impact for different number of child dependents.
|Number of children||Previous Deduction (with exemptions)||New Deduction||Extra Tax Credit||Savings|
Note 1: The additional tax credit may actually be higher at incomes greater than $110,000 for married filing jointly. That is so because the child tax credit was phased out for such taxpayers in previous years. In 2018, the full $2000 per child is available for incomes up to $400,000 for married filing jointly, assuming your child meets IRS requirements.
Note 2: The savings shown in the table are not the total change in tax (since that depends on lowered tax rates and other rules). Do not use the number above directly to estimate tax changes and to update the W4 or estimated taxes. Tax professionals can help clients with individualized calculations specific to their situation.
It may also be worth reminding your clients that many deductions can still be claimed even when using the standard deduction. For instance, contributions to eligible retirement accounts, cost of health plans purchased by tax-payers such as through healthcare.gov, medical expenses and the student loan deduction, are still tax-advantaged.
Tax professionals have an opportunity to offer value by reviewing their client's tax-planning strategies for the coming year well before the client commits to decisions involving items that impact taxes.
Check out these proven ads that attract tax clients to help tax clients find you.
Also, remember that email is not secure to send or receive W4s and other sensitive paperwork. Use the free Encyro Essentials document portal to keep electronic documents secure.
Disclaimer: The information in this article is not intended as tax advice or financial advice. It is only intended for your education and awareness, such as to help you consider the issues raised. Please consult relevant professionals or other sources for advice when making decisions or taking actions related to this information.
This article was originally published on December 23, 2017 and most recently updated on December 28, 2017.