The new federal tax law has dramatically shifted the individual taxation landscape, leading CPAs to rethink old assumptions about how best to plan for their clients. The process is becoming simpler for some and more complicated for others, and with these changes come opportunities.
One of the biggest disruptions to come from the Tax Cut and Jobs Act of 2017 (TCJA) is the doubling of the standard deduction to $12,000 for individuals and $24,000 for married couples. Ronald B. Hegt, a tax partner at Citrin Cooperman and a member of the NYSSCPA Taxation of Individuals Committee, said that this change has paradoxically both simplified and complicated tax planning for clients.
Many more people will be able to take the standard deduction for the first time ever, so their returns will be much easier to prepare. Consider, he said, a hypothetical client who qualifies for a $10,000 state and local tax (SALT) deduction, an $8,000 mortgage interest deduction and a $5,000 charitable donation deduction; this adds up to $23,000.
“But there’s a $24,000 standard deduction,” he said. “His return just got a lot simpler! And think about it: The numbers I just described are not lower- to middle-class numbers. Those are some comfortable people earning comfortable six-figure salaries that will be standard-deduction people for the first time in their lives.”
On the other hand, tax strategy planning has become more complicated, according to Hegt. Not only is it twice as hard to clear the standard deduction; the new law suspended many of the tools preparers had long used to do so. It removed unlimited SALT deductions, home equity indebtedness deductions, all miscellaneous deductions subject to the 2 percent floor, moving expense exemptions, alimony payment deductions, and a whole host of other breaks. There are also several provisions that, while not suspended entirely, have been heavily modified, including the home mortgage interest limit, which was reduced to $750,000, and the personal casualty loss deduction, which now only covers events within a federal disaster zone. All this means that if a client doesn’t want to take the standard deduction, CPAs will need to be much more creative than they had been in the past.
The loss of these deductions has been a major area of concern for the clients of Catherine M. Censullo, founder and head of Catherine M. Censullo, CPA/CMC Wealth Management and a member of the Personal Financial Planning Committee.
“New York clients are more scared than excited, because New Yorkers are paying a heavier price because of all the changes from itemized deductions. … The miscellaneous itemized deductions have been removed from availability in the tax laws, so that’s something gone right now. That’s gotten them concerned,” she said. The New York state budget for fiscal year 2019 includes legislation to reduce the impact of the TCJA’s doubling of the standard deduction, and its cap on state and local tax (SALT) deductions. (Another article in The Trusted Professional will offer analysis of New York state’s workarounds to the TCJA.)
Censullo added that the alternative minimum tax, while eliminated for corporations, still applies to individuals. The law did modify it by increasing the exemption to $109,400 for married joint filers with a million-dollar phaseout threshold and $70,300 for individuals with a $500,000 phaseout threshold. While Censullo said this modification will certainly help, she estimated that many clients will still get caught within its boundaries, which only adds to client worries.
In response to these changes, many CPAs have talked about grouping two years’ worth of the deductions they still can take in order to achieve maximum effect. David M. Barral, a senior financial planning associate with Mariner Wealth Advisors and the vice chair of the Personal Financial Planning Committee, called this technique “bunching.”
“You get all your medical expenses [where the floor went from 10 percent to 7.5 percent of adjusted gross income] done in one year, and the charity you want to do, let’s also do that all this year,” he explained. “If you say, ‘I like to give $5,000 to charity every year,’ if [you] now have this $24,000 [standard deduction threshold], you’re not going to get any benefit for the charity. So planning now becomes: Let’s do all our charity in one year.”
Censullo mentioned another area where old strategies no longer work: Roth IRAs. Previously, if individual taxpayers converted from a traditional IRA to a Roth IRA but later changed their minds (for example, if the market became unfavorable), they could switch back, provided they did so before the tax filing deadline.
The new law, though, has eliminated this option, which she said has made clients much more cautious about converting. This means that Roth conversions are now more of a long-term strategy for growth than a short-term tactic for immediate gain.
“Before, if you did it and the market went down, you could change your mind. Now, people are more reluctant to do Roth conversions since they can’t change their mind,” she said.
Still, the tax law has created new opportunities for clients as well. The child tax credit has been doubled to $2,000 per qualifying child; the tax on a child’s investment and other unearned income in excess of $2,100 (known as the “kiddie tax”) has been simplified to follow the ordinary and capital gains rate of trusts and estates; 529 investment account plans now apply to elementary and secondary school as well as college; and the charitable contribution limit was raised to 60 percent of adjusted gross income, among many other changes. The TCJA’s change in the tax brackets from 10, 15, 25, 28, 33, 35 and 39.6 percent to 10, 12, 22, 24, 32, 35 and 37 percent, and its near elimination of the marriage penalty also will benefit individual taxpayers. Johnpaul Crocenzi, a tax principal at Raich Ende Malter and Company and a member of the Taxation of Individuals Committee, said that these changes, based on computer projections, will largely balance out the deduction losses for his clients.
“We actually compared 2016 to 2018 returns, and even though they’re losing the deductions, they’re still saving money, and it was a considerable amount of savings in federal taxes,” he said.
Hegt reported a similar outcome, saying, “It’s not all doom and gloom,” though he stressed that assessments of who’s up or down will vary on a case-by-case basis—he explained that geography can be a key factor.
“Because all the tax brackets from the bottom up have been cut, we’re finding New York state residents … that have salaries upwards of $3, $4 million are actually going to pay less tax,” he said. “Now, it’s a different result for the New York City person, because they’re paying significantly more income taxes because of the city tax on top of the state tax.”
Overall, the new tax law presents a wealth of planning opportunities for clients, as many people’s once-stable situations have changed, according to Censullo. CPAs will be spending a lot of time sitting down with their clients and running the numbers on how this will all impact them.
“When something … happens that changes the numbers, you obviously need to tweak your plan and re-look at it, and wonder what the impact will be,” she said. “So I see that as a big focus for this year—just looking at how this will impact people, …how you will reposition assets, and what things you want to strategize to help with that.”
__________________________________________________________________________________________________________________
Estate tax changes benefit higher-net-worth individuals
Another benefit of the new tax law for higher-net-worth clients has been the doubling of the federal estate tax thresholds in the TCJA, which sunsets in 2026. The Tax Cut and Jobs Act of 2017 (TCJA) increased the basic exclusion amount from $5 million to $10 million for individuals and $22 million for married couples. This means that the estate tax no longer applies to many clients who before had fallen within its range. Of course, said attorney Kevin Matz, a partner at Stroock & Stroock & Lavan and the chair of the NYSSCPA Estate Planning Committee, that this doesn’t mean everyone can just relax. The changes, indeed, create an even bigger impetus for people to take a hard look at their estate plans, according to Matz.
“There is now an immediate need for many wealthy individuals to review their estate planning documents (e.g., their wills and trusts), to ensure that their formula provisions do not create a ‘distortion’ that produces results in terms of ‘who gets what when you die’ that are significantly different than what the person had in mind,” said Matz.
Philip London, a tax partner emeritus at Wiss and Co. and chair of the New York, Multistate and Local Taxation Committee, also pointed out that while many have now been placed outside the federal estate tax threshold, planning must still account for New York’s own laws, which have a $5.2 million threshold as well as a significant cliff once that is exceeded. London said that this conflict raises many questions.
“Will they double the phasein to meet the new federal threshold? And then, with the federal law, when we’re good until 2025 and then [in 2026, when] it reverts back to the current levels, is there going to be a clawback on any gifts made in that time period? The answer is that our esteemed Congress delegated that answer to the Secretary of the Treasury,” said London, who noted that there has not been guidance from the Treasury Department regarding these questions.