Now that the tax overhaul is law, what planning strategies can advisors use going forward? There will be some planning headaches — and opportunities — for advisors and their clients.
529 FOR ALL EDUCATION COSTS
Section 529 plans have typically only been available for college education expenses, with Coverdell Education Savings accounts being used for pre-college education. A revision in the law means that 529 accounts could be used for any education expense, from elementary to college, and even home school expenses. Pre-college expenses are limited to $10,000 per year.
For families who have been paying for pre-college education out-of-pocket, they could now reroute those expenses, up to $10,000 per year, through their state’s 529 plan. If available, they could take a state income tax deduction.
One caveat with this planning opportunity: if families start using money in the accounts for pre-college expenses without adding more cash, it will shrink the amount available for college. This means future costs would need to be funded through cash flow or loans.
HELOC DEDUCTABILITY ELIMINATED
As of today, interest on HELOC and home equity loans (up to $100,000 loan balance) has been deductible against income. However, for all current and future loans used for expenses other than making home improvements, no interest on any current or future loan could be deducted against income.
While a popular strategy for many has been to roll consumer and student loan debt into a HELOC to lower the rate and deduct the interest, this strategy has lost some of its luster.
Another way to accomplish both of these goals is to refinance a primary mortgage (now subject to a $750,000 deductibility cap versus $1,000,000) and roll those debts into the new mortgage.
INVESTMENT EXPENSE DEDUCTION ELIMINATED
A favorite selling point among investment managers has been that investment expenses paid out of taxable accounts were deductible against income.
This provision, as well as all expense listed under IRC Section 67, has now been eliminated by the law. As well as investment expenses, the law also eliminates the deductibility of tax preparation fees (accountants and software), unreimbursed employee business expenses, safety deposit box fees and others.
With investment expenses typically being the largest of these, the easiest way to reclaim some of that money would be to pay as much as is legally allowed out of tax-deferred IRA accounts. While an IRA cannot pay financial planning fees (otherwise it’s classed as a distribution) or fees for another tax-classification of accounts, it could pay its own management fee.
If not being done already, allocating an IRA to pay for its own management fee will allow a client to pay with tax-deferred funds.
ALIMONY DEDUCTION ELIMINATED IN 2019
2018 is potentially going to be a busier year for attorneys involved in divorce agreements and settlements.
Starting in January 2019, alimony would not be a deductible expense. This means taxable income will be increasing for those paying it.
Depending on the size of the alimony payments, this could put the payer into a higher tax bracket as they’ve lost a deduction, phase-out other current deductions due to an increased income, and make them ineligible for Roth or deductible IRA contributions. It may also have knock-on effects with financial aid if the parent paying the alimony has custody of the child and it increases income on a FAFSA form.
LUXURY BUSINESS VEHICLE PURCHASE DEDUCTIBILITY EXPANDED
Businesses that buy cars may see benefits. It has been the case that firm that buy vehicles can deduct the purchase price over a period of years: $2,560 for the 1st taxable year, $4,100 for the 2nd taxable year, $2,450 for the 3rd taxable year and, $1,475 for each succeeding taxable year. Changes have increased these limits to $10,000 for the 1st taxable year, $16,000 for the 2nd taxable year, $9,600 for the 3rd taxable year and, $5,760 for each succeeding taxable year.
These higher limits — some more than 4x — would make purchasing a vehicle in a business more attractive than in prior years, given that only the business portion of a lease payment is able to be deducted against business income. This amendment is ideal for clients who operate high-end livery or transportation businesses. Not only could they move away from lease-agreements which might constrict their business operations, but this increased deductibility could allow them to expand more quickly given their increased cash flow.
There are many changes to the current tax code and many planning opportunities — both business and personal — for clients in the upcoming years. The most significant change is going to be related to the increased in standard deduction. This increase may cause many clients to forgo itemizing their deductions and making the annual filings of taxes much easier.