By Matt Sommer

from JanusHenderson.com

2 January 2018


The 503-page Tax Cut and Reform Bill will have sweeping implications to both individual and business taxpayers beginning in 2018. So, what do financial advisors need to know and how can they be ready to provide guidance to their clients? The following seven items identify those issues most pertinent for advisors to share with high-net-worth investors.

Most aspects of the reforms will sunset. To comply with very complicated congressional budgetary rules, the vast majority of these changes will sunset on December 31, 2025. That means come 2026, any changes will revert back to the rules that are in place today, unless additional action is taken by Congress. The exceptions to the sunset provisions impact businesses, specifically the 20% deduction for pass-through entities and the 21% corporate rate (more on that later). The sunset is especially problematic for estate planning, and flexibility will need to be incorporated into impacted clients’ legal documents including wills and trusts.

Seven marginal brackets remains in place. Despite all the discussion of simplification and desire to reduce the number of brackets, the legislation leaves seven tax brackets in place. The good news is that five of the seven brackets are lowered. Beginning in 2018, the seven brackets for individuals are 10%, 12%, 22%, 24%, 32%, 35% and 37%. Interestingly, the current five bracket structure for trusts and estates will change to four brackets next year, with rates of 10%, 24%, 35% and 37%. The trust and estate brackets will now be used to calculate the tax on a minor’s unearned income instead of the customary kiddie-tax rules that used a parent’s marginal bracket. The 3.8% net investment income tax remains in place, despite the elimination of a penalty for failing to maintain minimum essential health care coverage. The favorable rules for long-term capital gains and qualified dividends also remain unchanged.

Some deductions survive, many are eliminated. As expected, the personal exemption is eliminated as are a host of itemized deductions. A few deductions did survive including charitable deductions, mortgage interest (but only on a maximum loan amount of $750,000 for property purchased on or after December 15, 2017) and unreimbursed medical expenses to the extent they are in excess of 7.5% of adjusted gross income (previously the hurdle was 10% of AGI). Additionally, taxpayers will be able to deduct up to $10,000 of state, local and/or property taxes. Of the deductions eliminated, advisors should pay close attention to alimony. For marriages that end after 2018, alimony will no longer be deductible by the payor or be taxable to the payee. This change impacts how divorce settlements are negotiated and will certainly require budgeting and other assistance from advisors who specialize in this area. Finally, for those taxpayers who will still itemize their deductions, rather than take the new $24,000 (married) standard deduction, the rule that phased-out deductions at higher income levels has been eliminated.

AMT and estate tax narrowed, the Child Tax Credit expanded. While not completely repealed, both the alternative minimum tax (AMT) and estate tax should impact far fewer families. For a married couple, the AMT exemption will be increased from $84,500 to $109,400 and the phase-out from $160,900 to $1,000,000. These two changes should significantly decrease the number of households who are subject to the AMT, and of those who are, lower their AMT liability. Also, the applicable exclusion amount doubles from $5,490,000 to $10,980,000 per person. This change effectively means that couples can shield up to $21,960,000 from estate tax. Unfortunately, the sunset will reduce this number by half come 2026. High-net-worth families may want to make use of a disclaimer trust and other techniques that build flexibility into their estate plan. A typical disclaimer trust strategy leaves all property to a U.S. citizen spouse outright, but provides for a credit shelter trust to be on “stand-by” upon the death of the first spouse. The bottom line is that the survivor can choose to ignore or use the credit shelter trust when the time comes, depending upon the current set of circumstances including the estate tax rules at the time. Finally, the child tax credit increases from $1,000 to $2,000 and the phaseout increases from $110,000 to $400,000 of AGI for a married filer ($75,000 to $200,000 for a single filer). Some higher income clients may therefore now be eligible to take advantage of the credit beginning next year.

529 College Savings Plan and ABLE changes. The legislation will allow tax-free distributions up to $10,000 per year, per child from a 529 College Savings Plan to be used for elementary and secondary education. Further, 529 plans may be rolled into an ABLE for the same beneficiary or member of the beneficiary’s family but the rollover will count towards the $14,000 annual contribution limit. Last, a beneficiary of an ABLE may make contributions in excess of the $14,000 ceiling by the lesser of half the federal poverty line or compensation earned during the taxable year.

Retirement cleanup. A few provisions that impact retirement plans were added that primarily serve as fixes or policy improvements. First, taxpayers will no longer be allowed to recharacterize Roth IRA conversions (recharacterizing contributions are still permitted). The original intent of a recharacterization was to allow taxpayers to unwind a Roth conversion if they later learn their AGI exceeded the $100,000 threshold. Since this eligibility requirement has been repealed, taxpayers were using recharacterizations to create an arbitrage opportunity. In essence, they would keep their conversion if the account value increased but unwind their conversion if their account value decreased. This strategy irked policy makers and has long been up for consideration. Secondly, for participants who separate from service with an outstanding loan from their employer-sponsored retirement plan, the deadline to repay the loan has been increased from 60 days to their tax-filing deadline including extensions. Repaying a loan will avoid a taxable event and potential 10% penalty.

Businesses win. As expected, the corporate tax rate has been decreased, but to 21% rather than the previously discussed 20% or even 15%, starting in 2018. Pass-through business income from sole proprietors, partnerships and S corporations will still pay taxes at ordinary income rates but be eligible for a 20% deduction. Limitations and exclusions apply, however, once income exceeds $315,000 for married taxpayers and $157,500 for single taxpayers. Lastly, for property acquired and placed in service between September 28, 2017, and December 31, 2022, businesses can deduct 100% of the investment in the year of purchase rather than follow the customary depreciation tables. Further, eligible property may be new or used. Advisors equipped with lending solutions should make these services available to their business owner clients.

These tax law changes offer advisors an opportunity to bring additional value to their most important relationships, in addition to consulting with other client providers including CPAs and attorneys. Forward-thinking advisors will use these changes to not only help clients maximize their opportunities but differentiate their practice in a very crowded marketplace.


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This article by Matt Sommer was originally published at JanusHenderson.com


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