Breaking down the tax reform bill through the eyes of a financial planner

Disclaimer: Please speak with a tax professional about your specific tax situation. I usually place the disclaimer at the end of a financial piece to recognize that clients should go through the proper channels for final tax decisions. However, for this submission I am putting it out in the beginning to recognize the fact that I honestly can't make heads or tails of the new tax reform bill. I certainly can recognize the impact that some aspects of the bill will have (as I cite below), but I cannot determine whether I do or do not want this bill to pass. I am not completely certain whether this bill will cause my taxes to increase or decrease, or how it will affect the people in my practice as a whole. It is a convoluted bill, and without getting too political, I am willing to bet that's the way Congress wants it. I am going to use this month’s submission to highlight a couple of things I recognized in the tax bill that will have a large impact on how I work with my clients. This is just the tip of the iceberg of what is in the bill, and every time I read it I find new nuggets of information. I recommend to anyone interested in the bill language that it is okay to start with my thoughts, but you need to do your own deep dive to determine how the bill will impact you. And so, here are a couple aspects of the tax reform bill that I, as a financial planner, found interesting. The elimination of the state and local tax deduction (SALT): This is the big one, and the current language of both the House’s and Senate’s bill eliminate a taxpayer's ability to deduct their state and local taxes from their federal adjusted gross income. This is a big hit to the states with high state taxes. California, New York and New Jersey are prime candidates. To simplify this new role, look at what you paid in state and local taxes last year, and assume that is how much your adjusted gross income is going up for your next federal return under this bill. There is a caveat, as there is language in the bill stating that property taxes can be deducted up to $10,000, but this is a relatively small number for most of the people I work with. Decrease in the mortgage interest deductions cap from $1 million to $500,000: Taxpayers will still be able to deduct the interest of their mortgage, but only up to a mortgage balance of $500,000 from the previous amount of $1 million. In addition, the interest deduction for home equity loans will be eliminated. This is a gigantic tax change for metropolitan areas on both coasts. In short, this will make home ownership less appealing from a monetary standpoint, and time will tell how this will affect home values. Retirement account contribution limits WILL NOT be lowered: There was a rumor that 401k contribution limits would be reduced drastically, but to date that is not the case. Medical deductions will still be allowed: Another small victory for an aging population. It would have been horrible for a medical emergency or medical condition to become a double economic burden. With other deductions being removed I am glad that there is still at least some tools that tax payers can use to decrease their burden. Pass-through income to be taxed at the corporate rate: The corporate rate is likely to be reduced and many small businesses will be able to take part in that reduction by filing as a pass-through entity. This includes S Corps, Partnerships and Sole Proprietors. While this is good for the bulk of small businesses around the country, there is a limit for service industries which include legal services, financial services, tax professionals, etc. Service providers will not be able to qualify for the pass through income tax rate if they make more than $75,000 a year (when filing single) or $150,000 (when filling jointly). Another ‘benefit’ that is likely to be missed for the bulk of my practice who don’t fall into the income requirements. Elimination of IRA re-characterization: Re-characterization is the strategy of moving funds from a Roth IRA (after a Roth conversion) back to an IRA, when your assets have not fared well in the market. This allows individuals to reverse their conversion when they would be paying taxes on a balance that is higher than the current balance due to a market downturn. While I will still promote Roth conversions for long-term investing, this certainly sours the process a bit. Moreover, what really irks me is that there is language in the house version of the bill that says that this change is being done so that people don't “game the system”. I apologize for being a bit curt towards those wonderful members of Congress, but the entire tax system, with all of its glorious loopholes, is history’s greatest example of “gaming the system”. Using that language for one specific item that many people benefit from is a little disingenuous. Tax credit for home sales: A slight language change would require an owner of a primary residence to live in that residence for five out of eight years, instead of the current two out of five years, to qualify for the $250,000 capital gains credit on a sale. This is not likely to affect many people, but it is an example of how people really need to pay attention to the details of the new legislation. I will not speculate on the likelihood of this bill passing, or put on my political hat and prognosticate how it will affect the federal budget, or the funding of federal programs, but I will say that major changes are coming if this bill does get passed. And (I admit to being biased on this point), this is as important a time as ever to make sure you have the right professionals in your corner to adjust to these changes in the most efficient manner possible. There is a high possibility that we will all have a lot of work to do in the near future.

  1. Until then, enjoy your Thanksgiving meal! Enjoy time with friends and family! And don't forget to set a plate aside, with a wing and a leg for Uncle Sam.

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