Objective information about retirement, financial planning and investments

SALT and Your Taxes

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One of the big topics this tax season is SALT. This is not a seasoning for food, but rather SALT stands for state and local taxes. The treatment of these expenses in terms of their deductibility for those who itemize is a major change for the 2018 tax year, arising out of the Tax Cut and Jobs Act passed at the end of 2017.

What is SALT?

As mentioned above this includes state and local taxes. In most cases the biggest components will be your state income tax, state and local sales taxes and the real estate taxes on your home.

The SALT cap 

Beginning with the 2018 tax year, SALT taxes have been capped at $10,000 as an itemized deduction. This could represent a significant reduction for many taxpayers compared to prior years. Those in states with high state income taxes and areas with high real estate taxes will likely feel the greatest impact.

Our latest real estate tax bill alone has put us over the cap limit. The state income tax rate for Illinois stands at 4.95%. This means that none of the state income taxes paid on income earned by my wife and I will be eligible as an itemized deduction for 2018 and beyond.

Fewer taxpayers can itemize 

One estimate indicates that the number of itemizers will drop from about 46.5 million in 2017 to about 18 million in 2018. The increase in the standard deduction is another major change impacting the ability to itemize along with the SALT cap.

  • For those filing married and joint the standard deduction increased from $12,740 to $24,000 for 2018.
  • For single filers the standard deduction increased from $6,350 to $12,000.

This means for those with itemized deductions less than these amounts it makes financial sense to just take the standard deduction.

What impact does the SALT cap have on your taxes? 

Beyond whether or not you can still itemize deductions, you will need to determine the effect of the SALT cap and other changes under the new rules on your overall tax situation.

For example, a married couple might have previously been able to claim $18,000 in itemized deductions. Now with the SALT cap, their itemized deductions will be lower, and they will be forced to claim the standard deduction. However, the $24,000 standard deduction likely provides a greater benefit than the amount they itemized in prior years.

Other factors to consider:

  • Tax rates are generally lower than in prior years starting with 2018.
  • Some businesses and the self-employed might be eligible for a pass-through deduction of 20% of their business income in some cases. In our case this will be helpful to our situation for 2018.
  • The income limits on the child-care credit have been increased allowing more parents to take advantage of this credit. Remember a direct credit on your taxes is worth more than a deduction in income.
  • The alternative minimum tax will impact fewer tax payers than in past years due to changes in the income limits.
  • Along with the increase in the standard deduction, the personal exemption has been repealed under the new rules. This was worth $4,050 per person in 2017.

The point is the SALT cap will impact each of us differently depending upon our situation.

The impact on real estate

Some have said that the SALT cap was retribution to those in “blue” states that didn’t support the president in the last election. I’ll leave that to you the reader to decide.

This cap disproportionately impacts states with high state income taxes and relatively high real estate values. According to one study, New York, New Jersey, Connecticut, California and Maryland were the top five states in terms of the deduction for SALT as a percentage of taxpayer’s AGI (adjusted gross income) in 2016.

The inability to fully deduct property taxes and mortgage interest will make the after-tax cost of buying a home in high cost areas more expensive. Some have speculated that the cap on the ability to deduct these taxes might influence decisions about where people live and potentially cause some people to relocate to lower tax, lower cost states. It could also have an impact on the level of housing starts in these high cost areas, and the fortunes of home builders and related industries.

Planning around the SALT cap

Most of the changes enacted as part of the Tax Cut and Jobs Act expire after the 2025 tax year, so the SALT cap will be around for a few years. Here are some planning considerations.

Bunch deductible expenses. This could involve deferring or accelerating expenses that are eligible for itemizing into one year to get you over the standard deduction threshold. A couple of examples:

  • Bunch your charitable contributions in to a single year. If you were going to make say $5,000 in contributions over several years, bunch all or as much of that amount as possible into a single year if it will help you to reach the level where you will be able to itemize.
  • Same thought process as above with elective medical expenses. If there is a procedure or other elective expense, plan to incur it in the year that is most beneficial tax-wise if possible.

Max out your retirement plan contributions. This has nothing to do with itemized deductions, but this can provide the double benefit of a larger tax break if you aren’t currently doing this along with the added savings for retirement. If your company offers a 401(k) or similar plan be sure that you are contributing as much as possible. If you are self-employed be sure that you have a retirement plan set-up and that you are contributing as much as possible as well.

Review your mortgage and real estate situation. It may behoove you to pay down your mortgage if you can, especially if you can no longer itemize. If you are looking at buying a new home, be sure to take the SALT cap into account when calculating the after-tax cost of ownership.

The Bottom Line 

Tax season is a good time to take a look at your tax situation not only for last year but also going forward. Be sure to consult with a qualified tax or financial professional to help you review your situation as needed.

Need help looking at your overall financial plan and want another opinion on where you stand? Not sure if your investments are right for your situation? Concerned about stock market volatility? Check out my Financial Review/Second Opinion for Individuals service for detailed guidance and advice about your situation.

NEW SERVICE – Financial Coaching. Check out this new service to see if it’s right for you. Financial coaching focuses on providing education and mentoring on the financial transition to retirement.

FINANCIAL WRITING. Check out my freelance financial writing services including my ghostwriting services for financial advisors.

Please contact me with any thoughts or suggestions about anything you’ve read here at The Chicago Financial Planner. Don’t miss any future posts, please subscribe via email. Check out our resources page for links to some other great sites and some outstanding products that you might find useful.

Charitable Giving and Tax Reform

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The Tax Cuts and Jobs Act passed in December of 2017 marks the biggest overhaul in the tax code in many years. One area that will be impacted under tax reform is charitable giving.

While charitable contributions remain eligible as an itemized deduction under tax reform, the ability to actually deduct your contributions may have been impacted by some changes in in the rules. Here are some thoughts for this holiday season and throughout the year.

SALT Cap

SALT stands for state and local taxes. Tax reform capped the amount of these taxes that can be used as an itemized deduction at $10,000 for 2018 going forward. The two biggest SALT components for most people are their state income taxes and their property taxes. This will especially impact those people living in states with high income taxes and locations with high property values/property taxes. Many commentators say this was politically motivated since taxpayers in “blue states” seem to be disproportionately impacted, I’ll leave that to you the reader to decide.

Higher standard deduction

The other major change that may impact your ability to itemize deductions is the increase in the standard deduction. Starting in 2018, the standard deduction increases to $24,000 for those who are married filing jointly and $12,000 for single filers. This means that if your itemized deductions are less than these thresholds, you will be better off taking the standard deduction versus itemizing.

Note that these and most provisions under tax reform expire after the 2025 tax year, so we will see what the future holds for these and other provisions beyond that. 

Deductibility of charitable contributions under tax reform 

The deductibility of charitable contributions was not eliminated under tax reform, in fact it was expanded for some high-income taxpayers. The issue for many taxpayers is whether or not they can still itemize deductions with the changes to the standard deduction limits and the SALT cap discussed above.

For those whose situation might not allow them to itemize, here are some ways to make your charitable giving more tax-efficient.

Bunch contributions

Let’s say that you and your spouse file a joint return. In this example let’s say your mortgage interest is $10,000 for the year and your SALT taxes are capped at the $10,000 level. With other deductible expenses your itemized deductions would come to $21,500, leaving you $3,500 short of the $24,000 standard deduction threshold.

One option would be to bunch expenses that would qualify as itemized deductions into 2018 (or any appropriate year) to get over the $24,000 hurdle.

In the case of charitable contributions, you might consider making additional contributions in the current tax year to help your reach the threshold where you can itemize. If you normally would make contributions of $1,500 per year and can afford to do so, you might try to make 2-3 years’ worth of contributions to the organizations of your choice in the current year to get your deductions above the threshold.

Give appreciated securities or assets 

Using appreciated securities held in a taxable account to make charitable contributions has long been an excellent method to make charitable contributions. Stocks, mutual funds and ETFs that have appreciated in value are good gifts. Other types of appreciated assets can be used as well, such as art, collectibles and real estate. These types of assets will need to have an appraisal to determine their value as a gift, versus using the market value on the day of the gift for appreciated securities.

There are two potential benefits:

  • The value of the gift can be deducted as a charitable contribution for those who can itemize deductions.
  • There are no capital gains taxes that will be due on the contributed shares. If you were to sell the shares first and then contribute the cash, you would owe capital gains taxes on the amount of the realized gain on the sale.

This strategy can also be used as part of your overall portfolio rebalancing, it can be a tax-efficient way to rebalance your holdings.

Even for those who cannot itemize under the new rules, the benefit of not having to pay taxes on the capital gains can be a significant benefit.

If you have a security that has declined in value, you are generally better off selling it, realizing a loss on the sale and then contributing the cash.

If this is a route that is appropriate for you, be sure to contact the organization to ensure that they can accept gifts of appreciated securities or other types of assets.

Donor-advised funds 

A donor-advised fund is a fund that allows you to have your contributions to the fund professionally managed, offering the opportunity to make contributions to qualified charitable organizations over time. DAFs have been around for many years and are offered by such big-name financial services organizations like Vanguard, Schwab and Fidelity among others.

After establishing your account, contributions to the DAF can be made via check, securities or other assets. The details may vary a bit from fund to fund.

The fund invests your contributions professionally, typically through a list of individual funds or several managed portfolios they might offer. The money grows, and contributions can be made over time to the organization(s) of your choosing, as long as they are qualified charities. Most DAFs have minimum initial and future contribution levels, as well as minimum donation levels.

DAFs fit well into the new tax environment in that they can accept appreciated securities and can be a great vehicle to bunch your contributions in order to be able to itemize in certain years. They also allow you to space out your charitable donations if your desire is to give a certain amount each year.

RMD – Qualified Charitable Distribution (QCD) 

For those who are age 70 ½ or older, you can direct some or all of your required minimum distribution (RMD) to a qualified charitable organization each year in what is called a qualified charitable distribution (QCD). The limit is $100,000 annually.

The QCD has been around for a number of years. The amount directed to the charity is not taxed. This is beneficial for many reasons, including keeping your income in a range that offers the lowest future Medicare costs.

The amount of the QCD does not qualify as a deductible charitable contribution. If you have charitable intentions, this can be a tax-efficient way to make charitable.

The Bottom Line 

Contributing to charity is a great thing to do for those of us who are able to do it. As a Jesuit priest told me back in my graduate school days at Marquette University, you might as well take any tax breaks possible when making donations. The ideas above can help make your contributions a bit more tax-efficient.

As with any tax or financial planning issue, be sure to consult with a qualified tax or financial professional to determine if these ideas make sense for your situation.

Please contact me with any thoughts or suggestions about anything you’ve read here at The Chicago Financial Planner. Don’t miss any future posts, please subscribe via email. Check out our resources page for links to some other great sites and some outstanding products that you might find useful.

Approaching retirement and want another opinion on where you stand? Not sure if your investments are right for your situation? Need help getting on track? Check out my Financial Review/Second Opinion for Individuals service for detailed guidance and advice about your situation.

FINANCIAL WRITING. Check out my freelance financial writing services including my ghostwriting services for financial advisors.

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Tax Reform and Divorce

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The tax reform legislation passed in late 2017 provides the most sweeping changes in the tax code in years. While there are a number of changes that will impact many of us in various ways, the changes in the tax treatment of alimony payments could have a profound impact on couples contemplating divorce.

Tax Reform and Divorce

Divorce is an emotional issue that can have a significant and lasting impact on the couple involved and their families. Divorce is also a significant financial event as well.

Alimony payments 

Under the current tax rules, alimony payments are a deductible expense by the ex-spouse making the payments. Generally, alimony payments are made by the ex-spouse with the higher income. The current rules shift the tax burden of these payments to the ex-spouse receiving the payments, who is often in a lower tax bracket.

The new rules that go into effect for divorces that are finalized after 2018 eliminates the tax deduction for alimony payments.

Under the current rules here’s how the alimony deduction would work at the federal level.

Income of ex-spouse paying alimony            $500,000

Federal tax bracket                                                 35%

Annual alimony payment                               $100,000

Tax deduction                                                   $35,000

After-tax cost of alimony                                 $65,000

Without the tax deduction the after-tax cost of the alimony increases to the full $100,000.

These changes could result in lower alimony payments going forward. The attorney for the alimony-paying ex-spouse could argue that the amount of alimony their client can now afford to pay will be reduced due to the loss of the tax deduction. If the argument is successful in reducing the amount of alimony, the ex-spouse receiving the payments will suffer financially on an ongoing basis as a result.

Boomers impacted

In a recent study, the Pew Research Center found that the rate of divorce among couples 50 and older more than doubled from 1990-2015. Many in this demographic are in high tax brackets and this change comes at a bad time for this group as they head into retirement. This is especially true if one spouse, often the wife in this age group, has been out of the workforce for a number of years raising children and/or serving as a caregiver to older family members.

Focus on divorce financial planning 

This change due to tax reform doesn’t change the fact that divorce is a major financial event that requires careful financial planning during the process by both spouses.

It is important the couple seek sound, unbiased financial guidance from a fee-only financial advisor to ensure that a settlement that is as fair and equitable for both spouses is reached. Moreover, decisions need to be made with as little emotion as possible. For example, keeping the family home may be a poor financial choice if the costs of ownership will be a strain on the ex-spouse receiving this asset. It is important that all marital assets be considered as part of this process.

For couples nearer to retirement it’s important to understand the rules governing Social Security benefits from ex-spouses. These rules remain intact and both spouses need to incorporate them in their retirement planning.

Summary

Overall the loss of this tax deduction is an incentive for couples looking to divorce to get things finalized in 2018 if possible. Delaying things until 2019 or beyond might result in a lower alimony payment and will result in less money for one or both ex-spouses. Pre-divorce financial planning remains a critical part of the divorce process.

Approaching retirement and want another opinion on where you stand? Not sure if your investments are right for your situation? Need help getting on track? Check out my Financial Review/Second Opinion for Individuals service for detailed guidance and advice about your situation.

NEW SERVICE – Financial Coaching. Check out this new service to see if its right for you. Financial coaching focuses on providing education and mentoring in two areas: the financial transition to retirement or small business financial coaching.

FINANCIAL WRITING. Check out my freelance financial writing services including my ghostwriting services for financial advisors.

Please contact me with any thoughts or suggestions about anything you’ve read here at The Chicago Financial Planner. Don’t miss any future posts, please subscribe via email. Check out our resources page for links to some other great sites and some outstanding products that you might find useful.