The New Tax Law
If you did not prepare for the new tax law in 2018 do not delay, now is the time to start preparing for 2019. The new tax law has created some new planning opportunities. Here are a few changes of note:
Kiddie tax rules
A child’s unearned income is now taxed at fiduciary (trust) rates. The trust rates are not as kind as the ordinary rates. Investment earnings over $2,100 are taxed at the same rates as trusts. Basically, anything over $12,500 will be taxed at a 37 percent rate. Just to give you a frame of reference, the 37 percent tax rate does not kick in until $500k in earnings under the individual tax rates. Depending on the income generated and the parents’ income level, this could lead more tax payers to consider using Roth IRAs and 529 plans for their children or grandchildren if the funds were earmarked specifically for college.
When 529 plans were created in 2001, they were designated for college expenses for qualified educational institutions. Now you can use your 529 plan funds to pay tuition for private primary and secondary schools (including religious) up to $10,000 per year per student. You can now use a tax-advantaged account to pay for a child or grandchild’s K through graduate school expenses. Keep in mind, many states, including South Carolina, provide a state tax deduction on contributions to a 529 plan.
Charitable giving has been affected in a few ways. First, the adjusted gross income (AGI) limitation on cash gifts has increased from 50 percent to 60 percent. In the past, if you made a cash contribution of $60,000 and your AGI was $100,000, you were only able to deduct up to $50,000 on your income tax return. Now, it is a $60,000 deduction. This increase in percentage of AGI can be helpful for those who also have given in the past but were unable to take the full deduction due to AGI levels. You may now be able to accelerate the carryforwards. The rule for non-cash contributions such as stock and mutual funds remains the same at 30 percent of AGI.
Donor-advised funds (DAF) allow you to contribute money and receive the current tax benefits allowed (cash 60 percent of AGI and non-cash 30 percent) and then use those funds for a qualified charity of your choice when you choose. It provides the flexibility to name your favorite charity or charities and to stop giving to certain charities if your preferences change over the years.
You can use the DAF to switch between itemizing and using the standard deduction. You can lump your charitable contributions into specific years to take advantage of itemizing and then apply the standard deduction in other years.
Another way you can use DAF is if you are charitably inclined and plan to retire in a few years. If you expect your income to decrease in retirement, you can accelerate your charitable giving a few years before retirement by placing the funds into a DAF, receive the current income tax deduction while your income and tax rates are higher, and then spread out the distribution of those funds over the years in your retirement as your favorite charities evolve or priorities change.
The new tax law has temporarily increased the federal estate tax exemption to $11.2 million for an individual and $22.4 million for a married couple. (This is from $5.6 million for an individual and $11.2 million for couples.) The new amount will also be indexed for inflation. However, this will revert to the limits under current law in 2025.
The fact that these new limits are temporary creates a need for estate planning. In reality, most people would not have hit the exemption anyway; however, the desire to 1) avoid probate, 2) keep control of your assets, and 3) make sure your wishes are enacted are still some of the fundamental reasons for establishing an estate plan.
Additionally, many states have their own estate or inheritance taxes that are not as generous as the federal estate tax exemption, and spousal portability may not be available. Therefore, you need to take into consideration your state or states of residence when preparing your estate plan.
As you can see, some additional planning opportunities have arisen, but mostly it is a matter of applying current methods of planning with some strategic changes to truly maximize the benefits of the new tax law. Please consult your financial, estate and/or tax advisor regarding your personal circumstances to determine if these strategies may be suitable for you.