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The 2017 Tax Reform Law and Your Retirement Finances

Last update on: Jun 17 2020

Let’s start this issue with the important individual income tax changes you need to know in the Tax Cuts and Jobs Act of 2017, which was signed into law in late December. The estate planning and IRA changes are in another article in this issue.

Most of the individual income tax changes are in effect from 2018 through 2025. Very few changes
were retroactive to 2017. To comply with procedural rules in the Senate, the individual provisions couldn’t be permanent. Congressional leaders expect the individual provisions will be extended at some point in the future. Most of the business tax changes take effect in 2018 and are
permanent.

There now are seven individual income tax brackets. The top bracket is reduced to 37%, and the break
points for the different rates occur at higher income levels than in the past. The result is taxpayers have lower rates than in 2017 at every income level, except for married couples filing jointly with taxable incomes from $400,000 to $424,950 and single taxpayers with taxable incomes from $200,000 to $424,950. The marginal tax rates rise from 33% to 35% in those income ranges.

The “marriage tax” is eliminated for individuals with taxable incomes of up to $500,000 each.

As before, trusts reach the top income tax bracket very quickly. The 37% bracket kicks in when trust
taxable income exceeds $12,500.

You won’t see many changes in the tax rules on investment income, and the few changes are positive.
The maximum tax rate on long-term capital gains and qualified dividends remains at 20%. Also,
the 20% rate is imposed only on the highest-earning taxpayers. Long-term gains and qualified dividends
are taxed at the 0% rate for married couples with taxable incomes up to $77,000 and for single taxpayers with incomes up to $51,700. Above those income levels, gains and dividends
face a 15% rate for married taxpayers with taxable incomes up to $479,000 and singles with incomes
up to $452,500.

The 28% rate on long-term gains from collectibles (including gold) remains.

The alternative minimum tax (AMT) will hit far fewer individuals, because of significant increases in
the exemptions. There’s a $109,500 exemption for married couples and $70,300 exemption for all others. The AMT exemption phases out at higher incomes, $1 million for married couples and $500,000 for singles.

In addition to the lower individual tax rates, there are changes in a number of deductions.

There are no personal and dependent exemptions after 2017. But the standard deduction is doubled, to
$24,000 for married couples filing jointly and $12,000 for single taxpayers. These two changes are
among the few individual tax changes that are permanent.

Residential mortgage interest still is deductible as an itemized expense on Schedule A, but with a
new limit. Acquisition mortgages in place by December 15, 2017, face no changes. Interest attributable to up to $1 million of principal remains deductible. For acquisition mortgage debt incurred after that date, only interest attributable to up to $750,000 of principal is deductible. The interest is deductible for first and second homes; an early version of tax reform would have eliminated deductions for second homes.

Home equity mortgage interest, however, isn’t deductible after 2017. It doesn’t matter when the loan was taken out; the interest isn’t deductible in 2018 and later years.

State and local taxes also still are deductible as itemized expenses, but only up to a total of $10,000 each year.

Some itemized expenses are eliminated after 2017. These include moving expenses, casualty and theft
losses (except losses from presidentially declared disasters), and alimony related to decrees and settlements after 2018. Also eliminated are deductions for miscellaneous expenses incurred for the production of income, such as investment expenses, tax planning and preparation costs, and employee business expenses.

The medical expense deduction is increased for a couple of years, and this one is retroactive. You might recall that a few years ago the law was changed so medical expenses were deductible only if they exceeded 10% of adjusted gross income (AGI). For 2017 and 2018, that floor is changed to 7.5% of AGI. The 10% floor returns after 2018. Remember, medical expenses are deductible only if you itemized deductions on Schedule A.

There are few changes in the charitable contribution deduction. Now, cash contributions to public
charities can be deducted up to 60%of your AGI, increased from 50%. Other charitable deduction limits
are unchanged. Also, after 2017 no deduction is allowed for contributions that earn seating rights to
college athletic events.

Owners of interests in pass-through businesses might receive a deduction from taxable income of up to 20% of their share of business income. A pass-through business is a sole proprietorship, subchapter S
corporation, partnership, or limited liability company taxed as a partnership or proprietorship. The entity generally doesn’t pay income taxes. Instead, the owners include their share of the income on their tax returns, whether or not the income is distributed to them. This deduction is directly from taxable income. It doesn’t reduce AGI or the self-employment tax.

The pass-through income deduction might make investments in real estate investment trusts and publicly traded partnerships more attractive, because the deduction applies to income from most of them. The deduction reduces the effective tax rate on the income, making these investments more competitive with other income investments. Prices of these investments increased after the final tax reform package was released, so the benefit might be reflected in the market already.

Some of the “Stealth Taxes” are eliminated or reduced.

The AMT, as mentioned, will snag far fewer taxpayers. The phaseout of personal exemptions at higher
incomes is eliminated, as is the reduction of itemized expense deductions. The major Stealth Taxes that
remain unchanged are the inclusion of Social Security benefits in gross income, the Medicare premium
surtax and the 3.8% net investment income surtax.

Under the new tax law, most investment tax strategies are unchanged. You still pay a lower tax
rate on long-term capital gains and qualified dividends than on ordinary income, though the difference might be lower than in the past. You also have some ability to determine the tax basis of securities sold when you sell less than your entire holding of a position. That helps control the gains and losses recognized on your tax return.

Tax-exempt bonds might be less attractive to some investors, because of the lower tax rates. But any effect from the tax law probably is already reflected in the prices.

As mentioned above, real estate investment trusts and master limited partnerships might be more attractive because of the pass-through income deduction.

The tax law is a reason to be cautious about high-yield bonds and leveraged loan or bank loans. The
law restricts interest deductions for businesses. This could reduce the cash flow of highly leveraged businesses. The change also could reduce the number of potential buyers of businesses and major assets or the prices they’re willing to pay. You won’t be able to deduct any investment- and finance-related expenses after 2017. Those deductions simply are disallowed, as mentioned earlier.

Tax diversification also remains an important strategy. You can have taxable, tax-deferred and tax-free
accounts. In retirement, you have some discretion about which accounts to draw funds from, giving
you greater control over your tax bill. With proper planning, many people can pay no more than a 15%
or 20% effective rate on their income throughout retirement. Charitable strategies also aren’t
changed. You still receive significant tax breaks for donating appreciated securities or other assets to charity. You also continue to receive multiple benefits from creating a charitable remainder trust or funding a charitable annuity.

Some people will lose the additional tax benefits from charitable contributions and other itemized
expense deductions. You deduct the itemized expenses, including charitable contributions, only when
their total exceeds the standard deduction. The higher standard deduction means fewer people will
itemize expenses, so they won’t receive an additional tax benefit from those expenditures.

Many people might be able to itemize deductions after 2017 if they make some changes. For example,
you could bunch expenses in one year when possible. Instead of making regular charitable contributions during each year, consider making two or three years of charitable contributions in one year and none for the next year or two years.

Or you could make a significant charitable contribution in one year. If there isn’t a single charity
you wish to benefit this much, consider donating a lump sum to a donor-advised fund. You take the
charitable deduction in the year of the contribution, but you can dole the money to individual charities over the coming years. If you need income from the money, you can donate through a vehicle such as a charitable annuity or charitable remainder trust. I discussed some of these strategies in the December 2017 issue in the Estate Watch article and this month’s Estate Watch article.

I cover these and other aspects of the new tax law in more detail in the January 2018 edition of my new
online seminars, the Retirement Watch Spotlight Series. To learn more about my new Spotlight Series,
go to the top of the RetirementWatch.com home page, and select the Spotlight link.

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