Looking Ahead: Tax Ideas to Keep in Mind in 2018
Now that tax season has arrived, you're likely digging through receipts and tax forms to pull together your 2017 returns — and your 2018 taxes may be the furthest thing from your mind. Thanks to big changes (read our previous article for the specifics) in the new Tax Cuts and Jobs Act bill, there are some tax planning strategies that you might be able to take advantage of.
Plan big medical treatments for 2018
One new break in the tax bill is a tweak to the medical expense deduction. If you've been putting off some sort of medical treatment, go ahead and make that appointment. Most taxpayers are surprised at what types of expenses they can deduct, such as travel costs to visit a medical specialist, reading or prescription eyeglasses, and wheelchairs. Elective cosmetic procedures are not covered, however.
Taxpayers who spend more than 7.5% of their adjusted gross income in either 2017 or 2018 on medical expenses will be able to deduct those costs. That's lower than the previous 10% threshold. For married couples if one spouse has high medical expenses, filing separately might also increase the deduction.
Rather than giving to your charities annually consider moving three to ten years of charitable contributions into one or two years to get your deductions over the standard deduction limit each year. You may also consider opening a donor-advised fund, a charitable investment fund that directs donations toward your favorite charities. Contributions to the fund are deductible immediately, but you can still spread out contributions to your charities over multiple years.
If you are over 70 ½ in the current tax year, use your IRA for charitable contributions if you aren’t going to meet the standard deduction threshold and get a tax-free IRA distribution. Note that this is limited to the amount of your annual required minimum distribution (RMD) as anything withdrawn above that amount would count as taxable income.
Paying for private education
If you have children or grandchildren expected to go to private elementary and secondary school, consider socking more money away into a 529 plan. Under the new law, up to $10,000 per year from 529 plans can be used for K-12 tuition. Many states and Washington, D.C. also offer a tax deduction or credit when families invest in the plans. Check Savingforcollege.com to find out if your state’s plan offers a tax break.
It’s important to remember that these state tax breaks are only available when the funds are withdrawn to pay for expenses that the state considers qualified, which may or may not include K-12 tuition. States are currently reviewing the impact of the federal tax change to determine whether updates to state legislation are required. At the state level, non-qualified withdrawals may be subject to state income tax and, in some cases, a penalty on the earnings portion. You may also have to repay any deductions or credits claimed. Click here to find out if your state considers K-12 tuition as a qualified expense.
Convert IRA money to a Roth IRA
The new tax law makes converting assets held in a traditional IRA (and similar types of accounts) to a Roth IRA more attractive. Converting now assures you will pay taxes at the law’s reduced tax rates vs. uncertain and potentially higher tax rates in the future. The new law’s wider tax brackets also give you potentially more leeway to do the conversion without being bumped into a higher tax bracket. You will owe money on the conversion since it’s counted as taxable income, but you will be paying those taxes with dollars you might not have had without the tax cut.
How to get the 20% business pass-through deduction
The tax overhaul provides a 20% write-off to owners of pass-through businesses such as S corporations and sole proprietorships. But important limits kick in above $157,500 of taxable income for single filers and $315,000 for married couples.
By filing separately, a married couple might get the break for the business owner. Under the law, the 20% deduction applies to spouses filing separately up to $157,500. So if one spouse is a business owner and his or her earnings are under this limit, this strategy could save some couples several thousand dollars a year.
If you are a business owner whose taxable income is too high for the 20% deduction, consider saving even more money for retirement. This year, the overall contribution limit for defined contribution plans is $55,000 — that includes the $18,500 employees can sock away in a 401(k) and employer contributions. For older business owners setting up a defined benefit plan may allow you to contribute even more.
Another option for the business is to shift to a cooperative. A cooperative is a worker-owned, worker-run enterprise whose members earn salaries and share profits paid out as so-called patronage dividends. Members then pay ordinary tax rates on them. The dividends are deductible to the cooperative, which pays the corporate tax rate on anything retained for reinvestment in the business. Employees who aren’t members typically receive regular wages.
The new tax law lets cooperatives apply the 20% deduction to their gross income instead of net taxable income, which is gross income minus expenses and the like. For certain service professionals in the health, law and service professions the deduction is disallowed completely if taxable income exceeds $207,500 for an individual and $415,000 for married taxpayers filing jointly. However, those limits apply only to pass-through entities, not cooperatives.
Another strategy to consider is to divide diverse businesses into a separate businesses. A company which offers services and also sells products could be split into two entities so that the product sales business could qualify for the deduction.
S corps don't have to pay self-employment taxes on profits, but they do have to pay them on the salary they collect. These taxes add up to 15.3% and go toward Social Security and Medicare. However, profits taken out are potentially eligible for the pass-through deduction. Business owners will look to classify more of their money as "profit" so that it isn't subject to the self-employment taxes. Business owners need to pay themselves a reasonable salary and the IRS has some guidelines here, but you could argue the reasonableness of your pay.
It’s unclear yet whether these strategies will be eventually be fixed or will require new legislation, and the Internal Revenue Service has yet to issue guidance on how to interpret the hastily passed law. As always make sure to discuss any of these strategies with your tax professional.
Presented by Carl Holubowich, CFP®