As you know there were changes to the tax code after a big tax bill was passed in late December 2017. Tax Day is coming up around the corner, and there are a few things you need to know about standard deductions and Donor Advised Funds (DAF) before you file.
Rachel Rasmussen, MBA, CFA and David A. Foster, CPA, CFP® of Foster & Motley wrote this article to help you.
All opinions in this article belong to the authors and no payment has been exchanged between us.
Rachel Rasmussen is a fee-only financial advisor and married to a physician. You can contact her through her company website and in the private Physician Finance Facebook Community.
Tax Planning for 2018 and the Standard Deduction
You are well aware that a new tax bill was passed by Congress and signed into law by the President in late December last year. You are likely familiar with some of the provisions, as there has been considerable news coverage. This brief article will focus on the significant change in the personal tax deductions, in particular, the increased standard deduction and the potential planning that flows from that change.
For 2018, there is a big increase in the standard deduction; up to $24,000 for married taxpayers filing jointly. This means several things. First, tax preparation may be a lot easier for many of you; no need to gather up medical deductions, charitable contribution records, etc. That is a good thing. But this also means that you may receive little or no tax benefit from, mortgage interest and charitable gifts, for example.
To be sure, many folks will still make charitable contributions with or without a tax break, but those of you over 70 with an IRA might want to consider doing a “Qualified Charitable Distribution” (QCD) from your IRA to your favorite charities. IRA distributions (up to $100,000) that go to charity will count towards your required minimum distribution (RMD) but will not be treated as a taxable distribution. Essentially it is tax free. You don’t get a charitable deduction, but you don’t care anymore because you don’t itemize. So, if you are in this camp, consider doing QCD’s this year and beyond.
As noted above, if you no longer itemize, then you won’t get any tax break for the mortgage interest you might be paying. This may be a reason to look harder at paying off your mortgage or at least paying it down at a faster rate (it is now costing you more after tax). This isn’t a “slam dunk” and needs to be considered in the totality of your financial picture. But it is worth thoughtful consideration.
The larger standard deduction gives potentially greater weight to the idea of “bunching” deductions. By this I mean loading up every other year with those deductions where that might be possible. Again, this would only be useful if you are likely to exceed the $24,000 (joint) or $12,000 (single) standard deduction.
Let’s review an example: You are married and pay $4,000 in real estate tax, $2,000 in state income tax, and you have about $3,500 per year in mortgage interest (but declining slowly). You typically give $10,000/year to charity. So, in a normal year, your deductions add up to $19,500; well below the $24,000 standard deduction. But let’s say you decided at the end of 2018 to prepay 2019 charitable contributions and completed $20,000 of charitable contributions in 2018. Further, let’s assume you could legitimately prepay your 2019 real estate tax bill ($4,000). Now your deductions for 2018 add up to $33,500 – well above the $24k standard deduction, allowing you to deduct $9,500 that would have otherwise provided you no tax benefit.
Taking that “bunching” idea a step further, you could “front load” multiple years of charitable contributions by using a Donor Advised Fund. This is a charitable fund that you set up, make deductible contributions to, and then disburse funds over time to charities of your choice. Continuing with the example above, you typically gift $10,000 per year. You could (resources permitting) make a $30,000 gift to your Donor Advised Fund in 2018. It would be fully deductible in 2018. But you could essentially decide how and when to dole those funds out to the charities of your choice over the next few years. Donor advised funds can be set up through local community organizations (like the Greater Cincinnati Foundation) or through large financial firms (Schwab has a Donor Advised Fund).
State and Local Taxes
Starting in 2018 the limit for deduction is $10,000. This includes all state, local and real estate taxes. From a planning perspective, perhaps the biggest (though most inconvenient) option is moving. State, local and real estate taxes have always been a meaningful consideration in choosing where to live, especially when eyeing a retirement destination, but perhaps now even more so. Short of moving, there may be opportunities for bunching as noted above, but the IRS will have more to say about prepaying taxes and whether or not that will fly.
There is no change for your existing qualified home mortgage interest. But interest on home equity debt that was NOT used to substantially improve your home is no longer deductible. Further, for new loans (after December 2017), the interest deduction is limited to $750,000 of qualified residential mortgage debt.
Miscellaneous Itemized Deductions
These deductions are gone entirely. This whole category of deductions, which included tax preparation fees, job related expenses, investment advisory fees to name a few, is gone.