AssetGrade – 2018 Tax Law Information Center
How the New Tax Law Impacts You
By Pat Cote
Most of us have been impacted by the new tax law. You have probably already heard of the major provisions, such as lower rates overall and the reduced ability to deduct state and local taxes. If you are a business owner, particularly of a pass-through like an LLC, there are more significant changes that are quite relevant.
At AssetGrade, taxes play a critical role for most of our clients, so we work very closely with our clients and their CPAs to maximize their after-tax investing performance.
At 1,097 pages, the new tax law is a large document - realistically, it will take a while for everyone to absorb and think through the implications. There are already some immediate implications emerging for 529 accounts and Roth IRAs that we will be addressing shortly.
We are dedicating this section of our website to keep all of the key information and investing ideas/implications we develop or come across from other people. We encourage you to check in on it from time to time, as we will keep adding to it throughout the year.
Pass-Through Income of $200K - $500K
By Pat Cote
One of the biggest changes in the new tax law is that pass-through businesses, such as S corporations and LLCs, now get a 20% deduction for income. This deduction is available whether the standard deduction is taken or deductions are itemized.
There is a big constraint that applies to service businesses. Engineers and architects do not have a limit on their income, however all other businesses that are based on reputation/skill face a limit. This limit applied to health, law, consulting, athletics and yes, financial services. The limit is:
- Single – taxable income threshold of $157.5K with phase-out of $207.5K
- Married filing jointly – taxable income threshold of $315K with phase-out of $415K
In effect, there is a large penalty that kicks in with income over the thresholds, since the 20% deduction disappears.
In practice, this means that small business owners would not want to have income just over the thresholds, as that extra little bit of income can cost them thousands of dollars in extra taxes.
Fortunately, small business owners can reduce their taxable income by large amounts by setting up retirement plans. If you are an employee, you can contribute only $18.5K to a 401(k) in 2018, plus an additional $6K if you are age 50 or older. However, if you are the business owner, you can contribute an extra $36.5K to the 401(k). If you need to put even more aside, you can set up a defined benefit or cash balance plan and contribute an additional $150K+. In total, you might be able to save $200K+/year in these retirement plans, which can help bring your taxable income below the threshold and help you receive the 20% deduction. Susan describes how the process works below.
How to Bring Down Taxable Income by $200K+/Year
By Susan Powers
Do you own a small business and find yourself confused by the new tax law? As Pat mentioned above, retirement plans can play a big role in helping you take advantage of the new tax law.
Setting up a combined 401(k) and defined benefit/cash balance plan can be one of the most effective ways to bring down your taxable income by $200K+/year. Setting up these retirement plans requires specialty expertise with an investment advisor, actuary and recordkeeper. At AssetGrade, we have years of experience designing plans that allow for large tax-deductible contributions, well beyond the limits of a 401(k). We make it easy for you by acting as quarterback for the entire process.
According to the IRS, cash balance plans are the fastest growing type of retirement plan in the United States. Changes in the tax laws are likely to accelerate their growth even more, as business owners seek to keep their pass-through income below the thresholds outlined above in order to get the 20% deduction.
If you have a profitable small business, discretionary cash flow and are able to commit to the plan design for at least three to five years, a cash balance plan may be right for you.
Small Business - New IRS Clarification for QBI
By Susan Powers
Looking for a great tax deduction? Proposed regulations from the Internal Revenue Service regarding the new 20 percent qualified business income (QBI) deduction were issued August 8th. They attempt to clarify the definition of QBI and “Specified Service” businesses, how phase out rules can reduce or eliminate QBI deductions and an anti-abuse rule designed to prevent separating out parts of otherwise disqualified business.
Often referred to as a deduction for pass-through businesses, let’s be clear. These rules apply to owners of sole proprietorships, partnerships, trusts and S corporations allowing them to deduct 20 percent of their QBI.
Those who earn less than $157,500 if single, or $315,000 for a married couple, can take full advantage of the 20% deduction. However, the new QBI rules phase out the deduction for high-income “Specified Service” businesses. These include lawyers, accountants, doctors, consultants, and financial advisors. In these cases, the tax break fully phases out if they earn more than $207,500 if single, $415,000 if married filing jointly.
S corporations exclude reasonable compensation to owners when calculating QBI. The same applies to guaranteed payments paid to partners. Taxpayers may claim the QBI deduction regardless of whether or not they itemize or claim the standard deduction.
Example - Bob and Sue are married and earn $225,000 a year, which includes $110,000 in wages from Bob’s job with a utility company, and $115,000 of net income from Sue’s retail clothing store, a sole proprietorship reported on her Schedule C.
In 2018, the couple will be eligible for a $24,000 standard deduction if they don’t itemize, reducing their $225,000 of income down to $201,000. In addition, they will receive a $23,000 QBI deduction (20% of the $115,000 form the store), further reducing their income to $178,000. Because Bob and Sue are in the 24% bracket, the QBI deduction of $23,000 saved them $5,520 in taxes.
The rules regarding QBI can be quite complex and everyone’s situation is unique. Please consult your tax professional to determine how you can best take advantage of the new proposed regulations.
529 Accounts Can Now Be Used for K-12
By Kate Hennessy
Shortly after I wrote my article about 529 Plans, the new tax law was passed by Congress and signed by the President. As you may remember, my article from December touched on the differences between 529 Plans and prepaid tuition plans
The new tax law differentiates 529 plans and prepaid tuition plans even further, by allowing up to $10,000/year in 529 plans to be used for K-12 school tuition. This is a huge benefit for those families that have chosen to send their children to private primary and secondary school, as those costs can be north of $15,000/year and even higher in some other areas of the country.
There are two big areas of caution. First, many state tax laws have not yet caught up with the new federal tax law, so you should check on your specific state tax laws before using the 529 for K-12 tuition. Second, the typical investments used in 529 plans, the “target date” funds, may no longer be appropriate for investors that are planning to use the 529 plans for K-12 tuition.
We will address the impact of the new tax law on 529 plans in more detail in the coming months.
529 Accounts - Need to Invest Differently for K-12
By Kate Hennessy
The decision to send your child to a public or private school is a personal choice. At the end of last year, the new tax law went into effect and now allows up to $10,000 in funds each year from 529 plans to fund K-12 education.
The typical (most popular) investment options available in 529 plans for investing for college may not be appropriate. The reason is because the time horizon for funding K-12 education expenses is shorter than funding for college expenses. A typical target date fund, a fund that is a blend of equity and fixed income, may not be appropriate to fund a liability (like K-12 education expenses) that has a shorter time horizon.
One approach to funding K-12 education expenses is a liability-driven investment (LDI) strategy. This is an investment strategy based on using cash flows to fund future liabilities.
For example, if you know today that the average tuition per year of private high school in your area is $15,000 then you may consider investing a lump sum in certificate of deposits (CD’s) and laddering them so you can receive more yield (return on your investment) than a money market fund.
The math behind the matching of your investments vs. future education expenses can get complicated when doing K-12 and college, so you should work with an investment professional to do it correctly. Since the earnings for the additional 529 contributions can be tax-free, it is worth the effort!
By Pat Cote
Roth IRAs have long been one of our favorite types of investment accounts. Under the right circumstances, they can help investors lock in low income tax rates now, then be able to avoid having to pay any taxes on future earnings.
With the change in tax law, some people will be looking at much lower tax rates in 2018. Remember all of that talk about the Social Security and Medicare funding gap we used to hear about in the past? The underlying problem has not gone away and has actually gotten worse since the financial crisis of 2008. There is a possibility that tax rates may increase in the future to deal with those challenges. With the current situation of low rates today and potentially higher rates in the future, some people may be better off putting more $ in their Roth IRAs now – it really depends on the specifics of each family’s situation.
In the past, the IRS used to allow recharacterizations. In other words, if you changed your mind after converting a traditional IRA into a Roth, you could undo it up until October 15th of the following year. That option to recharacterize has now disappeared with the new tax law. That makes it all the more important to be sure you want to convert to a Roth before you start the process.
By Susan Powers
President Trump recently signed the Tax Reform Bill into law, and it contains substantial changes to the tax code for both individuals and corporations.
In fact, the bill represents the most significant tax changes in the United States in more than 30 years!
Our team will continue to stay on-top of the Tax Reform Bill to serve our clients to the best of our ability.
Full text of new tax law: