In December 2017, Congress enacted the most far-reaching reform of the federal tax code in more than 30 years. Virtually every American is affected in some way by these sweeping modifications, most of which became effective this year. Here is our summary of the impacts on areas such as charitable giving, residence shopping, and divorce.
Tax Reform & Charitable Giving
The good news for charities–and for taxpayers making charitable gifts—is that the widely used charitable tax deduction wasn’t limited and was actually expanded by the new law. The bad news, however, is that new limits on other tax deductions, such as state and local taxes (SALT), will dramatically reduce the number of taxpayers who itemize their deductions. It is estimated that about 85% of all taxpayers will now use the standard deduction, which is up from 70% under the prior tax law. As a result, donors using the increased standard deduction rather than itemizing deductions may not realize as much of a tax benefit from charitable giving.
A charitable strategy more attractive to donors who don’t itemize is the direct distribution to a charity from an IRA. Qualified distributions to charity from an IRA allow donors at least 70.5 years of age to make tax-free distributions directly to a qualified charity. This provision was not changed by tax reform. It will still be possible for donors to make tax-free gifts of up to $100,000 per year (total) from their IRAs. These gifts will also qualify as part of the required minimum distribution from an IRA for that year.
When donors give funds directly from an IRA to a qualified charity, they’re not required to report income; they also cannot count the gift as a charitable deduction on their tax returns. By reducing adjusted gross income, however, the gift may result in other savings, such as reduced Medicare premiums and other taxes tied to gross income, including the 3.8% excise tax on investment income. In addition, both Wisconsin and Minnesota will recognize the federal rules for state income tax purposes, at least in 2018.
Trust Point will again offer the fee-free “Philanthropic Conduit IRA” for individuals who have only a 401(k) or 403(b) employer plan and no IRA to take advantage of the charitable-giving strategy. However, the qualified plan must allow partial in service distributions. In all cases, we will encourage clients to consider a $500 minimum per charitable distribution.
Tax Reform & Residence Shopping
There has been much written regarding the new limit of $10,000 on the state and local tax deduction (SALT). Some state legislatures have considered legislation to get around this new limit, however the IRS recently said federal law will control the characterization of any payments. High-tax states are worried that thousands of high income earners could move elsewhere over the next few years. In the past, those high earners were able to reduce their high effective state income tax rate by one-third when they deducted those taxes from their federal tax liability.
Of course income taxes are only a small part of any relocation decision, so it remains to be seen what impact, if any, this new tax law will have on residence shopping. Actually, many states, such as Minnesota, New York, and California, are projecting a revenue windfall from the tax reform’s base broadening measures since tax reform reduced many deductions so more income is taxed at the state level. But if high tax states don’t consider reducing their tax levy, sharing a border with a high tax state might be the gift that keeps on giving, Stay tuned.
Tax Reform & Divorce
Divorce is stressful in and of itself, but a change in the new tax law regarding alimony may complicate things even further for divorcing couples. For decades the tax law allowed the higher- earning spouse to deduct alimony paid to the lower-income spouse who reported the payments as taxable income. Starting in 2019, however, the new law eliminates the paying spouse’s ability to deduct alimony; also, the receiving spouse won’t have to pay income taxes on the money. This change affects only divorce agreements signed after December 31, 2018, so pre-existing alimony orders will not be impacted.
However, married couples with prenuptial agreements probably need to review their contracts since many of those agreements likely contain alimony provisions based on the prior law. Those provisions may no longer reflect what was intended. Thus, it may be beneficial to contact your attorney and review existing prenuptials before the new alimony rules take effect January 1, 2019.
IRA 5498 Forms on Their Way
Form 5498 is an informational tax form we sent this month to all Traditional and Roth IRA account holders. The form reports the December 31, 2017, fair market value as well as any contributions, rollovers, conversions, and characterizations received in the account for 2017. If you have multiple IRAs with Trust Point, you will receive a 5498 for each account. It is informational only, but each form should be retained along with other documents in your income tax files.
IRS Auditing Fewer Individuals
The percentage of individuals receiving tax audits declined for the sixth consecutive year in 2017, reaching the lowest level since 2002. The IRS audited 0.62% of individual returns in the fiscal year that ended Sept. 30, according to data released a couple of months ago. That represents an audit of about 1 in 160 individual returns in 2017, down from 1 in 90 in 2010, the peak year in the past decade. The audit rate for all income groups declined, even for households with income of more than $1 million.