How High-Income Households Are Impacted by the New Tax Bill
The tax overhaul that takes effect this year will have wide-ranging impacts on high-net-worth families. While they stand to benefit from lower tax brackets, higher estate tax exemptions and a less stringent alternative minimum tax, high-income earners face new limitations on some favored deductions and notable revisions in charitable write-offs.
Here is a quick overview of some of the more significant changes, along with broad strategies for approaching the new tax rules. We’ve also included a handy planning guide that details the new brackets and other information, on page 20.
The top tax rate has been lowered from 39.6% to 37% and the income level at which that rate is triggered has been raised. For couples filing jointly, the maximum rate now applies to income topping $600,000, up from $470,700 in 2017. Rates on qualified dividends and long-term capital gains remain the same.
The mortgage interest deduction has been capped at loans of no more than $750,000, although the previous $1 million limit remains in effect for home purchases under contract before December 15, 2017. Interest on home equity loans is no longer deductible.
Among the most significant changes is a $10,000 cap on state and local tax deductions. That is likely to weigh heavily on those in high-tax states such as New York and California, where combined income and property taxes often far exceed that threshold.
The new law retains the controversial alternative minimum tax. But it raises exemption amounts and the income levels at which those exemptions phase out, so fewer families are likely to be ensnared by it.
The law affects charitable giving in several ways. Previous rules capped deductions on cash donations to public charities at 50% of adjusted gross income (AGI). That’s been raised to 60%, but families must itemize to claim specific write-offs. Given that the standard deduction has been raised to $24,000 for married couples filing jointly, some households may not have enough deductions to make itemizing worthwhile.
It may be helpful in such situations to “bunch” deductions in certain years. For example, a family could pool two years’ worth of deductions into a single year, itemizing in the year the donations are made and claiming the standard deduction in the following year when they’re not. You can also consider using a donor-advised fund, which allows taxpayers to contribute money in a given year and take a deduction for that amount but distribute the funds to charities in regular intervals over time.
The much-debated estate tax was not repealed, but estate holders will benefit from a doubling of the lifetime estate, gift and generation-skipping transfer tax exclusion amounts. Though the top estate tax rate remains 40%, lifetime exclusion amounts have been raised to $11.2 million for individuals. Families subject to estate taxes should consider traditional wealth transfer strategies and review existing plans to fully assess the impact of the new law.
Business owners and independent contractors with so-called pass-through income may benefit from the new law. This refers to income that is not taxed at the business level but instead passes through to the owner’s personal income tax return.
Taxpayers may be able to take a 20% deduction from their AGI for qualified business income. In addition, there is no limit on deductions for business-related state and local taxes. The top rate of 37%, combined with the 20% deduction, makes the effective maximum rate on qualified business income 29.6%.
There is increased flexibility for 529 education-savings accounts, which were previously limited to college-related costs but can now be used for K-12 expenses, up to a limit of a $10,000 per year. Rules on tax-deferred retirement accounts, including 401(k)s, individual retirement accounts and SEP-IRAs, remain the same.
Because we don’t provide legal or tax advice, we highly encourage you to discuss all of these planning strategies with your tax advisor to determine which ones might work best for you.
The above article originally appeared in the Winter 2018 issue of Quarterly Insights magazine.