8 MIN READ
The year 2018 brought substantial changes to many of our clients' tax situations. Perhaps most notably, the increase in the Standard Deduction to $12,000 for single filers and $24,000 for joint filers is having a large impact on the vast majority of taxpayers. Most taxpayers are seeing their taxes go down in 2018, but there are still actions you can take to reduce your taxes further.
Given all the changes, we’ve assembled a concise list of strategies you can use to reduce your taxes under the provisions of the new tax law.
1. Bunching Charitable Contributions Every Other Year Can Significantly Reduce Your Tax Bill
In the past, taxpayers who itemized deductions could deduct contributions to charities. The new tax plan made the standard deduction so high that many fewer taxpayers will itemize, thus losing the tax benefit of charitable contributions. The National Council of Nonprofits even expects charitable donations to decrease by $13 billion as more taxpayers will use the standard deduction and lose the incentive to donate to charities.
One way to reap the benefits of those charitable contributions is to use a technique called bunching. Through this method, you will make double the contribution in a single year, and claim charitable contributions by itemizing your deductions every other year. In the years when you don’t claim charitable contributions, you will choose the Standard Deduction.
If you prefer to issue contributions to a charity annually while enjoying the same benefits, explore the use of donor advised funds (DAF) for charitable contributions. A DAF is a type of account that allows you to make an irrevocable transfer of your personal assets such as cash, real estate, and stocks. This technique allows you to claim tax deductions right away and decide which charities to contribute to later. One benefit of that is that the assets can grow tax free before they are donated to a charity.
DAFs have different requirements and limitations. Typically, you can only deduct 30-60% of your AGI via a contribution to a DAF, depending on the type of asset. Some fund administrators have minimum donation amounts and different administration fees.
Check these requirements before choosing a sponsor and consult a tax advisor on how to optimize your taxes with the use of a Donor Advised Fund.
2. Make Extra RE Tax Payments If You’re Opting for Itemized Deductions
The new tax law made major changes to the state-and-local tax deductions (SALT deductions). You can now deduct a maximum of $10,000 of state and local taxes per year. Often these come in the form of property taxes. In order to maximize this deduction, you can sometimes post-pay and pre-pay the prior and future years’ taxes in order to maximize your deduction for the present tax year. This technique is similar to the bunching technique discussed above.
Another note: The new tax policy made significant changes to the mortgage interest deduction. Beginning in 2018, you can only deduct the mortgage interest on a principal loan amount of $750,000. If the home was purchased before Dec 15, 2017, the deduction cap applies to $1,000,000 of principal.
In addition, taking the mortgage interest deduction has become less attractive to many taxpayers who will find that they’d be better off taking the standard deduction than deducting their mortgage interest, which may not be that much because of low interest rates over the previous 10 years (though they are rising now).
Related Article: 10 Changes You Need To Know For Your 2018 Tax Prep
3. Check If You Qualify For The 20% Income Exclusion for Pass-Through Businesses, Also Known As QBI
The Tax Cuts and Jobs Act introduced the 20% income exclusion for individuals who own domestic pass-through businesses. A “pass-through business” refers to a sole proprietorship, partnership, or LLC where the passes through to the business owner’s personal tax return. The income from these businesses is also taxed at individual tax rates. Your tax advisor can help you understand if this deduction is appropriate for your small business situation.
Related Article: Do I Qualify for the 199A QBI Deduction?
4. Use A 529 Plan To Save and Pay For Private Elementary and Secondary School
A 529 Plan is an investment vehicle that encourages saving for education expenses by allowing tax free growth, and tax free withdrawals (no capital gains tax) for qualified education expenses. Some 529 Plans allow a state income tax deduction or credit for the contribution. Until 2018, 529 Plans could only be used for qualified education expenses at the college level only, and not for K-12 education.
The new tax law expanded qualified expenses to include those for private, religious, elementary and secondary education (i.e. K-12 education). You can now use funds from a 529 plan for private elementary or secondary school tuition in the amount of $10,000 per year.
What if you have K-12 expenses this year? One technique to optimize your taxes for the current tax year is to contribute money to a 529 and withdraw it immediately to pay tuition to your child’s elementary or secondary school or college. Most states have no minimum holding period for these plans but be sure to check your state’s unique requirements - some states limit a state income tax deduction to the net contribution for the year as opposed to the gross contribution.
Using 529 funds for elementary or secondary school can only be deployed all 50 states, but use caution in the 17 states that haven’t adopted the new federal rules. Some states haven’t updated their laws to permit use of 529s for private elementary and secondary school. If you use a 529 for elementary or secondary school in those states, you may face penalties or extra taxes or may lose the tax deduction or credit for the contribution.
You might also opt to keep the funds in the 529 for use later and benefit from the tax-free appreciation through capital gains.
Note that deductions and credits for contributing to a 529 apply only to the state income tax, not on federal income tax returns. In other words, 529 plan contributions are not federal tax deductible. With these funds, it’s also wise to keep contributions within $15,000 limit for gift taxes for each taxpayer. A married couple gifting jointly owned property to a child can give up to $30,000. Contributions above these limits would be subject to the gift tax rules.
Your Taxes May Change This Year - It Pays To Be Informed
How will the new laws affect your taxes? With recent changes in laws and provisions, you can’t rely on muscle memory to plan your tax strategy.
Rather than getting caught off-guard with in April, it pays to be prepared. MYRA can help you optimize your unique tax strategy for the current year and years ahead.