President Trump signed the Tax Cuts and Jobs Act into law on December 22, 2017 with the promise that it would cut down on loopholes for the wealthy. Now, a year later, sweeping changes have emerged allowing taxpayers to reduce next year’s bills if they take action by December 31.
These tactics allow taxpayers to take advantage of tax law changes, such as lower tax rates for owners of pass-through entities including partnerships and limited liability companies, and a higher exemption amount for the estate tax. Other strategies are designed to avoid new limits of the law, including the cap on state and local tax deductions.
Bunching Expenses
A 20% deduction on taxable income was granted to self-employed individuals and owners of partnerships, limited liability companies (LLCs) and other pass-through entities. However, there are limitations starting at taxable incomes of $315,000 for married couples filing jointly ($157,500 for others). To avoid this, pass-through owners can “bunch,” or increase expenses/deductions in 2018, which will help to reduce their taxable income and allow for the full deduction.
For example, partnerships and LLCs planning to spend more money on equipment and improvements to their facilities could do all of it before the end of the year instead of spreading it out over several years. Companies could also give higher bonuses or accelerate bonuses to maximize the 2018 deduction for wages.
Business owners without significant payroll costs may want to consider using a defined benefit pension plan to get a retirement deduction that greatly exceeds the $61,000 limit for 2018. But act fast – the plan must be in place by December 31 in order to take a deduction this year.
Non-grantor Trusts
The new tax law placed a $10,000 cap on deductions for state and local taxes (SALT). Tax attorneys and accountants have been able to help clients in high-tax states by setting up special trusts to work around the limit. Clients can transfer their homes into limited liability companies, and then transfer the interests in the LLCs into non-grantor trusts. Each trust takes the maximum $10,000 deduction. If a taxpayer has a $50,000 property tax bill, they can set up five separate trusts, with a $10,000 deduction for each one.
This tactic could have some problems for taxpayers. Establishing trusts can be expensive and the owner would need to put sufficient income-generating assets into the trust to balance out the $10,000 deduction. For those with high incomes living in high-tax states, the savings could justify the costs and the inconvenience, however, a tax professional should be consulted to determine if this strategy would be beneficial.
IRA Donations
Individuals over 70 ½ must take required minimum distributions (RMDs) from their retirement accounts, which creates taxable income. If charitably inclined, these taxpayers could make charitable donations up to $100,000 directly from IRAs to satisfy their RMDs. This eliminates the additional taxable income and meets this requirement.
An additional benefit of the IRA donation is that these taxpayers do not have to itemize deductions on their taxes to qualify for the benefit. The expectation is that more taxpayers will take the new, expanded standard deduction of $24,000 for a couple rather than itemizing deductions. The standard deduction is greater for taxpayers over 65 years old.
The donation will not qualify for a charitable deduction since the tax benefit is realized by not having to count the IRA distribution as taxable income.
Opportunity Zones
Special tax breaks were granted in Opportunity Zones and economically disadvantaged areas where the United States government is aiming to promote investment. Investors can use capital gains — those from the sale of stock or a business, for example — and put them into Opportunity Zone funds to defer and perhaps reduce taxes. Investors can also avoid taxes on the funds’ gains completely.
Opportunity Zone designations are valid for 10 years, but time is critical for investors who have sold their stock or business recently. The rules state that gains have to be reinvested into a fund within six months of the sale to be eligible. Click here to learn more about Opportunity Zones (link to previous blog article).
Dynasty Trusts
The dynasty trust has been an important tool for the wealthy. The new tax law doubled the lifetime gift tax exemption – the amount that can be given to beneficiaries without being subject to estate and gift taxes. Trusts can be funded tax-free with assets up to $22 million for married couples. Amounts that are over the exemption level are taxed at 40%.
Taxpayers had been worried that in 2026, when the higher exemption amounts are set to end, the IRS may try to collect taxes on gifts that were made under the doubled exemptions. The IRS said in November that it would not seek such retroactive taxes.
Additionally, folks can give each family member up to $15,000 annually without using up any of their lifetime exemption.
If you have questions about how you can take advantage of these tax strategies, contact an MCB Advisor at 703-218-3600 or click here. To review our tax news articles, click here. To learn more about MCB’s tax practice and our tax experts, click here.