The Tax Policy Center estimates that recent changes to the tax code in the form of last year's Tax Cuts and Jobs Act (TCJA) "... will cut individual income taxes for 65 percent of households overall, but raise taxes for about 6 percent of households." Even so, why not resolve to improve your financial situation even more in the New Year. Depending on your circumstances, there may be a variety of moves to make to further reduce your tax bills (or to offset them by saving money in other ways).
About five years ago, Wall St. Journal reporter Anna Prior interviewed me for an article entitled Ten Ways You're Probably Leaving Money on the Table. Let's revisit some of the tax-saving tips in that article in light of the current tax rules.
Use IRA's for Non-working Spouses
It's a common misconception that there's an "income phase-out" involved in making IRA contributions, i.e. that having income above a certain limit precludes a taxpaying household from making contributions to traditional IRA's. On the contrary, everyone with any "earned income" as defined by the IRS (wages, salaries, commissions, bonuses, self-employment income, but NOT pension and annuity income, IRA and retirement plan distributions, Social Security benefits, or rental and investment income) can contribute to an IRA.
What's also misunderstood in many married households is that a non-working spouse may "borrow" the working spouse's earned income for the purpose of making an IRA contribution. In other words, as long as the tax-paying household as a whole generates $11,000 in earned income, both the spouse with a job and the one without may contribute $5,500 each to an IRA. The latter's is often referred to as a "spousal IRA".
It is true that the tax-deductibility of these IRA contributions will be determined by: (1) the household's modified adjusted gross income, and (2) whether or not the IRA contributor and his/her spouse is covered by a retirement plan at work. However, even non-deductible IRA's can be useful as retirement savings vehicles because of their tax-deferred nature. And non-deductible IRA's may also serve as cost-effective fodder for future conversions to Roth IRA's.
Use a Health Savings Account (HSA)
I wrote about HSA's earlier this year in Making the Most of Health Savings Accounts (HSA's), contribute to one myself, and argue that it should be the first "retirement" account funded after getting any employer match available in your retirement plan. At a glance, an HSA contribution is also the only one of the ten ideas in the WSJ article that would still allow taxpayers in all tax brackets to reduce their federal tax bills for 2018 after December 31.
In order to accomplish this, you must first be covered by a qualifying high-deductible health plan (HDHP), and you must have room left under the HSA annual contribution limits (e.g. $6,900 for a family for tax year 2018, without the age-55 $1,000 catch-up contribution). But more and more of us are being covered by HDHP's as employers continue to shift the burden for health care expenses to workers.
So how much could you save in current taxes by contributing to an HSA? All other things being equal (and they rarely are with the interdependencies of the individual tax code), we would expect the income tax savings from each dollar that taxable income is reduced to be determined by the taxpayer's marginal tax rate. For example, taxpayers in the TCJA's new 24% tax bracket should save roughly 24 cents in federal taxes for every dollar they reduce their taxable income. So, in that same tax bracket, if you can reduce taxable income by $6900 via an HSA contribution, you should expect to be able to save about $1656 in federal taxes.
Gift Securities to Charity
Since our stock market has risen markedly during the five years since the Wall St. Journal article was originally published, embedded capital gains in taxpayer investment portfolios have only increased. Moreover, for upper-income taxpayers, the 20% long-term capital gains tax rate and the 3.8% net investment income tax still exist under the Tax Cuts and Jobs Act (TCJA). In these respects, the argument for using appreciated individual stocks or stock mutual funds as charitable contributions has grown stronger.
However, the tax landscape surrounding charitable donations has changed somewhat under the TCJA. In general, donors to charity only receive tax benefits to the extent that the value of their gifts combine with other itemized deductions to exceed their standard deduction. Since the standard deduction for both single and married taxpayers has almost doubled from last year to this, and since several of the most commonly claimed itemized deductions have now been capped under the new tax rules, it's estimated that 28.5 million fewer taxpayers will itemize this year, leaving only 12% of all filers. In this regard, it has become more important than ever for taxpayers to consider bunching charitable gifts (whether of appreciated assets or not) into one tax year to make the most of the associated tax benefits.
Let's consider a simple example. A couple with a total of $20,000 in other (non-charity) itemized deductions every year (e.g. home mortgage interest payments, and state and property taxes) is considering whether to make: (a) $8,000 in charitable donations this year and another $8,000 next, or (b) $16,000 in charitable donations this year and none next year. Approach (a) results in their taking itemized deductions of $28,000 this year and another $28,000 next (since that sum exceeds the $24,000 standard deduction for couples) for a two-year total tax deduction of $56,000. Approach (b) results in their taking $36,000 in itemized deductions this year and the $24,000 standard deduction next (since that exceeds their $20,000 in itemized deductions) for a two-year total tax deduction of $60,000. Bunching charitable gifts (again, whether of appreciated assets or not) pays off in higher total tax deductions and therefore, in lower total tax bills.
Deduct 529 Plan Contributions
Like Ohio, the state of Utah also offers a tax benefit for contributions by Utah residents to its 529 plan, the my529 plan, (formerly known as the Utah Educational Savings Plan or UESP) Our tax benefit comes in the form of a 5% state tax credit on the first $3920 contributed in 2018 by a married couple to each beneficiary's account, resulting in as much as a $196 reduction in state taxes owed per student (5% of $1960 = $98 per student for those filing as single).
While the amount of this tax benefit has grown steadily in the past five years with inflation, the more noteworthy change to 529 plans in general came in the Tax Cuts and Jobs Act. Now, distributions from 529 plan accounts of up to $10,000 per year may be used for K-12 tuition and will still be considered as qualified.
Have a Healthy and Prosperous New Year!
About the Author
Paul Winter, MBA, CFA, CFP® is a Fee-Only financial advisor and fiduciary in Salt Lake City, UT. His independent wealth management firm, Five Seasons Financial Planning, provides professional portfolio management and objective financial planning services to individuals and families, and to their related entities including trusts, estates, charitable organizations, and small businesses. To contact Paul, please click here.