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by Robert A. Westley, CPA/PFS, CFP®

Robert A. Westley, CPA/PFS, CFP®, is a wealth adviser with Northern Trust in New York City. He specializes in developing, implementing, and monitoring holistic financial plans and wealth management solutions for high-net-worth families.

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The October 15 extended tax filing deadline signified an excellent opportunity to conduct a postmortem on your client’s 2018 tax return and begin 2019 year-end tax planning. Many high-net-worth taxpayers will now see—for the first time—how their tax liabilities were impacted by the 2017 Tax Cuts and Jobs Act (TCJA). Smart tax planning will undoubtedly be top of mind, and the 2018 Form 1040 is a natural starting point in identifying advantageous tax and financial planning strategies.

This article will highlight some personal tax planning strategies discernable from an individual’s 2018 Form 1040.

Form 1040, U.S. Individual Income Tax Return, Page 1

State of residence. Start the analysis by noting the client’s state of residence. If the client is domiciled in a high-tax state such as New York, New Jersey, or California, discuss the potential income and estate tax benefits of moving to or retiring in a low-tax state. High-tax-state residents will surely want to understand how the new $10,000 state and local tax deduction limitation under TCJA impacts their federal income tax liability. It’s essential to discuss not only the tax benefits associated with a residency change, but also how to establish domicile and document a move to a low-tax state.

Dependents. Page 1 of the 2018 Form 1040 also lists your client’s spouse and dependents, offering a great segue into a conversation about family estate planning opportunities. For clients with exposure to a federal or state estate tax, remind them that they can give their dependents (or any other individual) up to $15,000 per beneficiary per year without consuming their lifetime estate tax exclusion or paying a gift tax.

Continue the planning conversation by explaining that the current increased estate, gift, and generation-skipping transfer tax exclusions under TCJA are scheduled to sunset effective Jan. 1, 2026 (or potentially sooner, depending on the outcome of the 2020 U.S. presidential election). This fact pattern may create a use-it-or-lose-it proposition for high-net-worth families.

In assessing the suitability of completing large lifetime gifts, first help your clients determine whether they can afford to irrevocably part with their assets. From conversations with the client and knowledge of their tax return, estimate the amount of primary capital the client needs to support their desired lifestyle for their remaining lifetime and quantify the excess capital they can manage to part with.

Form 1040, U.S. Individual Income Tax Return, Page 2

Employer-sponsored plans. The first six lines of the second page of the 2018 Form 1040 details different sources and character of income. If a client has wages listed on Line 1, review their form W-2 and confirm they are maximizing the use of their available employer-sponsored plans. Encourage clients to maximize contributions to their available qualified retirement plans, keeping in mind the catch-up contributions that may be made if age 50 or older. Additionally, look for opportunities to utilize nonqualified deferred compensation plans, if offered by their employer.

One word of caution: be mindful of your client’s expected future tax rate when the deferred income may become taxable. A multiyear tax projection is critical, as the highest tax efficiency will be accomplished by deferring income while in high-tax rate years and realizing income in lower-tax rate years.

Withholding. Many taxpayers have not been pleased with the outcome of their 2018 tax returns, even if their total tax liability had decreased from 2017. The IRS revised the withholding tables, resulting in less withholding for most taxpayers and consequently smaller refunds or even balances due at tax time. Now that the 2019 year-end is approaching, advise clients to check in with their CPA to see if additional withholding or estimated tax payments are needed. Also, be sure they consider any bonuses received in 2019, because the supplemental wage withholding rate for supplemental wages up to $1 million dropped from 28 percent to 22 percent. The withholding rate is 37 percent on supplemental wages exceeding $1 million during 2019.

Required minimum distributions. If a client has a distribution listed on Line 4, confirm whether the distribution is a required minimum distribution (RMD) or not. If the client also has wages listed on Line 1, there may be an opportunity to defer their RMDs by rolling their IRA into their employer-sponsored plan. Generally, upon attaining age 70½, clients will need to take RMDs from their IRA. However, employer-sponsored plans, such as a 401(k), can be deferred until April 1 of the year following retirement. This exception, however, does not apply to taxpayers who own more than 5 percent of the company sponsoring the retirement plan.

Many employer-sponsored plans now accept IRA rollovers (IRA to 401(k) rollover). Not every plan will allow for it, but many do, and employees will need to first check with their plan sponsor. This creates a meaningful opportunity for your client to delay RMDs on all qualified retirement assets by rolling those assets into the plan of the employer for which they are currently employed.

Qualified charitable distributions. An IRA owner who has attained age 70½ may also want to consider directing the distribution of up to $100,000 per year from their IRA to one or more qualified charitable organizations. This distribution counts toward satisfying their RMD and will not be taxable to them. Instead of qualifying for a charitable income tax deduction, the distribution is entirely excluded from the client’s income. It is imperative to discuss the benefits of qualified charitable distributions with your clients, as many clients will no longer itemize under the TCJA and will not benefit from a charitable income tax deduction.

Itemized Deductions from Schedule A (Form 1040)

Bunch deductions. Review itemized deductions on Schedule A and take note of clients making charitable gifts who now opt for the standard deduction under the TCJA. Since charitable donations are fully controllable, it may be advantageous to bunch multiple years of contributions into one tax year.

The more substantial charitable gift can be made to a donor advised fund and then paid to charities incrementally over the next few years. Bunching the contributions together, rather than contributing smaller amounts on an annual basis, may help the client exceed the standard deduction hurdle, thereby receiving a more significant tax benefit for their charitable giving.

Interest and Dividends from Schedule B (Form 1040)

Asset location. Review Schedule B, interest, and dividends, as well as the corresponding 1099s for asset location planning opportunities. Asset location planning entails considering the different tax characteristics of investments and the vehicles or accounts in which they are held to gain the best possible after-tax rate of return. Take note of high taxable yielding mutual funds, hedge funds, or REITs that may be better located in a tax-deferred account.​​

Tax-equivalent yield. For some clients, the new lower tax brackets under TCJA may have altered the efficacy of using tax-exempt fixed income. Leveraging the tax return, note the client’s 2018 marginal tax bracket and compute the taxable-equivalent yield of any tax-exempt bonds listed on Schedule B. The tax-equivalent yield is calculated by dividing the tax-exempt yield by one minus the investor’s marginal income tax rate. A client’s municipal bond portfolio may no longer be the most tax efficient investment choice under the lower tax brackets of TCJA.

Capital Gains and Losses from Schedule D (Form 1040)

Capital loss carryforwards. A review of Line 13 on Schedule 1, net capital gain or loss, shows any net capital losses up to $3,000 with the balance carrying forward and detailed on Schedule D. This presents an opportunity to discuss a strategy to leverage the capital loss carryforward. Consider opportunities to improve investment portfolios by selling and improving or diversifying low-basis assets.

Tax loss harvesting. During bouts of stock market volatility, look for opportunities to harvest tax losses to offset any gains your client may have recognized or will recognize during 2019. When harvesting tax losses, make sure clients keep in mind the wash sale rules that apply when buying back into the market.

Zero percent capital gains tax bracket. The preferential rates for long-term capital gains and qualified dividends of 0 percent, 15 percent, and 20 percent continue to apply under the TCJA. Financial planners should be sure to take note of the zero percent tax rate on capital gains that apply in 2019 to married individuals filing jointly with taxable income up to $78,750, and single individuals with taxable income up to $39,375. The client may go through a period of time with uncharacteristically low taxable income, and this is an excellent opportunity to add value by notifying the client that gains can be harvested—to a certain degree—free of capital gains taxes.

Form 8606, Nondeductible IRAs

Roth conversions. IRS Form 8606, nondeductible IRAs, is filed with your client’s tax return and functions to track after-tax contributions made to traditional IRAs. Nondeductible IRA contributions are reported each year on Part I of Form 8606. Take note of any basis in your client’s IRA and strongly consider a Roth conversion for high-basis IRAs.

Basis in your client’s IRA, coupled with the lower tax rates provided under the TCJA creates an attractive opportunity for a Roth conversion. However, be sure to help clients analyze the Roth conversion and plan carefully because, under the TCJA, a recharacterization or redo is no longer available. Roth conversions will result in having to pay the income tax on the original amount, even if the value of the account decreases or the tax burden is more substantial than initially projected.

The 2018 Form 1040 is the perfect starting point in identifying relevant tax and financial planning strategies specific to today’s current economic and regulatory environment. As clients finalize their 2018 tax returns, financial planners should be sure to review and uncover smart strategies that can lower the tax burden for the 2019 tax year and beyond.  

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