Beneath the Surface of Reform: Finding Hidden Tax Gems for Individuals– February 06, 2019 by Sue McGovern

Tax planning for high-net-worth individuals has never been one size fits all. But since the signing of the Tax Cuts and Jobs Act (TCJA), those in the higher brackets are concerned that losing key deductions and other changes will leave them worse off. Is that really the case?
While it’s true changes to some coveted tax items stand to impact this class of taxpayers, Sue McGovern, co-chair of Cohen & Company’s Family Wealth Group, says it’s the totality of deductions and changes to the law that has to be considered to know where taxpayers stand.
Below is an interview adapted from Taxonomics magazine in which McGovern shares why not to assume the worst and how taxpayers may even help bring out the best in the TCJA.
Taxonomics: There has been a lot of talk about the tax benefits to “Middle America” as a result of the TCJA. But what is the overall outlook for high-net-worth individuals?
McGovern: There is some concern and uncertainty, especially regarding lost or reduced deductions like the new cap on state and local tax deductions. However, if you take a closer look at the numbers, there isn’t necessarily cause for concern — and in some instances, many will see positive changes. The key will be evaluating the entire picture of each tax situation through December 31, 2025, when many of these provisions are scheduled to sunset. Maybe you lose a deduction that helped you in the past, but now you are no longer subject to AMT. That, plus the new lower tax brackets alone, could leave you better off. And for those who do stand to see a negative change, there are certainly planning ideas to help mitigate the impact.
Taxonomics: Let’s discuss some of the most impactful changes, starting with the cap on state and local income tax deductions.
McGovern: The TCJA imposed a $10,000 cap on state and local tax deductions, and the impact will be significant to most high-earning individuals. For example, if a married couple has $1 million in taxable income and lives in Connecticut, they could pay state taxes of approximately $69,000 on that income. Let’s also say they had $20,000 in real estate taxes. While they used to be able to deduct the full $89,000, assuming they weren’t in AMT, they would now be capped at $10,000. The remaining $79,000 at the highest tax bracket of 37% could result in an increase of about $29,000 in taxes. That’s a big number to anyone.
Taxonomics: How are states responding?
McGovern: Tax-aggressive states with a higher percentage of taxpayers in the top brackets are leading the way to find workarounds to mitigate the impact — states like Connecticut, New York and New Jersey. Many expanded their charitable donation programs in an attempt to circumvent the limitation; however, the IRS issued proposed regulations effectively eliminating that tactic for individuals. The new trend is creating entity-level taxes on pass-through entities that flow through a credit to the individual owners. Currently, both Connecticut and Wisconsin passed entity-level taxes with additional states considering similar changes. It’s going to be interesting to see how the IRS approaches these types of workarounds.

>> Read “Wisconsin Adds Pass-Through Entity Tax as Workaround to State and Local Deduction Cap”

>> Read “Connecticut Passes State and Local Tax Deduction ‘Work Around’: May Require Action Before June 15 Payment”
Taxonomics: The TCJA also limits the deduction on mortgage interest. How does this impact high-net-worth individuals?
McGovern: It may not impact them as directly as others, but it certainly is something to be aware of. Before the TCJA, a taxpayer could fully deduct mortgage interest on up to $1 million of debt. Interest is now limited to $750,000 of debt for new mortgage loans incurred after December 15, 2017. Prior loans are grandfathered in and therefore are not affected. Additionally, prior law allowed a taxpayer to deduct mortgage interest on home equity loans up to $100,000 for regular tax purposes, regardless of how the proceeds were used. Now to deduct the interest, a taxpayer must use the loan to buy, build or substantially improve a qualified residence.
Taxonomics: Charitable contributions are often a key element of tax planning. What changed in this area, and what planning options are available?
McGovern: One positive change stemming from the TCJA is that the annual charitable giving deduction increased from 50% of adjusted gross income to 60%. So taxpayers potentially can receive a larger current-year itemized deduction, perhaps minimizing some of the impact of lost state and local tax deductions.
As far as planning, taxpayers may want to consider “bunching” annual donations. For example, let’s say a taxpayer generally gives $100,000 a year to charity. This year the taxpayer has more income than usual, so it may make sense to “bunch” donations and give more this year. That would help reduce the taxpayer’s income and the associated tax liability, while taking advantage of the larger deduction. A donor-advised fund can often help execute the bunching technique.
Taxonomics: How does a donor-advised fund work?
McGovern: Think of it as a charitable savings account. Individuals can set up a fund, often through public charities or community foundations, into which they can donate cash or even securities and receive the full deduction in the same year — even before deciding which charity it will go to. Once the money is in the fund, the taxpayer can determine where the donation goes.
Taxonomics: Will estate planning feel much of an impact from the TCJA?
McGovern: Absolutely, but in a good way. One of the biggest changes is that now taxpayers can gift significantly more before becoming subject to the gift tax. The TCJA doubled the exemption to an inflation-adjusted $11.2 million for individuals and $22.4 million for married couples. These amounts are available through December 31, 2025, after which exemption levels are scheduled to revert to their 2017 levels of $5,490,000 and $10,980,000, respectively, adjusted for inflation. So the next eight years are a prime opportunity for taxpayers to consider increasing gifts made during their lifetime to minimize tax upon their death. And it’s imperative to make sure older estate planning documents are up to date, especially if they reference the prior exclusion number.
Taxonomics: How can the new Section 199A deduction benefit high-net-worth taxpayers?
McGovern: In its broadest sense, Section 199A allows business owners of pass-through entities, such as LLCs, partnerships and S Corporations, to deduct up to 20% of their qualified business income, pending certain phase outs and limitations. The rules are complex; however, if the business income qualifies, the tax benefit can be impactful. Even if an owner does not qualify one year due to income, he could qualify for the deduction the next year if his income changes.
>> Read “IRS Finalizes Qualified Business Income Deduction Regs & Provides Guidance”
Taxonomics: What is the mindset taxpayers should bring to the table during year-end planning?
McGovern: While there are certainly still questions right now from both taxpayers and CPAs, the key is to stay open-minded. It is going to be important to work with advisors to run the numbers, taking into account all of the moving parts, and weigh the benefits versus the ultimate cost.
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