Category: Tax Planning

Secure Act Bring Changes to Your Planning – Part 1

Over the summer of 2019, the House of Representatives passed the bipartisan Setting Every Community Up for Retirement Enhancement (SECURE) Act. On December 19, 2019, the Senate passed the bill, and it was signed into law by the President on December 20, 2019.

The bill affects many Americans and may potentially result in the update of many financial plans here at Longview. The bill is long and covers many areas including the following:

  • Required Minimum Distributions from qualified accounts
  • Contributions to Traditional IRAs past the age of 70.5
  • Changes to the stretch provision in Beneficiary IRA accounts
  • Updates to exceptions of penalties for early distributions from accounts
  • The use of 529 accounts to pay off qualified education loans.

There is a lot to cover! Over the next few weeks, I will be breaking down certain areas of the SECURE Act into a series of blog posts. In this post, we’ll start with the updates to Required Minimum Distributions (RMDs) from qualified accounts, which include vehicles like Traditional and Rollover IRA as well as 401(K) and 403(B) accounts that are in your name.

Required Minimum Distributions

As many of you are well aware, the magic age of 70 and a half (70.5) signifies the start of Required Minimum Distributions – a time in which you have to distribute a portion of certain types of accounts. The amount distributed is based on the balance of the account at the end of the previous year and a divisor based on your age at the current year. Let’s break that down a little more using Steve as an example:

Steve is 74 as of January 1, 2020, and his birthday is December 2. On December 31, 2019, Steve had an IRA that totaled $1,085,000. With his birthday in December, that means that Steve will be age 75 as of December 31, 2020, which will make his RMD divisor 22.9. So, knowing those two numbers, this is how we determine Steve’s RMD.

$1,085,000/22.9 = $47,379.91

As you can see, Steve must take $47,379.91 by December 31, 2020, and report that distribution as income on his 2020 tax return. Failure to take the distribution means he would face a 50% penalty on the amount in which he failed to distribute. To get a better understanding of what your RMD may look like, check out the IRA Required Minimum Distribution Worksheet from the IRS.

So, what does this have to do with the SECURE Act? RMDs are still the same in that a portion will need to be distributed based on your age in the current year; however, the age in which an individual has to start RMDs is now age 72 but only for those turning 70.5 after December 31, 2019. So, for those born before or on June 30, 1949, sorry, you still have to take Required Minimum Distributions starting at age 70.5.

As for those born on or after July 1, 1949, you will not have to start taking RMDs until you reach age 72. Let’s use Sue as an example as to how the change in the law will work now:

Sue’s birthday is July 11, 1949. In her annual meeting in 2019, Sue’s advisor told her of her upcoming RMDs starting 2020, given the fact that she would not turn age 70.5 until January 11, 2020. With the SECURE Act now in place, her RMD does not have to start until at least 2021, which in turn may present opportunities to consider and implement from both a financial and tax planning perspective.

One thing to note about her first RMD that is very similar to the former distribution rules is that she will not officially have to start taking her RMD until April 1 following the year that she reaches her RMD age. Under the old RMD rules, while she would have turned 70.5 in 2020, her first RMD would technically not have to be taken until April 1, 2021. The only caveat is that she would have to take her 2020 and 2021 distribution both in 2021, which would raise the amount of tax she would have to potentially pay on her 2021 tax return.

With the new RMD rules, Sue doesn’t have to take her first RMD until April 1 in the year following her 72nd birthday, which would be April 1, 2022. Again though, like before, if she did move forward with that, she would need to take both her 2021 and 2022 RMD in 2022 and report both of them on her tax return. Sometimes, this may make sense, but before implementing that, we strongly encourage you to speak with your financial planner before to see if it makes sense from a taxation standpoint, because it could affect not only the taxes paid but also your Medicare premium in future years. 

Qualified Charitable Distributions

For many of our charitably inclined clients, we may make a recommendation for them to complete a Qualified Charitable Distribution (QCD). For those who are unaware of what this is, when an individual reaches age 70.5, they can take their RMD or a portion of it (up to $100,000) and have that money sent directly to a charitable organization. The amount that is contributed by way of QCD is not counted towards any income on the income tax return. This has become even more important over the past couple years with the recent Tax Cut and Jobs Act of 2017, which increased the Standard Deduction, thus for many Americans there isn’t a tax benefit from an itemization standpoint of donating to a charitable organization.

The QCD has created a new way of making charitable donations a de-facto tax benefit. Here’s an example: 

Let’s say that Joe is 75 and has to take an RMD of $50,000. Joe is also charitably inclined and would like to give $10,000 to his favorite charity, but will still take the Standard Deduction on his tax return. With a QCD, Joe can take $10,000 from his RMD, give that directly to the Charitable Organization and then only have to report $40,000 towards his income on the tax return.

The QCD has always coincided with age 70.5 and the RMD age. Going forward, under the SECURE Act, while the beginning RMD age has changed for some, the QCD age will remain at age 70.5, meaning that an individual may have a couple of years to give from their qualified accounts before their RMD start age of 72. This, in turn, not only contributes to the goals for those who would like to give to charity but may also lower future RMDs, thus potentially lowering future tax liability too. As with any distribution strategy from your accounts, please consult with your financial planner to determine the most appropriate action to take that is in line with your goals, as well as provides benefits for you both now and in the future.

Tax Cut and Jobs Act of 2017 Overview

We previously shared with you details from the U.S. House of Representatives’ Tax Cut and Jobs Act  and the U.S. Senate’s Joint Committee on Taxation’ version under the same bill name, Tax Cut and Jobs Act. After negotiations between the two governing bodies, the Tax Cut and Jobs Act of 2017 is finalized and headed to the President’s desk.

Below is a brief rundown of some of the most notable changes for individuals and families. Most of the new tax laws are in effect for tax year 2018 and beyond unless otherwise noted.

Individual Income Tax Brackets

While House Republicans had proposed a four bracket system for income taxes, the TCJA retains the seven bracket system. However, rates and income thresholds have been adjusted. This means that almost all U.S. taxpayers will see a reduction in income taxes for tax year 2018. The current system’s income tax brackets are 10%, 15%, 25%, 28%, 33%, 35%, and 39.6%. The new system sets the brackets at 10%, 12%, 22%, 24%, 32%, 35%, and 37%.  The income threshold amounts will continue to adjust for inflation.

Brackets Individuals Married Filing Jointly
10% Up to $9,525 Up to $19,050
12% $9,526 – $38,700 $19,051 – $77,400
22% $38,701 – $82,500 $77,401 – $165,000
24% $82,501 – $157,500 $165,001 – $315,000
32% $157,501 – $200,000 $315,001 – $400,000
35% $200,001 – $500,000 $400,001 – $600,000
37% $500,001 + $600,000 +

The decreased tax rates are not permanent, however, as there is a sunset provision. After 2025, without future legislation, the tax rates would increase. The Senate and House will be faced with deciding the fate of the sunsetting provision in future years.

Changes to Exemptions and Standard Deduction

One of the most notable pieces of the TCJA is the elimination of personal exemptions. The new legislation instead combines personal exemptions and the standard deduction into one single increased standard deduction amount. The new standard deduction amount is $12,000 for individuals, $24,000 for joint filers, and $18,000 for head of household. The additional standard deduction of $1,250 for blind individuals or someone over age 65 remains.

For larger families, this will mean an overall decrease in the combined amount when compared to the current combination of exemptions and standard deduction. However, the TCJA increases and expands the Child Tax Credit, from $1,000 to $2,000 per child, which should more than offset the loss of exemptions in most families. High income earners, $200,000 for individuals and $400,000 for couples, begin to phase out of the Child Tax Credit.

Changes to exemptions, standard deductions, and the child tax credit are subject to the 2025 sunset provision.

Changes to Itemizations

The Pease limitation on itemized deductions has been repealed. The Pease limitation is a reduction in certain itemized deductions that takes affect depending upon your filing status and income level. Once your income crossed the threshold amount ($261,500 for individuals and $313,800 for married filing jointly in 2017), itemized deductions would begin phasing out. The rule acts as a surtax on high income earning households. The repeal will result in a 1% to 1.3% reduction in taxes for high income earners. The sunset provision applies to this repeal, meaning the Pease limitation could return in 2026.

Additional changes to itemizations include:

  • Elimination of miscellaneous itemized deduction, including tax preparer fees, investment management fees, and unreimbursed employee business expenses.
  • $10,000 cap on combined state/local income tax and local property taxes.
  • Deductible mortgage interest only on the first $750,000 of new principal debt. Mortgages taken prior to December 15th, 2017 retain deductibility on the first $1,000,000 of principal debt.
  • Elimination of home equity indebtedness interest deductibility.
    • If a home equity loan is used to substantially improve the home, it is treated as “acquisition debt” and is still deductible.
  • Medical deductions were not repealed. Instead, the deduction was temporarily reduced to 7.5% of AGI for tax year 2017 and 2018. It reverts back to 10% of AGI in 2019.

Charitable Donations

Current rules limits donations to public charities to 50% of your AGI. The new rules increase the limitation to 60% of AGI making it easier to claim larger contribution or use carryforward charitable deductions.

The charitable mileage rate, which was expected to be increased, remains unchanged at 14 cents.

Capital Gains and Dividend Rates

There had long been concern that the 0% long-term capital gains and qualified dividends tax rate would be eliminated, but the TCJA retains the three-bracket system of 0%, 15%, and 20%. Under the old system, taxpayers in the 10% and 15% income tax bracket had a 0% capital gains tax rate. With the new tax bracket system, the capital gains rate is tied to an income threshold amount rather than the brackets. Thus, individuals with $38,600 and couple with $77,200 or less in income will have a 0% capital gains tax rate.

Instead of having the 20% capital gains tax rate take effect at the highest tax bracket, it now takes affect at the threshold amounts of $452,400 for individuals and $479,000 for couples. This means some tax payers in the new 35% income tax bracket will find themselves in the highest capital gains tax rate.

Unfortunately, the 3.8% Medicare surtax on capital gains and qualified dividends still applies. Individuals with income over $200,000 and couples over $250,000 will face the additional surtax. This effectively retains a four tax brackets of 0%, 15%, 18.8%, and 23.8% for capital gains and qualified dividends.

No Repeal of the Alternative Minimum Tax

The original bills by both the Senate and the House proposed a complete repeal of the Alternative Minimum Tax (AMT) system for individuals. Unfortunately, in negotiations, the AMT survived although the exemption amount has increased.

This difficult-to-understand supplemental income tax system dates back to 1969 and was originally designed to ensure wealthy taxpayers paid their fair share of taxes. Yet, over the years, the AMT began affecting more and more middle-income taxpayers. With the exemption amount increased to $70,300 for individuals and $109,400 for joint filers, fewer middle class taxpayers will be affected.

Kiddie Tax Rules

The Kiddie Tax is a tax on unearned income for children under the age of 19 or full-time students under 24. In 2017, tax law allowed for the first $1,050 of unearned income to be tax-free, the following $1,050 taxed at the child’s rate, and any income above that amount taxed at the parent’s rate. TCJA changes this so that the any amount above $2,100 is taxed at trust tax rates, not the parent’s tax rate. This is significant because the highest trust rate is 37% at ordinary income of only $12,500. It would take total income over $600,000 at the parents’ joint rate in order for the 37% tax bracket to apply.

Estate and Gift Taxes

The estate and gift tax exemption has effectively doubled allowing an individual to pass $11.2M and couples to pass $22.4M estate tax free. Portability of the exemption survived; if the first spouse to die doesn’t use the exemption, the surviving spouse can port the unused amount to themselves. The top rate remains at 40%. Some early discussion indicated that the estate tax could be repealed at a future date, but the repeal did not make it into the legislation. These changes are subject to the 2025 sunset provision.

Trust and Estate Tax Brackets

Tax brackets for trusts and estate were compressed, much like the individual income tax rates, leaving just four tax brackets – 10%, 24%, 35%, and 37%. However, the income thresholds tied to those tax rates did not change very much. Thus, it only takes $12,500 in trust or estate income before hitting the top bracket.

Education Planning

While a number of changes were expected to affect education planning, such as repeal of the Coverdell ESA plan and education tax credits, most did not make it into the final bill. However, one change is significant. You can now use up to $10,000 per year from 529 plans for private school expenses for elementary and secondary education. Previously, only the Coverdell ESA could be used tax-free for private educational institutions.

Alimony Credit

The bill eliminates the tax deduction for alimony paid and no longer taxes the alimony received for divorces finalized after December 31st, 2018.

Miscellaneous

  • Deductibility of student loan interest and out-of-pocket classroom expenses for teachers remains unchanged.
  • The mandate requiring that individuals retain health insurance has been repealed for 2019 and beyond.
  • No changes to 401(k) plans, IRAs, and Roth IRAs. However, the ability to recharacterize a previous Roth conversion has been repealed.
  • There are new rules for deferred compensation plans and equity granting plans, like stock option plans, that could result in funds being taxed earlier than under current plan designs. As a result, there may be changes to current plans.

Alabama Tax Credit Could Lead to Even Greater Savings For Those With Alternative Minimum Tax (AMT)

An AL.com contributor called the Alabama Accountability Tax Act of 2013 the “most radical education reform in decades”.  Similar legislation had only been passed in 16 other states at the time the Alabama Accountability Act passed in February 2013.1 It was developed with the intent to allow flexibility in meeting children’s educational needs, improve overall education performance, encourage innovation in meeting the needs of school systems and provide financial assistance through income tax credits.2 Since it was passed, there has been a great deal of controversy over the Act, which lead to a lawsuit over the constitutionality of the document. On March 2nd, the Alabama Supreme Court upheld the Act, so it is important to know how you may benefit from it.

The Act opens the door for Alabama residents to make donations to a Scholarship Granting Organization (SGO). Scholarship Granting Organizations are 501(c)3 (charitable) organizations that are created with the purpose of granting scholarships to eligible students at failing public schools so they may transfer to a private school.  The scholarships are provided to students who qualify based on family income requirements. All taxpayers who make a donation to a SGO qualify for a state tax credit of 50% of their state income taxes, up to $7500. C corporations also qualify for a 50% credit, but there is not a maximum limit on the amount of the credit. In addition, taxpayers can claim the donation as a charitable deduction on their federal return. For some, this is just a zero-sum game. The taxpayer receives a credit from the state, which lowers the state tax deduction by the same amount of the federal charitable deduction taken. However, for those who pay Alternative Minimum Tax (AMT), it actually results in additional savings because state taxes are disallowed for the AMT calculation, while charitable contributions are not.  

The Alabama Accountability Act outlines a process for making SGO donations and claiming the tax credit. The state has earmarked $25M for these credits on a first come, first serve basis. Please let us know if you are interested in learning more about this opportunity or about how to make a donation and claim a credit. This is not something you want to plan on waiting until the end of the year for if you are interested.

*In full disclosure, Jessica Smith serves on the board of a local Scholarship Granting Organization.

1 McClendon, Robert. (March 1, 2013) “Alabama Accountability Act FAQ, a guide to the most radical education reform in decades.” Retrieved April 24, 2015 from AL.com: http://blog.al.com/wire/2013/03/alabama_accountability_act_faq.html

2Alabama Accountability Act of 2013 (HB 84, 2013)


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