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With the passage of the Tax Cuts and Jobs Act (“TCJA” or “2017 Tax Act”) late in 2017, we have spent most of 2018 determining its impact on taxpayers and seeking clarification and guidance from the Internal Revenue Service (IRS) on various provisions.

Potential legislation dubbed “Tax Reform 2.0” has been introduced. However, further tax reform this year is questionable. Some year-end tax-planning strategies will remain effective regardless of any future tax reform.

For individuals, we have the current tax environment in place:

  • Personal income is subject to a top ordinary rate of 37% and a potential high-wage earners Medicare tax of 0.9%.
  • Special maximum tax rates generally apply to long-term capital gains and qualified dividends (0%, 15%, or 20% with different breakpoints than in prior years).
  • There is still a 3.8% Medicare surtax on net investment income.
  • Higher alternative minimum tax (AMT) exemption amounts are in effect and adjusted for inflation.
  • Standard deductions have been increased; personal and dependency exemptions have been eliminated.
  • State and local tax deductions are capped at $10,000, qualified home interest deduction rules have changed, the former Pease limitation has been removed, some prior miscellaneous itemized deductions are gone, and there is the new qualified business income deduction for pass-through income.

Here are the top 10 wealth-planning ideas to consider for 2018 based on current legislation:

1. Check your tax situation as soon as possible to avoid surprises.

With the major tax reform changes implemented for 2018, you should have a projection done and check to make sure that you have paid in the right amount through withholding, or quarterly estimates, to avoid an estimated tax penalty. Having a tax projection done can avoid having a large tax refund or prepare you for owing a large balance due. Because of the change in tax rates and brackets, increases in the standard deduction, and the loss of the personal exemption and certain itemized deductions, many taxpayers may need to adjust the amount of tax they pay during the year.

Remember: There is still time to change withholding before the end of the year.

2. Review your portfolio.

The year-end planning process should include a review of your overall portfolio. A review can tell you whether you need to re-balance and help you decide whether re-balancing should be done before or after year-end to minimize your potential tax liability. You should also make sure your asset allocation is appropriate for your time horizon and goals. A thorough review also looks at tax-efficient investing, asset location, use of tax-free investments, and managing gains and losses.

Remember: You should harvest gains to take advantage of the 0% and 15% capital gains rates today and harvest losses to offset any capital gains to reduce income subject to the net investment income tax.

3. Maximize charitable contribution deductions.

With the number of taxpayers that itemize deductions projected to decline and more taxpayers instead taking the now higher standard deduction, how can you maximize your charitable gifts? Taxpayers should consider bunching charitable deductions into particular years or consider making gifts to a donor-advised fund to obtain the deduction now and make actual distributions from the fund at a future date. Consider gifting low-basis assets directly to charity and avoiding paying capital gains tax on the appreciation of the asset. Alternatively, sell loss assets first and then gift the cash to charity, in order to take advantage of the loss to offset other capital gains.

Consider the charitable IRA rollover, which allows an individual age 70½ or older to make a qualified charitable distribution (QCD) from their IRA directly to a charity and exclude the distribution from gross income (up to $100,000 per year). You may not receive a separate tax deduction for the charitable donation, but there are several benefits to this strategy. It can be used to satisfy a required minimum distribution (RMD), and the reduced adjusted gross income (AGI) can have an impact on the taxability of Social Security and the overall marginal tax rate, capital gains rate, or applicability of the 3.8% Medicare surtax on net investment income. Also, consider setting up a non-grantor irrevocable trust for your gifts. If drafted properly, the trust can distribute income to charity and provide a charitable income tax deduction (limitations apply).

4. Reduce taxable income so that the qualified business income deduction (QBI or Section 199A deduction) can be maximized.

Manage your taxable income so that you are under the limitations. Take advantage of additional contributions to defined-contribution or defined-benefit plans, use bonus deprecation or Section 179 expensing where available, and use charitable contributions or tax-free investments. Also, consider shifting income to lower-income taxpayers, such as children or non-grantor trusts to maximize the QBI deduction.

For those that are in a non-specified service trade or business and with income projected to exceed the taxable income limitations, focus on ways to manage wage and property limitations. For example, generate extra capital by purchasing qualified property or increase wages by replacing independent contractors with employees.

5. Start IRA to Roth IRA conversions.

As you get close to year end, determining your 2018 marginal tax bracket and projected investment income can be done with more certainty. If you are trying to convert your traditional IRA to a Roth IRA to fill up a tax bracket, start that analysis now. Traditional IRA to Roth IRA conversions can reduce future required minimum distributions and create a potential tax-free inheritance for children.

Higher-earning taxpayers who cannot contribute directly to a Roth IRA may be able to contribute to a nondeductible IRA that might later be converted to a Roth IRA. Just be mindful that the ability to re-characterize Roth conversion contributions was eliminated by the 2017 Tax Act for tax years beginning after December 31, 2017.

6. Maximize the use of tax-advantaged savings vehicles.

Increase pre-tax salary deferrals to employer-sponsored retirement plans (401(k), 403(b), 457 and SEP-IRA plans). If your plan allows after-tax Roth contributions, these should be considered because of the lack of an income-level phaseout for contributions and the potential for tax-free growth.

Use current income to pay for current medical expenses and let your health savings account grow tax-free for use in funding future retiree healthcare costs.

Alternatively, to minimize future gift or estate tax and enable tax-free growth of investments, consider gifting up to $15,000 per year, per individual, to a 529 plan. 529 plans also offer the opportunity to front-load five years of giving in a single year, allowing additional offsetting of potential tax burdens. (Now tax-free distributions can be made for elementary or secondary school tuition, not just for qualified college tuition.)

7. Capitalize on the increased federal estate and gift exemption.

With the federal estate and gift exemption amount nearly doubled now to nearly $11.2 million per person, those with taxable estates should make use of the increased exemptions with the use of lifetime gifts. Also, for transfers that could potentially be subject to the generation-skipping tax, take advantage of the increased generation-skipping transfer (GST) tax exemption as well by making current gifts to skip persons or making late allocations of GST exemption to trusts that previously were not exempt.

8. Take advantage of low interest rates.

The Section 7520 rate is used to value annuities (other than commercial annuities), life estates, term interests, remainders and reversions for estate, gift, and income tax purposes. Although the rate has risen recently, it is still well below historical averages. The lower rate allows family members to enter into a private annuity and transfer property at the lowest possible cost to younger family members. For a grantor retained annuity trust (GRAT), the lower interest rate increases the value of the annuity retained by the grantor and thus reduces the value of the gift of the remainder in a GRAT.

For a charitable lead annuity trust (CLAT), the lower interest rate results in a larger gift or estate tax deduction for the annuity interest going to charity and a smaller value for any gift of the remainder interest going to those individuals or trusts to support those you love. For those interested in utilizing intra-family sales, the applicable federal rate for loans is still attractively low. Refinancing an existing intra-family promissory note could be advantageous.

9. Review estate plans.

The increase in the federal estate tax exemption may have unintended consequences for some individuals and families with wealth under the threshold.

With the potential for a sunset of the tax law after December 31, 2025, drafting flexibility into an estate plan is wise.

Estate taxes are just one facet of estate planning—make sure you have the proper named guardians, beneficiaries, ages for distributions, need for trusts (including future asset protection), titling of assets, powers of attorneys, and beneficiary designations of retirement plans.

10. Beware of the premature TCJA tax strategies being touted by the media and tax strategists.

With the introduction of the new law came a slew of articles regarding how to take advantage of it. However, many of these tactics were introduced early on, prior to the issuance of any interpretive guidance.

For example, in response to the state and local tax deduction cap, some states created public funds (charities) that provided state tax credits. Since then, the Internal Revenue Service has issued several notices and the Treasury has issued proposed regulations offering clarification basically limiting the amount claimed as a charitable deduction.

Therefore, pay attention to the date of when any article or advice was issued. Ask your tax advisor for any updates before taking any strategies into consideration.

The end of 2018 is fast approaching, and it is important to understand your tax situation and options now in order to make any final adjustments before time runs out.

For more information, contact your KeyBank Relationship Manager or your tax advisor.

This information was compiled and provided by Key Private Bank. This piece is not intended to provide specific tax or legal advice. You should consult with your own advisors about your particular situation.

Any opinions, projections or recommendations contained herein are subject to change without notice and are not intended as individual investment advice.

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