New Tax Rules; What To Do Next?
With the passage today of the Tax Cuts And Jobs Act Of 2017, CFPs and CPAs are already digging in to figure out the best new tax strategies that will enable clients to keep as much of their earnings and savings as possible. Even if Congress should shift to a Democratic majority in 2019, the new tax rules are likely to be with us for at least the next four years. Here are some initial steps to consider as you digest the changes.
First, this new law combines personal exemptions (previously $8K for two adults without children) and the standard deduction (previously $12K for MFJ status) into a new single higher standard deduction of $24K. At the same time, aside from charitable contributions, the larger contributors to itemized deductions (state taxes, property taxes, and mortgage interest) are being significantly reduced as follows:
- A limit of $10K (combined, not each) for state and property tax deductions.
- A reduction in the mortgage interest deduction from the first $1M of principal to only the first $750K of principal for new mortgages. In addition, HELOC interest on existing loans will no longer be deductible unless used directly to improve the home.
These changes mean that for many of you living in California or in some other high-tax state it will no longer be practical to itemize deductions starting in 2018 unless your combined mortgage interest and state & property taxes exceed $24K. If you are in that situation, I recommend considering immediately taking the following steps:
- Pre-pay your second half 2017 property tax bill (ordinarily due in 2018) before the end of this year. This may be your last chance to get the full property tax deduction. Even if your annual property taxes are less than $10,000, the higher standard deduction threshold might eliminate the value of your taking itemized deductions at all in the future.
- Pre-pay your 4th quarter 2017 estimated CA tax payment (ordinarily due on January 15th) before the end of this year if you pay estimated taxes. As above, it may not be practical any more to take this deduction starting next year.
- Pre-pay your January mortgage payment before the end of this year if you think you will not be able to take advantage of itemized deductions starting in 2018. (If you do pre-pay, be sure to indicate that you are prepaying principal and interest, not just principal.)
Of course, if you do not have the cash flow to support such payments this month, then there’s nothing to be done. If you do have the money, you have one week to act.
Next let’s consider what to do about your investments. The cornerstone of the Republican tax plan is a reduction in the corporate tax rate from a high of 35% to only 21%. This is unquestionably positive for earnings and consequently for publicly-traded company stock prices. Should you therefore sell all your bond funds and pour the money into stocks or stock funds?
As I wrote recently (see http://www.cognizantwealth.com/2017/11/15/why-are-global-stock-markets-doing-so-well/), it’s virtually impossible to predict future market pricing. In fact, there are countless occurrences of counter-intuitive stock price movements. Some examples:
- In June 2016 the UK voted to leave the EU in a public referendum vote (so-called Brexit) which shocked the world. UK stock prices tumbled the following Monday, but by the end of the week had completely recovered. They went on to set new highs later in the year.
- The anti-austerity party won the Greek election in January 2015, causing widespread fear that Greece would leave the EU. European stocks staged an unexpected rally in response.
- An inability to reach political agreement on the U.S. budget in 2012 forced sequestration (automatic budget cuts) in early 2013, which economists predicted would lop off as much as a half of a percent from GDP. Despite the doom and gloom, the S&P 500 ultimately closed the year up 16%.
In other words, will U.S. stock prices continue to rise as a result of the new tax law, or are investor expectations already baked-in to current prices? I have no idea. Nor does anyone else. What’s the next step? Do nothing other than continue to follow an investment strategy based on your future goals rather than on one based on your guess as to what you think the markets will do.
Other than that, stay tuned. There will be more opportunities for tax savings as we uncover them.