We recently completed the first tax season following passage of the Tax Cuts and Jobs Act. There were sweeping changes, and most taxpayers — and their advisers — experienced many unforeseen surprises. Rather than lament, we should learn from these surprises and turn them into planning opportunities this year. Let's take a look:
Surprise No. 1: Many taxpayers owed money or received smaller refunds than expected.
The new tax laws increased the standard deduction and lowered tax rates, but many taxpayers who were expecting sizable refunds were unpleasantly surprised come April 15. The primary reason for this was the government's reduction in withholding amounts. To provide taxpayers with "evidence" of big tax reductions (conveniently prior to the November midterms), wage earners brought home larger paychecks as a result of the lowered withholding. Unfortunately, many of these taxpayers did not experience a tax cut because of the reduction in itemized deductions as well as the loss of personal exemptions.
What is our opportunity? Advisers need to proactively plan for clients' withholding and estimated tax payments. This will prevent unpleasant surprises and underpayment penalties.
Surprise No. 2: Itemized deductions weren't very useful.
With the increase in the standard deduction and the elimination or reduction of several itemized deductions, many former itemizers found that they no longer had deductions in excess of the standard deduction. Of great concern was the loss of any tax benefit from charitable contributions.
What is our opportunity? We can help our clients to "bunch" deductions so they can at least itemize every other year. Strategies include paying three property tax installments one year and one installment the next year, bunching charitable deductions by using a donor-advised fund, and prepaying January's mortgage payment every other year.
Surprise No. 3: Qualified charitable distributions are much more useful than before!
Clients over age 70½ who have individual retirement accounts can avail themselves of charitable write-offs — even if they don't itemize — by distributing part or all of their required minimum distributions (up to $100,000) directly to charity.
What is our opportunity? Identify retired clients who are claiming the standard deduction and still wish to contribute to charity. Be sure to do this before distributing required minimum distributions, and you can save your clients a lot of tax dollars.
(More: Early planning of qualified charitable distributions produces better tax results)
Surprise No. 4: The qualified business income deduction is more complicated than we thought!
There were changes and clarifications made to the QBI rules throughout tax season. The ability to properly implement these rules was, therefore, severely limited. For example, real estate rentals qualify for QBI treatment sometimes (if the activities rise to the level of a "trade or business"); self-employed health insurance, retirement plan contributions and half of the self-employment tax reduce total QBI; and dividends from REITs and
REIT mutual funds qualify for the 20% QBI deduction.
What is our opportunity? For extended or potential amended returns, check to make sure clients are taking full advantage of QBI deductions. At a minimum, all advisers should inform their clients that REIT dividends qualify as QBI — especially since many custodians missed this on their 1099s.
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Sheryl Rowling is head of rebalancing solutions at Morningstar Inc. and principal at Rowling & Associates.
