Tax Law change under the new Trump Administration? Maybe, but too soon for planning

Enacting Major Changes Will Take Time

(as also appeared online in IRIS.xyz)

President Trump made tax reform a key issue in his campaign. He is now president and Republicans are in charge of the House and Senate, so the likelihood of overhauling the federal tax system is better than they have been for decades.

However, President Trump and Congress are trying to enact changes to the Affordable Care Act as well as addressing budget issues and foreign relations. Also, dealing with all the recent hearings involving the FBI have diverted attention. Finally, there are many details that need to be worked out, making it unlikely that major changes will happen until 2018.

Change in IRS Regulations

President Trump has already made changes in IRS regulations. On his first day in office, he temporarily froze tax regulations and then shortly thereafter, ordered that two existing regulations had to be removed for each one that was added. What is the impact?

  • The Trump administration has stated that the two-for-one exchange rule only applies to significant regulatory actions. The rule may not affect the many IRS regulations that are procedural in nature or are needed by taxpayers.
  • One new regulation that has been threatened is the Department of Labor’s new fiduciary rules for retirement advisers. This updated regulation requires retirement advisers to act in their clients’ best interests, which is a stricter standard than was previously required.
  • Also affected are the new partnership audit procedure. A 2015 law streamlined the exam process of large partnerships. The IRS released proposed regulations which implemented the regime on January 18. However, it later pulled the regulations in response to the freeze.

Possible Tax Law Changes – Lower Corporate Tax Rate

Currently, the corporate tax rate tops out at 35%. House Republicans want to lower it to 20% with 25% for businesses that pass income through their owners and for those that are self-employed. President Trump is calling for a 15% corporate tax. In 2014, nearly 25 million Americans filed taxes as sole proprietors (Schedule C), so the change affects many taxpayers.

Tax strategy: Under this change, individuals who are high-earning could become independent contractors or set up LLCs to shift income and advantage of the lower corporate tax rate. Additionally, those who own pass-through businesses could reduce their salaries and take higher profits.

This is how residents of Kansas responded to a similar state law. The state is now working to repeal a law passed in 2012 that exempted pass-through firms from state income tax. The result was that many individuals and businesses in the state restructured their business as pass-through entities or created new businesses to take advantage of the tax break. In just a few years, the number of pass-throughs in the state almost doubled. The state is now facing a large budget deficit as a result because the pass-through exemption is estimated to have cost the state $472 million in 2014 alone. The cost for 2015 was even higher.

The impact of this tax strategy on the 15% tax at the federal level would be expensive. It is estimated to cost up to $1.95 trillion in lost tax revenues over the next ten years. The Trump administration is considering ways to prevent abuse of this low tax rate but any attempt to prevent gaming the system will likely add more complexity to the tax code. Tax-savvy practitioners will likely still be able to find loopholes.

Tax only on Income Earned inside the US

Worldwide income is taxed presently, with credits for foreign taxes paid. The proposed law would generally tax only income that is earned within U.S.

Multinational Tax: A new, low tax on multinationals is part of the proposed tax, added to raise revenue to fund other rate reductions.

Estate Tax Repeal

Republicans would like to repeal the estate tax. President Trump would impose a tax on pre-death appreciation of assets, with a $10 million per couple exemption. There would be no step up in basis at death. And it is likely that gift tax rules would be retained.

Even if the federal estate tax law is repealed, many states will continue to impost a tax. Massachusetts only exempts $1 million of assets passing to someone other than a spouse, such as a trust. New York and other states have higher exemptions. Thus, planning is still important for most people.

Planning Opportunities

With the uncertainty of any change being enacted, this is not an easy year for planning. For example, this may not be the year for a Roth conversion, if tax rates will go down next year. It may not be the time for complex estate planning techniques involving irrevocable transfers, if the estate tax is eliminated in 2018.

We will keep monitoring this to assess any moves that do make sense and update this post when the likelihood of real changes becomes clear.

Year-end planning, 2016 version

The election of Donald J. Trump could have a significant impact on your finances. Individual and corporate tax laws may change, the Affordable Care Act may be eliminated, trade war may ensue, infrastructure building may boost jobs and sectors of the economy, and national defense and diplomacy could lead almost anywhere – your guess is as good as anyone else’s.

So then, how do you incorporate this into year-end planning? Very carefully!

Corporate Taxes

Our analysis starts with a review of his proposal to limit corporate income taxes to 15% as a way to illustrate how tricky planning is:

Analysis of the way this limit applies to pass-through entities suggests that the 10-year cost could be anywhere from $4.4 trillion, assuming owners of pass-throughs pay 33% tax, to $5.9 trillion, assuming owners only pay a 15% tax.

Those are hefty cost numbers, which is why it is tricky to assume that any major tax changes will be enacted in 2017.

Income Taxes

There could be three rates on ordinary income: 12%, 25% and 33%, with the latter starting at $225,001 for married filers and $112,501 for single filers. The 0.9% and 3.8% Affordable Care Act surtaxes on upper-incomers would be eliminated. So would the AMT (“alternative minimum tax”). The 20% maximum capital gains tax would remain. Standard deductions would go up, personal exemptions would be eliminated and breaks for dependent care would be increased.

Check here for 2017 tax rates.

Estate taxes

The President Elect has revised his estate tax proposal, calling now for pre-death tax on appreciation in assets of large estates, subject to a $10-million-per-couple exemption. This may be accomplished by limiting the step-up in basis for heirs who inherit capital assets from large estates.

Another change would be elimination of the IRS’s proposal to restrict the use of valuation discounts for gift and estate tax purposes on intrafamily transfers of closely held firms.

Investing and retirement

Infrastructure building could boost certain investments, while conflicts on trade agreements could hurt many.

His proposed tax changes for retirement plans include extending the age for which contributions to IRAs are allowed and delaying required minimum distributions (RMDs).

Okay, enough, how does one act now?

Some moves still make sense

Tax plan – deferring income into 2017 and adding deductions to 2016 should work well, unless doing so puts you in the AMT, in which case the reverse will work best.

Most of our suggestions from our 2015 year-end planning post still work, including RMDs, 3.8% Medicare surtax, itemized deductions, stock options, investment income and sole proprietor and small business income. Also check out our estate planning post for more ideas.

If your deductions include donating to charities, gifting appreciated assets leverages your donation. That is, you can avoid the income tax on capital gains while still benefiting from the charitable deduction. Watch for the rules on exceeding 30% of your adjusted gross income and donating to private charities.

Research Your Charities

Check out websites like such as ImpactMatters and GiveWell to make sure what you donate has the best impact. Other tools include Agora for Good, a tool to track donation impact over many sectors.

Investing – your strategy should not be altered in any dramatic way now.

If you do sell mutual funds, be sure to wait to buy replacement funds until after the dividend distribution date, so you do not end up with a taxable distribution on gains in which you did not participate

Summary

Many of the income and estate tax rules may change during 2017. However, for now, your safest plan is to assume little changes and stick to the “traditional” techniques outlined above.

If you have any questions, please contact me!

“Simplify your finances? No; “Gain control, understand your finances?” Yes

After reading a recent article in Kiplinger’s Finance Magazine  on simplifying your finances, I wondered if your personal finances can really be made simple.  While many of us may hope so, I am not sure that “simple” is best.

However, gaining control of your finances and gaining a better understanding do make sense.

clutter-286975_1920 Okay, that does need to be simplified!

Here are some ways that help you gain control that may also “simplify” your life:

Cash management and Debt management

Set up automatic payments with vendors so they use your bank or credit card, or set up payments using your bank website.

  • If the payments are regular, and of similar amounts, you save time and can plan on the withdrawals.
  • However, if you change banks, sorting and resetting auto-pay at the new bank can be a major headache. Similarly, if you change credit cards, you need to update information with all vendors.

You can also automate tracking of your spending by using websites like Mint or Personalcapital.  Or, you can use Quicken or QuickBooks software from Intuit to track your bank and credit card accounts.  You can download from your bank and credit card websites into the program and then review to analyze your cash flow and spending.

Setting up direct deposit for payroll into your checking is great.  You can also split part so it goes to savings or even have some go to your investment accounts.  You will then need to follow up to invest the cash that accumulates, but having money set aside saves it from being spent, and adds to your investments

Investing

Kiplinger’s recommended consolidating retirement accounts to avoid low balance fees.  It also makes updating beneficiary designations easier.

While avoiding fees makes sense, am not sure that putting all investments into a single retirement account does.  You cannot do this if you have Roth and pre-tax accounts like a 401(k) plan, and you probably should not do it if you have contributory IRA and 401(k) accounts that are subject to different tax rules.

Kiplinger’s also recommended using one broker for your taxable accounts.  This makes more sense, in that you have a higher balance which should mean lower fees and more attention from the broker.  However, I prefer using exchange traded funds, or ETFs, and avoiding most broker fees, which means essentially no attention from a broker.

One article said that your investment plan should be to “sign up and forget it.”  While avoiding investment pitfalls like second-guessing yourself out of panic when a fund goes down is good, I do think you need to review and rebalance your investments once a year.

Another article recommended using an “all in one” fund for investing.  Now, this really troubles me.  If your sole goal is retirement, then an age-targeted fund could make sense.  But, if you are saving for goals with different time horizons, this is a bad idea.

If you use an age-targeted fund, do your homework on the funds.  For example, if the fund plans to suddenly shift to bonds when you retire, that will not serve you well because you are likely to have several decades for which you will need the growth from stocks.

Protecting your information

Having a master password for access to all your other passwords reminds me of the joke about the student who repeatedly distilled his notes down, first to an outline, then to note cards, and finally to one word.  How did he do on the day of the exam?  He forgot the word.

Nonetheless, having passwords is clearly important so having a way to manage them is as well.  Check out this recent review of apps for managing your passwords PC Magazine Best Password Managers for 2015.  You can manage the passwords yourself by creating a document that you save as a PDF and then encrypt.  But don’t forget the password you used for the PDF!

Store files in one place

We did a post on using cloud storage when you do not need originals.  Here is another site to check out:  Shoeboxed

Credit cards

In addition to downloading transactions as noted above, you can track your credit score and credit history by using sites like Credit Karma

Estate planning

For insurance purposes, and for your estate plan, having a record of possessions, you can list all your property using sites like Know your stuff home inventory.

Conclusion?

There are ways to gain better understanding of your finances that also make your finances simpler.  But setting simplification as your primary goal risks distorting your finances – too simple may be a bad result.

P.S. Our sister website, www.wokemoney.com, encourages you to gain a better understanding of your finances so you can handle your own planning.  Let me know what you think.

Young people, don’t let this happen to you. Plan for retirement now!

Young people, a.k.a. “Millennials,” have the time horizon that should allow them to save well, and thus avoid the need to save much more in later years. Otherwise, they will end up like those now nearing retirement that Theresa Ghilarducci describes in her 2012 article on retirement:

Seventy-five percent of Americans nearing retirement age in 2010 had less than $30,000 in their retirement accounts. The specter of downward mobility in retirement is a looming reality for both middle- and higher-income workers. Almost half of middle-class workers, 49 percent, will be poor or near poor in retirement, living on a food budget of about $5 a day. See Our Ridiculous Approach to Retirement.

Acting now is crucial, but what do you do?

Step 1 – As a Millennial, accept that you need to start saving now and commit to acting. For encouragement, remember that:

The 35-year-old would need to boost her contribution rate to 9 percent to achieve the same result as the 25-year-old starter who was saving 6 percent. (from Retirment Saving for Young People) See You can Ignore Most Financial Planning Rules.

Step 2 – Identify how much you need to save by using a retirement calculator. There are many calculators you can use – see what we listed in The results from retirement calculations on different websites vary. Why?

Step 3 – Follow this hierarchy for how to set up accounts for your savings:

Start with your employer plan, 401(k), 403(b) or if you are self-employed, SEP-IRA. The contributions you make to a 401(k) or 403(b) are made from payroll deductions, so you never get a chance to spend this money. The deductions reduce your taxable income now, so the government is effectively helping you to save. Also, the amounts invested grow “tax sheltered,” meaning that you pay no tax on any interest, dividends and capital gains. However, when you retire and withdraw from the plan, you are taxed on that amount as regular income.

If you save more, use a Roth IRA next. Set up an auto debit from your checking to fund your Roth IRA, so contributing works like payroll deductions. The amount contributed to a Roth IRA is not deductible, but amounts withdrawn at retirement are not subject to income tax. The amounts invested grow tax sheltered.

Finally, if you still need to save more, set up a “taxable account,” meaning an account with no tax sheltering benefit. You can use auto-debit to add to this account.

Note: for the Roth IRA, you must qualify and have earned income from which to make contributions to the account. Also note that, for any of these tax sheltered plans, withdrawing funds before age 59½ may subject you to a 10% penalty in addition to income taxes, so do not fund any plan when you expect to need withdraw the money before retirement.

Step 4 – Invest. And when you invest, stick to the plan you set in place (this cannot be over-emphasized). The time to retirement is decades away so you can afford to take risks, some of which will take many years to pay off. If you panic and sell, you only lock in a loss; but if you weather the ups and downs, you will be far ahead. (see Don’t Let This Happen to You, Plan for Retirement Now)

Creating an asset allocation, where you diversify among stocks, bonds, real estate and cash. Include large cap, mid-cap and small-cap stocks, as well as international stocks. You man also include invest in real estate investment trusts (“REITs”) and hard assets. You can use exchange traded funds (“ETFs”). The low fees of ETFs leave more invested to grow, compared to high fee and load funds.

If you on-going advice, you may want to check out alternatives such as LearnVest and the new Future Advisor website.

5 Things Every Young Person Should Know About Retirement – You’ve got time, so use that time well!

If you are young, you’ve got time, and if you use that time well, you may even make up for the possibility of no pension and no Social Security benefits.

1. You won’t have what your parents had – no pension and no social security. Millennials are the first post-war generation to face retirement with virtually no pension. Fewer than 7% of Fortune 500 companies offer pension plans to new hires. Also, the way that the Social Security system is currently funded, there will be no reserves by 2033. Social security benefits are paid to retirees from the tax withholdings of the current workforce and also from the Social Security Reserves. Once the reserves are depleted, it is estimated the tax revenues the collected at that time will only be enough to pay out three quarters of the scheduled benefits. There are measures Congress could take to head off this eventual depletion, like changing the benefit formulas, raising payroll taxes or increasing the cap on taxable wage income. Until any changes are actually implemented, don’t count on any benefits!

2. Learn how to save and spend – now! It’s never too late to adopt good spending and saving habits, and the sooner you do it, the better. The more you can set aside that is invested now, the better off you will be. Also, avoid accruing any high interest rate debts. You can make your coffee at home if that is what allows you to max-out contributions to your 401(k) plan, especially if your employer matches what you contribute. If you do not have employer-sponsored plan, open a Roth IRA or even a traditional IRA. It’s a lot easier to put money aside now than it is to play catch-up in your 40s. And you can set up auto-debits so the investments are made as soon as your paycheck hits your bank account – keeping it out of your shopping slush fund!

3. We’re living longer, healthier lives. Longer, healthier lives are good, but they also require more investments at retirement. If you hit the Social Security full retirement of 67 now, the Center for Disease Control estimates you will live to around 86. That’s 19 years of retirement that you need to fund. But, if you are younger, living a longer, healthier life, then you will likely live longer, requiring more funds, unless you choose to work later in your life.

4. The good news is you have time. The Center for Retirement Research at Boston College suggests that, by setting aside money at age 25, you will need to save only about 10% of your annual income to retire at 65. If you wait to save, the percentage you need each year increases. If you wait ten years, starting at age 35, your target savings increases to 15%. Wait until you’re 45 and you’ll need to save 27% of your annual income. Imagine if you were 55 today and wanted to retire at age 67? The message is: don’t wait!

5. You also have great resources. With smartphone apps and do-it-yourself trading services, investing is more accessible and less costly than ever. Also, there are more affordable investment products available like ETFs (see our post), so you avoid high fund manager fees. Saving on fees means more to grow for your retirement. Over the course of 40 years, those fund manager fees add up to real money.

In sum, start saving now. Set up a simple portfolio and adjust it as you go along. The time you’ve got now will reward you later!