The Tax Cuts and Jobs Act of 2017 is the most sweeping overhaul of the US tax code since 1986. While its creators insist that it’s going to make filing easier for many Americans; the bill itself is hugely complicated, changes what benefits you may be eligible and has led to some surprising outcomes.
To help you navigate the new legislature as we gear up for tax season, Jeffrey Levine, CEO and Director of Financial Planning at Blueprint Wealth Alliance, and author of The Baby Boomer’s Guide to Savvy IRA Planning, joins me on the podcast after appearances on CNBC and CBS to talk about key takeaways and what you and your financial advisors need to watch out for.
In this podcast interview, you’ll learn:
If you enjoyed this podcast and have more questions for Jeff about the tax code, click here to ask us your tax questions
Hi, this is your host, Andrew Rafal, the founder and CEO of Bayntree Wealth Advisors and I wanted to personally welcome you to Your Wealth & Beyond, a podcast that will empower you, the entrepreneur and business owner, with the insight and information you need to effectively manage and control your personal and professional finances. My goal is to help each of you get your fiscal house in order so that you could take your business to the next level. I’m going to help you focus on growing your business, building your wealth, and most importantly, finding purpose in what matters most.
[00:00:45] Andrew: Welcome, everybody, to Your Wealth & Beyond. Today we have a fun topic that we’re going to dig into, a very timely topic in regard to the tax reform bill and how it’s going to affect each and every one of us both on the individual side as well as for you, business owners on the corporate and the business side. And in today’s podcast, I had the pleasure of speaking with Jeffrey Levine, the CEO and Director of Financial Planning of BluePrint Wealth Alliance. I’ve known Jeff for a number of years. He had been the Director of Retirement Education for the Ed Slott and Company Group. He’s also the author of The Baby Boomer’s Guide to Savvy IRA Planning and if anybody knows his stuff in regard to the tax reform bill, it is Jeff. He’s been digging in over the last week. We’ve pulled him away. Two days ago, he was on CNBC, this morning on CBS, and we’re going to talk high level on how this bill is going to affect you both positively and potentially negatively. And after the show, if you have any questions, you’ll be able to reach out to both Bayntree as well as Jeff. So, without further ado, my podcast with Jeff Levine on the tax reform bill.
[00:01:56] Andrew: Jeff, welcome today. I appreciate it. I know you’re very busy. How are you?
[00:02:31] Jeff: I’m good, Andrew. Thanks for having me today.
[00:02:33] Andrew: You are very welcome. And with this podcast, it’s built to help the business owner, the entrepreneur, building their wealth, building their business, and finding purpose and today’s going to be one of the more timely podcast that we’re going to get out and it’s in regard to the tax reform. And it’s been in the news whether you follow it like Jeff and I do or not. We’re going to talk today and drill down on how the tax reform is going to affect you both on the individual side as well as for business owners some of the complexity of the pass-through and how it’s going to affect you there. So, Jeff, I know you’ve been busy. Recently saw you on CNBC and then you had indicated to this morning, was it CBS that you just had interviewed with?
[00:03:15] Jeff: Oh yeah. We did a spot for the CBS This Morning show. Yep.
[00:03:18] Andrew: Awesome. And I know looking through some of your tweets last week, you were digging in late night in helping for all of us to kind of break this down and see how it’s going to fit so I appreciate everything you do there.
[00:03:29] Jeff: Oh, so nice to give it to us on a Friday afternoon. Really made the weekend nice for me.
[00:03:34] Andrew: That’s right. I did see that you are a Steelers fan. Is that correct?
[00:03:38] Jeff: Die-hard Steelers fan, absolutely. Yep.
[00:03:40] Andrew: So, if I knew that going in, I probably won’t be able to do this podcast because I grew up in Cleveland and die-hard Cleveland fan, although, it’s not really a rivalry anymore is it like it used to be when we grew up in the 80s and 90s?
[00:03:53] Jeff: No, no, at least you’re not from that New England team that begins with the letter P then we might have to go to fisticuffs.
[00:04:00] Andrew: There you go. Yeah. Should be another maybe AFC Championship between the two of you guys. Nonetheless, let’s start first on the individual side and I think the more basic areas of this tax reform bill is the changes to the tax bracket. So, Jeff, kind of go through what they were thinking in regard to changing of lowering some of those brackets across the board.
[00:04:24] Jeff: Yeah. Absolutely. So, we started out. We keep in the same number of brackets as we had last year. We’re just seeing a shift in some of the percentages and really that 10% starting tax bracket for everyone remains the same but after that, we’re starting to see a drop. So, for instance, the 15% bracket really now is kind of a 22% bracket. There are different income levels where they phase in and out versus the previous years but one of the more interesting changes is the very, very top rate. I say it’s one of the more interesting changes because what happened here was the House passed one version of the tax reform bill and then the Senate passed a separate version but of the same bill. When that happens, they go to a conference committee which is what ultimately occurred. They tried to hash out their differences and then you vote on it and you try to get the package passed. Now usually when two people argue, you try to meet somewhere in the middle. Someone says 50, someone says 100. You probably end up somewhere close to 75. What was interesting here was that the House bill called for the top rate to stay at the previous level of 39.6. The Senate rate had to drop to 38.5 and they settled on the top rate of 37%. So, there’s a new high-income tax bracket of 37% which interestingly enough is lower than both the House and the Senate proposals were on their own.
[00:05:41] Andrew: It’s one of those happy compromises I guess.
[00:05:45] Jeff: I guess. Yeah. You know what, if you’re in the 37% bracket, it’s a real happy compromise for you.
[00:05:50] Andrew: You know, it definitely is. I think from across the board there with the lowering the tax brackets, it’s definitely I think a win psychologically too. That’s one thing that they can push out. Some of the things we’ll dig into are some of the areas that they taketh away. It’s giveth and then taketh away but in this case here for the higher income, what’s the thought there? Why would they lower that highest bracket? What are they thinking in that regard?
[00:06:15] Jeff: Well, I mean, there’s a couple of thoughts. There’s some, first off, who just simply believe that the very wealthy are already paying more than their fair share and whether or not you subscribed to that or not is obviously a personal feeling but there is a strong contingent of people who believe the wealthy pay far too much in taxes and so they need to have a break. There’s also a potential economic argument for that in that if you give wealthy individuals this break, they’ll go back, and they’ll reinvest it to businesses and then for the economy, and then eventually that will, the famous term, trickle down to everyone else. So, there’s a couple of reasons for that. There’s also going to be some removal of deductions, etcetera, that did previously favor some of the higher earners. And so, what may and ultimately happen for a lot of people, the end result of this may be that some people pay tax on more income, but they pay a lower rate on that greater amount of income. So, for some people, it might result in a tax decrease. For some people, it might be pretty much a wash and then others still might even see their tax increase even though the brackets themselves have been lowered.
[00:07:20] Andrew: And if we think about some of the states that are going to be affected, certain people are going to hold out. But what’s going on with the state income tax deduction that’s been so prevalent all these years as well as the property tax and how is that going to affect states where you live on the East Coast as well as California and some of the other higher tax states out there for the individuals and the corporations?
[00:07:43] Jeff: Yeah. So, it’s one of the major bones of contention. And frankly, I’m a little surprised that they were able to hash this out and pass it where they ended up. So, the final result of the bill is that taxpayers are able to take a $10,000 or up to $10,000 deduction for state and local taxes. And that is kind of a pooled deduction if you will between their state and local income taxes, their state and local property taxes, and state and local even sales taxes. So, for some individuals like, for instance, in my neck of the woods, a modest house you might easily have $1,000 a month property tax bill. Now I know in some areas of the country people are listening to this and they’re saying, “These must be mansions. They must live in 10,000-square-foot homes.” No. A very modest home, 1,500, 2,000 square feet could very easily in our neck of the woods have $1,000 a month property tax bill. But that means is that under the new law, that $12,000 is capped out at $10,000 plus all the income tax deduction that that person would’ve had for the state and local level are now gone because anything north of $10,000, cumulative between all of these, will be disallowed.
Now the one saving grace though for some people is that in these high tax states, some high earners typically between let’s say $200,000 or maybe $500,000 or so of income, a lot of them get hit with the alternative minimum tax or AMT as it’s commonly referred to. Under the current bill, which we may get to the later, that is being repealed for the coming years. And so, the AMT actually disregarded the state income tax and property tax deduction already. So, for people that were hit with AMT, they may not be hurt as much as they previously thought.
[00:09:35] Andrew: Okay. So, it may not be as ugly as some of what the news has been reporting and so forth.
[00:09:40] Jeff: Yeah. I mean, we talked earlier about the spot that was on the CBS This Morning or earlier today and one of the tax returns actually had to be calculated was for a family in California who before they saw the results fear that they’d be in a much worse situation. They made somewhere around $300,000, $350,000. They had very, very large state and local income tax deduction. And when I put everything together and I looked at all the different provisions of the bills and how it would impact them, the repeal of the AMT, the changes in the tax rates, the reduction of their deduction which is a negative but coupled with that let’s say an increase in the child tax credit, at the end of the day that family who thought they were probably going to end up paying more, my estimate is that they were going to actually end up paying $13,000 less. So, it’s very hard to look at just one single provision of this bill and figure out how it’s going to impact you. It’s really got to be looked at in its totality.
[00:10:34] Andrew: And one thing that they were looking at is how do we simplify the tax bill? Well, obviously, you and I both know no matter when they do these sweeping reforms, it’s not going to simplify it. It’s going to make it in some cases more complex but let’s talk about the standard deductions and the exemptions and what they were in a sense striving for in the case of maybe eliminating or minimizing some of the itemization that about 30% of the taxpayers we’re using. So, walk us through what that means and then the elimination of the personal exemption and how it kind of all correlates.
[00:11:07] Jeff: Sure. So, the biggest benefit really is that a lot of people now who were not previously using the standard deduction will do so, and that does a couple of things. First off, it makes the taxpayers life a little bit easier. You don’t have to keep track of all these receipts, etcetera. You just go in and take the standard deduction. It also helps from a compliance aspect in that you don’t really have to audit individuals with standard deductions the same way as you would individuals with itemized. In other words, you can’t really cheat on your standard deduction. It really is what it is. It’s much more difficult rather to cheat when you have that standard deduction. So, audit rates for those individuals will go down, etcetera. A good example of this would be let’s imagine that this year you’re a married couple and you file a return and it’s a joint return, your standard deduction is about $12,000 give or take.
Now let’s suppose that you have $18,000 of itemized deductions this year because that $18,000 when I say this year, of course, being the rest of 2017. For 2017, that $18,000 exceeds your standard deduction of roughly $12,000, therefore, instead of taking a standard deduction, you would itemize and be able to deduct that $18,000 of income off of your tax return. However, if we fast-forward until next year, that standard deduction is now going up to $24,000 for the married couple. And so, at that level, at that point, that $24,000 now exceeds the $18,000 itemized deductions you have no longer matter and instead of taking the itemization, that taxpayer would now switch to the standard deduction. So, just a quick tax planning point for those of you that may be listening to this before the end of the year, if that’s you and you’re going to go from being an itemized filer to a standard deduction filer next year, one of the things you might think about doing before the end of 2017 is accelerating certain deductions.
[00:13:09] Jeff: For instance, maybe you give to charity $1,000 a year. Maybe instead of giving just $1,000 this year and $1,000 next year, why don’t you make next year’s contribution December 31 this year and kind of count it in your own mind towards next year. This way you still get the benefit on your itemized deductions this year and you don’t lose out on the benefit when you switch to the standard deduction.
[00:13:30] Andrew: And on that note, when we look at the state income tax going up, can we prepay our 2018 state and local taxes before end of year?
[00:13:40] Jeff: You can always prepay your taxes. The government will always be happy to take your money. Now the other question though is can you deduct it? Now that’s a different question. That’s a horse of a different color, right? And interestingly enough, when they wrote this tax bill and, Andrew, I suspect you know this which is why you asked, they included a provision that said if you prepay your 2018 income taxes which is a very common strategy for people to do at the end of year is bunch tax deduction then they will actually treat any amount paid for 2018 state and local income taxes as a 2018 payment. In other words, you’d be able to deduct in 2018 but not in 2017 so that doesn’t work unfortunately and that actually strikes in the face of the advice that many tax professionals including myself were giving before this final bill came out because that little wrinkle was not included in either the previous House or Senate version. It was kind of a surprise.
[00:14:37] Andrew: When you were talking about the standard deduction going up, personal exemption is going away. Now you touched a little bit on the child tax credit and a lot of the listeners out there they’re business owners and they’re growing their family. Let’s dig in a little bit about what that means and how the child tax credits are going to work and how they can be a benefit for those that do have multiple children, etcetera.
[00:15:01] Jeff: Yeah. That’s one of the biggest changes and certainly families with multiple children, many of them are going to be in for a very pleasant surprise when they look at their tax returns next year. And when I say next year, I guess, it’s going to be in April of 2019 but the 2018 tax return. So, first, you mentioned personal exemptions. This is another way in which the Tax Cut and the Jobs Act is seeking to simplify the tax code. So before, in general, if you are married you’d be able to take one exemption for you, one exemption for your spouse, and then if you had children you generally be able to claim them as dependents and take an additional deduction for each of their exemptions as well. Now this year 2017, each person was worth about a $4,000 deduction. So, if you had a family of four, unless you are very high earners where that would get phased out, you’ll be able to take the $16,000 deduction roughly speaking for personal exemptions. That’s going away next year. It’s kind of rolled up in the larger standard deduction and that again on its own is not a great thing.
However, when you couple that with the increased child tax credit that a lot of families will receive, this is going to be a big boom. Currently today, the child tax credit in 2017 you get a maximum of a $1,000 credit for each child under the age of 17. Going forward, that’s doubling to $2,000. Now that’s a big change in and of itself but the bigger change for a lot of families out there is going to be the increase in the amount of income you can have and still qualify for that tax credit. For instance, right now at $110,000, that credit begins to get phased out for married couples filing a joint return. Now I know $110,000 is nothing to sneeze at and that’s a pretty good amount of income for a lot of people but there are also a decent amount of Americans out there raising kids, frankly, they lose that tax benefit at that level.
[00:17:00] Jeff: Again, just going back to kind of my neck in the woods, it’s very expensive to raise kids here in this area of the country and not surprising, there’s a lot of people that will end up losing out on those credits in this area. Under the new law, that phase out where you can still make below that amount of that income and claim the credit goes from about 110,000 for joint filers, all the way up to $400,000. So, imagine now, just quick, let’s say you have a family with three kids and the mom and dad each make $100,000 a year so they have $200,000 of total income. Pretty good income. That family today would get zero dollars of child tax credit because they’re completely phased out. Going forward, however, they’re below $400,000. So, no longer are they phased out and that credit is doubling from $1,000 to $2,000 per eligible child. Three eligible children times $2,000 each, a $6,000 dollar-for-dollar credit reduction in that couple’s taxes next year in 2018. That’s a big difference.
[00:18:07] Andrew: Yeah. That’s real money. That’s real money in your pocket. Now the question that a lot will ask is, okay, we’ve got these phased out numbers, $400,000 adjusted gross income. So, what does that mean for the business owner? If they come in at $404,000 of income, do they get zero of that tax credit then? It completely phases out?
[00:18:28] Jeff: No. There’s a phase-out range so it’s going to gradually go away. I believe it’s $50 of credit reduction for every $1,000 over the threshold. So that’s one of those things where it will go away fairly quickly but if you’re just over it then it’s not like a cliff where you hit $400,001 and that last dollar cost you $6,000 of credit. It doesn’t work like that.
[00:18:52] Andrew: And then for the listeners that put away money into whether it be 401(k)s or SEP-IRA accounts or defined-benefit plans, would that come off as a deduction? So, ultimately let’s say that I put away 50+ thousand, maxed out my SEP-IRA account in 2018, what would that look like in regard to situations like this with the phase-out? Would that come off the top line or the bottom line? Or below the line?
[00:19:17] Jeff: Yeah. Generally, AGI deductions or SEP, simple IRAs are generally looking at above the line deductions. So, when we’re looking at comparing AGI, it’s a very important metric to be looking at there.
[00:19:29] Andrew: Perfect. So, those of you that are building your business and earning good income, it is imperative to diversify having all of your risk in the business and look at saving for the longer term and then understanding by saving the tax dollars that you’re saving and then also potentially protecting from losing some of these credits due to the phase-out. So, that’s where planning, listeners, doesn’t just happen on April 10. You need to start planning now and you need to be working with your financial team to make sure that you’re understanding how this is going to look, how your cash flow is going to look, what you should ultimately do in regard to funding or expensing the business and then also looking out through retirement.
Jeff, as you know, working with lots and lots of clients, too many times business owners forget to put money for the long-term. They’re just so focused on growing the business and that’s a lot of risks when you’ve got it all in the business and then you may not have the ability down the road to have other avenues to create income if the business doesn’t continue working out and that’s something that you got to be proactive in that planning.
So, we’ll circle back. I want to talk a little bit about the itemization and how that’s affected with the mortgages and home equity. But before we do that, I know we’re just talking about the tax and families and child taxes. So, with regards to 529 that I know a lot of people do use to save for higher education, they did expand that now to include K-12 also allowing for private school tuition. So, walk us through what that looks like and why that may make sense for somebody who hadn’t been funding the 529 to look at that as a viable option.
[00:21:08] Jeff: Sure. Frankly, there are a lot of people who aren’t so sure that their child or other family member are even going to go to college. Well, what if they get a scholarship? These are the things that people worry about and sometimes they are a little bit hesitant to fund a 529 plan. Now, it is a big change though to now go to elementary and to secondary school because previously, it had to be for higher education which is essentially college and up, could be vocational school after high school as well but generally you’re looking at college, graduate school, etcetera. And so, one of the big changes here is that you can now use it for these lower levels of education, elementary school, and high school. Private school, even homeschooling included here up to $10,000, one of the big benefits of the 529 plan is that it has tax-free appreciation and you are able to take the funds out of that 529 plan and use it for those qualified education expenses and any gains are not taxable.
So, let’s say you put $5,000 into a 529 plan a couple of years ago. The market’s been really good and now that $5,000 has gone up to $11,000. If you take that $11,000 out today and you spend it on college, there is no tax liability at all owed on that, even the gain. And you don’t pay taxes on the interest, dividends, capital gains while it’s in the 529 plan either, very similar to the way an IRA works. So, it’s a real big benefit for individuals who are able to get that sort of growth inside the 529 accounts who then use those funds to pay for qualified education expenses. And again, those expenses going forward will include primary school, secondary school, as well as homeschooling. So that’s one big benefit.
[00:22:52] Jeff: The other thing is that some states like for instance my state, New York, we offer a state tax deduction for 529 plan contributions and that’s important because the big benefit of the 529 plan, in general, is the ability to use the gains tax-free, pay for education. But with that state tax deduction, let’s say I’m paying $10,000 a year for my child to go to private school today, I’d be better off in New York now just putting it right into the 529 plan and then taking it right back out because I still get my state income tax deduction.
[00:23:23] Andrew: And you indicated not every state, right? I know Arizona, where I reside, there is a minimal deduction, but it isn’t where it’s every state has that. You have to look to see.
[00:23:34] Jeff: No, not at all. It’s a state-by-state basis and everybody needs to make sure that they’re looking at their own state’s rules. Yep.
[00:23:40] Andrew: Okay. Great. I haven’t seen anything on what I think is one of the best longer-term in a sense investment is the health savings account. Was there anything on the HSA side that they changed or is everything in business, as usual, moving forward in 2018 and beyond?
[00:23:56] Jeff: It’s pretty much status quo. What I always caution people is that almost any time to change a tax law and someone asked the question, is there any change to X? The answer is almost always yes but a lot of times it’s not a direct change. It’ll be some sort of indirect change that, for instance, we just talked about the child tax credit before and how that’s calculated based on someone’s AGI. Actually, technically it’s modified adjusted gross income which is AGI plus a few changes here or there but that means that anything that changes AGI could impact someone’s ability to claim the child tax credit. There’s not a lot but there are a few things in this tax bill that could change a person’s AGI, all things otherwise being equal. So, there’s always those indirect kind of gotchya’s and that’s why, again I think I mentioned this earlier, you can’t just look at any single provision of the law and judge how it’s going to impact you.
You really have to go through it and I’ve actually now done mocked tax returns by hand because, obviously, the online forms or even tax software for sure are out to help us cover this or to help us project this. So, I’ve done a couple of these tax returns by hand and there’s been a couple of people that I thought that would actually see significant increases but when we looked at some other provisions, they saw decreases. And I’ve also seen a few returns now where it’s going the other way. We thought they would actually end up paying a little bit less and it turns out they’re going to pay a little bit more because of some other provision that impacted things. It’s almost like a pinball machine. Instead of one little spot and all the bells and whistles, everything starts humming.
[00:25:32] Andrew: Yeah. I mean, so in reality, for especially individuals, some may win, some may lose but it’s not going to be this huge difference for a lot of people of what they’ve been paying.
[00:25:43] Jeff: No. For individuals, most people are projected to fare a little bit better under the tax law but the biggest changes, not surprisingly, are going to be at those with the highest income. So, as individuals have more income, the likelihood of in terms of percentage change for last year and dollar amount, both of those are skewing more heavily towards the higher income person.
[00:26:06] Andrew: We talked a little bit about the HSA but those of you that qualify and that are not contributing to an HSA, it’s like you’re missing the boat. It’s one of those assets or one of those ability for you to get kind of the triple combo and this is the pinnacle when we’re looking for how to utilize retirement savings and tax deductions. But when you look at an HSA as a family under 55, 2018 max is $6,900 and as you put that money in, it’s a straight deduction right off of your income then you have the ability to invest it. So, the money grows tax-deferred similar to your IRAs, 401(k)s, even like the 529 plan, as well as the Roth. The main difference though is when you take this out, it’s tax-free if using for qualified medical, Medicare premiums, etcetera. So, are you a big proponent of the HSA if somebody qualifies there to get the triple combo of the deduction, the tax deferral, and then the tax-free when it comes out?
[00:27:08] Jeff: Oh, 100%. It’s the best account out there. It is the single greatest tax account or account from a tax perspective that exists. You’re getting the tax benefit of the traditional IRA tax deduction and the tax benefit of Roth IRA tax redistribution all rolled up into one account. Now, again, it’s got to be used for healthcare expenses but let’s face it, who doesn’t have healthcare expenses today? It’s one of the biggest cost that a lot of Americans have and if you don’t use it right now, you can just let it keep growing so that when you have expenses in the future, you use them then. So, yeah, 100% I couldn’t agree with you more, Andrew.
[00:27:43] Andrew: And I’ve changed it even how I use it individually as I had put the money in and then we would take it out for prescriptions or if there was…
[00:27:51] Jeff: You use it as the medical account slush fund, right, like most people?
[00:27:54] Andrew: Yeah. And I think I changed my tune about a year-and-a-half ago and I started thinking about this and I know you’ve addressed this and talk about the benefits. And I want you, listeners, to really think about this as not so much as the present of using it as that slush fund but think of it more of a longer-term investment strategy just like your other retirement accounts. And I think that with the HSA, we’re going to start seeing especially in the financial planning side, more and more looking at that for the longer term and building up accounts that have 60, 70, if not six figures in it because one thing we know to be true, Jeff, we don’t know how long we’re going to live but we know healthcare costs are increasing and most people are living a lot longer than they ever thought they would.
[00:28:33] Jeff: Absolutely. It’s one of those things that people should really, really look at. And if you have the money, again, I can’t emphasize what Andrew is saying, the key here is if you have the ability to do it, you fund your HSA and then forget it exists. That’s not where you turn to pay your medical expenses. Pay them with the cash in your pocket. It might feel like you’re paying a lot more for healthcare right now but you’re going to save ten-fold down the road when you need it even more and when you don’t have to pay for the tax bill when it comes out.
[00:29:03] Andrew: Yeah. I mean, there’s not many no-brainers out there. This is one. And even if you can’t max out, put a little bit away and think of it as a combination of that and saving for your retirement. So, let’s shift to mortgage interest deduction. I know this has been a hot button and we had two different types of mortgage deductions that some have changed to not drastically and then some have changed quite drastically. So, walk the listeners through what the final bill has in regard to primary home, mortgage interest deduction, and how that’s going to look and work, and then we’ll talk a little bit about home equity.
[00:29:36] Jeff: Got you. So, let’s start with the mortgage interest. Good news is for those of you that have had your mortgage in place before December 15, there’s absolutely zero change. You’re grandfathered in for the tax treatment of your old mortgages. For those of you that had a mortgage that started on December 15 or later or you’re going to get one in the future, there is an important change that you used to be able to deduct the interest on up to a $1 million mortgage. That is now dropping to $750,000. However, one of the changes or one of the change that they did not make was there was a lot of talk of making this applicable only to a primary home in a real gift let’s say to the housing market or the real estate industry or the real estate lobby maybe, they kept the second house available as well. So, you can take up to a mortgage interest deduction still on your tax return going forward for a mortgage of up to $750,000 split between any two homes. Now you also mentioned home equity loans. That’s where we’re going to see the bigger change.
[00:30:41] Andrew: And, well, before we jump into home equity loan, and even in the old version, the million dollars that people are grandfathered in, how do we track that? I mean, you look at each and every year, you get the 1099 from the mortgage company and ultimately show you how much interest that you did pay. Who’s tracking this limit of a million and now moving forward to 750?
[00:31:01] Jeff: Well, listen, it’s like all things. Ultimately, no matter what you get from a company on a 1099 or anything, at the end of the day, the bottom line is when you put something on your tax return, when you say this is true, the IRS doesn’t care where that information came from. You are responsible for the information that’s on your tax return and for complying with the tax laws. I mean, we see this all the time. Even with things like required minimum distribution, people say, “Well, I took it because that’s what the company calculated.” I mean, if the company calculate it wrong, yeah, they calculate it wrong, but you’re still responsible for doing the right thing. It’s the same thing here. At the end of the day, the taxpayer is responsible for managing their affairs and for complying with the law.
[00:31:45] Andrew: I think too with algorithms and so forth especially like RMBs, they always think in your mind they’re going to catch you if you’re not following through and I always like to think about it as before you make any decisions and kind of taking things to that gray area, it’s almost think of the IRS standing right behind you and they’re watching over you making that decision because ultimately you got to look at it as you’re going to get figured out at some point. So, just be careful there everybody. So, when it comes to home equity line of credits, this has been a major bone of contention maybe within the real estate community, etcetera. What’s happened there? What did they make a change on moving forward?
[00:32:21] Jeff: It’s just gone. I mean, this one’s pretty easy to explain. Coming forward in 2018, if you have a home equity loan, you are no longer be able to deduct that interest with the one caveat that if you’re using it as a qualified mortgage indebtedness. Let’s say you want to build a second floor in your home then it’s treated almost like a mortgage at that point and you can deduct it but your general home equity loan, “Hey, I need extra money. I’m running short. I want to pay off other bills,” you’re not going to be able to deduct that interest.
[00:32:48] Andrew: Well, is that grandfathered in to people that currently have a home equity line of credit that they’ve been utilizing all these years?
[00:32:54] Jeff: It is not.
[00:32:55] Andrew: Ooh. It is not, ladies and gentlemen. It’s not grandfathered in. I think that could have some major changes. You think it could affect real estate prices or, ultimately, people using that to pay down credit cards, etcetera?
[00:33:09] Jeff: Yeah. Sure. I mean, look, any time you change the tax treatment of anything, it’s going to impact how people react. For instance, you always hear, “Oh, it’s good debt because it’s deductible.” Well, there’s a lot of arguments you made whether any debt is good debt or bad debt but it’s certainly a lot. It’s not as good as it was before, let’s say that, because let’s say you’re in a 25% tax bracket and we’re paying 4% home equity loan interest, you’re really paying a 3% home equity loan interest on an after-tax basis. Now you’re back paying a real 4% rate. So, there is a big difference there and yeah, sure, I would impact. I would expect that to impact people’s actions without a doubt.
[00:33:48] Andrew: Well, then also a lot of these home equity line of credits are variable rates. And as interest rates are starting to pick up and the Fed Reserve indicates that they’re probably going to increase it a couple of times more next year, this is something that without getting that deduction, there may be in our side here there’s planning of looking at this debt as not as good as it used to be and then figuring out how do we get that paid down. Because, ultimately, it may make more sense to use other assets that you’ve been letting grow or maybe having in the market and seeing that upside that we’ve seen in equities and using some of that to systematically pay down the home equity line of credit. And I think it’s also, I mean, it could be a good thing, people not using their home like they did in the mid-2000s as now a lot of people have equity to get in that home and not using it to make dumb decisions or dumb investments.
[00:34:35] Jeff: Absolutely. Yeah. And as you mentioned, with rates rising, the bigger the rates go, the more this change of eliminating that deduction will impact people.
[00:34:42] Andrew: So, Roth IRAs and conversion, this is something you and I love, and we live and breathe it. So, there was a major overhaul with regards to the characterization or the recharacterization of a Roth conversion. For those of you that aren’t in the world like Jeff and I are, Jeff, can you kind of simplify that what that means in regard to what is going to be taken away moving forward in 2018 and the impact that that’s going to have potentially on the Roth conversion strategy?
[00:35:09] Jeff: Sure. There’s an elimination of the Roth recharacterization which is just a fancy word that people like me and Andrew used to say, undo. It’s a tax word. It just means undo. I’m going to make it like it never existed. So, when you do a Roth recharacterization, you eliminate the tax bill that was owed on that initial conversion and that’s a huge change going forward because right now we were able to undo a – we were always able to undo a conversion up until October 15 of the year following the year the conversion occurred. And because of this change, we will no longer have this flexibility. Now that means we must be very confident that we can pay the tax bill that will be generated from that conversion before we make it because we won’t be able to reverse it.
The other thing it does is it really changes the paradigm of Roth conversion planning. Right now, it’s always been better to convert early in the year because, “Hey, what’s the big deal? If the worse comes to worst, I’ll undo it,” and converting early in the year give you more time to evaluate that. Converting on January 1 gave you 21.5 months to decide if you wanted to keep it. Converting on December 31 gave you 9.5 months and more time is valuable. That’s why people pay more for options that go out further from a time perspective. So, it was always better to convert early in the year. Now I’m questioning that. I actually think going forward, it would make sense to convert later in the year. Why? Aren’t you losing out on what could be tax-free appreciation during the year? Yes. That’s the downside of what I’m suggesting. But the upside is that by the end of the year, you have a much better handle on what your income looks like for the year and what your deductions will be. And so, you can make a much more accurate projection come that time as to whether or not that Roth conversion makes sense for you even to begin with.
[00:37:02] Andrew: And if this whole Roth conversion topic is new to you, listeners, make sure you go back to your advisor and you talk to them and say, “How does this Roth conversion, how could it potentially fit into my overall strategy?” We’re firm believers of it and looking at the tax brackets and looking at paying a little bit of tax today, converting that to tax-free later, as Jeff and I work with a lot of those that are now getting to the top of retirement and they built up hundreds, if not millions of dollars in qualified pre-tax, it does become a ticking tax time bomb. And if there are ways to alleviate that and pay a little bit tax where we believe that over these next seven, eight, nine years, the taxes are going to be the lowest that we’re going to see in our lifetime, it’s a long-term strategy where it’s a little painful today but a lot of benefit for the long-term. So, just make sure having those conversations with your advisory team. And then one that I know of, Jim Morrison was still here with us that he would love the backdoor Roth and ultimately, they didn’t take that away. So, this is for those of you that are higher income that are phased out of contributing to a Roth IRA which I believe next year is all just about 200,000 of AGI. What’s going on with the backdoor Roth? So, they kept that in there, luckily?
[00:38:16] Jeff: Yeah. They did. Actually, they did. Now, of course, you won’t be able to undo that conversion anymore but, yes, they did keep the backdoor Roth in there. Now that’s a great strategy for people who are phased out of that Roth IRA contribution, who really want to get money in there and want to have tax-free dollars in the future without a doubt.
[00:38:32] Andrew: So, basically, a simple applied version of it is that you contribute to a pretax or a traditional IRA. For those of you, you may not and probably won’t get, well, in this case, you want to get the deduction but then taking that pretax money, you didn’t get the deduction then you convert it to a Roth so you’re paying taxes on it today but then you’re allowing it to grow tax-free forever. Would you say that’s the simplified version of what the backdoor works if people are trying to understand it?
[00:38:57] Jeff: Yeah. Absolutely. It’s where, again, because there’s no limit on the income that you can contribute or rather no limit on the income when it comes to making a traditional IRA contribution. You put that money into the traditional IRA again, and you mentioned you may not have a deduction at that point but that’s okay. Who cares? Because if you don’t get a deduction, you’re now just taking after-tax money and converting it and you don’t pay tax on after-tax money. So, it’s six to one half a dozen other.
The only difference or the only thing to watch out here is that if you have any other IRA accounts so you have existing IRA accounts that are held in other institutions or with other advisors or anywhere else, any traditional even including your simple IRAs or SEP-IRAs provided by employers, those balances kind of get aggregated together with that contribution you just made and it’s something known as the pro-rata rule can actually limit the benefit of this backdoor strategy. So, bottom line is without getting too complicated, if you have other IRA money, you really want to make sure that you’re checking with your tax or your financial advisor to make sure that the strategy will work for you.
[00:40:06] Andrew: Awesome stuff. And as we kind of wind down and thanks, Jeff, for spending the time. I know how busy you are this time of year, especially with all these changes. Let’s just touch on the deduction or the changes and, first just high level, the corporate tax for the C corp but then let’s spend a little bit of time just for a lot of our listeners out there or business owners and/or pass-through entities whether it’ll be an LLC or filing as an S corp, what are some of the changes in regard to that and the longer term thinking of that back to what you said earlier, that trickle down effect?
[00:40:36] Jeff: Sure. Again, if you put money back into the hands of the business owners, the theory here is that those business owners will use it to go out and hire more people or will invest in infrastructure, will use it to grow their businesses even larger, to employ more people, etcetera. And so, as part of that and perhaps more from a political perspective since so much was done on the corporate tax code, there were some changes made to the pass-through deductions for businesses like S corporations, sole proprietorships even, and also partnerships. If you’re an LLC, there is no LLC taxation at the federal level. You’re either going to be taxed as an S corp or you’ll be taxed as a partnership generally. So, those types of businesses all kind of fall into this pass-through category. Now what they did was they created a new deduction, a new 20% deduction on pass-through income.
Now what’s interesting is that the business itself is not getting the deduction. So, actually, a deduction that the person, a taxpayer would take on their own return and it’s a new category of deduction on an individual’s return because it’s not an above-the-line deduction. In other words, it doesn’t subtract from gross income to arrive at that AGI limit we talked about before. It does not help to reduce adjusted gross income. However, you can take that deduction even if you don’t itemize. So, you might have heard things before called above-the-line deductions or below-the-line deductions. That line that those terms are referring to is AGI. And so, this isn’t an above-the-line deduction. It’s not a below-the-line deduction. It’s actually what some people are now calling an in-between-the-line deduction just to make things even more complicated. I got to have a job there. That’s really what it comes down to. So, this new in-between-the-line deduction will allow individuals who receive pass-through income from these businesses to deduct up to 20% of those amounts on their tax return.
[00:42:35] Jeff: Now the good news is that for people making below certain income thresholds, you’ll be able to take that deduction no matter what. It doesn’t matter how much you pay in salary. It doesn’t matter how much you invest in depreciable assets. For taxpayers with larger income, for taxpayers with income in excess of certain thresholds, they are going to have to, and by the way, those thresholds are $157,000 roughly for single filers and roughly $315,000 for married couples. If your income is over those thresholds, then you’re going to have to start looking at various tests. For instance, one test looks at how much wages did you pay out and it limits the deduction to a percentage of the wages you paid out. Another test looks at a combination of wages and depreciable assets.
Now you might have been listening to the television, the radio, read online about something called what the Democrats at least are calling the corporate kickback. You’ve probably seen articles about this bill enriching real estate investors. This is what they’re talking about, this 20% deduction on a pass-through income in instances where there’s wages paid or large depreciable assets and obviously buildings. Property is one of the biggest categories of depreciable assets there is. So, that’s kind of what’s been out there in the news. Bottom line though is that these business owners should, in most cases or many instances, pay less tax on the business income than they otherwise would, thanks to this new potential 20% pass-through deduction. It is without a doubt one of the most complicated aspects of the new law. Andrew, I think we could do like maybe another 45-minute podcast just on this one provision and we might still run out of time. So, for anybody in that case…
[00:44:32] Andrew: Yes, indeed. And hopefully the listeners wouldn’t have fallen asleep if we did that, but I think for the same thinking though is if I have more money in my pocket as a business owner, I am going to hire more, increase wages, and invest in the business. And I think on the small business side, those listeners out there, I think that’s definitely going to ring true, definitely know it’s complicated and the one thing too is don’t screw with the system. You still have to take a reasonable salary. Don’t look at it as I’m going to lower my salary, and everything is going to be distributions. I think the IRS is going to definitely be looking at this and trying to figure out because it’s all about that cat and mouse.
So, just be careful. Don’t take it to that gray level but make sure that you understand how it works and how to utilize it because this is potentially real money in your pocket that then you can use to grow the business. On the corporate side, pretty simple in this world. We lowered it from 35 to 21 and the thinking there again is you had said is the businesses, the corporations, hopefully, will grow their business, increase wages, hire more. I guess that’s going to be up to a time will tell. We look back to the 80s to see if that actually worked but is that kind of what your thinking is that we don’t know? We just don’t know if it’s going to work or not?
[00:45:49] Jeff: Yeah. I mean there have been times when it’s worked and the times when it hasn’t. And frankly, there are economists that spend their entire lives devoted to this very subject and we still don’t have an answer.
[00:46:00] Andrew: Well, the one thing and you’re starting to see this now with Wells Fargo and I think AT&T. Who knows? Is it just PR? But they’re providing bonuses to a lot of employees. I think AT&T was over 200,000 employees are going to get some small bonus that they’re going to bring down. So, I mean, that’s a great PR. I think the real benefit will be if the shareholders, the executives don’t line their pockets with buybacks and increased salary for the higher executives and they really take the additional savings and they plow back into the economy and invest in the business. And I guess that’s going to be one that we’ll talk a couple of years from now to see if that actually work. Maybe a decade from now, we’ll see if it worked.
[00:46:45] Jeff: Yeah. That sounds like a plan.
[00:46:46] Andrew: Cool. All right. Well, listen, Jeff, I know we went through a lot, listeners. The key component here is there’s a lot of good stuff in this tax reform bill. There’s maybe some negative but hopefully today Jeff was able to bring a high level for you guys as to how that’s going to affect you and ultimately make sure before you do any decision-making that you sit with your financial team. If you have questions, Jeff, what’s the best way to somebody reach out to you? Is it just go to your website that they can then hit a Contact Us and if they have questions on how this affects them that you guys would be able to provide some answers to them?
[00:47:23] Jeff: Yeah. They can do that or if they’re always welcome to email us directly. They can just go to firstname.lastname@example.org and be happy to answer whatever questions that we see.
[00:47:33] Andrew: Wonderful. Well, Jeff, thanks again and one day I won’t be waiting for next year and the Browns will actually beat the Steelers and then we’ll have a podcast just on that. But until that day, continued good success with the Steelers and hopefully, they can take it this year.
[00:47:48] Jeff: That sounds good. And, listen, I hope I speak to you before that and I hope that day never comes.
[00:47:54] Andrew: Oh man, you sound like my daughter now. She’s like, “Daddy, why do you watch them on Sundays?” But hey, it’s just ingrained in us. But anyway, thanks again, listeners, and tune in later. Well, I guess it will be in January for the next episode of Your Wealth & Beyond. Have a wonderful New Year, happy holidays, be safe, and we’ll talk to you next year. Thanks.
Thank you for joining me for today’s episode of Your Wealth & Beyond. To get access to all the resources mentioned during today’s podcast, please visit Bayntree.com/Podcast, and be sure to tune in later this month for another episode of Your Wealth & Beyond.
Investment advice is offered through Bayntree Wealth Advisors, LLC, a registered investment advisor. Insurance and annuity products are offered separately through Bayntree Planning Group, LLC. Bayntree is not permitted to offer and no statement made during the show shall constitute legal or tax advice. You should talk to a qualified professional before making any decisions about your personal situation.