New Dynamics and Other Things We’ve Learned Under the Trump Tax Plan

The Trump Administration tax plan implemented in 2018 not only brought terms such as “lumping,” “bunching,” “SALT” (short for state and local taxes) and “pass-through business” into the mainstream personal finance and tax lexicon, it also has ushered in a variety of new tax strategies since taking hold almost two years ago.

What have personal finance and tax experts learned about efficiently managing taxes under the Tax Cuts and Jobs Act of 2017? Here’s a look at some of the maneuvers that are proving popular among financial/tax professionals and their clients:

Lumping/bunching/stacking deductions. The 2017 tax law brought an increase in the standard deduction to $12,000 indexed  ($12,200 for 2019) for individuals and $24,000 indexed ($24,400 for 2019) for married couples filing jointly, up from $6,500 and $13,000, respectively. It also eliminated the $4,050 personal exemption for each person claimed on a federal tax return, while altering the tax-deductibility of widely used personal deductions, including charitable donations, state and local taxes, mortgage interest, medical expenses and more.

All those changes have meant that many people who itemized their income tax deductions under previous tax policy (using Schedule A on their federal tax form) now take the standard deduction, chiefly because their itemized deductions aren’t collectively sizable enough each year to warrant claiming them rather than the standard deduction. As a result, more taxpayers have resorted to concentrating multiple years’ worth of deductions — including charitable donations, medical expenses and state/local taxes — into a single year, an approach termed lumping, bunching or stacking. Instead of taxpayers itemizing their deductions each year, the bunching/lumping/stacking approach may mean they itemize every two or three tax years, and claim the standard deduction in other years, explains FPA member and CERTIFIED FINANCIAL PLANNER™ (CFP®) professional Tim Doehrmann, founder and president of Eagle Ridge Wealth Advisors in Morton, Ill.

Larger charitable gestures via donor advised funds. With the emergence of bunching/lumping/stacking strategies, Doehrmann says, more charitably inclined taxpayers are turning to a giving vehicle known as the donor advised fund, in which one can contribute cash, stocks and/or other assets such as real estate. The donor then advises the fund administrator to which IRS-qualified charity or charities they wish to donate. This structure enables a person to claim a charitable deduction for the full amount of the donation in a single year (provided the amount of their itemized deductions exceeds the amount of the standard deduction), then spread their charitable donations over a period of years via the donor advised fund.

Direct donations of appreciated assets. Another important tax consideration for the charitably inclined: donating securities (such as stock holdings) whose value has appreciated in the time you’ve owned them allows you to avoid having to pay capital gains taxes that you otherwise would have incurred if you sold the securities. If in a given year the amount of donated assets exceeds the standard deduction, the taxpayer would benefit from a) not recognizing the capital gain associated with the appreciated value of those securities and b) receiving the tax deduction for the charitable donation. Here’s another scenario to consider using a donor advised fund, according to FPA member Scott A. Bishop, CFP®, executive vice president for financial planning at STA Wealth Management in Houston, TX. “DAFs are also a good way to unload appreciated securities without paying capital gains taxes” on those securities, he explains. “And when taxpayers put their appreciated securities into a DAF, they get to deduct the full current value of those securities from their taxable income that year.”

Roth IRA contributions. The 2017 tax program reduced income tax rates virtually across the board. Based on an assumption that income tax rates eventually will go higher, the current lower tax brackets make prioritizing contributions to a Roth IRA a wise move for some taxpayers. With a Roth IRA, contributions are taxed on the way in, unlike with a 401(k) or traditional IRA, where money is taxed on the way out, once distributions begin, typically at age 70.5. This strategy appeals to people who believe the prevailing tax rate that applies to Roth contributions made today will be lower than the rate they’re likely to pay on the distributions they will take later from tax-deferred retirement accounts.

Roth IRA conversions. The same logic — capitalizing on today’s lower tax rates, assuming those rates are likely to be higher later — is prompting taxpayers to convert qualified assets in 401(k)s, traditional IRAs, etc., into Roth IRAs. “It’s a good way to leverage the low tax brackets,” says Doehrmann.

Such a maneuver typically entails paying taxes on the converted amount during the tax year in which the conversion is executed. What’s more, given the relatively low rates at which people in lower income brackets are being taxed under the current federal tax program, people in lower income brackets, such as new retirees, could see particular benefit from a Roth conversion, he explains. “It’s a way to diversify the tax treatment of your retirement assets, so you have more options” in how you ultimately draw down retirement assets.

Adds Conshohocken, Pa.-based FPA member Sean M. Pearson, CFP®, CLU®: “If you start [making Roth conversions] now, you can create a plan to convert part or all of an IRA or old 401(k) into a Roth account, which makes the growth of the account tax-free in the future — and therefore more accessible in an emergency,” because Roth accounts generally provide more flexibility with withdrawals than qualified tax-deferred retirement accounts.

Stock market investing. Corporations as a whole have flourished as a result of the Trump tax plan’s lowering of the corporate tax rate from 35% to 21%. The lower rate has increased corporate earnings, which in turn can contribute to higher stock values. As a result, investments in the stock market, either in the form of shares of individual company stock, mutual funds, etc., are likely to appreciate at a higher rate than they might otherwise. It’s important to keep in mind, however, that even with lower corporate tax rates, stock market investments and other equity investments still are subject to market risk — to the risk that they will lose value.

Saving for a child’s education. So-called 529 savings plans have long been a popular tax-favored vehicle for saving toward a college education. The Trump tax program expanded how funds in 529 plans can be used, allowing up to $10,000 annually to be withdrawn to cover tuition expenses for enrollment at an elementary or high school. Here it’s important to note that certain states do not recognize the federal government’s broader definition for 529 plans and still only allow 529 funds to be used penalty-free for higher education (college or graduate school but not high school or elementary school). Check with the appropriate 529 plan administrator to determine your state’s status.

November 2019 — This column is provided by the Financial Planning Association® (FPA®) and FPA of Central Florida, the principal membership organization for Certified Financial PlannerTM professionals. FPA seeks to elevate a profession that transforms lives through the power of financial planning. Through a collaborative effort to provide members with tools and resources for professional education, business support, advocacy and community, FPA is the indispensable resource in the advancement of today’s CERTIFIED FINANCIAL PLANNER™ professional. Please credit FPA of Central Florida if you use this column in whole or in part. The Financial Planning Association is the owner of trademark, service mark and collective membership mark rights in: FPA, FPA/Logo and FINANCIAL PLANNING ASSOCIATION.  The marks may not be used without written permission from the Financial Planning Association.