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How Advisors on Each Coast Help Clients Navigate New Tax Code

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Advisors typically do not like to give their clients surprises but that’s what’s happening at some year-end planning meetings. “It’s a tale of two tax payers this year,” says Beverly Hills-based advisor Jeff Fishman. “If you’re a high-net-worth individual making seven figures, the impact of the new tax code on your finances is likely going to be far different than that of a mid-level earner, especially for those who reside in high-tax states.”

On the opposite side of the country in Farmington, Connecticut, advisor Robert Karn agrees. “There’s no question,” he says from his office in a state nearly as notorious for taxes as Fishman’s native California. Karn regularly consults with clients’ accountants when providing year-end planning services. “Depending on a client’s circumstances there remain ways in which one may lessen their tax burden but it’s a new ballgame as far as explaining the landscape plus outlining and implementing new strategies,” he says.

It’s no secret that 2017′s Tax Cuts and Jobs Act aims to provide lower individual income tax rates, a doubled standard deduction and the loss of personal exemptions, impacting those in high-tax states particularly hard.

The new tax code modifies what had been a long-standing federal deduction for state and local taxes (SALT), hitting high-tax state residents such as those in California, New York, New Jersey and Connecticut particularly hard. Previously taxpayers deducted the full amount of their state and local taxes from federal taxable income. Thanks to SALT they are limited to deducting just $10,000, including property and income taxes.

Jeff Fishman

“Taxes and financial planning go hand-in-hand,” says Fishman. “While tax planning is a regular part of our process, this year as we begin to digest the new tax code, for the first time clients are getting a view in real dollar terms of how they may be affected. We’re working with accountants to generate tax projections.”

To his point, some so-called high earners, those with seven-figure salaries, will likely be paying substantially more in taxes in 2019.

“In some cases we’re looking at a tax bill increase of to $250,000 from last year,” says Fishman. “Plus the loss of the property tax deduction in some cases. ”While no one’s ever pleased about paying more in taxes, the much anticipated “shock value” among clients has actually been minimal according to Karn. “There’s been enough talk and media coverage about this so nearly everyone knows things are going to change. I have not sensed any panic among clients. Sometimes, in fact, things seem a little too quiet,” he says with a smile.

In addition to urging clients to maximize retirement plan contributions, Karn is advising clients to take all non-qualified losses, i.e., to aggressively tax harvest.

Robert Karn

“It can pay to bunch,” says Karn. With an increased standard deduction, spreading major expenses across several years may no longer be as practical as before. To maximize deductible expenses, including medical, real estate taxes and charitable contributions, it will likely pay to “bunch” them in the same tax year, enjoying the deduction each year you meet the requirements.

Qualified dividends, those meeting specific IRS criteria, are typically taxed at a lower rate than ordinary dividends (for individuals meeting the holding requirement). Some qualified-dividend tax rates can be up to 20 percentage points lower than those generated by ordinary dividends and ordinary income. This can be important for those with taxable accounts as well as for those seeking to lower future tax liability.

Playing Defense

While real estate had received relatively favorable treatment in the eyes of the IRS for generations, with rising mortgage rates and $10,000 annual SALT limitations, that favorable treatment is no longer so good.

“We’ve advised some clients on downsizing,” says Karn. “This can make financial sense, especially if the kids are gone. It will likely result in lower real estate tax and lower expenses across the board such as for insurance and maintenance. Renting can offer similar savings.”

Similarly, an impending divorce may have planning implications under the new tax code. “It eliminates alimony deductibility for divorces finalized after Dec. 31, 2018,” notes Fishman. “It’s then tax free to the recipient spouse. This needs to be factored in for pending divorces if they can be finalized before year end.”

Fishman adds that “Donor advised funds have proven to be very good for our high-net-worth clients who often like the idea that they are generally eligible to take an immediate tax deduction,” but cautions that “It helps when the client is philanthropically inclined.”

Donor advised funds have become one of the easiest and most tax-advantaged ways to give to charities. Cash, stocks or non-publicly traded assets such as real estate can be donated and the client gets a tax receipt. Further, a donation can potentially grow, providing a greater gift to a recognized charity and furnish federal and state deductions. While the funds can be distributed over an extended time period the tax deduction is immediate.

The Tax Cuts and Jobs Act is here to stay – at least until a new tax code is passed. Until then, advisors serving high-tax state residents may be well served to communicate the ramifications of the new tax code early while underscoring the potential benefits of remaining deductions.

Joseph Finora is a media consultant to financial advisors.