By Susan E. Campbell
December is good time for business people to meet with investment, accounting and tax professionals to look at the year behind and the one ahead.
At Paul Dowen’s office, Whittemore Dowen and Riccaiardelli, LLP in Queensbury, the team is working to manage retirement accounts in a way that maximizes deductions and minimizes tax liabilities under the new rules.
Even though all individual tax brackets, except the 10 percent bracket, are lower because of the Tax Cuts and Jobs Act, the experts can offer some tried-and-true tips for managing the tax burden.
“The biggest jump in the new tax tables is from the 12 percent bracket to 22 percent, so the challenge is how we keep more income at the 12 percent rate,” said Dowen. “The first step is to make sure the maximum amount allowed has been contributed to the company’s 401(k) plan.”
These plans must be funded by salary deductions before year-end, so time is running out to play catch-up.
“The new tax laws mean a tax cut or a break-even for retirees,” said Don Tenne of Tenne Financial Group in Glens Falls. But for small proprietors and the self-employed who file a Schedule C, there are two hefty tax breaks now in the code.
“Starting in 2018 there is up to a 20 percent deduction in taxable income for those businesses,” said Tenne. “If net profit is $200,000, for example, $40,000 is not taxed, a savings of $12-13,000 or more. That’s huge.”
Business owners will also be able to write off equipment purchases in the first year, within certain guidelines, rather than depreciating those costs over a period of time, he said.
“Put these two changes together and certain businesses can trim taxes like never before,” said Tenne. “When every self-employed person in town gets a deduction on income taxes, they will be in a position to hire more people, buy more equipment, and grow. We should expect to see a positive impact on our communities.”
“An employee who maxes out his 401(k) right now might have a zero paycheck, but will have taken advantage of a provision for reducing taxable income,” said Anthony Capobianco of Capobianco Financial Advisors in Clifton Park.
Traditional IRA account holders can wait until April 15 to fund the plan and claim a deduction for 2018, if eligible, as IRA deductibility is phased out by household income.
For higher-income taxpayers who earn under a set threshold, there is the non-deductible Roth IRA, and Dowen and Capobianco agree that for some, it may be a good time to convert a traditional IRA to a Roth.
Under this conversion arrangement, the plan holder pays income tax on the amount converted in the current year in exchange for the benefit of tax-free withdrawals from the Roth account, including all its earnings, over future years.
Plus, there is no required minimum distribution (RMD) from a Roth, making Roths useful for achieving estate planning and generation-skipping goals. Every retiree age 70 1/2 and older is required to take an annual RMD from a traditional IRA or 401(k) plan by Dec. 31 or face an IRS penalty, Dowen said.
“Roth conversions make sense in the long run, but not if there will be a jump in the tax bracket during the year of the conversion,” said Dowen. “This is not an easy decision and cannot be reversed once made.”
“The IRA money does not have to be converted all at once, but can be spread out, perhaps over five years, and taxed at the taxpayer’s ordinary income tax rate applicable those years,” he said.
“The concept of the Roth conversion is very good, but you have to pay the taxes at conversion out of your own pocket rather than have the IRA custodian withhold them,” said Capobianco. “That means you have to write that tax check and people are hesitant to do that.”
Dowen points out that with all “miscellaneous itemized deductions” like attorney costs, investment fees and out-of-pocket business expenses disappearing from the Schedule A starting in 2018, IRA plan holders can save money in the way they pay their annual custodial fees.
“In the past I recommended clients pay their IRA fees with a personal check and deduct the amount on their tax return,” he said. “Now I am instructing them to have the fee taken out of the investment account and thus pay with pre-tax dollars.”
Capobianco said he believes Roth IRAs are the “retirement plan of the future. Clients may have accumulated $1 million, but really may have only $600–700,000 based on their tax bracket.”
Dowen believes that one of the greatest risks to retirement investors today is that no one can plan what the tax brackets of the future will be. The current rules are set to expire in 2025, unless some of the provisions can be changed before then.
“A client in the 33 percent bracket today may assume to be in a lower bracket in retirement, but can find their tax bracket is just the same,” which might negate the tax breaks during the accumulation years, he said.
“To not do it, though, to not put aside funds for your own retirement is a bigger gamble,” Dowen said. “Better to take the chance of a lower bracket and hopefully the retirement account has grown substantially.”
Capobianco said one of the greatest risks to retirement investors today is the growing cost of medical care, “not just health insurance costs, but if someone needs medical care of any kind, how they are going to pay for it.”
He said he is selling more long-term care insurance than ever before, without actively marketing it.
“We all know someone with a real life situation who lost all their money to medical costs,” he said.
“Long-term care insurance premiums can run $3,500 a year and up, depending on the provisions and term of the coverage,” he said. “But this insurance gives clients the maximum options for the type of care and facility they choose while protecting their financial assets.”
Often Capobianco works with legal professionals to make sure the long-term care policy he offers dovetails with the irrevocable trust they create for their mutual client.
Year-end is also the time to sign on for a Health Savings Account, or HSA, though the employer, the experts said.
An HSA allows an employee with a high deductible health insurance plan to pay medical costs with before-tax money because the account is funded with salary reductions, said Capobianco.
“High deductible plans keep insurance premiums lower and offer HSA eligibility,” he said. “Max out your HSA and accumulate a nice sum that can be used for the future.”
HSAs are different from FSAs, or Flexible Spending Arrangements designed to be used along with lower deductible health care plans.
“If you don’t use up the FSA account during the year the employer gets to keep the money,” Dowen said. “To benefit, add up what you think your co-pays will be for the year and try to break even.”
Dowen said given limited dollars to put aside, maximize retirement contributions first and then fund the HSA, or FSA if available through the employer or a financial institution.