The Trump administration’s tax plan, implemented in 2018, not only brought terms such as “lumping,” “bunching,” “SALT” (State and Local Taxes) and “pass-through business” into the mainstream personal finance and tax lexicon, it also ushered in several new tax strategies.
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 for individuals and $24,000 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 these changes have meant that many people who itemized their income-tax deductions under the previous tax policy now take the standard deduction, chiefly because their itemized deductions aren’t collectively large enough each year to warrant claiming them rather than the standard deduction.
As a result, more taxpayers are concentrating multiple years’ worth of deductions – including charitable donations, medical expenses and state/local taxes – into a single year, an approach called lumping, bunching or stacking. Instead of taxpayers itemizing their deductions each year, the lumping/bunching/stacking approach may mean they itemize every two or three tax years, and claim the standard deduction in the other years.
• Roth IRA contributions. The new 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. This strategy appeals to people who believe the prevailing tax rate will be lower than the rate they’re likely to pay on the distributions they will take later from the tax-deferred retirement accounts.
• Saving for a child’s education. 529 savings plans have long been a popular vehicle for saving for a college education. The Trump tax program expanded how funds in 529 plans can be used, allowing up to $10,000 to be withdrawn annually to cover tuition expenses for enrollment in an elementary or high school.
But 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).
Check with the appropriate 529 plan administrator to determine your state’s status. Fortunately, Rhode Island and Massachusetts do, in fact, do recognize the broader definition.
JASON E. SIPERSTEIN, CFA, CFP, is the president-elect of the Financial Planning Association of Rhode Island and president of Eliot Rose Wealth Management. Contact him by email, firstname.lastname@example.org.