over the succeeding years in smaller
Hickey: One of the most problematic
changes was removing the client’s ability to take an itemized deduction for
financial-planning costs that are more
than 2% of adjusted gross income. This
punishes retired clients who live off
their investment income.
For example, imagine an elderly couple with $1 million in a portfolio. The
portfolio generates 8% realized return
(or $80,000). The advisor charges 1%
AUM, or $10,000. Now, that $10,000
expense is not deductible beyond the
first $1,600 (or less depending on the
client’s other itemized deductions). The
client cannot deduct $8,400 if they itemize, or over 10% of the total return. That
makes a huge difference!
It also unfairly discriminates against
financial advisors as compared to funds.
Fund expenses are still fully deductible
for fund managers. Thus, if an advisor builds an investment portfolio for
a client, it’s not deductible. However,
if the client invests in a fund, the fund
expenses are deductible.
Ultimately, this may lead to suboptimal
behavior and create a greater public burden. If elderly individuals modify their
behavior to DIY because of tax treatment, they will likely invest suboptimally. There are costs to all
of us if this happens, because it is more likely they will outlive
their saving or not have the savings for a critical need.
The other overlooked change was capping interest deductions for companies at 30% of adjusted income. Long term,
this will lead to a delevering of corporations because the tax
benefit of leverage is capped. This means less corporate investment grade and high-yield debt will be available. This also
means lower yields because of limited supply, and investors
will have to pay up for exposure.
Wolf: C Corps’ tax rates are down to 21% from 35% — that’s
a 40% decrease and is incredibly dramatic. C corps still are not
better if you want to pass out your income, or in other words,
distribute income to owners. But if you want to keep income in
the business because you want to grow the business, a C Corp
might be a better vehicle for the first time in a long time.
Then there’s the loss of state income and property taxes as
deductions. In high-tax states like California and New York,
most people have state income and property taxes that are
more than $10,000, so the deduction doesn’t go very far.
It’s a hot topic in Los Angeles, where I have a lot of cli-
ents who are very upset. They think
their taxes will go up because they can’t
deduct [all their] state income and prop-
erty taxes anymore. But I tell them, ‘Wait
a minute. Before we had the Alternative
Minimum Tax, which basically wiped
out a lot of benefits of state income/
property tax deductions anyway.”
Your taxable income is important. If
it’s between approximately $80,000 and
$300,000, you’re subject to the AMT
more so than other people. But the AMT
no longer applies, because the main item
that caused AMT was the state income
tax deduction. So, the AMT is not a sub-
stantial factor anymore.
Who gets hit worse? Generally, people
who make more than roughly $400,000
and have a lot of property and state
income tax will be hurt with the limited
deductibility of those items.
Of course, now there is the standard
deduction of $24,000 (married/joint filing). Also, rates come down from a maximum of 39.6% to 37%. Still, on balance,
if you make more than approximately
$400,000 to $500,000 a year, you’ll likely have a net tax increase.
Astrinos: Because of the changes to
tax law, a combination of new and old
tax financial planning strategies will
become more popular. As mentioned
previously, because of the increases to the standard deduction,
many households will no longer itemize deductions, which
means that tax deductions that were once commonly used in
full, such as state and local income taxes, property taxes, mort-
gage interest, and charitable deductions, may not be utilized.
It’s important to note that just because these deductions
may not be utilized does not mean that the client is worse off;
the impact on each client will vary. For example, some clients
who were above the previous standard deduction but well
below the current standard deduction may now benefit from
an overall increase in total deductions, which will lower their
overall tax liability.
On the other hand, clients who were above the previous
standard deduction and still below, but very close to the current
standard deduction, may no longer “get credit” for some of their
deductions. As a result, we will begin to see a lot more timing
strategies focused around grouping deductions together in
order to maximize the benefit in any given year, meaning itemiz-
ing in some years and taking the standard deductions in others.
Tools such as the use of Donor Advised Funds where clients
can control the timing and amount of charitable deduction will
“One of the most
was removing the
client’s ability to take
an itemized deduction
costs that are more
than 2% of adjusted