The Tax Cuts and Jobs Act’s elimination of the personal exemptions for taxpayers made it hard to predict how replacing these exemptions with a new child tax credit would net out. A tax credit is more valuable than a tax deduction since the credit reduces the tax dollar for dollar. So it initially appears for some clients that the tax credit might cut the tax bill more than the personal exemptions do, unless you don’t qualify.

The credit is $2,000 per qualifying child, but this credit only applies to children under age 17, subject to the income limits ($400,000 for joint filers, $200,000 for all others). The tax credit for children age 17 or older and other dependents is only $500. While the child tax credit can certainly reduce the tax on a Roth conversion (unless the conversion is so large that it pushes income over the limits), for some taxpayers it turns out that the lost exemptions exceeded the benefit of the tax credit, unexpectedly increasing the cost of the Roth conversion. Now that advisors can look at the completed 2018 tax return, the impact of children and other dependents on a 2019 Roth conversion can be more accurately projected.

Another child-related change is the so-called “kiddie tax.” A child’s unearned income will no longer affect the parent’s tax return. The children will pay the taxes, if applicable, on their own tax returns at trust and estate tax rates. This is one of the few items that the tax law truly simplified. It will be a bit easier to project the tax on a Roth conversion for parents who no longer must include the child’s income on their tax returns. This change might lower the tax bill on conversions for these parents.

5. Alimony: No Deduction, But Tax-Free To The Recipient

Beginning for 2019 divorces, alimony will no longer be deductible, and alimony received is no longer taxable income. Pre-2019 alimony arrangements are not subject to these new rules, unless the taxpayers opt in.

Unlike many other provisions of the 2017 law, alimony stands apart in two ways. First, while most other changes in the law took effect in 2018, this one takes effect in 2019, so this year will be the first for clients who are subject to the new alimony tax rules. Second, this tax change is permanent. Most of the other changes expire after 2025.

How can these new rules impact Roth conversions? In two ways: One, the client paying the alimony cannot count on the alimony tax deduction to offset Roth conversion income, and two, the spouse receiving alimony income might be able to convert more since the alimony income won’t be taxable. Since 2019 was the first year for these changes, they will only affect those clients divorced in 2019 and those who elected to have the new rules apply to their pre-2019 arrangement. This is just something to keep in mind when projecting the tax bill on a 2019 Roth conversion for recently divorced clients.

In addition to the items listed here, there are the usual things advisors should consider when projecting the tax on a Roth conversion: year-end bonuses, as well as other onetime spikes in income or deductions; any tax benefit, deduction, credit or other provision tied to income levels, such as medical expenses (10% of the adjusted gross income limit for 2019, which is new for this year); the entire array of education credits and deductions; and real estate losses.

The 3.8% tax on net investment income can also be triggered by a Roth conversion. The conversion itself is not subject to the 3.8% tax, but it can raise income to the point that the 3.8% tax kicks in for investment income, where it wouldn’t otherwise. This should also be looked at when you are projecting the tax on a client’s Roth conversion.

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