December 2017’s Tax Cuts and Jobs Act—the grandest tax-code overhaul in three decades—yielded epic changes. The new rules are vast, their reach great. The consequence for advisors is that some age-old planning strategies are history, others are enhanced, and wholly new approaches have been born.

Consider itemized deductions. “Many of our clients are not going to be able to itemize deductions now,” says Kenneth Bagner, a CPA and managing member of the tax practice at Sobel & Co. in Livingston, N.J.

Here’s why: This year’s hurdle for itemizing, a.k.a. the standard deduction, has jumped to $24,000 for joint filers and $12,000 for single taxpayers, almost double last year’s amounts. Compounding the problem is the fact that fewer deductions are permitted. Miscellaneous itemized deductions have been sacked, while deductions for state and local taxes are now capped at $10,000—the so-called “SALT” limitation.

For very successful clients, the SALT limitation takes away tens of thousands of dollars in deductions. “You could start losing money on tax reform once your income is close to seven digits and you’re in a high income tax state,” Bagner says. Although the top federal ordinary tax bracket today is 37%, down from 39.6%, Bagner says that in the past, “39.6% minus the savings from the state and local tax deduction was less than 37%. Now you’re paying more tax for every dollar of income when you’re in the highest tax bracket.”

That’s the last straw for some folks. They’re packing their bags, and states like New York and California face possible emigration of the wealthy. But those states fight back.

“If you move out of New York and you’re a seven-figure earner, there’s a very high probability of being selected for audit, especially if you keep a home there,” says CPA Barry S. Kleiman, tax principal at Untracht Early LLC in Florham Park, N.J. “So we talk to clients about residency audits and legitimately changing their residence. The biggest thing is the planning beforehand, making sure you have the documentation all lined up.”

Clients should retain an accountant in the state they’re leaving, someone well versed in that state’s residency rules, advises Christopher Van Slyke, a partner in the Jackson, Wyo., office of WorthPointe Wealth Management. (Van Slyke says there’s been greater growth at WorthPointe’s offices in Wyoming and Texas—states that do not impose an income tax—than in its California practice, perhaps a reflection of the wealthy’s migration.)

Year-End Planning For Individuals

Now that it’s harder to itemize, clients should put more emphasis on year-end charitable planning. One strategy they could pursue is to bunch charitable contributions—i.e., make a large donation in one year in order to itemize that year. “Many of our clients are accomplishing this by using donor-advised funds,” says CPA/PFS Michael A. Tedone, a partner at Connecticut Wealth Management in Farmington, Conn. “The client receives the charitable contribution deduction in the year of the gift to the donor-advised fund and in future years determines how the gift should be distributed to charity.”

One happy consequence of the new tax law is that it should now be easier to plan for the alternative minimum tax. Fewer clients will owe it for 2018, according to Kleiman, in part because of the increase in the AMT exemption. Moreover, now that state and local tax deductions have been curtailed and miscellaneous itemizations scrapped, clients will have fewer deductions to add back to income under the alternative tax system, which helps prevent the tax from applying, Kleiman says.

Advisors should also put divorce planning on the list for the end of the year. Clients won’t be able to deduct any alimony paid under divorce or separation instruments executed after December 31, and alimony received under such instruments won’t be taxable.

Helping Business Clients

Tax reform set entrepreneurs alight when it drubbed the corporate tax rate from 35% to 21%. Many pondered converting their businesses into C corporations. But few have actually gone through with it, tax pros say. The lower rate “helps the big multinationals,” observes Mark Merric, an international business attorney in Denver. “But it doesn’t have much of an effect on the choice of entity for closely held businesses.”

A C corp only makes sense when a business “has a need to retain the earnings and doesn’t intend to distribute them,” says Minneapolis tax attorney Andrea Mouw, a principal in the national tax practice of Eide Bailly LLP. That means such structures are more appropriate for capital-intensive businesses, Mouw says. Otherwise, “the math just doesn’t work.”

Take a C corp earning $100. It will pay $21 in corporate tax. If the remaining $79 is paid out as a dividend, the shareholder could lose 23.8% to federal taxes (the maximum 20% tax on qualified dividends, plus the 3.8% net investment income tax), or $18.80. That works out to a 39.8% effective tax rate on distributed C corp profits, says Mouw’s colleague, Adam Sweet, also a principal in Eide Bailly’s national tax practice, in Spokane, Wash.

Meanwhile, owners of non-C corporation businesses, including sole proprietors, may be able to deduct as much as 20% of their qualified business income under new Internal Revenue Code Section 199A. This deduction could lower the highest tax rate on business profits to 29.6% (the 37% top individual rate times 80% taxable equals 29.6%). Sweet says, “The 20% deduction is a real game changer. Even if your deduction is limited, you’re going to beat the effective corporate rate of 39.8%.”

Still, the 20% deduction of business profits can be limited for any owner whose taxable income exceeds $315,000 when filing jointly with a spouse or $157,500 when filing single. Even worse, the deduction can be wiped out completely for clients with specified service businesses, including doctors, lawyers, accountants, investment managers and other professionals. These people are subject to a phase-out that eliminates the deduction once their taxable income reaches $415,000 on a joint return or $207,500 on a single filer return.

In addition to these service businesses, broad language in the tax act called for the deduction-killing phase-out to apply to any trade or business where the principal asset is the reputation or skill of one or more of its employees or owners, Sweet notes. However, proposed Treasury regulations issued on August 8 limited this to mean income from endorsements or for the use of an individual’s image, name or likeness, as well as to appearance fees, including income paid to “reality performers performing as themselves on television, social media or other forums, radio, television, and other media hosts, and video game players.”

As the end of the year approaches, business clients have ample opportunity to maneuver their income below these or other important thresholds. Buying equipment, either new or used, and writing off the full cost immediately under tax reform’s 100% bonus depreciation is one way to lower business earnings.

Another strategy is to adopt a defined benefit pension plan. Under the right circumstances, a business may be able to contribute six figures to the owner’s retirement, which is an expense that reduces the business’s income, while making modest contributions for the workers.

But pensions have pitfalls, cautions Lem Moorman, a CPA and owner of Qualified Pension Services Inc. in Littleton, Colo. “Employers don’t understand that with a defined benefit plan they have to make the same contribution every year, within a narrow range, for at least three years,” Moorman says.

More To The Story

The Tax Cuts and Jobs Act raced through Congress in a mere seven weeks, CPA Anthony (Tony) Nitti reminded accountants in a recent teleconference. Given the frenetic pace, it’s inevitable that the law contains “mistakes and big gaps in guidance ... in spades,” according to Nitti, a partner at WithumSmith + Brown in Aspen, Colo.

For example, Congress intended interior improvements to a nonresidential building, such as a restaurant, to be eligible for 100% bonus depreciation. But a drafting error in the law instead requires such improvements to be languidly depreciated over 39 years.

Nitti predicts that desperately needed technical corrections to the law won’t come until after the midterms. That’s unfortunate for clients, he says, because even if the fixes are allowed retroactively, “it’s kind of pointless if the uncertainty prevents taxpayers from moving forward with the improvements that they had planned.”