Advisor Authority

Reform’s Giant Shift

For many investors, tax season is really just getting started

by Craig Hawley

Mr. Hawley is head of Nationwide’s advisory solutions business. Visit

April 17th is behind us and 2017 tax returns have been filed. But in the wake of the recent passage of the most dramatic tax reform package in nearly three decades, tax season is just getting started. It’s important to understand the new regulations, because these provisions will lead to substantial changes for tax planning in 2018, and most will remain in place until the end of 2025. It will take time to learn all the details—but the impact on your clients is already under way.

According to our Advisor Authority 2018 study of more than 1,700 RIAs, fee-based advisors and individual investors nationwide, roughly 8 in 10 (79%) Registered Investment Advisors (RIAs) and fee-based advisors say that the majority of their clients will benefit from the newly implemented Tax Cuts and Jobs Act—but just over half (56%) of investors agree. It is clear investors’ outlook varies considerably based on their Net Worth. While less than half (49%) of Mass Affluent Investors (investable assets of $100,000 to $500,000) expect to benefit, nearly three-fourths (74%) of Ultra HNW Investors (investable assets $5 Million or more) are confident they will.

These reforms were expected to simplify the tax code, but many clients still need your help. As Advisor Authority shows, RIAs and fee-based advisors are taking action to clear up the complexity and develop proactive strategies to help clients at every income level and stage of life. For clients in the accumulation phase, especially the high earner, taxes remain a top concern—and one of their biggest investing expenses. Likewise, retirees will still benefit from tax-efficient withdrawal strategies to maximize income, and tax-efficient investing strategies such as asset location, to increase returns without increasing risk. By starting now, you have an opportunity to ensure that your clients can benefit as well.

Among the biggest changes, a majority of taxpayers will be in a new bracket, many will want to evaluate their approach to itemizing deductions, more are likely to benefit from changes to the alternative minimum tax, the child tax credit and new rules for 529 plans. Raising the estate tax exemption and lowering the tax rate for owners of some pass-through businesses will be especially important to the High Net Worth. These key considerations are discussed below:

Reduction in individual tax brackets

Possibly the biggest impact of the new reforms is the reduction in individual tax brackets effective for the 2018 tax year. Nearly all taxpayers are likely to see at least a small reduction in their individual income taxes. The lowest bracket of 10% remains the same, but nearly every other bracket is reduced. The top rate for the highest earners is now 37% compared to the previous 39.6%.

Standard deduction, personal exemption and itemized deductions

The second major change likely to impact a wide range of taxpayers is an increase in the standard deduction, along with elimination of the personal exemption and many itemized deductions. For single filers, the standard deduction for individuals rises from $6,350 to $12,000; for married couples filing jointly, the standard deduction increases from $12,700 to $24,000. But at the same time, the personal exemptions of $4,050 per person has been eliminated entirely.

Itemized deductions allowed taxpayers, if qualified, to reduce their taxable income. According to IRS data, roughly 30% of taxpayers have been itemizing deductions in recent years. But this could decline to under 10%, as millions more are likely to take the standard deduction instead. As a result, more advisors will use timing strategies—in certain years grouping deductions together to maximize the benefit of itemizing, in other years taking the standard deductions. Of the many changes, the deduction of mortgage interest and state and local taxes may have the biggest impact on many of your clients:

Limits on mortgage deduction

Historically, the cost of owning a home was made more affordable by the deductibility of mortgage interest and real estate taxes. Now, for any mortgage incurred after December 15, 2017, the interest deduction on a qualified residence will be limited to $750,000 ($375,000 married filing separately)—reduced from $1 million ($500,000 married filing separately). Interest is still deductible for a second home; however, the $750,000 limit is applied to the first and second home in the aggregate. Also note, interest paid on home equity loans will no longer be deductible—unless proceeds are used for specific purposes such as to buy, build or improve a main home or second home.

Limits on deduction for state and local taxes (SALT)

Many consider this to be one of the most controversial provisions in the new tax law. Some have gone so far as to suggest that the loss of the SALT deduction will drive wealthy clients out of high-tax states like California and New York. The aggregate amount of all state and local property, income and sales taxes that are deductible per year will be $10,000 (individual or married filing jointly) and $5,000 (married filing separately). Previously, this deduction was not subject to limitation.

Alternative minimum tax (AMT)

While originally intended for high-income households, the alternative minimum tax (AMT) began to impact an increasing number of taxpayers in recent years. However, exemption amounts and the phase-out thresholds are now increased under the new reforms, making it less likely for the AMT to be triggered. The exemption amount increases to $109,400 up from $86,200 for joint filers, and increases to $70,300 up from $55,400 for single filers and $43,100 for married filing separate. The phase out thresholds are increased to $1 million up from $164,100 for joint filers, and increased to $500,000 up from $123,100 for single filers and $82,020 for married filing separately.

Child tax credit

RIAs and fee-based advisors are taking action to clear up the complexity and develop proactive strategies to help clients at every income level and stage of life

Another positive change for most clients with dependent children is the increase in the child tax credit and the income levels at which it applies. While the loss of the personal exemption will impact families with children, the new child tax credit may help alleviate the loss. Under the new tax law, the child tax credit is doubled from $1,000 to $2,000 for each child under the age of 17 claimed as a dependent. The credit will phase out for high earners, but this now begins at $400,000 (joint filers) under the new reforms vs $100,000 (joint filers) last year.

529 account expansion

The new tax law expands the use of 529 plans to now cover the cost of elementary and secondary education, including public, private and religious school expenses. Up to $10,000 per year per student can be distributed tax-free and penalty-free. Previously 529 plan assets could only be withdrawn tax- and penalty-free for qualifying college expenses.

Capital gains taxation

Tax rates for long-term capital gains and qualified dividends do not change, and continue to use prior income thresholds. As a result, they no longer line up with a client’s ordinary income bracket. Short-term capital gains are still considered ordinary income, and now follow the new ordinary income tax brackets. The 3.8% surtax on investment income to fund the Affordable Care Act remains unchanged. Ultimately, you should continue to help clients structure tax-efficient portfolios, remain sensitive to taxes during re-balancing, and use asset location with tax deferred vehicles.

Estate and gift tax

One significant change for the High Net Worth is that new reforms essentially double the amounts that can be transferred free of the federal estate and gift tax and the generation-skipping transfer (GST) tax. The exemption amount increases to $11.2 million per person and $22.4 million per couple, up from $5.49 million per person and $10.98 million per couple. The annual gift exclusion amount also increases to $15,000 per gift per recipient, while the basis step-up rules remain unchanged. The higher exemption will provide a greater opportunity to increase basis in inherited property. As a result, clients may want to gift cash or high-basis property during their lifetime, while low basis property may be better suited for transfer at death so that it receives a step-up in basis. Other beneficial techniques include the use of irrevocable trusts, family limited partnerships and grantor retained annuity trusts.

Pass-through corporations

A major impetus of the new tax law was to reduce the corporate tax rate, by replacing a graduated rate that ranged from 15% to 35% to a permanent flat tax rate of 21%. But big businesses aren’t the only ones to benefit from the tax overhaul. “Pass-through” entities—including S-corporations and limited liability companies—get a break, too.

Under the previous law, profits from a small business would pass-through to the owner and be taxed at their individual rate, which could be as high as 39.6%. The new provision creates a 20% deduction on qualified business income (QBI), with some limits, for sole proprietors, owners in partnerships and other non-corporate enterprises, helping them save on taxes. Each partner or owner calculates their own deduction based on their own income, so that the value of the QBI deduction will vary from one partner to the next. For the High Net Worth, the lower pass-through tax rate, compared to 37% for regular income, can help them with their private investments and their family-owned businesses.

Start planning—and start reaping the benefits

The new tax law was not only sweeping—it was sudden. This should serve as a reminder that taxes are often used as a political bargaining chip. At some point, a new administration could reverse these reforms and raise taxes to previous rates. Prepare your clients with greater tax diversification, including a range of different taxable accounts and tax-deferred vehicles, to control not only how much clients pay in taxes—but also when they pay those taxes.

Even with these new reforms, taxes can be the single biggest investment expense a client will face, especially the High Net Worth. Taxes can still be as much as 40 percent or more of client’s earnings every single year, when Federal and State taxes are combined.  As complex market dynamics make every basis point of performance count, while competition continues to increase, you can differentiate your firm and create more value for your clients by demonstrating your expertise in tax planning. In fact, 6 in 10 RIAs and fee-based advisors (60%) say that tax reform will provide them with the opportunity to expand their services and generate more business related to tax planning. Tax Season has just started, and the sooner you begin planning, the sooner your firm and your clients can begin to reap the benefits. ◊


For more insights on advisor and investor perspectives on tax reform, financial professionals can also download the latest Advisor Authority infographic at: