Tax season is never fun. But this year, taxpayers have the added challenge of preparing their returns for the first time under the Tax Cuts and Jobs Act of 2017. The new law is larded with little surprises, not all of which are pleasant.
Despite the lowering of the tax rate on the top bracket of earners, for example, Thomas McGraw, Head of Tax Advisory at J.P. Morgan Private Bank, notes that “a lot of clients are finding they need to pay more taxes because of the loss of itemized deductions.”
In light of the possibly treacherous new terrain, J.P. Morgan specialists have some advice for making the season run a little more smoothly and for avoiding the pitfalls in the new law.
The first thing, McGraw says, is to bring your paperwork in line with the new order. Once you determine your 2018 tax liability, he suggests all wage earners review their W-4s and, if necessary, make sure they adjust their withholding for 2019. Also, now is the time to be thinking about whether you need to be changing your estimated payments, since the first quarterly estimates are due April 15.
Because of the uncertainty created by the new tax law, the Internal Revenue Service has provided relief from the underpayment penalty for those who have paid 85% of their 2018 tax liability.
Once you’ve determined your 2018 tax liability and appropriate tax payments for 2019, the next task is to think about the most advantageous way to pay any additional 2018 taxes due in April. For many people, the right answer may be to borrow.
Every year, a significant portion of our Private Bank clients pay their taxes with a line of credit, says Scott Milleisen, U.S. Head of Lending Solutions for J.P. Morgan Private Bank. An unusually high tax bill is a reason to consider such a move, but hardly the only one. Even clients who have cash on hand should consider using it strategically. Many people have carefully balanced portfolios, and using up a big chunk of cash can unnecessarily upset that, and, in some cases, may trigger capital gains.
Milleisen explains: “Having access to a line of credit allows you to smooth your cash flows and separate your investment decisions from your liquidity needs.” He adds that such a credit line, while used most heavily for springtime taxes, is useful all year long. Most people think about paying taxes once a year, on April 15, but the fact of the matter is that many high-income earners are paying estimated quarterly taxes.
Reporting foreign accounts
One big red flag for the government these days is foreign accounts. You must inform the Treasury Department if you maintain a financial interest in, or signature authority over, foreign financial accounts that, in the aggregate, contained more than $10,000 at any time during the past year. There are two discrete foreign financial disclosure filings to be made.
- The Foreign Bank and Financial Accounts Report (FBAR) doesn’t go to the IRS but to the Financial Crimes Enforcement Network (FinCEN). It can only be filed electronically.
- The Statement of Specified Foreign Financial Assets Form needs to be attached to your income tax return.
While the government has required reporting of foreign accounts to discourage tax fraud since 1970, it has very much amped up prosecution of people who failed to comply in recent years. In fact, among the charges brought against President Donald J. Trump’s one-time campaign manager Paul Manafort was his failure to disclose several foreign accounts. Of course, most people won’t face a public debacle like Manafort’s, but be aware the government has been doling out stiff penalties for violators.
Taking advantage of opportunities
Not every development is bad news. The tax law does provide some enticing new opportunities. For example, it offers tax incentives to those who invest in Qualified Opportunity Zones (QOZs), areas in need of economic revitalization that require capital. If you’ve enjoyed large capital gains for any of a broad range of reasons, a new provision in the tax law offers deferral and possibly forgiveness of capital gain taxes if the gain is invested in a Qualified Opportunity Fund (QOF) (generally) within 180 days of the sale of the assets.
Assuming you invest within the 180 days, the government will forgive 10% of the original, deferred gain on the investment after five years, and an additional 5% after seven years. It will defer taxes on the remaining 85% of the gain until whichever comes first: the QOF is sold or exchanged—or December 31, 2026. All new gain arising within the QOF may be forgiven for taxpayers who hold a QOF investment for at least 10 years.
The new tax law also preserves the tax advantages of IRAs. McGraw reminds clients that April presents two important dates for IRA holders. April 15 is the last day to make contributions to your traditional and Roth IRAs for the previous year. And remember, at age 70½, retirees must start taking Required Minimum Distributions (RMDs) from their IRAs (unless it is a Roth) or face penalties. If you turned 70 in the first half of 2018, the deadline for taking your first RMD is April 1. Subsequent RMDs must be taken by December 31 of each year.
Thinking of leaving a high-tax state?
Because the new law caps property and state income tax deductions, some people in high-tax states are considering switching domiciles to a low-tax state. If you are just starting now, you are, of course, way too late for this year’s tax returns, but you may be just in the nick of time for your 2019 returns.
“Changing domicile for tax purposes is not as a simple as buying a new home and hiring movers,” McGraw warns. “Often, a number of actions need to be taken to convince the taxing authorities in your previous state that you no longer live there and owe them taxes.” For example, among other things, clients should move as soon as possible, establish connections with that new location, and keep a detailed calendar of days spent at their new residence. To help you with this effort, be sure to download our Changing Domicile Checklist and to enlist the help of your J.P. Morgan advisor.
Your J.P. Morgan advisor is available to help with all your wealth planning needs.