By Barbara O’Neill, Ph.D., CFP®, Rutgers Cooperative Extension, oneill@aesop.rutgers.edu
At this time of year, many people are focused on 2017 income tax preparation. Common activities include: downloading tax forms from the IRS web site, purchasing tax preparation books and software (e.g., TurboTax), gathering and tallying up receipts to document itemized deductions, and/or contacting the VITA (Volunteer Income Tax assistance) program or a professional tax preparer for assistance.
Another recommended strategy during tax season is to spend some time on 2018 income tax planning. In other words, projecting ahead how your income taxes might be affected by affected by changes in income (e.g., a raise, pay cut, or freelance income), family relationships (e.g., marriage, widowhood, parenthood, divorce), and provisions contained within the Tax Cuts and Jobs Act (TCJA) that was passed in December 2017.
Below are six income tax planning recommendations for Personal Financial Management (PFM) program staff to pass along to military families:
Revisit Your W-4 Form
Taxpayers should complete a new W-4 form for tax withholding at their place of employment when life changes in a way that affects their income taxes (e.g., marriage or the birth of a child). In addition, withholding will likely need to change as a result of the TCJA. The standard deduction has increased to $12,000 for singles and $24,000 for couples and itemized deductions for state income taxes and local property taxes (i.e., so-called SALT deductions) are capped at $10,000. As a result, fewer taxpayers will be able itemize deductions for mortgage interest and charitable contributions in the future.
Consider Bunching Itemizing Deductions
Taxpayers who you don’t have enough itemized deductions to deduct every year to exceed the much higher standard deductions that take effect in 2018 could try “bunching” them together every other year to exceed the standard deduction and be able to itemize. Use envelopes or file folders to save receipts for each tax deduction category (e.g., charitable contributions).
Begin or Increase Savings in the TSP
The Thrift Savings Plan (TSP), the tax-deferred retirement savings plan for service members, defers taxes on employee contributions and earnings on these contributions until retirement withdrawals are made. If a service member is in the 22% marginal income tax bracket and contributes $1,000 annually to the TSP, this would lower federal income taxes by $220 (0.22 times $1,000).
Know Your New Tax Bracket
The tax savings for TSP contributions is based on a taxpayer’s marginal tax rate, i.e., the rate paid on the highest dollar of earnings. There are seven different tax rates in 2018 as a result of the TCJA: 10%, 12%, 22%, 24%, 32%, 35%, and 37%. The higher the marginal tax rate, the more an investor benefits from pre-tax dollar contributions to retirement savings plans and tax-deferred earnings.
Take Advantage of Investment Tax Breaks
Examples include Roth and Traditional IRAs for all workers with earned income and SEP accounts for those with self-employment income. Other tax-advantaged strategies are holding investments in taxable accounts for more than a year to qualify for long-term capital gains tax rates and purchasing tax-deferred annuities (note: select only annuities with low expenses).
Do a Tax Law Impact Calculation
The best way to determine if the TCJA will help (read: lower taxes) or hurt (read: higher taxes) a military family is to plug personal data into an online calculator. Below are three calculators that incorporate TCJA tax law changes and can help with 2018 tax planning projections:
GOP Tax Plan Calculator (Wall Street Journal)
Tax Bill Calculator (New York Times)
Tax Proposal Calculator (Tax Policy Center)
