We all got a Christmas present last year in the form of a tax reduction. Many jumped up and down and said it was about time. The United States has not had meaningful tax reform since the Ronald Reagan era; but was it reform or just change? How will the present look when applied with our individual lenses? Let us look at some of the big changes and see what consequences they might bring.
First, the new tax bill brought significant increases in the estate tax exemption. In 2017, the estate tax exemption was $5.49 million; the new law has doubled that to approximately $11 million per person or $22 million per couple. While this is not a permanent change (nothing in estate tax law is ever permanent), it does change the taxes that we look at in the future for large estates. No longer will people look toward their estate-planning lawyer to fix their estate tax problems, they will now look toward their real estate agent. State estate taxes have not changed, but have now moved up in priority. For example, the state of Illinois' estate tax exemption is a mere $4 million, and it is not indexed. At a maximum rate of 16 percent, for the very wealthy, it would behoove them to contact their real estate agent and move to one of the 36 states that do not have an estate tax.
Second, the taxation of flow through entities, S-corps, LLC's, LLP's, etc., just got really complicated. The idea was to lower the tax rate on businesses to spur growth. Great idea, hard to implement. The flow through status of these entities really complicates things. They did not want every consultant on the planet to become an S-corps for the sole reason of lowering their tax rate. As a result, they had to put income restrictions, and even business restrictions, on what businesses can and cannot use the new pass through rates. So much for simplification.
Third, because of the new rates for businesses, some might be better off moving from an S-corp back to a C-corp. This statement would be heresy a couple of years ago, but with this new tax bill, it might make sense under certain circumstances. In order to determine whether this makes sense or not, you would need to do a thorough analysis of your business income, your personal income and your next three-year projections. I envision a lot of accounting firms completing this kind of analysis in the next year.
Fourth, planning for Roth conversions and recharacterizations just got trickier. Prior to 2018, the IRS allowed a "do over" for Roth conversions. This was very effective in tax planning and managing income. The new tax bill has taken that away from planners. Once a Roth IRA is converted, there is no going back. The result will be lower amounts being converted over longer periods of time.
I have only mentioned a few issues with the new tax bill that everyone should know. The reality of this bill is that it is much more complicated than people expect. While I wish that all Americans could put their tax returns on a post card, reality will just not allow that and let the politicians keep their job.
• Sean Sebold, CFA, CFP®, is with Sebold Capital Management Inc. in Naperville. Contact him at (630) 548-9700 or firstname.lastname@example.org