Updated 2019 Tax Numbers

The IRS has released the key tax numbers that are updated annually for inflation, including tax brackets, phaseouts, standard deduction, and contribution limits.  Due to rounding limitations, not all numbers have changed from last year, but tax bracket thresholds have increased by just over 2%.  The notices containing this information are available on the IRS website here and here.  Some notable callouts for those who don’t want to read all the way through the update:

  • Max contributions to 401k, 403b, and 457 retirement accounts will increase by $500 to $19,000 (+$6,000 catch-up if you’re at least age 50).
  • Max contribution to a SIMPLE retirement account will increase by $500 to $13,000 (+$3,000 catch-up if you’re at least age 50).
  • Max total contribution to most employer retirement plans (employee + employer contributions) increases from $55,000 to $56,000.
  • Max contribution to an IRA will increase by $500 to $6,000 (+$1,000 catch-up if you’re at least age 50).
  • The phase out for being able to make a Roth IRA contribution is $203k (married) and $137k (single). Phase out begins at $193k (married) and $122k (single).
  • The standard deduction increases by $400 to $24,400 (married) and by $200 to $12,200 (single) +$1,300 if you’re at least age 65.
  • The personal exemption remains $0 (the Tax Cuts & Jobs Act eliminated the personal exemption in favor of a higher standard deduction and child tax credits).
  • The child tax credit is not inflation-adjusted and remains at $2,000, phasing out between $400-440k (married) and $200-220k (single).
  • The maximum contribution to a Health Savings Account (HSA) will increase to $7,000 (married) and $3,500 (single).
  • The annual gift tax exemption remains at $15,000 per giver per receiver.
  • Social Security benefits will rise 2.8% in 2019.  The wage base for Social Security taxes will rise to $132,900 in 2019 from $128,400.

You can find all of the key tax numbers, updated upon release, on the PWA website, under Resources.

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Q3 2018 Returns By Asset Class

For the last several quarters, I’ve posted returns by asset class (by representative ETF), as well as year-to-date, last twelve months, and last five years. While there is still no predictive power in this data, I updated those charts as of the end of Q3 2018 for those of you that are interested (see below).

2018Q3 Asset Class Performance

A few call-outs from the data:

  • US stocks, especially large caps (+7.6%), led the way in Q3, with small caps a bit behind them (+4.9%).  International developed markets were slightly positive (+1.3%), with emerging markets lagging (-1.7% for both stocks and local currency bonds).  Commodities were the worst performers (-2.5%) for the quarter.  US aggregate and short-term corporate bonds finished around the flat-line, despite another hike in interest rates by the Fed (rising rates are a short-term negative for fixed rate bond funds because their value falls, though as those bonds mature, they are replaced with new bonds that pay a higher rate which makes that a long-term positive).  Overall, most diversified portfolios saw gains of a couple of percentage points with more aggressive allocations (more stocks) seeing a slightly more gains and more conservative (more bonds) being closer to flat on the quarter.
  • Over the last year, there is a wide divergence between the performance of US stocks, both large and small caps, and the rest of the world.  While it’s impossible to know the exact cause, we suspect it’s because the US tax cuts (corporate and individual) are providing a stimulus here that simply isn’t present around the globe.  The boost from those tax cuts and some deregulation has offset the negative impact of rising rates and economic uncertainty caused by building trade wars.  In other parts of the world, especially emerging markets, trade tensions and rising US rates are putting pressure on currencies and bloated budget deficits, leading to even more political instability which feeds a vicious cycle (Turkey, Argentina, etc.).  Valuations fully reflect this though, with emerging markets being the far cheapest equity asset class and fairly cheap by historical standards, and US large cap (especially growth) stocks, being the most expensive and fairly expensive by historical standards.   As I said last quarter, while everyone would love to see all asset classes moving up, a well functioning market has some dispersion in asset class performance.  The fact that US stocks can rise while emerging markets fall is a sign (at least for now) that a 2008-like meltdown is probably not on the horizon.
  • The Fed raised rates again in Q2 at their September meeting, continuing the once-per-quarter hike trend that they’ve set for the market.  The Fed Funds rate target is now 2.00-2.25%.  Futures markets show the market expecting the Fed to stay on that course for most of the next year, with an ~80% chance of one more hike this year and about a 50-50 chance of rates approaching 3% a year from now.  While increasing rates put pressure on bond prices, the advantage of shorter term bond funds is that they mature quickly and are replaced by new, higher paying bonds.  As a result, floating-rate bond funds are now yielding over 2%, with both US aggregate bonds and short-term US corporate bonds in the 3.25-3.50% range.  Emerging market bonds (in local currency) are now yielding over 7%.
  • Not much has changed from last quarter’s 5-year chart.  Commodities are still deep in the red due to big losses in 2014 and 2015.  US stocks continue to be the outperformers, with rest of the world lagging behind and trying to play catch up.  US stocks also continue to be the most expensive from a valuation perspective, with the rest of the globe, and especially emerging markets, looking cheap.

IRS Squashes Most State SALT CAP Workarounds

When the Tax Cuts and Jobs Act (“TCJA”) was passed in late 2017, the standard deduction was increased and certain itemized deductions were eliminated or capped as an offset. One of the most noteworthy is the State And Local Tax (“SALT”) deduction, which allows taxpayers to deduct for Federal tax, what they pay in state/city income tax and property taxes on their residences. For many mid-upper income taxpayers in high-tax states, these deductions were already limited by the Alternative Minimum Tax (“AMT”) under prior law. Under the TCJA, SALT deductions are now limited to $10k per year for both single and married taxpayers. To give a real world example, if you make $150k and live in a state with a 6% effective tax rate, you’re $9k of state income taxes are still deductible, but only $1k of property taxes would be deductible on top of that.

Some states have taken action to try to circumvent the SALT limits by enacting laws that allow the creation of charitable funds to which taxpayers can donate money and receive a state income or property tax credit offsetting the amount “donated”. CT, NY, and NJ have passed laws that do this, while CA, IL, and RI had pending legislation as of June. Others are definitely looking into it. In late May, the IRS released a statement that they would be proposing regulations that would emphasize “substance over form” in these types of arrangements, essentially reminding everyone that a charitable contribution for which you get a tax credit is just really a tax paid and not a charitable contribution. Yesterday, the IRS released new regulations as promised. They also released a summary statement (below), which captures the essence of the regulations. That is, if you make a contribution to one of these charitable funds and receive a tax credit in return, the amount of the credit has to be subtracted from the contribution to determine your deductible amount. In other words, the work around created by these states won’t help.

The regulations go into effect on 8/27/2018, though the IRS points out that they’re not really a change of prior law (one was always required to subtract the benefit received from a charitable contribution to arrive at the deduction), but just a clarification. Technically though, you could make the argument that the law was previously unclear and that if one made a contribution pre-8/27 to one of these funds, it should be treated as a charitable contribution. The odds of audit increase in doing so, and there’s a decent chance that the IRS would nix the contribution, but for those who want to take a shot, that shot is probably available. Of course before doing so, you should of course check with a CPA, EA, or tax attorney to get a qualified tax opinion on the matter. The point is moot in most locations, because most states haven’t enacted laws that allow these types of funds to be set up. Even NJ and CT, who have enacted laws, have not, to my knowledge, set up the funds administratively. Why some municipalities in NY may have set them up (Scarsdale being one), most don’t seem to be available there either. If you have the option of making a contribution to one of these charitable funds in your state (meaning they passed legislation allowing the funds and the state or municipality actually set one up to receive money already), AND you’re comfortable making the claim that the limits imposed by the IRS regulations are new rather than clarifying existing law, then it would benefit you to make the contribution before 8/27. For all others, I don’t believe there’s any action to take on this.

You should also be aware that NY, NJ, MD, and CT have sued the Federal government over the SALT deduction caps as being unconstitutional. A few states have also threated that they will fight any IRS regulations that attempt to limit workarounds (e.g. the regulations that were released yesterday). I’m definitely not a legal expert, but it feels like this one is going to drag on for a very long time until we have a firm answer. With that said, the law of the land as of 8/27 (and probably before) is that if you make a charitable contribution and receive a tax credit in return, your Federal deduction is limited to the difference (in most cases, see below for details).

Lastly, existing programs that allow contributions to education or medical charitable funds in exchange for tax credits (e.g. GA’s GOAL program) are also impacted by this. The IRS has stated that it previously let those go because if the charitable contribution wasn’t made, then the state income tax paid would be higher and that was previously deductible for most tax payers (except those in AMT) anyway. You can still contribute to those funds and get a state tax credit for doing so, but the Federal charitable deduction is no longer available, at least starting 8/27.

From the IRS:

Treasury, IRS issue proposed regulations on charitable contributions and state and local tax credits

WASHINGTON — Today the U.S. Department of the Treasury and the Internal Revenue Service issued proposed regulations providing rules on the availability of charitable contribution deductions when the taxpayer receives or expects to receive a corresponding state or local tax credit.

The proposed regulations issued today are designed to clarify the relationship between state and local tax credits and the federal tax rules for charitable contribution deductions. The proposed regulations are available in the Federal Register.

Under the proposed regulations, a taxpayer who makes payments or transfers property to an entity eligible to receive tax deductible contributions must reduce their charitable deduction by the amount of any state or local tax credit the taxpayer receives or expects to receive.

For example, if a state grants a 70 percent state tax credit and the taxpayer pays $1,000 to an eligible entity, the taxpayer receives a $700 state tax credit. The taxpayer must reduce the $1,000 contribution by the $700 state tax credit, leaving an allowable contribution deduction of $300 on the taxpayer’s federal income tax return. The proposed regulations also apply to payments made by trusts or decedents’ estates in determining the amount of their contribution deduction.

The proposed regulations provide exceptions for dollar-for-dollar state tax deductions and for tax credits of no more than 15 percent of the payment amount or of the fair market value of the property transferred. A taxpayer who makes a $1,000 contribution to an eligible entity is not required to reduce the $1,000 deduction on the taxpayer’s federal income tax return if the state or local tax credit received or expected to be received is no more than $150.

Treasury and IRS welcome public comments on these proposed regulations. For details on submitting comments, see the proposed regulations.

Updates on the implementation of the TCJA can be found on the Tax Reform page of IRS.gov.

Withholding Checkup

The IRS recently launched a campaign urging taxpayers to conduct a paycheck checkup and review their withholding settings in light of the new tax law. To quote from the IRS:

The Tax Cuts and Jobs Act, passed in December 2017, made significant changes, which will affect 2018 tax returns that people file in 2019. These changes make checking withholding amounts even more important. These tax law changes include:

  • Increased standard deduction
  • Eliminated personal exemptions
  • Increased Child Tax Credit
  • Limited or discontinued certain deductions
  • Changed the tax rates and brackets

Checking and adjusting withholding now can prevent an unexpected tax bill and penalties next year at tax time. It can also help taxpayers avoid a large refund if they’d prefer to have their money in their paychecks throughout the year. The IRS Withholding Calculator and Publication 505, Tax Withholding and Estimated Tax, can help.

Special Alert: Taxpayers who should check their withholding include those who:

  • Are a two-income family.
  • Have two or more jobs at the same time or only work part of the year.
  • Claim credits like the Child Tax Credit.
  • Have dependents age 17 or older.
  • Itemized deductions in 2017.
  • Have high income or a complex tax return.
  • Had a large tax refund or tax bill for 2017.

Withholding doesn’t seem like it should be complicated, but it really is. You may think that your employer could just apply your tax rate based on your fully year salary to your pay each period and voilà, done. But your employer doesn’t know your mortgage interest or property taxes for deduction purposes. They don’t know your bonus in advance (and by the way, they use a completely different rate on bonus income in most cases too!). They don’t know what tax credits apply to you. They don’t know your spouse’s salary. They don’t know your investment income or any other special circumstances that lead to an increase in income, deductions, or credits. We account for all those things by setting the “allowances” and the extra amount withheld per pay period on your W-4 so that it MacGuyer’s the system into something close to the right amount of tax over the course of a full year. With all the changes to the tax rules this year, the mid-year implementation, and some still unclear tax rules that are awaiting IRS guidance, well… it reminds me of MacGuyver without access to duct tape.

Here’s the good news… In most cases, underwithholding will simply lead to delaying the same amount of tax you would have paid during calendar 2018 to the time you file for 2018. That is, the total tax you’ll pay will be the same whether you pay it during the tax year or at the time of filing. Partial interest could be charged if you owe a substantial amount and the total amount that you had withheld during the year is less than 110% of your total tax liability for 2017. Overwithholding will of course result in a refund at the time of filing. In other words, getting withholding exactly right is not a huge deal for most people. We just want to get it close so that we’re not surprised by a large tax bill in April or a large refund (which means you provided the government with an interest-free loan all year),

If you are concerned about your withholding and want help conducting a paycheck checkup, please contact your advisor. Send a recent paystub for each earner in the family, the final paystub for any employment that may have ended earlier in the year, and an estimate of the regular pay and (if applicable) bonus pay that you’ll receive for the remainder of the year. Using last year’s deductions, the new tax laws (our understanding of them), and the pay information, we should be able to figure out if you’re in the ballpark on withholding, or if you should make some adjustments to avoid a big shock in April.

Q2 2018 Returns By Asset Class

For the last several quarters, I’ve posted returns by asset class (by representative ETF), as well as year-to-date, last twelve months, and last five years. While there is still no predictive power in this data, I updated those charts as of the end of Q2 2018 for those of you that are interested (see below).

2018Q2 Asset Class Performance

A few callouts from the data:

  • Q2 was led by REITs (Real Estate Investment Trusts) (~+9%) with weakness in emerging market stocks and bonds (~-10% and ~-12% respectively) on weak currencies, fiscal issues (too much debt), the impact of a potential trade war with the US, and political instability.  This is par for the course with emerging markets…  when they’re hot they’re hot as that’s where much of the world’s growth comes from.  But when unstable political systems and fears of a slowdown hit, they can take a hit quickly.  Notably, Q1 performance was the exact opposite of Q2 with respect to emerging markets and REITs.  EM stocks and bonds led all asset classes and REITs were the worst performers.  Yet another signal that past performance, especially over the short-term, is not indicative of future results.
  • While everyone would love to see all asset classes moving up, a well functioning market has some dispersion in asset class performance.  The fact that US stocks can rise while emerging markets fall sharply in a quarter is sign (at least for now) that a 2008-like meltdown is not on the horizon.
  • The Fed raised rates again in Q2 at their June meeting, continuing the once-per-quarter hike trend that they’ve set for the market.  The Fed Funds rate target is now 1.75-2.00%.  Futures markets are pricing in a ~90% chance of at least one more hike this year and a ~55% chance at two.  While increasing rates put pressure on bond prices, the advantage of shorter term bond funds is that they mature quickly and are replaced by new, higher paying bonds.  As a result, US aggregate bonds are now yielding ~3.25%, with short-term corporate bonds not far behind at just over 3%.  Emerging market bonds (in local currency) are yielding a whopping 6.5%.
  • Not much has changed from last quarter’s 5-year chart.  Commodities are still deep in the red due to big losses in 2014 and 2015.  US stocks continue to be the outperformers, with rest of the world lagging behind and trying to play catch up.

Q1 2018 Returns By Asset Class

For the last few quarters, I’ve posted returns by asset class (by representative ETF), as well as year-to-date, last twelve months, and last five years. While there is still no predictive power in this data, I updated those charts as of the end of Q1 2018 for those of you that are interested (see below).  Note that there is no year-to-date chart in this quarter since year-to-date and last quarter are the same.

2018Q1 Asset Class Performance

A few callouts from the data:

  • Most asset classes finished Q1 down between 0.5% and 1.5%.  This is a far cry from “Markets In Turmoil”, as CNBC likes to call it whenever stocks move down for a few days in a row, but it is still the first down quarter in a long time.  The standouts on both sides of the flat line were Emerging Market Bonds (+~4%), Emerging Market Stocks (+~2.5%) and US Real Estate Investment Trusts (REITS) (-~8%).
  • All asset classes other than REITs remain positive over the last 12 months, led by Emerging Markets and Foreign Developed Markets.  As I’ve pointed out quite a few times in the last few years (and as can be seen on the 5-year chart), foreign stocks a have a lot of catching up to do vs. US stocks from a performance perspective.  Of course there’s no way to know whether they will catch up with the US or if there’s good reason for their underperformance.  At least over the last year, a bit of catch-up has occurred.
  • After smooth sailing in 2017, volatility returned for Q1 2018.  You’ll notice a lot more ups and downs on the 12-month chart over the last 3 months.  What feels like a bit of a roller coaster over the last few months is actually much more normal from a historical perspective than 2017 was.
  • Bonds (short and medium term) are still up slightly over the last 12 months despite another interest rate hike by the Fed.  The Fed Funds rate target is now 1.50-1.75%.  Futures markets are pricing in another two Fed rate hikes in 2018, with about a 30% chance of three more hikes.

Budget Deal Extends Some Expired Tax Provisions

The budget deal that was agreed upon in Congress and signed by the President early this morning includes “Tax Extenders”, which extend some previously expired tax provisions retroactively to 2017. These include the exclusion from gross income of discharge of qualified principal residence indebtedness, the ability to deduct mortgage insurance premiums, the deduction for college tuition and fees, and the credit for residential energy improvements (windows, etc.). See this summary (https://email.steptoecommunications.com/22/1412/uploads/summary-of-tax-extenders-agreement.pdf) for a full list. Make sure to consider these items when gathering inputs for your 2017 taxes.