The new tax law and your financial plan

The headline-grabbing news of the 2017 Tax Cuts and Jobs Act centered around a permanently lower corporate tax rate of 21% and temporarily lower income-tax rates for individuals. However, the sprawling legislation touches nearly all corners of the economy, from healthcare to small businesses and personal finance. Our legal and tax teams at John Hancock Investment Management took a look at how the law affects some popular savings vehicles. The changes suggest that now may be a good time to talk to your financial professional about what the new tax law means for your financial plan. 


Changes affecting municipal bonds

The real news here is that the final version of the tax legislation didn’t have as much impact as initially expected. The tax bills introduced in Congress included the elimination of the exemption for interest paid on private activity bonds (which is subject to an alternative minimum tax, or AMT) as well as the elimination of the AMT. However, the tax law as enacted did not eliminate the exemption for private activity bonds, but it did repeal the exemption provisions relating to tax-credit bonds and advance refunding bonds issued after December 31, 2017. Some commentators note that the change to advance refunding bonds could reduce the overall supply of municipal bonds.

The new law changes the AMT in ways that may affect municipal bond holders. While the AMT was eliminated for corporations, it was retained for individuals but with higher exemption and phaseout thresholds. The AMT exemption amount for individuals (married, filing jointly) increases from $86,400 in 2017 to $109,400 in 2018. The phaseout threshold increases from $164,000 to $1,000,000. These changes may make the inclusion of private activity bonds in a portfolio more beneficial for both corporate and individual investors.

Another impact of the new tax law on tax-exempt bonds results from the general reduction in income-tax rates applicable to both individuals and corporations. Lower rates could reduce the appeal of tax-exempt interest-bearing investments. On the other hand, the effect of reduced income-tax rates could be offset by the loss of certain itemized deductions and the cap on deductions for state and local taxes. Balancing these factors to maximize your tax situation will be key in the year ahead.

An expanded role for 529 plans

The new law expands the market for 529 plans, educational savings plans that are exempt from income tax under Section 529 of the tax code if the money is used for qualified education expenses. Prior to the new legislation, the money in 529 plans could only be used to pay for qualified higher-education expenses (i.e., college). Historically, these state-sponsored programs have been referred to as college savings plans. Under the new law, the definition of qualified education expenses is expanded to include public, private, and religious elementary and secondary schools. 529 plans may now distribute up to $10,000 per year—tax free—in expenses for tuition incurred during the taxable year in connection with enrollment at a public, private, or religious elementary or secondary school. (The $10,000 per year limit does not apply to distributions for post-secondary school expenses.) 

For 2018, the IRS has increased the annual gift tax exclusion from $14,000 to $15,000 for 2018. The new law does not alter the ability for an individual to make five years' worth of contributions in a single year, effectively turning that $15,000 contribution into a $75,000 contribution. The new law makes an additional accommodation for contributions to Achieving a Better Life Experience, or ABLE, accounts (529A plans for paying qualified disability expenses) under certain circumstances. Under the temporary provision, once the annual $15,000 contribution limit is reached, an ABLE account’s designated beneficiary may contribute an additional amount, up to the lesser of (a) the federal poverty line for a one-person household or (b) the individual’s compensation for the taxable year. What’s more, the provision temporarily allows a designated beneficiary of an ABLE account to claim the saver’s credit for contributions made to his or her ABLE account. The provision does not apply to taxable years after December 31, 2025. Finally, rollovers are now permitted from qualified tuition programs (529 plans) into qualified ABLE programs (529A plans).

New deduction for REIT dividends, with caveats

The new law allows noncorporate taxpayers (individuals, trusts, and estates) to deduct 20% of their ordinary real estate investment trust (REIT) dividend income. However, this deduction is available only to those who own REIT shares directly, versus through a mutual fund or other registered investment company. As with some of the other changes in the tax law, this provision may alter the way investors choose to receive REIT dividend income. 

Other changes affecting investment companies

The tax law includes a number of other provisions that affect investment companies such as mutual funds One such change is to the dividends received deduction (DRD), a long-standing tax rule that allows corporations to subtract dividends received from other domestic corporations. Corporate shareholders of mutual funds are entitled to the same deduction for mutual fund dividends that are based on domestic corporate dividends received by the fund; the DRD was put in place to avoid multiple instances of taxation on the same dividend income. Prior to the new law, corporations were generally entitled to a 70% DRD from other corporations or an 80% DRD from a corporation in which the corporate parent owned 20% or more of the stock (or a 100% DRD for affiliates). Under the new law, the 70% and 80% DRDs have been reduced to 50% and 65%, respectively. In light of the tax law’s lowering the corporate income-tax rate from 35% to 21%, however, the reduction in the DRD percentages does not effectively increase a corporation’s income tax on dividends it receives.

One final item to mention relates to a proposal of the draft tax bill to make first in, first out (FIFO) the mandatory method of selecting securities for sale from a tax perspective (fund shareholders would have had to use FIFO or average cost, while funds themselves would have been exempt from this provision). Fortunately, this proposal did not make it into the final law. The old rules remain in place, so shareholders can continue to choose from a variety of tax lot selection methods.

A good time to check in with your financial or tax advisor

With so many changes to income-tax rates and tax savings vehicles, the passage of the new tax law makes now an ideal time to review your financial plan. Your financial or tax advisor can help you identify exactly how the new law will affect you and how you can make the most of it. As always, the John Hancock Investment Management tax center has resources designed to make your tax filing easier, including a schedule of 2018 tax rates and limits, tax forms, and more.