The pdf for the issue in which this article appears is available for download: Bifocal, Vol. 39 Issue 4.
Last year’s $1.45 trillion tax rewrite is certain to impact older Americans, but how?
The Urban Institute’s Tax Policy Center estimates that the new law will reduce taxes on average for all income groups in both 2018 and 2025. A few will see their taxes increase, more over time due to the inclusion of “Chained-CPI,”[1] which grows more slowly than the standard inflation rate. Many more could see an increase after 2025 when much of the individual tax provisions expire.
Today, many seniors do not pay any tax and will not under the new law. That’s because a large number of older adults rely almost entirely on Social Security, which is exempt from taxation at lower levels of income.
Older households that do pay taxes tend not to itemize deductions. A major aspect of the tax re-write was to limit the number of households that itemize and to reduce their impact overall. It’s likely therefore that as a group they will see a modest benefit, particularly early on, from the tax cuts.
So, whose taxes could increase among older adults? Major itemizers, who are more often those in places with high state and local income and property taxes.
Thankfully though, the new law does not make the radical changes to limiting itemized deductions that were originally proposed. For instance, the National Academy of Elder Law Attorneys, AARP, and a number of other advocates fought to save the medical expense deduction. Ending the deduction would have caused serious harm to many seniors who have high medical or long-term care costs.
Thanks to the outcry, the final legislation not only keeps the medical expense deduction, but temporarily expands it for two years.
Rethinking “Bunching” with the New Tax Law
When planning for seniors, major changes to be aware of include the new tax rates and brackets, increases to the Alternative Minimum Tax (AMT), and the impact of doubling the standard deduction. One important planning tool going forward will be “bunching deductions.”
With the shift of income to different brackets, it is important to at least consider what bracket a person will be in and whether to bunch deductions in one year as opposed to taking the standard deduction. Given the elimination of the personal exemption, doubling in standard deductions, and a $10,000 cap on state and local tax (SALT) deductions, the taxpayer may not have significant medical deductions together with SALT deductions when added to charitable contributions and mortgage interests to file an itemized deduction schedule. This will certainly have a bearing on both the Federal Tax Return as well as on the State Return as in some states, itemized deductions may not be taken on the State Return unless they are taken on the Federal Return as well.
Similarly, the AMT has increased to $70,300 for a single person and $109,400 for a married couple. These amounts now phase out when a single taxpayer reaches $500,000 and a married taxpayer reaches $1 Million. Again, with limitations on itemized deductions, the AMT may also not be as critical to those payers who do not itemize.
Given the difficulty in itemizing deductions, “bunching” expenses becomes a greater consideration. Taxpayers could potentially reduce their overall tax liability over several years, by pre-paying their real estate taxes and front loading other deductions, such as charitable expenses, in one year, allowing them to itemize their deductions, when they’d otherwise never meet that threshold.
For instance, a taxpayer could pay all of their real estate taxes for 2018 in 2018, and if the fiscal tax year for the city or town they live in begins in 2018 for 2019, the taxes could be paid also in 2018. Charitable deductions for 2018 would also be paid in 2018 as well as having 2019’s pledges or proposed charitable contributions paid in the same year. Therefore, the itemized deductions will be taken in 2018, but perhaps not in 2019. This process would be repeated in 2020, 2022, etc. Keep in mind that many of the changes which were enacted expire at the end of 2025 unless extended. So, attorneys should keep up on the law when considering this procedure.
Also, a taxpayer over the age of 70.5 with their primary income from their IRA and Social Security may be required to pay income taxes on a portion of their Social Security. If their charitable contributions are not deductible, they should consider having the charitable gifts made directly from their IRA to the charities. Their gifts qualify for the minimum required distribution, but the amounts will not be taxable. Therefore, their income is less for 1) amounts will purposes of taxation, 2) inclusion of Social Security Administration benefits, 3) reduction of Medicare D premium, and 4) qualification of any Governmental benefits.
Assessing the Broader Impact
Many aging advocates oppose the legislation not for reasons related to direct taxes, but its broader consequences. One risk already averted was the automatic cuts to Medicare under the budget rules. To avert those cuts, many Democrats joined Republicans to waive those rules. Yet more concerns remain:
• Destabilization of the Individual Health Insurance Market. The end of the individual mandate threatens to raise taxes and undermine health coverage for many people. Those aged 55-64 often have high health costs, meaning some could be less economically secure and less healthy as they enter traditional retirement age as a result.
• Pressure on States to Cut Spending. The law caps state and local tax deductions to $10,000. Unless states find a work around, it could undermine the ability of states to finance key programs, such as Medicaid.
• Decline in Charitable Services. By doubling both the Estate Tax threshold and the standard deduction, households will have less incentives to donate to charity. Many seniors rely on non-profits for a wide range of services. Fewer donations mean fewer services available to seniors.
• Legitimizing Chained-CPI for Social Security. In the past, entitlement reformers have offered Chained-CPI as a means to increase Trust Fund solvency by cutting cost-of living increases to beneficiaries. Some advocates fear the use of it in the tax code will add new legitimacy towards applying it to Social Security.
Renewed Calls to Cut Entitlements. Some worry that the decline in revenues will increase pressure to cut entitlement programs. CBO already gives entitlement reformers plenty of ammunition about U.S. debt, in part by assuming average interest rates will spike to 4.7% in the future and health expenditures will grow 1.0% faster than GDP indefinitely. In addition, Social Security’s Actuaries project that the combined Trust Fund is set to lack sufficient funds to pay out all claims starting in 2034.
As long these projections continue, so will the pressure to cut entitlements.
A primary impetus of the tax bill was to lower taxes for Corporations and move to a territorial system, where U.S. companies don’t need to report offshore income. Will it really raise wages as Republicans suggest? Or will it lead to greater off-shoring, more stagnant wages, and increased inequality? Its potential impact on the economy and the political consequences that result could ultimately be the most important of all. It’s also the hardest to predict.
David M. Goldfarb, Esq. is the National Academy of Elder Law Attorney’s Senior Manager of Public Policy. He previously worked as a Pension Policy Analyst for the American Academy of Actuaries and supported Sen. Bill Nelson (D-FL) on tax related issues as his Economic Policy Fellow. He was inducted into the National Academy of Social Insurance in 2017.
Hyman G. Darling, CELA, NAELA Fellow, CAP is current President of the National Academy of Elder Law Attorneys. He is a partner in the Western Massachusetts firm of Bacon Wilson, P.C., where he has practiced since 1981. He concentrates in the areas of trusts, estates, taxes, estate planning, probate, guardianships, special needs, and elder law.
[1] Editor’s Note: Chained CPI is short for Chained Consumer Price Index for All Urban Consumers. The new tax law uses chained CPI to compute price increases. The probable consequences of the use of chained CPI are set out in this article. To learn more about the chained CPI concept, read this article from Bloomberg News. https://www.bloomberg.com/news/articles/2017-11-20/why-chained-cpi-has-links-to-u-s-tax-debate-quicktake-q-a