Olly Ludwig: With tax season just around the corner, it’s time for investors and advisors to take careful measure of how the new tax law the U.S. Congress passed late last year may require them to approach tax planning differently.

Today we’re going to cut through much of the noise surrounding the Tax Cut(s) and Jobs Act of 2017 that President Trump signed into law just before Christmas of last year and provide investors with insights about how to think about this new law of the land.

We invited one of our experts on taxes and tax policies here at Vanguard, and she’ll guide us through this brave new world of U.S. tax policy and provide us with some good ideas as April 15, 2019, approaches.

Welcome to Vanguard’s Investment Commentary podcast series. I’m Olly Ludwig, and in this month’s episode, which we’re taping on November 13, 2018, we’ll review the broad implications of the new law and then do a deeper dive in one area that’s likely to apply to almost all investors and advisors, namely changes in the realm of standard deductions.

Jackie Youssef, a Senior Tax and Wealth Planning Specialist, is with us to help advisors and investors strategize as they turn their attention to the new rules now in effect for the 2018 tax year. Jackie, thank you for joining us today.

Jacklin Youssef: Thank you, Olly, for having me.

Olly Ludwig: I wanted to set the stage before we really take the deep dive. Let’s talk about taxes and taxation in broad brushstrokes just to kind of appetize us as we move into the real detail that we want to explore today.

Jackie Youssef

Jacklin Youssef: Sure, so perhaps I’ll start with a personal story. I studied Egyptology for a number of years in college, and a few years back I found out that the Franklin Institute in Philadelphia was holding an exhibit on Cleopatra, the last queen of Egypt. So, naturally, I was one of the few people that decided to make it to the exhibit.

What I stumbled upon at the exhibit was the oldest tax document that we have discovered to date. This is…

Olly Ludwig: Perfect find for you, right?

Jacklin Youssef: Absolutely. It’s a tax exemption that essentially was for one of Mark Antony’s associates. And it was signed by Cleopatra herself, supposedly, in Greek; and essentially translates into “Make it happen.”

So, the point of this story is taxes have been around for more than 2,000 years at this point, and they will continue to be with us, which essentially brings this to the current law that we have in place, the Tax Cuts and Jobs Act. It takes effect in 2018 through the end of 2025. So if Congress does absolutely nothing, we’ll essentially be back into 2017 tax rates and rules at that point.

Olly Ludwig: Interesting. Now just to put into context last year’s law, the previous instance when there was such a dramatic shift in U.S. tax policy, you have to go back to 1986, right?

Jacklin Youssef: That is correct.

Olly Ludwig: Perfect. Tell us some of the general concepts that advisors and investors need to be thinking about that are different now than they were before this new law went into effect.

Jacklin Youssef: Perhaps we should start with three main highlights. If we take a look at the marginal tax brackets, we still have seven tax brackets. Those are progressive that start from the bottom 10%; progressing all the way up to 37%. And those, essentially, were reduced from what we had in place last year. So for most individuals, most advisors, they ought to think about if this is probably a good time to do some Roth conversion.

Olly Ludwig: I’m glad you brought up Roth conversions. We had a wonderful Investment Commentary podcast on the Roth conversion subject a month ago, so it’s on everybody’s mind. But, anyway, I interrupted you. Please carry on.

Jacklin Youssef: So, if that individual is considering doing some Roth conversion, probably it may cost them less in tax dollars to do that in 2018, as compared to what it may have cost them in 2017. So certainly think about the planning there.

The other main area that I generally bring up to individuals’ attention is the capital gains brackets. While there have not been significant changes to the brackets of capital gains—there have been minor changes to at what point the capital gains will go from 0 to 15 to 20%. With the markets really doing very well over the past ten years, a number of clients are considering: Is this a good time for me to rebalance my portfolio? Do I need to go back and start shifting back the asset allocation? And my suggestion is: Absolutely, do the planning. If you have the opportunity to do some of the rebalancing and pay 0 or 15%, absolutely go for it; because if you don’t, guess what—the markets will actually do it for you.

Olly Ludwig: You’re saying, don’t be complacent. There are clear opportunities for rebalancing, don’t overlook the fact that there are potential planning opportunities.

Jacklin Youssef: That is correct.

Olly Ludwig: Right.

Jacklin Youssef: Now the third area is around the increases in the standard deduction, and how that may impact whether investors, taxpayers, financial advisors would be talking about itemizing deductions or not.

There are really two main areas that were changed in that case. We’ll start with the standard deduction, which almost doubled. So now, for a single individual, we have $12,000 as their standard deduction. For a married couple, now it’s up to $24,000. And that, along with the fact that a number of the itemized deductions either have been eliminated or limited, certainly will make a question now as to does it behoove me to itemize my deduction?

Olly Ludwig: So do you have a sense of how many people are going to be itemizing this year versus what they were doing before?

Jacklin Youssef: Great question. The statistics actually showed that one in three taxpayers were able to itemize their deductions in 2017…

Olly Ludwig: Before the law?

Jacklin Youssef: Before the law took effect. The estimates now would actually show that one in ten taxpayers may potentially be itemizing their deductions.

Olly Ludwig: Wow.

Jacklin Youssef: Under the new laws.

Olly Ludwig: Hold on, hold on. Sorry to interrupt you, but one in ten, versus one in three?

Jacklin Youssef: Exactly.

Olly Ludwig: That’s really, really different.

Jacklin Youssef: Absolutely.

Olly Ludwig: So let’s take the deep dive into standard deductions and explore this. I find it kind of astonishing. One in ten versus one in three, so take it away.

Jacklin Youssef: So this brings into highlight the concept of bunching. It’s not necessarily a brand new concept, but it definitely gained a lot of traction based on the new rules that we have in place.

Olly Ludwig: So, bunching?

Jacklin Youssef: It’s a technical term.

Olly Ludwig: So tell us about bunching, please.

Jacklin Youssef: So this is where maybe I’ll use an example of Harry and Happy Golucky, a married couple who live in the State of New Jersey, like me. So they pay real estate taxes actually over $10,000. But all they can deduct now is $10,000. Let’s say they have no mortgage. They’ve actually paid off their home, so they have no mortgage interest. And they generally want to give $10,000 each and every year to their local Red Cross chapter.

So in that situation, Harry and Happy Golucky will not be able to itemize their deductions because the total of these two areas that they have still does not exceed $24,000, which is their new higher standard deduction here.

Olly Ludwig: So what does this couple do if they really want to engage in some good charitable giving to the Red Cross, as you say? Is there a way out?

Jacklin Youssef: Absolutely. Rather than giving the annual $10,000, they can, let’s say, accelerate the next three years’ worth of charitable gifting into one. So now they’re giving a $30,000 check, plus their own real estate taxes that they’re able to deduct. Now if you take a look at the total, it exceeds $24,000. They’re able to now fully itemize, get potentially the benefit of that bunched charitable deduction in that year.

The next two years, they certainly don’t necessarily need to write the check again to the Red Cross because they already gave it in 2018. But 2019, 2020 in that case, they’re now taking the higher standard deduction.

Olly Ludwig: Understood.

Jacklin Youssef: So, they could be strategic, intentional, and coordinate all those types of deductions here to determine what’s the best timing. Does it make sense now for me to itemize my deduction or to now opt for the higher standard deduction amount that I’m afforded?

Olly Ludwig: There’s a choice here.

Jacklin Youssef: There is a choice.

Olly Ludwig: There’s a planning opportunity.

Jacklin Youssef: Absolutely.

Olly Ludwig: Right, and let’s just review really quickly. What are the things that you can begin to itemize? You talked about SALT, the state and local taxes, right?

Jacklin Youssef: Right.

Olly Ludwig: You talked about charitable giving.

Jacklin Youssef: Correct.

Olly Ludwig: Medical expenses.

Jacklin Youssef: Uh-huh.

Olly Ludwig: I didn’t hear anything about mortgage interest. That fits in there somewhere, does it not?

Jacklin Youssef: Yes.

Olly Ludwig: Can you develop that a bit, please?

Jacklin Youssef: Absolutely. So the decision in that situation is does it make sense for me to continue to maintain my mortgage or do I pay it off? Do I still get a benefit of my mortgage interest to be able for me to just get past some of those hurdles to now itemize my deductions?

So the rules have changed a little bit for new mortgages, but individuals that still have their mortgages for a number of years can still keep the grandfathered rules around the mortgage interest.

Olly Ludwig: So they have the rules that were applicable at the time they signed their mortgages.

Jacklin Youssef: Exactly.

Olly Ludwig: It’s only new mortgages that will be subject to these new-

Jacklin Youssef: To some new limits, right.

Olly Ludwig: Understood. Now I wanted you to drill a little bit into the actual itemized amounts, $12,000 for an individual, $24,000 for a married couple.

Jacklin Youssef: Correct.

Olly Ludwig: Put it in some kind of historical perspective. How did this change? Where were those deduction limits before?

Jacklin Youssef: If we compared 2017 to 2018, it was a little over half of the figures that we have in place today—the $12,000, the $24,000 magic numbers we’re talking about.

And that’s where we did have the mortgage interest, the charitable contribution rules, the state and local, the miscellaneous deduction. Right now we have most of those, but a number of them have either been eliminated or limited to a large degree which, starting in December, of course, created a lot of buzz. Taxpayers, financial advisors, everybody was worried as to how does this impact what they have to deal with?

My sense is that after the close of tax season in the first quarter of 2019, that’s when we’re actually going to find out how much of an impact those changes really have. Some of our taxpayer clients may actually end up walking away with a surprise, and that could actually be a positive surprise. Or sometimes they may not necessarily be as thrilled, based on the outcome. And that’s our role as advisor to encourage planning ahead of time to avoid those surprises.

Olly Ludwig: So what you’re telling us today is your best guess as a tax professional. But reality may end up presenting a different set of circumstances than what has been foreseen.

Jacklin Youssef: Exactly, absolutely.

Olly Ludwig: Are there any other broad considerations that we haven’t brought into focus here that you would want to put out on the table?

Jacklin Youssef: I would say that planning generally is year-round, not necessarily year-end. So my hope is that over time, and with some of those new rules, that that would actually bring the spotlight back on the concept of year-round planning.

Olly Ludwig: Now one of the things you brought into focus—I’m glad you did, this law would expire in 2025 if Congress were to do absolutely nothing in the next several years. You said at the beginning of this conversation that the law would revert to what it was before President Trump signed that bill.

Jacklin Youssef: Yes, that would be a déjà vu moment for us.

Olly Ludwig: So let’s assume that’s not what happens. Let’s assume the Congress does something. What do you see as a likely frontier of tax policy?

Jacklin Youssef: Great question. So we just had a midterm election. I don’t believe that would mean significant changes in the rules we have in place at least through the end of 2020. But 2020, of course, is when we do have a Presidential election coming our way, so there may be some additional changes.

So that may bring attention to what I call the staying power of this tax law. I would echo the concept of planning based on the rules we have in place today, but recognize that there could be changes that could come sooner than the end of 2025.

Olly Ludwig: Yes, that’s great. Great way to bring it to a head, Jackie. Thanks for visiting with me today and sharing your keen insights on taxation and on some of the decisions advisors and investors should be thinking about now that this new law is in place.

Jacklin Youssef: Oh, my pleasure, Olly.

Olly Ludwig: To learn more about Vanguard’s thoughts on various tax-related financial planning topics, check out our website and also be sure to check back with us each month for more insights into markets and investing. Also remember that you can always follow us on Twitter and LinkedIn. Thanks for listening.

Olly Ludwig: All investments are subject to risk, including the possible loss of the money you invest. We recommend that you consult a tax or financial advisor about your individual situation. The information presented in this podcast is intended for educational purposes only and does not take into consideration your personal circumstances or other factors that may be important in making investment decisions.


Withdrawals from a Roth IRA are tax free if you are over age 59½ and have held the account for at least five years; withdrawals taken prior to age 59½ or five years may be subject to ordinary income tax or a 10% federal penalty tax, or both. (A separate five-year period applies for each conversion and begins on the first day of the year in which the conversion contribution is made).

You may access and download this podcast only for your personal and noncommercial use. You may not use it in any other manner or for any other purpose without Vanguard’s written permission. Copyright 2018, the Vanguard Group, Inc., all rights reserved.