This Year’s Tax Blues

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If you’re like many Californians, your tax return this year was a big disappointment — instead of the higher refund that you expected, you may have had to write a check to the IRS instead, even though nothing in your personal circumstances had changed. In fact, the IRS reports that average refunds were down about 8% compared to last year.¹

This was in stark contrast to President Trump’s promise that his tax changes, passed in 2017, would give most Americans a tax cut.

The unwelcome result of the Trump Tax Plan is due in large part to the new limits on the state and local tax (SALT) deduction. Prior to Trump, there were no limits to the SALT deduction. The Trump Tax Plan caps the total you can deduct for state and local taxes to $10,000 per year, no matter whether you are single or married, and no matter how much you actually paid. The Treasury Inspector General reported that about $11 million taxpayers lost out on $321 billion of tax deductions because of this change.²

This new limit didn’t cause much grief in states like Florida, Alaska and Texas, where no state income taxes are imposed. The negative impact of the new limits predominantly affected residents of states where real estate values are high, and state income tax rates are also high — like New York, New Jersey, Minnesota, and California.

For example, if your home is close to the median price in California (about $548,000), your state and local taxes, including property taxes (1.25%), would put you close to the $10,000 SALT cap. However, in metropolitan areas, many homes have a value greater than the median, resulting in a state income tax liability that is greater than the cap.²

Some people argue that this portion of the Trump Tax Plan was designed as retribution against Democratic-leaning states where the cost of living is high, like California, New York and New Jersey. The California Franchise Tax Board reported that in 2015, about 2.6 million taxpayers deducted more than $10,000 in state and local taxes on their federal tax return. In their 2018 filing, that group paid an additional $12 billion in taxes.³

In this uneven tax landscape, what smart money moves can you make to reduce your taxes? One way is to maximize contributions to your retirement accounts, like 401(k), 403(b) or 457 plans. If you are not eligible for an employer-sponsored plan, you can maximize your IRA contributions ($6,000 if you are under age 50; $7,000 if you are age 50 or over).

Another way is to invest more heavily in municipal bonds. If you live in California, and if the bond qualifies and is issued in California, it may provide income to you that is free of both state and federal taxes. Munis are an attractive alternative to taxable bonds, and even more attractive in states like California where the SALT limitation is, in effect, an added tax on residents.

The Trump Tax Plan has already boosted sales of some municipal bonds. Mutual funds that invest in California municipal bonds have attracted $1.2 billion in new investments in January and February of this year. New York has generated an additional $382 million in New York municipal bond mutual bonds sales. Minnesota, with the fourth-highest state income tax in the country, saw $90 million in new muni bond mutual fund inflows in the first two months of 2019.⁴

If you feel that you’re paying too much in taxes, and have a taxable diversified portfolio (where your investment is spread broadly in U.S. and international large, medium, and small companies, emerging market companies, real estate and bonds), you might consider swapping the bond portion of your portfolio for municipal bonds approved for the state in which you reside. This strategy may help you to reduce your tax burden, especially if you live in a state where real estate values and state taxes are high. Consult with your CPA and Certified Financial Planner™ to design a solution that is customized for your particular circumstances.

¹ National Public Radio 2/14/2019

² Forbes 3/6/2019

³ Sacramento Bee 3/27/2019


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