Financial planning dialogues around Form 1040.

• Author: Sarenski, Theodore J.

The new tax act, P.L. 115-97, known as the Tax Cuts and Jobs Act (TCJA), includes wide-ranging, albeit mostly temporary, changes to the individual income and transfer tax regime. As a result, given the integrated nature of tax laws and personal financial planning, many strategies that were once beneficial may no longer be worthwhile in the new tax environment, and new strategies may be needed. Since individuals commonly have the broad financial planning goal of maximizing their after-tax wealth, tax advisers must give thought to their clients' strategies and tactics under the TCJA.

An individual's tax return is a natural starting point to evaluate the impact of changing tax laws on a financial plan. Therefore, CPAs and tax advisers are at the forefront of encouraging individuals to fine-tune their financial plans by opening a dialogue about their tax return and raising relevant questions. CPAs have a unique opportunity to add value to their tax compliance engagements by communicating the TCJA's impact on clients and helping them navigate the issues it raises in their financial plan. Proactively identifying pitfalls and uncovering opportunities are at the core of this practice.

This column outlines several financial planning concepts, recognizable from an individual tax return, that the TCJA may have disrupted or introduced in a broad range of circumstances.

Tax-efficient investment planning

Taxes have a significant impact on investment returns and the management of an investment portfolio. Since after-tax performance is what matters to investors, a change in marginal tax rates calls for an update to a portfolio's projections and analytics.

Investment advisers and portfolio managers generally use marginal tax rates when evaluating investment tradeoffs and planning decisions. Investment professionals may assume that a client with a large asset base or high cash flow is subject to the highest marginal income tax rate. However, they might not consider changing tax rates and brackets or the tax characteristics of different types of cash flows and investment accounts. CPA financial planners can add value to their clients' investment planning by ensuring any tax assumptions underlying the portfolio analyses are accurate. As CPAs begin to prepare projections and pro forma tax returns for the 2018 tax year and beyond, they should pay close attention to changes in anticipated marginal income tax rates.

Tax-equivalent yield

When reviewing a tax return with a client, the CPA should note lines 8a and 8b of the 2017 Form 1040, U.S. Individual Income Tax Return, on which are entered interest income from, respectively, taxable and tax-exempt bonds and other sources. Since the absolute yields of the two types of bonds are not directly comparable, investors need to consider taxequivalent yields when evaluating the after-tax return on their fixed-income portfolio. The tax-equivalent yield is calculated by dividing the tax-exempt yield by the difference of one minus the investor's marginal income tax rate.

Example 1: A married couple filing jointly with $475,000 of taxable income were formerly in the 39.6% federal income tax bracket but are in the 35% bracket in 2018. The lower tax rate may alter the efficacy of their fixed-income investments. A high-grade 10-year municipal bond may have an average yield of approximately 2.5%, while a high-grade 10-year corporate bond may have an average yield of about 4%. The yield on the federally tax-exempt municipal bond equates to a 4.14% taxable yield for an investor in the 39.6% tax bracket, but the tax-equivalent yield falls to 3.85% for an investor in the 35% tax bracket. Consequently, under a new, lower income tax bracket, the investor's...