Advisors Have an Opportunity to Help Clients Navigate Regulatory and Tax Reforms 

A change in what measure the Internal Revenue Service (IRS) uses to apply adjustments to deductions and income tax brackets is expected to lead to higher tax payments over time – just as Americans may have been settling in to the benefits of last December’s Tax Cuts and Jobs Act.

The December legislation resulted in lower individual income tax rates, doubled standard deductions and eliminated personal exemptions. But according to tables released November 15 by the IRS, the amount taxpayers will be able to deduct will move higher more slowly than it would have due to the IRS’ shift from the consumer price index known as CPI-U to chained CPI-U, which is short for Chained Consumer Price Index for All Urban Consumers, or C-CPI-U.

For married couples filing jointly, for example, the standard deduction will increase to $24,400 for taxable years beginning in 2019, up from $24,000. Without the change to chained CPI, however, it would have been $24,550, according to calculations by the Tax Foundation, an independent tax policy nonprofit organization, cited here.1

The tax reform package passed in December 2017 included a provision to use the chained CPI to determine when to adjust tax brackets and eligibility for deductions. The change means that the standard deductions and tax brackets will likely grow more slowly than they otherwise would have using CPI-U.

“The expected effect of using the new index is smaller inflation adjustments over time, as compared to what they would have been under the CPI-U,” Bloomberg Tax said this past September in a report highlighting the projected inflation adjustments for 2019. “The cost of living calculated using the C-CPI-U has risen 39.7% since 2000, compared with a 45.7% gain using the CPI-U.”2

Chained CPI employs a formula, the Bureau of Labor Statistics (BLS) says, which reflects the effect of substitution that consumers make across item categories in response to changes in relative prices. It takes into account, for example, substituting a particular food staple if one CPI item category rises and another doesn’t. The BLS uses pork and beef prices as an example.3

Sources: Bloomberg Tax, Internal Revenue Service. (https://www.prnewswire.com/news-releases/bloomberg-tax-projects-smaller-post-tax-reform-inflation-adjustments-300712398.html; https://www.irs.gov/pub/irs-drop/rp-18-57.pdf?mod=article_inline)

Advisor Opportunity?

The recently released inflation-adjusted items from the IRS follow the release of a study in October which found, among other things, that high net worth clients are looking for more from their advisors than just investment management.

Indeed, more than half of the 639 millionaires who took part in the 2018 Fidelity Millionaire Outlook study said they would be willing to pay more for financial advisors if they were able to help them navigate the recent tax reforms and minimize taxes.

And while four in 10 millionaires with advisors said that their advisors proactively reached out to them regarding the impact of tax reforms, roughly that same number said they haven’t had any conversations with their advisors regarding the reform.

“Given the willingness of investors to pay more for this, we believe it represents a missed opportunity on the part of some advisors,” Fidelity says. “Topics like regulatory or tax reforms are something advisors should proactively communicate on.”4

What’s the Bottom Line?

The impact of the change in how inflation is applied to standard deductions and tax brackets may not be immediately known given that individual taxpayers’ situations vary. Congress’s Joint Committee on Taxation estimated, though, that it will cost taxpayers $133.5 billion over the next decade, according to data cited in the Inc.com article.

The impact over time for the 37% tax bracket, the highest individual bracket, is increasing to $510,301 for 2019, up from $500,000 in 2018. It would have been $512,075 under the old inflation measure and by 2025 the difference from using chained CPI-U instead of CPI-U is projected to be $10, 325, according to estimates from the Tax Foundation cited in this Wall Street Journal report.5

 

Sources:
1 “Remember the Big Tax Cuts? The IRS Just Announced a Surprising Change That Will Probably Make Yours Smaller,” Inc.com. https://www.inc.com/bill-murphy-jr/remember-big-tax-cuts-irs-just-announced-a-surprising-change-that-will-probably-make-yours-smaller.html (accessed November 19, 2018).
2 “Bloomberg Tax Projects Smaller Post-Tax Reform Inflation Adjustments,” Bloomberg Tax. https://www.prnewswire.com/news-releases/bloomberg-tax-projects-smaller-post-tax-reform-inflation-adjustments-300712398.html (accessed November 19, 2018).
3 “Frequently Asked Questions about the Chained Consumer Price Index for All Urban Consumers (C-CPI-U),” Bureau of Labor Statistics. https://www.bls.gov/cpi/additional-resources/chained-cpi-questions-and-answers.htm (accessed November 19, 2018).
4 “2018 Fidelity Millionaire Outlook Study Press Release,” Fidelity Investments. https://clearingcustody.fidelity.com/app/literature/press-release/9884620/2018-fidelity-millionaire-outlook-study.html (accessed November 19, 2018).
5 “Trump Tax Cut to Be Eroded Next Year by Inflation Switch,” The Wall Street Journal. https://www.wsj.com/articles/trump-tax-cut-to-be-eroded-next-year-by-inflation-switch-1542302217?mod=searchresults&page=1&pos=6 (accessed November 19, 2018).

 

 

For Financial Professional Use Only—Not For Use With The Public. 

Each client’s individual needs differ and should be considered before making any specific recommendations.  The information provided is not written or intended as specific tax or legal advice. Shurwest, its employees and representatives are not authorized to give tax or legal advice. You, your clients and prospective clients are encouraged to seek advice from a qualified tax professional or legal counsel.