October 16, 2019
To Our Clients and Friends:
With year-end approaching, now’s the time to take steps to cut your 2019 tax bill. Here are some relatively foolproof year-end tax planning strategies to consider, assuming next year’s general election doesn’t result in retroactive tax changes that could affect your 2020 tax year.
Year-end Planning Moves for Individuals
Managing the Increased Standard Deduction Allowances. For 2019, the standard deduction amounts are $12,200 for singles and those who use married filing separate status, $24,400 for married joint filing couples, and $18,350 for heads of household. If your total annual itemizable deductions for 2019 will be close to your standard deduction amount, consider making additional expenditures before year-end to exceed your standard deduction. That will lower this year’s tax bill. Next year, you can claim the standard deduction, which will be increased a bit to account for inflation.
The easiest deductible expense to accelerate is included in your house payment due on January 1. Accelerating that payment into this year will give you 13 months’ worth of interest in 2019. Also, consider state and local income and property taxes that are due early next year. Prepaying those bills before year-end can decrease your 2019 federal income tax bill because your itemized deductions will be that much higher. However, the maximum amount you can deduct for state and local taxes is $10,000 ($5,000 if you use married filing separate status).
Warning: This can be a bad idea if you owe Alternative Minimum Tax (AMT) this year. That’s because write-offs for state and local income and property taxes are completely disallowed under the AMT rules. Therefore, prepaying those expenses may do little or no good if you’re an AMT victim. Contact us if you’re unsure about your exposure to AMT.
Accelerating other expenditures could cause your itemized deductions to exceed your standard deduction in 2019. For example, consider making bigger charitable donations this year and smaller contributions next year to compensate. Also, consider accelerating elective medical procedures, dental work, and vision care. For 2019, medical expenses are deductible to the extent they exceed 10% of Adjusted Gross Income (AGI), assuming you itemize.
Carefully Manage Investment Gains and Losses in Taxable Accounts. If you hold investments in taxable brokerage firm accounts, consider the tax advantage of selling appreciated securities that have been held for over 12 months. The maximum federal income tax rate on long-term capital gains recognized in 2019 is only 15% for most folks, although it can reach a maximum of 20% at higher income levels. The 3.8% Net Investment Income Tax (NIIT) also can apply at higher income levels.
To the extent you have capital losses that were recognized earlier this year or capital loss carryovers from pre-2019 years, selling winners this year will not result in any tax hit. In particular, sheltering net short-term capital gains with capital losses is a sweet deal because net short-term gains would otherwise be taxed at higher ordinary income rates.
What if you have some loser investments that you would like to unload? Biting the bullet and taking the resulting capital losses this year would shelter capital gains, including high-taxed short-term gains, from other sales this year.
If selling a bunch of losers would cause your capital losses to exceed your capital gains, the result would be a net capital loss for the year. No problem! That net capital loss can be used to shelter up to $3,000 of 2019 ordinary income from salaries, bonuses, self-employment income, interest income, royalties, and whatever else ($1,500 if you use married filing separate status). Any excess net capital loss from this year is carried forward to next year and beyond.
In fact, having a capital loss carryover into next year and beyond could turn out to be a pretty good deal. The carryover can be used to shelter both short-term and long-term gains recognized next year and beyond. This can give you extra investing flexibility in those years because you won’t have to hold appreciated securities for over a year to get a preferential tax rate. Since the top two federal rates on net short-term capital gains recognized in 2020 are 35% and 37% (plus the 3.8% NIIT, if applicable), having a capital loss carryover into next year to shelter short-term gains could be a very good thing.
Key Point: If you still have a capital loss carryover after 2020, it could come in handy if the general election results in increased tax rates for 2021 and beyond.
Take Advantage of 0% Tax Rate on Investment Income. The TCJA retained the 0%, 15%, and 20% rates on Long-term Capital Gains (LTCGs) and qualified dividends recognized by individual taxpayers. However, for 2018–2025, these rates have their own brackets that are not tied to the ordinary income brackets.
Note: The 3.8% NIIT can hit LTCGs and dividends recognized by higher-income individuals. This means that many folks will
actually pay 18.8% (15% + 3.8% for the NIIT) and 23.8% (20% + 3.8%) on their 2019 LTCGs and dividends.
While your income may be too high to benefit from the 0% rate, you may have children, grandchildren, or other loved ones who will be in the 0% bracket. If so, consider giving them appreciated stock or mutual fund shares that they can sell and pay 0% tax on the resulting long-term gains. Gains will be long-term, as long as your ownership period plus the gift recipient’s ownership period (before the sale) equals at least a year and a day.
Giving away stocks that pay dividends is another tax-smart idea. As long as the dividends fall within the gift recipient’s 0% rate bracket, they will be federal-income-tax-free.
Warning: If you give securities to someone who is under age 24, the Kiddie Tax rules could potentially cause some of the resulting capital gains and dividends to be taxed at the higher rates that apply to trusts and estates. That would defeat the purpose. Please contact us if you have questions about the Kiddie Tax.
Also, one can be doing pretty well income-wise and still be within the 0% rate bracket for LTCGs and qualified dividends. Consider the following examples:
• Your married adult daughter files jointly and claims the $24,400 standard deduction for 2019. She could have up to $103,150 of AGI (including LTCGs and dividends) and still be within the 0% rate bracket. Her taxable income would be $78,750, which is the top of the 0% bracket for joint filers.
• Your divorced son uses head of household filing status and claims the $18,350 standard deduction for 2019. He could have up to $71,100 of AGI (including LTCGs and dividends) and still be within the 0% rate bracket. His taxable income would be $52,750, which is the top of the 0% bracket for heads of household.
• Your single daughter claims the $12,200 standard deduction for 2019. She could have up to $51,575 of AGI (including LTCGs and dividends) and still be within the 0% rate bracket. Her taxable income would be $39,375, which is the top of the 0% bracket for singles.
Give Away Winner Shares or Sell Loser Shares and Give Away the Resulting Cash. If you want to make gifts to some favorite relatives and/or charities, they can be made in conjunction with an overall revamping of your taxable account stock and equity mutual fund portfolios. Gifts should be made according to the following tax-smart principles.
Gifts to Relatives. Don’t give away loser shares (currently worth less than what you paid for them). Instead, you should sell the shares and book the resulting tax-saving capital loss. Then, you can give the sales proceeds to your relative.
On the other hand, you should give away winner shares to relatives. Most likely, they will pay lower tax rates than you would pay if you sold the same shares. As explained earlier, relatives in the 0% federal income tax bracket for long-term capital gains and qualified dividends will pay a 0% federal tax rate on gains from shares that were held for over a year before being sold. (For purposes of meeting the more-than-one-year rule for gifted shares, you can count your ownership period plus the gift recipient’s ownership period.) Even if the winner shares have been held for a year or less before being sold, your relative will probably pay a much lower tax rate on the gain than you would.
Gifts to Charities. The principles for tax-smart gifts to relatives also apply to donations to IRS-approved charities. You should sell loser shares and collect the resulting tax-saving capital losses. Then, you can give the sales proceeds to favored charities and claim the resulting tax-saving charitable deductions (assuming you itemize). Following this strategy delivers a double tax benefit: tax saving capital losses plus tax-saving charitable donation deductions.
On the other hand, you should donate winner shares instead of giving away cash. Why? Because donations of publicly traded shares that you have owned over a year result in charitable deductions equal to the full current market value of the shares at the time of the gift (assuming you itemize). Plus, when you donate winner shares, you escape any capital gains taxes on those shares. This makes this idea another double tax-saver: you avoid capital gains taxes while getting a tax-saving donation deduction
(assuming you itemize). Meanwhile, the tax-exempt charitable organization can sell the donated shares without owing anything to
the IRS.
Convert Traditional IRAs into Roth Accounts. The best profile for the Roth conversion strategy is when you expect to be in the same or higher tax bracket during your retirement years. Given the current political environment, that’s certainly a reasonable expectation for many folks! The current tax hit from a conversion done this year may turn out to be a relatively small price to pay for completely avoiding potentially higher future tax rates on the account’s earnings. In effect, a Roth IRA can insure part or all of your retirement savings against future tax rate increases.
A few years ago, the Roth conversion privilege was a restricted deal. It was only available if your modified AGI was $100,000 or less. That restriction is gone. Even billionaires can now do Roth conversions!
Take Advantage of Principal Residence Gain Exclusion Break. Home prices are on the upswing in many areas. More good news:
Gains of up to $500,000 on the sale of a principal residence are completely federal-income-tax-free for qualifying married couples who file joint returns. $250,000 is the gain exclusion limit for qualifying unmarried individuals and married individuals who file separate returns. To qualify for the gain exclusion break, you normally must have owned and used the home as your principal residence for a total of at least two years during the five-year period ending on the sale date. You’ll definitely want to take these
rules into consideration if you’re planning on selling your home in today’s improving real estate environment.
Take Advantage of Flexible Spending Accounts (FSAs). If your company has a healthcare and/or dependent care FSA, before yearend you must specify how much of your 2020 salary to convert into tax-free contributions to the plan. You can then take tax-free withdrawals next year to reimburse yourself for out-of-pocket medical and dental expenses and qualifying dependent care costs. Watch out, though, FSAs are “use-it-or-lose-it” accounts—you don’t want to set aside more than what you’ll likely have in
qualifying expenses for the year.
If you currently have a healthcare FSA, make sure you drain it by incurring eligible expenses before the deadline for this year. Otherwise, you’ll lose the remaining balance. It’s not that hard to drum some things up: new glasses or contacts, dental work you’ve been putting off, or prescriptions that can be filled early.
Consider a Health Savings Account (HSA). If you are enrolled in a high-deductible health plan and don’t have any other coverage, you may be eligible to make pre-tax or tax-deductible contributions to an HSA of up to $7,000 for a family coverage or $3,500 for individual coverage—plus an extra $1,000 if you will be 55 or older by the end of 2019. Distributions from the HSA will be tax free as long as the funds are used to pay unreimbursed qualified medical expenses. Furthermore, there’s no time limit on when you can use your contributions to cover expenses. Unlike a healthcare FSA, amounts remaining in the HSA at the end of the year can be carried over indefinitely.
Maximize Contributions to 401(k) Plans. If you have a 401(k) plan at work, it’s just about time to tell your company how much you want to set aside on a tax-free basis for next year. Contribute as much as you can stand, especially if your employer makes matching contributions. You give up “free money” when you fail to participate to the max for the match.
Adjust Your Federal Income Tax Withholding. If it looks like you are going to owe income taxes for 2019, consider bumping up the federal income taxes withheld from your paychecks now through the end of the year. When you file your return, you will have to pay any taxes due less the amount paid in and/or withheld. However, as long as your total tax payments (estimated payments plus withholdings) equal at least 90% of your 2019 liability or, if smaller, 100% of your 2018 liability (110% if your 2018 adjusted gross income exceeded $150,000; $75,000 for married individuals who filed separate returns), penalties will be minimized, if not
eliminated.
Make Charitable Donations from Your IRA. IRA owners and beneficiaries who have reached age 701/2 are permitted to make cash donations totaling up to $100,000 per individual IRA owner per year—$200,000 per year maximum on a joint return if both spouses make QCDs of $100,000—to IRS-approved public charities directly out of their IRAs. These so-called Qualified Charitable Distributions, or QCDs, are federal-income-tax-free to you, but you get no itemized charitable write-off on your Form 1040. That’s
okay because the tax-free treatment of QCDs equates to an immediate 100% federal income tax deduction without having to worry about restrictions that can delay itemized charitable write-offs. It also reduces your AGI. QCDs have other tax advantages, too. Contact us if you want to hear about them. Be careful—to qualify for this special tax break, the funds must be transferred directly from your IRA to the charity.
Take Your Required Retirement Distributions. Individuals with retirement accounts must generally take withdrawals based on the
size of their account and their age every year after they reach age 701/2. Failure to take a required withdrawal can result in a penalty of 50% of the amount not withdrawn. There’s good news though—QCDs discussed above count as payouts for purposes of the required distribution rules. This means, you can donate all or part of your 2018 required distribution (up to the $100,000 per individual IRA owner limit on QCDs) and convert taxable required distributions into tax-free QCDs.
Also, if you turned age 701/2 in 2019, you can delay your 2019 required distribution until April 1, 2020. However, waiting until 2020 will result in two distributions in 2020—the amount required for 2019 plus the amount required for 2020. While deferring income is normally a sound tax strategy, here it results in bunching income into 2020. Thus, think twice before delaying your 2019 distribution to 2020—bunching income into 2020 might throw you into a higher tax bracket or have a detrimental impact on your
tax deductions.
Don’t Overlook Estate Planning. Thanks to the Tax Cuts and Jobs Act (TCJA), the unified federal estate and gift tax exemption for 2019 is a historically huge $11.4 million, or effectively $22.8 million for married couples. Even though these big exemptions may mean you’re not currently exposed to the federal estate tax, your estate plan may need updating to reflect the current tax rules.
Warning: In 2026, the estate and gift tax exemption is scheduled to revert to the much-lower pre-TCJA level. Depending on political developments, that could happen much sooner than 2026. However, late last year, the IRS issued proposed regulations that would protect estates that make large gifts while the ultra-generous TCJA exemption is in place. These rules haven’t been finalized, so place your bets and act accordingly. We can help you assess the various risks.
Year-end Planning Moves for Small Businesses
Establish a Tax-favored Retirement Plan. If your business doesn’t already have a retirement plan, now might be the time to take the plunge. Current retirement plan rules allow for significant deductible contributions. For example, if you’re self-employed and set up a SEP-IRA, you can contribute up to 20% of your self-employment earnings, with a maximum contribution of $56,000 for. If you’re employed by your own corporation, up to 25% of your salary can be contributed with a maximum contribution of $56,000.
Other small business retirement plan options include the 401(k) plan (which can be set up for just one person), the defined benefit pension plan, and the SIMPLE-IRA. Depending on your circumstances, these other types of plans may allow bigger deductible contributions.
The deadline for setting up a SEP-IRA for a sole proprietorship and making the initial deductible contribution for the 2019 tax year is 10/15/20 if you extend your 2019 return to that date. Other types of plans generally must be established by 12/31/19 if you want to make a deductible contribution for the 2019 tax year, but the deadline for the contribution itself is the extended due date of your 2019 return. However, to make a SIMPLE-IRA contribution for 2019, you must have set up the plan by October 1. So, you might have to wait until next year if the SIMPLE-IRA option is appealing.
Contact us for more information on small business retirement plan alternatives, and be aware that if your business has employees, you may have to cover them too.
Take Advantage of Generous Depreciation Tax Breaks. 100% first-year bonus depreciation is available for qualified new and used property that is acquired and placed in service in calendar-year 2019. That means your business might be able to write off the entire cost of some or all of your 2019 asset additions on this year’s return. So, consider making additional acquisitions between now and year-end. Contact us for details on the 100% bonus depreciation break and what types of assets qualify.
Claim 100% Bonus Depreciation for Heavy SUVs, Pickups, or Vans. The 100% bonus depreciation provision can have a hugely beneficial impact on first-year depreciation deductions for new and used heavy vehicles used over 50% for business. That’s because heavy SUVs, pickups, and vans are treated for tax purposes as transportation equipment that qualifies for 100% bonus depreciation. However, 100% bonus depreciation is only available when the SUV, pickup, or van has a manufacturer’s Gross
Vehicle Weight Rating (GVWR) above 6,000 pounds. The GVWR of a vehicle can be verified by looking at the manufacturer’s label, which is usually found on the inside edge of the driver’s side door where the door hinges meet the frame. If you are considering buying an eligible vehicle, doing so and placing it in service before the end of this tax year could deliver a juicy write-off on this year’s return.
Claim First-year Depreciation Deductions for Cars, Light Trucks, and Light Vans. For both new and used passenger vehicles (meaning cars and light trucks and vans) that are acquired and placed in service in 2019, the luxury auto depreciation limits are as follows:
• $18,100 for Year 1 if bonus depreciation is claimed.
• $16,100 for Year 2.
• $9,700 for Year 3.
• $5,760 for Year 4 and thereafter until the vehicle is fully depreciated.
Note that the $18,100 first-year luxury auto depreciation limit only applies to vehicles that cost $58,500 or more. Vehicles that cost
less are depreciated over six tax years using percentages based on their cost. Contact us for details.
Cash in on More Generous Section 179 Deduction Rules. For qualifying property placed in service in tax years beginning in 2019, the maximum Section 179 deduction is $1.02 million. The Section 179 deduction phase-out threshold amount is $2.55 million.
Property Used for Lodging. The Section 179 deduction may be claimed for personal property used predominately to furnish lodging or in connection with the furnishing of lodging. Examples of such property include furniture, kitchen appliances, lawn mowers, and other equipment used in the living quarters of a lodging facility or in connection with a lodging facility such as a hotel, motel, apartment house, dormitory, or other facility where sleeping accommodations are provided and rented out.
Qualifying Real Property. Section 179 deductions can be claimed for qualifying real property expenditures. Qualifying real property means any improvement to an interior portion of a nonresidential building that is placed in service after the date the building is first placed in service, except for expenditures attributable to the enlargement of the building, any elevator or escalator, or the building’s internal structural framework. The definition also includes roofs, HVAC equipment, fire protection and alarm systems, and security systems for nonresidential real property. To qualify, these items must be placed in service after the nonresidential building has been placed in service.
Time Business Income and Deductions for Tax Savings. If you conduct your business using a pass-through entity (sole proprietorship, S corporation, LLC, or partnership), your shares of the business’s income and deductions are passed through to you and taxed at your personal rates. Assuming the current tax rules will still apply in 2020, next year’s individual federal income tax rate brackets will be the same as this year’s (with modest bumps for inflation). In that case, the traditional strategy of deferring income into next year while accelerating deductible expenditures into this year makes sense if you expect to be in the same or lower tax bracket next year. Deferring income and accelerating deductions will, at a minimum, postpone part of your tax bill from 2019 until 2020.
On the other hand, if you expect to be in a higher tax bracket in 2020, take the opposite approach. Accelerate income into this year (if possible) and postpone deductible expenditures until 2020. That way, more income will be taxed at this year’s lower rate instead of next year’s higher rate. Contact us for more information on timing strategies.
Key Point: If tax rates are increased for 2021 and beyond, the standard income deferral strategy might not work next year. You might have to take the opposite approach and accelerate income from 2021 into 2020. Stay tuned for developments and stay in touch with us for tax-saving strategies.
Maximize the New Deduction for Pass-through Business Income. For 2019, the deduction for Qualified Business Income (QBI) can be up to 20% of a pass-through entity owner’s QBI, subject to restrictions that can apply at higher income levels and another restriction based on the owner’s taxable income. The QBI deduction also can be claimed for up to 20% of income from qualified REIT dividends and 20% of qualified income from publicly-traded partnerships.
For QBI deduction purposes, pass-through entities are defined as sole proprietorships, single-member LLCs that are treated as sole proprietorships for tax purposes, partnerships, LLCs that are treated as partnerships for tax purposes, and S corporations. The QBI deduction is only available to noncorporate taxpayers (individuals, trusts, and estates).
Because of the various limitations on the QBI deduction, tax planning moves (or nonmoves) can have the side effect of increasing or decreasing your allowable QBI deduction. So, individuals who can benefit from the deduction must be really careful at year-end tax planning time. In addition, for those with rental activities, additional requirements may apply to qualify for QBI. We can help you put together strategies that give you the best overall tax results for the year.
Check Your Partnership and S Corporation Stock Basis. If you own an interest in a partnership or S corporation, your ability to deduct any losses it passes through is limited to your basis. Although any unused loss can be carried forward indefinitely, the time value of money diminishes the usefulness of these suspended deductions. Thus, if you expect the partnership or S corporation to generate a loss this year and you lack sufficient basis to claim a full deduction, you may want to make a capital contribution (or in the case of an S corporation, loan it additional funds) before year end.
Note: The Bipartisan Budget Act of 2015 (BBA) established a new audit regime for partnerships that will go into effect in 2018. The BBA regime creates new roles and responsibilities for partners. To avoid future disagreements, it is recommended that partnership agreements be reviewed by competent legal counsel and revised as needed.
Employ Your Child. If you are self-employed, don’t miss the opportunity to employ your child before the end of the year. Doing so has tax benefits in that it shifts income (which is not subject to the Kiddie tax) from you to your child, who normally is in a lower tax bracket or may avoid tax entirely due to the standard deduction. There can also be payroll tax savings since wages paid by sole proprietors to their children age 17 and younger are exempt from both social security and unemployment taxes. Employing your
children has the added benefit of providing them with earned income, which enables them to contribute to an IRA. Children with IRAs, particularly Roth IRAs, have a great start on retirement savings since the compounded growth of the funds can be significant.
Remember a couple of things when employing your child. First, the wages paid must be reasonable given the child’s age and work skills. Second, if the child is in college, or is entering soon, having too much earned income can have a detrimental impact on the student’s need-based financial aid eligibility.
Claim 100% Gain Exclusion for Qualified Small Business Stock. There is a 100% federal income tax gain exclusion privilege for eligible sales of Qualified Small Business Corporation (QSBC) stock that was acquired after 9/27/10. QSBC shares must be held for more than five years to be eligible for the gain exclusion break. Contact us if you think you own stock that could qualify.
Conclusion
This letter only covers some of the year-end tax planning moves that could potentially benefit you and your business. Please contact us at (402) 371-1160 or 1-800-694-1160 if you have questions, want more information, or would like us to help in designing a year-end planning package that delivers beneficial tax results for your particular circumstances.