As the end of the year approaches, it is a good time to develop tax planning strategies to help lower your future tax bills. Year-end planning for 2019 is even more important, as it takes place against the backdrop of some major changes in the rules for individuals and businesses.
For individual tax planning, the changes that took place beginning in 2018 included lower income tax rates, an increase in standard deductions, and severely limited itemized deductions. Additional changes included no personal exemptions, an increased child tax credit, and a lower alternative minimum tax (AMT).
For business tax planning, the changes that took place beginning in 2018 included reducing the corporate tax rate to 21%, eliminating corporate AMT, limiting business interest deductions, and implementing very generous expensing and depreciation rules. Also, non-corporate taxpayers with qualified business income from pass-through entities are entitled to a special deduction.
The time-tested approach of deferring income and accelerating deductions to minimize taxes is still effective for many taxpayers, along with “bunching” expenses into this year or the next to get around deduction restrictions.
This list of actions may help you save tax dollars if you act before year-end. Not all actions will benefit everyone’s particular situation. We can tailor the specific actions to fit your particular tax plan. Review the following list and contact us at your earliest convenience. We will provide you with the best tax planning proposal for your situation.
End-of-year Tax Planning for Individuals
Unearned Income Surtax
High earners will have a surtax on certain unearned income. The surtax is 3.8% of the lesser of: (1) net investment income (NII), or (2) the excess of modified adjusted gross income (MAGI) over a threshold amount. The threshold for joint filers or surviving spouses is $250,000 and $125,000 for a married individual filing a separate return. The threshold for all other cases is $200,000. A taxpayer’s approach to minimizing or eliminating unearned income surtax depends on their estimated MAGI and NII for the year. Some taxpayers should consider ways to minimize additional NII for the balance of the year. Others should try to see if they can reduce MAGI other than NII. Some individuals may also need to consider ways to minimize both NII and other types of MAGI as part of their tax planning strategy.
Medicare Tax Rate
The 0.9% additional Medicare tax applies to higher-income earners for whom the sum of their wages received with respect to employment and their self-employment income is in excess of a threshold amount ($250,000 for joint filers, $125,000 for married couples filing separately, and $200,000 in any other case). Employers must withhold the additional Medicare tax from wages in excess of $200,000 regardless of filing status or other income.
Self-employed persons must take the Medicare tax into account in figuring the estimated tax. An employee may need to have more withheld toward the end of the year to cover the tax. For example, if an individual earns $200,000 from one employer during the first half of the year and a like amount from another employer during the balance of the year, the taxpayer would owe the additional Medicare tax. Neither employer would account for the withholding for the additional Medicare tax since wages from each employer do not exceed $200,000.
Capital Gains Tax
Long-term capital gains taxes from sales of assets held for over one year are taxed at 0%, 15%, or 20%. This will depend on the taxpayer’s taxable income. The 0% rate generally applies to the excess of long-term capital gain over any short-term capital loss. When this amount is added to regular taxable income, it cannot be more than the “maximum zero rate amount” (e.g., $78,750 for a married couple).
Using this example further, the 0% rate applies to long-term capital gains taken earlier this year for a joint filer who made a profit of $5,000 on the sale of stock bought in 2009, and when other taxable income for 2019 is $70,000. In this situation, try not to sell assets yielding a capital loss before year-end, since the first $5,000 of such losses will not yield a benefit this year. If you hold long-term appreciated-in-value assets, consider selling enough of them to generate long-term capital gains sheltered by the 0% rate.
Should you postpone income until 2020 in order to accelerate deductions into 2019? Do this if it enables you to claim larger deductions, credits, and tax breaks for 2019 that are otherwise phased out over higher levels of adjusted gross income (AGI). Some of these opportunities for larger credits can come from deductible IRA contributions, child tax credits, higher education tax credits, and deductions for student loan interest.
Postponing income is also desirable for taxpayers who anticipate being in a lower tax bracket next year due to changed financial circumstances. However, in some cases, it may pay to actually accelerate income into 2019. For example, that may be the case where a person will have a more favorable filing status this year than next (e.g., head of household versus individual filing status), or expects to be in a higher tax bracket next year.
Consider a Roth IRA
If you believe a Roth IRA is better than a traditional IRA, and you are eligible to do so, consider converting traditional-IRA money invested in lower performing stocks (or mutual funds) into a Roth IRA in 2019. Keep in mind, however, that such a conversion will increase your AGI for 2019, and possibly reduce tax breaks geared to AGI (or modified AGI).
It may be advantageous to try to arrange with your employer to defer any year-end bonuses until early 2020. Deferring a bonus that may be coming your way could reduce as well as defer your tax.
Many taxpayers will not be able to itemize deductions this year because of the high basic standard deduction amounts that apply for 2019. They are $24,400 for joint filers, $12,200 for singles and for married filing separately, and $18,350 for heads of household. Also, many itemized deductions were reduced or eliminated. No more than $10,000 of state and local taxes may be deducted; miscellaneous itemized deductions (e.g., tax preparation fees and unreimbursed employee expenses) are no longer deductible; and personal casualty and theft losses are deductible only if they are attributable to a federally declared disaster and only to the extent the $100-per-casualty and 10%-of-AGI limits are met.
You can still itemize medical expenses but only to the extent they exceed 10% of your adjusted gross income. You can itemize state and local taxes up to $10,000, your charitable contributions, and interest deductions on a restricted amount of qualifying residence debt. However, payments of these items will not save taxes if they do not cumulatively exceed the standard deduction amount that applies to your filing status.
Some taxpayers may be able to work around these deduction restrictions by applying a “bunching strategy”. This will pull or push discretionary medical expenses and charitable contributions into the year where they will do some tax good. For example, do you know if you will be able to itemize deductions this year but not next year? You can benefit by making two years’ worth of charitable contributions this year, instead of spreading out donations over 2019 and 2020.
Use Credit Card for Deductible Expenses
Consider using a credit card to pay deductible expenses before the end of the year. Doing so will increase your 2019 deductions even if you do not pay your credit card bill until next year.
Adjust Employer Withholdings
Do you expect to owe state and local income taxes when you file your return next year? Will you be itemizing in 2019? Consider increasing the withholding of state and local taxes or making estimated tax payments for state and local taxes before year-end. This will pull the deduction of those taxes into 2019. However, remember that state and local tax deductions are limited to $10,000 per year. So this strategy is not a good one to the extent it causes your 2019 state and local tax payments to exceed $10,000.
The first step in retirement planning is to contribute savings through an employer-sponsored elective salary deferral plan. Salary deferral plans include 401(k) plans, 403(b) plans, and 457 plans. Your available options will depend on your type of employment. For 2019, the inflation-adjusted elective salary deferral limit for 401(k), 403(b), and 457 plans is the lesser of $19,000 or 100% of compensation. If an employer makes contributions, the total contribution for 2019 from both the employee and the employer is capped at $56,000, which does not include an additional $6,000 for catch-up contributions. Participants should contact their plan administrator about their options regarding year-end contribution increases.
Take Required Minimum Distributions
Take required minimum distributions (RMDs) from your IRA or 401(k) plan (or other employer-sponsored retirement plans). RMDs from IRAs must begin by April 1 of the year following the year you reach age 70½. That start date also applies to company plans. Non-5% company owners who continue working may defer RMDs until April 1 following the year they retire. Failure to take a required withdrawal can result in a penalty of 50% of the amount of the RMD not withdrawn. Thus, if you turn age 70½ in 2019, you can delay the first required distribution to 2020. However, if you do, you will have to take a double distribution in 2020 – the amount required for 2019, plus the amount required for 2020.
Think twice before delaying 2019 distributions to 2020. Bunching income into 2020 might push you into a higher tax bracket or it may have a detrimental impact on various income tax deductions that are reduced at higher income levels. Note, it could be beneficial to take both distributions in 2020 if you will be in a substantially lower bracket that year.
Charitable Distributions from IRA
Are you age 70½ or older by the end of 2019? Do you have a traditional IRA, and you cannot itemize your deductions? Consider making 2019 charitable donations via qualified charitable distributions directly to charities from your IRA. The amount of the contribution is neither included in your gross income nor deductible on Schedule A, Form 1040. The amount of the qualified charitable distribution reduces the amount of your required minimum distribution and can result in tax savings.
Are you younger than age 70½ at the end of 2019? Do you anticipate in the year you turn 70½ and/or in later years you will not itemize your deductions? Do you not have any traditional IRAs? Then establish and contribute as much as you can to traditional IRAs in 2019. If these circumstances apply to you, but you already have traditional IRAs, make maximum contributions in 2019. Then, when you reach age 70½, make your charitable donations by way of qualified charitable distributions from your IRA. Doing all of this will allow you to convert nondeductible charitable contributions made in the year you turn 70½ and beyond into deductible-in-2019 IRA contributions and reductions of gross income from age 70½ and later-year distributions from the IRAs.
Rollover Any Distributions
Are you facing a penalty for underpayment of estimated tax? Is your employer unable to increase your withholdings by the year-end to avoid the underpayment of estimated tax penalty? Take an eligible rollover distribution from a qualified retirement plan before the end of 2019. Income tax is withheld from the distribution and applied toward the taxes owed for 2019.
You can rollover the gross amount of the distribution plus the amount of withheld tax, to a traditional IRA. No part of the distribution will be includible in income for 2019. However, the withheld tax is applied pro-rata over the full 2019 tax year to reduce previous underpayments of estimated tax.
Flexible Spending Accounts
Consider increasing the amount you set aside for next year in your employer’s health flexible spending account (FSA) if you set aside too little for this year.
Health Spending Account
If you become eligible in December of 2019 to make health savings account (HSA) contributions, you can make a full year’s worth of deductible HSA contributions for 2019.
Make gifts sheltered by the annual gift tax exclusion before the end of the year. Doing so may save gift and estate taxes. The exclusion applies to gifts of up to $15,000 made in 2019 to each of an unlimited number of individuals. Unused exclusions cannot be carried over to future years. This can save family income taxes when income-earning property is transferred to family members in lower income tax brackets not subject to the kiddie tax.
Estate Tax Exemption Gifting – If you don’t use it, you could lose it!
Do you have a large enough estate that estate tax would be due upon your passing? Currently, the estate tax exemption is $11,400,000 per person (for a married couple in California that would equate to $22,800,000), which eliminates the estate tax for most taxpayers. However, under the current law, the exemption is scheduled to revert to $5 million (adjusted for inflation) in 2026. Also, there might be additional revisions if there is a change in administration in Washington. One proposal would lower the estate tax exemption to only $3.5 million.
If you have a large estate, you may want to consider gifting all of part of your $11,400,000 exemption in order to reduce your future estate tax bill. The exemption must be utilized before it is reduced in 2026, or possibly earlier under an administration change.
Income Tax Basis Planning vs. Estate Tax Planning
One might think that estate taxes are no longer a concern because of the size of the estate. However, income tax planning is an important part of planning an estate, especially the income tax basis of assets gifted or inherited.
Under the Internal Revenue Code, assets gifted during lifetime retain the income tax basis of the donor, but not in excess of their fair market value at the date of gift. However, assets inherited upon the death of the owner receive a new tax basis equal to their fair market value at the date of death. (This is commonly referred to as the “step up” in basis rule). For example, an asset that cost $100, but has a fair market value of $1,000, would have a tax basis to the donee of $100 if received by gift and a tax basis of $1,000 if received by inheritance.
From these income tax rules, the following are several significant planning tips:
- If an individual’s potential estate is materially below the applicable estate tax exemption, gifting of appreciated assets during lifetime rarely makes tax sense – gifting will in most cases cause a loss of basis step up.
- Any gifting deemed appropriate should be made, whenever possible, with high basis assets.
- If the potential estate is large enough that estate tax may be due, consider gifting assets with a high potential for future appreciation.
- Consider undoing trusts that may have been previously created in order to maximize the benefits of the step up in basis.
- For example, a trust created at the death of a decedent for a surviving spouse (commonly called a “bypass” trust, a “B” trust or a credit equivalent trust), which is holding appreciated assets, might allow (or might be reformed to allow) principal distributions to be made to a surviving spouse to be held by that person until death in order to obtain a step up in basis for those assets.
- Certain irrevocable trusts created during lifetime might be terminated, with distributions to the grantor or to the spouse of appreciated assets to be held by that person until death.
- In certain trusts that are treated as owned by the grantor for income tax purposes, a “swap” of higher basis assets in the hands of the grantor for lower basis assets in the trust could be advantageous.
- If your existing estate planning includes a trust created on the first death for the benefit of a surviving spouse, based on the rules discussed above, you should review whether revised documents that eliminate the trust would be advantageous.
Using Non-grantor Trusts to Avoid State Income Taxation
Most income tax planning is focused on minimizing federal tax liabilities. With state income tax rates as high as 13.3%, strategies that reduce state income tax liabilities are increasingly popular as well.
A recently popular strategy uses a non-grantor trust where portfolio assets that may generate significant income are contributed into a trust in a state with no state income tax to shift the tax exposure to that state’s 0% state tax rates, rather than the settlor’s high-tax-rate home state. The end result can be a significant state income tax savings.
For those who have significant assets and income, and investments with significant tax exposure, a trust structured properly can generate substantial state income tax savings.
Did you suffer uninsured or unreimbursed disaster-related losses in a federally declared disaster? You can choose to claim them either on the return for the year the loss occurred or on the return for the prior year (2018).
Settle Insurance Claims
Complete any insurance or damage claims in 2019 to maximize your casualty loss deduction. This also only applies to federally declared disasters.
End-of-Year Tax Planning for Businesses
Non-Corporate Business Entities
Taxpayers other than corporations may be entitled to a deduction of up to 20% of their qualified business income. For 2019, if taxable income exceeds $321,400 for a married couple filing jointly, $160,700 for single and head of household, and $160,725 for married filing separately, the deduction may be limited based on:
- whether the taxpayer is engaged in a service-type trade or business (such as law, accounting, health, or consulting),
- the amount of W-2 wages paid by the trade or business, and/or
- the unadjusted basis of qualified property (such as machinery and equipment) held by the trade or business.
The limitations are phased-in. For example, the phase-in applies to joint filers with taxable income between $321,400 and $421,400. It also applies to single taxpayers with taxable income between $160,700 and $210,700.
Taxpayers may be able to achieve significant savings with this deduction. They will need to defer income or accelerate deductions in order to come under the dollar thresholds (or be subject to a smaller phase-out of the deduction) for 2019. Depending on their business model, taxpayers may be able to increase the new deduction by increasing W-2 wages before year-end. The rules are quite complex, so do not make a move in this area without consulting your tax advisor.
Cash vs. Accrual method
Many “small businesses” will be able to use the cash (as opposed to accrual) method of accounting this year. One of the key requirements a taxpayer must meet to qualify as a small business is to satisfy the gross-receipts test. The gross-receipts test is satisfied in 2019 if, during the three-year testing period, average annual gross receipts do not exceed $26,000,000. The dollar amount was $25,000,000 for 2018, and for earlier years it was $5,000,000. Cash-method taxpayers may find it a lot easier to shift income by holding off billings until next year or by accelerating expenses. One example is to pay bills early or make prepayments.
Business Property Expensing
Businesses should consider making expenditures that qualify for the liberalized business property expensing option. For tax years beginning in 2019, the expensing limit is $1,020,000, while the investment limit is $2,550,000.
Expensing is generally available for most depreciable property and off-the-shelf computer software. It is also available for qualified improvement property, such as any improvement to a building’s interior. It does not include the enlargement of a building, elevators or escalators, or the internal structural framework. However, it does include roofs, HVAC, fire protection, alarm, and security systems. The generous dollar ceilings this year mean that many small- and medium-sized businesses that make timely purchases will be able to deduct most, if not all, outlays for machinery and equipment.
The expensing deduction may be claimed, regardless of how long the property is held during the year, making it a potent tool for year-end tax planning.
Machinery and Equipment Depreciation
Businesses can claim a 100% bonus first-year depreciation deduction for machinery and equipment. It applies to new or used equipment purchased and placed into service this year. The 100% write-off is available regardless of the length of time the asset is in service. As a result, the write-off is available even when assets are in service for a few days in 2019.
Book Tax Conformity Election
Businesses may be able to take advantage of the de minimis safe harbor election (also known as the book-tax conformity election) to expense the costs of lower-cost assets and materials and supplies, assuming the costs do not have to be capitalized under the Code Sec. 263A uniform capitalization (UNICAP) rules.
To qualify for the election, the cost of a unit of property cannot exceed $5,000 if the taxpayer has an applicable financial statement (AFS; e.g., a certified audited financial statement along with an independent CPA’s report). If there is no AFS, the cost of a unit of property can’t exceed $2,500. Where the UNICAP rules are not an issue, consider purchasing such qualifying items before the end of 2019.
If you are a small corporation anticipating a small net operating loss for 2019 and substantial net income in 2020, it may be worthwhile to accelerate enough 2020 income or defer just enough 2019 deductions to create a small amount of net income for 2019. This will permit the corporation to base its 2020 estimated tax installments on a relatively small amount of income on its 2019 return. This will avoid having to pay estimated taxes based on 100% of a much larger 2020 taxable income.
To reduce 2019 taxable income, consider deferring a debt-cancellation event until 2020.
Dispose of Passive Activity
To reduce 2019 taxable income, consider disposing of a passive activity in 2019 if doing so will allow you to deduct suspended passive activity losses.
IMPORTANT LIFE CYCLE CHANGES THAT AFFECT YEAR-END TAX PLANNING
In addition to changes in the tax law, taxpayers should also consider personal circumstances that changed during 2019 as well as what may change in 2020. These changes include:
- A change in filing status due to marriage, divorce, death, or head of household changes
- Change in dependents, such as a new-born child or grown child
- Changes in medical expenses
- College and other higher education expenses
- Change in employer
- Start retirement
- Personal bankruptcy
- Business successes or failures and succession plan
Summarized in this guide are some of the year-end strategies you may use to save taxes for yourself and your business. If you wish to discuss how Windes can tailor a plan that will work best for your particular situation, or have questions regarding your year-end tax planning, please do not hesitate to contact us at [email protected] or toll-free at 844.4WINDES (844.494.6337).