Top 10 Year-End Tax Planning Ideas for Individuals
Year-end tax planning for 2019 takes place against the backdrop of legislative changes that occurred in late 2017 that fundamentally altered the tax rules for individuals and businesses. The Tax Cuts and Jobs Act (TCJA) was the largest tax law change in 30 years, and 2018 was the first year that TCJA changes were in effect. It seems as if some taxpayers are still just filing their 2018 tax returns that were on extension and digesting the impact that the TCJA had on their situation, and now we are planning for the 2019 year-end already.
The issues to navigate for the remainder of 2019 involve the following items:
- For the wealthiest taxpayers, personal income is subject to a top ordinary rate of 37% and a potential high-wage earners Medicare tax of .9%.
- Special maximum tax rates generally apply to long-term capital gains and qualified dividends (0%, 15%, or 20%).
- There is still a 3.8% Medicare surtax on Net Investment Income.
- Fewer taxpayers are affected by Alternative Minimum Tax (AMT).
- Many more taxpayers are using the increased standard deduction.
- Many itemized deductions have been repealed or significantly reduced. State and local tax deductions are capped at $10,000, qualified home interest deduction rules have changed, the former Pease limitation has been removed, and some prior miscellaneous itemized deductions are gone.
- There is the new qualified business income deduction for pass-through income.
10 wealth tax planning ideas to consider for 2019
1 Defer income and accelerate deductions
Despite that tax rates for 2019 and the next year will remain the same (with modest increases for inflation), the time-honored approach of deferring income and accelerating deductions to minimize taxes still works for many taxpayers. For those taxpayers that will remain in the same tax bracket from year-to-year, deferring income will not cause them to be taxed at a lower rate. Rather, it just delays the recognition of income, bringing into play time value of money considerations. However, if you expect to be in a lower tax bracket, then you should consider deferring income using strategies such as the installment sale method to defer taxable gain on sales, postponing income received by cash basis taxpayers, or delaying the receipt of a bonus. For accrual basis taxpayers who want to defer the recognition of income, consider postponing the actual right to payment for services or merchandise delivered.
If you expect to be in a higher tax bracket in 2020 than in 2019 due to increased income or lower deductions or a change in filing status, you should consider accelerating income using strategies such as accelerating the installment sale gain or moving up the closing date of a sale.
For deductions that are subject to a floor, such as medical expense or charitable deductions, the tactic of “bunching” expenses into this year or the next helps to get around deduction restrictions imposed by TCJA. Prepay expenses where feasible. Use credit card charges to accelerate deductible expenses.
2 Make the most of the reduced capital gain tax rates
Long-term capital gains are taxed at a rate of 0%, 15%, or 20%. And, the 3.8% surtax on net investment income may apply. Work with your tax adviser and portfolio strategist near year-end for strategies to match capital gains and capital losses. Remember that for individuals, capital losses can’t be carried back, but they can be carried forward indefinitely.
Taxpayers wanting to realize paper losses on stocks while still retaining the same investment position can sell shares and buy shares in the same company or another company. Be sure to avoid the wash-sale rules, which disallow the loss if substantially the same shares are acquired within the 61-day period beginning 30 days before and ending 30 days after the sale.
You should take advantage of the lower taxed dividend income. Qualified dividend income is taxed at the same favorable tax rates that apply to long-term capital gains. Consider shifting investments out of holdings that generate income taxed at ordinary rates (e.g., bonds) and into dividend-paying stocks to achieve tax savings and result in higher after-tax income. However, be cautious that the 3.8% surtax on net investment income could apply.
3 Shift income and assets to other family members
Consider making gifts of income-producing property to donees that are in lower income tax brackets than the donor, resulting in overall family income tax savings. A transfer could also save any 3.8% net investment income (NII) surtax. Keep in mind that the maximum savings will be realized for a gift to a child of the donor only if the child is not subject to the kiddie tax.
Gift appreciated property to a lower-bracket family member. The appreciated asset can later be sold with a gain that could be taxed at a lower income bracket, potentially even the 0% or 10% capital gain rate.
4 Reduce taxable income so that the Qualified Business Income deduction (QBI or Section 199A deduction) can be maximized
Manage your taxable income so that you are under the limitations. If taxable income exceeds $321,400 for a married couple filing jointly, or $160,700 for all other taxpayers, the deduction is subject to multiple limits based on the type of trade or business, the taxpayer’s taxable income, the amount of W-2 wages paid with respect to the qualified trade or business, and/or the unadjusted basis of qualified property held by the trade or business.
Reduce taxable income by taking advantage of additional contributions to defined contribution or defined benefit plans, use bonus deprecation or Section 179 expensing where available, or use charitable contributions or tax-free investments. Also, consider shifting income to lower income taxpayers, such as children or non-grantor trusts to maximize the QBI deduction.
For those that are in a non-specified service trade or business and income is projected to exceed the taxable income limitations, focus on ways to manage the wage and property limitations. For example, generate extra capital by purchasing qualified property or increase wages by replacing independent contractors with employees.
5 Maximize charitable contribution deductions
With the number of taxpayers that itemize deductions projected to decline and more taxpayers instead taking the now higher standard deduction, how can you maximize your charitable gifts? Taxpayers should consider bunching charitable deductions into particular years or consider making gifts to a donor advised fund to obtain the deduction now and make actual distributions from the fund at a future date. Consider gifting low basis assets directly to charity and avoiding paying capital gains tax on the appreciation of the asset. Alternatively, sell loss assets first and then gift the cash to charity, in order to take advantage of the loss to offset other capital gains.
If you haven’t already taken your required minimum distribution (RMD) yet for 2019, consider the Charitable IRA Rollover, which allows an individual age 70 ½ or older to make a qualified charitable distribution (QCD) from their IRA directly to a charity and exclude the distribution from gross income (up to $100,000 per year). You may not receive a separate tax deduction for the charitable donation, but there are several benefits to this strategy.
It can be used to satisfy an RMD and the reduced adjusted gross income (AGI) can have an impact on the taxability of Social Security and the overall marginal tax rate, capital gains rate, or applicability of the 3.8% Medicare surtax on net investment income.
Also, consider setting up a non-grantor irrevocable trust for your gifts. If drafted properly, the trust can distribute income to charity and take a charitable deduction, without limitation.
6 Review your estate plan
With the federal estate and gift exemption amount nearly doubled now to nearly $11.4 million per person, those with taxable estates should make use of the increased exemptions with the use of lifetime gifts. Also, for transfers that could potentially be subject to the generation skipping tax, take advantage of the increased Generation Skipping Transfer (GST) tax exemption as well by making current gifts to skip persons or making late allocations of GST exemption to trusts that previously were not exempt.
Save on future estate taxes by utilizing the annual per-donee exclusion of $15,000. Post-transfer appreciation on the gift won’t be included in the donor’s estate. When reviewing your estate plan, consider the possibility that a reference to the exemption amount in an estate planning document that was drafted before the enactment of TCJA could create an undesirable result.
7 IRA to Roth IRA conversions
As you get close to year end, determining your 2019 marginal tax bracket and projected investment income can be done with more certainty. If you are trying to convert your traditional IRA to a Roth IRA to fill up a tax bracket, start those conversations now. Traditional IRA to Roth IRA conversions can reduce future required minimum distributions and create a potential tax-free inheritance for children. Under present law, there are no required distributions by the participant from the Roth IRA in future years. Higher earning taxpayers who cannot contribute directly to a Roth IRA may be able to contribute to a non-deductible IRA that might later be converted to a Roth IRA. Just be mindful that the ability to recharacterize Roth conversion contributions was eliminated by the TCJA for tax years beginning after December 31, 2017.
Also, with IRA planning, it is important to consider the future potential legislation that could limit what is known as the “stretch IRA”, a concept that allows IRA or defined contribution plan beneficiaries to draw down the remaining plan benefits over the beneficiary’s life expectancy. The new legislation would cause inherited IRAs and inherited defined contribution plans to be distributed within 10 years of the original owner’s death.
8 Maximize the use of tax-advantaged savings vehicles
Reduce taxable income by increasing pre-tax salary deferrals to employer-sponsored retirement plans (401(k), 403(b), 457 & SEP-IRA plans). If your plan allows after-tax Roth contributions, these should be considered because of the lack of an income-level phase out for contributions and the potential for tax-free growth.
Don’t forget to consider contributions to IRAs for non-working spouses as well. Also, maximize savings using tax-favored Heath plans such as Health Savings Accounts (HSAs). Remember that if you become eligible in December to make an HSA contribution, you can make a full year’s worth of deductible HSA contributions for 2019.
9 Qualified opportunity zone investments
The TCJA also created a new tax-deferred investment opportunity called the qualified opportunity zone (QOZ) and led to the emergence of some QOZ funds. Taxpayers may defer and partially reduce capital gains tax due on the disposition of existing property by reinvesting the capital gains into a QOZ though a qualified opportunity fund (QOF). In order to benefit from the 15% step-up in tax basis, the QOZ must be held for seven years, so gains would need to be harvested before the end of 2019 and reinvested within 180 days beginning on the date of the sale or exchange. The taxes on the deferred gain would be due when the QOF is sold or at the end of December 2026 (whichever comes sooner). After holding the investment for 10 years, 100% of the post-reinvestment gain could be exempt from federal tax.
Investors should carefully consider the lock-up commitments of QOZs. If you may need access to funds invested in a QOZ within the next 10 years, this may not be a suitable investment for you. Before you consider investing in a QOZ, consider constraints such as liquidity, minimum investment criteria, and the infrequent valuations. They are likely to include large minimums, limited transparency, and delayed tax reporting (Schedule K-1).
10 Changes in itemized deduction planning
The TCJA eliminated or limited several traditional itemized deductions. These rules apply until Jan. 1, 2026. These changes introduced a new world regarding itemized deduction planning.
A few items to consider regarding itemized deductions:
- Taxpayers who live in high state tax jurisdictions, who felt the high taxes were a fair price to pay for better schools, roads, etc., have a different decision model now that their deduction for those high taxes is limited to $10,000, and, with the higher standard deduction, those taxes may provide no deduction at all. It does not appear that the $10,000 limitation is indexed for inflation.
- Similarly, taxpayers with mortgage interest have a different decision model regarding prepaying their mortgage if the mortgage is over $750,000 or they will no longer itemize.
- The cost of a home equity loan that isn’t used to buy, build, etc. a personal residence has become more expensive to persons who previously got a tax benefit for the interest.
- Taxpayers who are employees, who aren’t reimbursed for expenses like entertaining their customers, travel to their customers, or continuing education, may want to cut back on those items because they no longer provide a tax deduction.
- Deductions previously permitted in determining net hobby income are now generally disallowed.
- Personal casualty losses are deductible only if the losses were incurred in federally declared disaster areas.
The end of 2019 is fast approaching. Review your tax situation with your tax advisor now and make adjustments before time runs out.
For more information, please contact your Key Private Bank Advisor.