As the end of the year approaches, it is a good time to think of planning opportunities that will help lower your tax bill for this year and possibly the next.
Year-end planning for 2018 takes place against the backdrop of a new tax law (i.e., the TCJA) that makes major changes in the tax rules for individuals and businesses. For individuals, there are new, lower income tax rates, a substantially increased standard deduction, severely limited itemized deductions and no personal exemptions, an increased child tax credit, and a watered-down alternative minimum tax (AMT), among many other changes. For businesses, the corporate tax rate is cut to 21%, the corporate AMT is gone, there are new limits on business interest deductions, and significantly liberalized expensing and depreciation rules. In addition, there's a new deduction for non-corporate taxpayers with qualified business income from pass-through entities.
The following is a checklist of tax saving strategies and actions that individuals and business owners should consider before year end.
- If you have large portfolio gains this year, take advantage of recent market volatility by selling any investments at a loss before the end of the calendar year. This "tax loss harvesting" enables your gains to be offset by your losses, limiting realization of taxable capital gain. In addition, you can deduct up to $3,000 of capital loss against your ordinary income each calendar year.
- Conversely, if your income is low enough to qualify for 0% capital gains tax treatment, consider selling enough assets to generate long-term capital gains sheltered by the 0% rate. The 0% rate generally applies to the excess of long-term capital gain over any short-term capital loss to the extent that it, when added to regular taxable income, is not more than the “maximum zero rate amount” (e.g., $77,200 for a married couple).
- If you believe a Roth IRA is better than a traditional IRA, consider converting traditional-IRA money invested in beaten-down stocks (or mutual funds) into a Roth IRA if eligible to do so. Keep in mind, however, that such a conversion will increase your AGI for 2018, and possibly reduce tax breaks geared to AGI (or modified AGI).
- Beginning in 2018, many taxpayers who claimed itemized deductions year after year will no longer be able to do so. That's because the basic standard deduction has been increased to $24,000 for joint filers ($12,000 for singles, $18,000 for heads of household) while no more than $10,000 of state and local and real estate taxes may be deducted. As a result many itemized deductions (including those for charitable gifts) will be lost. Affected taxpayers should consider a “bunching strategy” to accelerate charitable contributions into the year where they will do some tax good. For example, if a taxpayer knows he or she will be able to itemize deductions this year but not the next five years, the taxpayer can make five years' worth of charitable contributions this year via a Donor Advised Fund (to enable itemization of deductions), and distribute the gifts from the Donor Advised Fund each year over the next five years while claiming the standard deduction.
- If you're planning on making charitable gifts before year end, consider using appreciated stocks/mutual funds in lieu of (or in combination with) cash. When you gift an appreciated security, neither you nor the charity receiving the asset pays capital gains tax when it's subsequently sold. This applies to gifts to a Donor Advised Fund as well as direct gifts to other qualified charities.
- Consider using a credit card to pay deductible expenses (such as medical expenses and charitable gifts) before the end of the year. Doing so may increase your 2018 deductions even if you don't pay your credit card bill until after the end of the year.
- If you are age 70-½ or older by the end of 2018, have traditional IRAs, and particularly if you can't itemize your deductions, consider making 2018 charitable donations via qualified charitable distributions (limitations apply) from your IRAs. Such distributions are made directly to charities from your IRAs, and the amount of the contribution is excluded from your gross income. The amount of the qualified charitable distribution also reduces the amount of your required minimum distribution, resulting in additional tax savings.
- Make gifts sheltered by the annual gift tax exclusion before the end of the year and thereby save gift and estate taxes. The exclusion applies to gifts of up to $15,000 ($30,000 for spouses) made in 2018 to each of an unlimited number of individuals. You can't carry over unused exclusions from one year to the next. A few examples of using these gifts include making 529 plan contributions, paying life insurance premiums in irrevocable trusts, and transferring income-earning property to family members in lower income tax brackets.
- Re-evaluate your entity structure in light of the 2017 Tax Cuts & Jobs Act. Consider the advantages and disadvantages of C Corp, S Corp and LLC/Partnership. Typically, tax elections are due 2.5 months after the start of the tax year to qualify for that tax year- so by middle of March 2019, to make the elections effective for entire 2019. Get started on this now – if it is applicable to you.
- Beginning in 2018, taxpayers who operate under "pass through" entities may be able to deduct 20% of qualified business income under Section 199A. For 2018, 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 limitations are phased in for joint filers with taxable income between $315,000 and $415,000 and for all other taxpayers with taxable income between $157,500 and $207,500. There is a great deal of flexibility available in designing retirement plans that would allow pass-through businesses to qualify for the deduction.
- More “small businesses” are able to use the cash (as opposed to accrual) method of accounting in 2018 and later years than were allowed to do so in earlier years. To qualify as a “small business” a taxpayer must, among other things, satisfy a gross receipts test. Effective for tax years beginning after December 31, 2017, the gross-receipts test is satisfied if, during a three-year testing period, average annual gross receipts don't exceed $25 million (the dollar amount previously was $5 million). Cash method taxpayers may find it a lot easier to shift income, for example by holding off billings until next year or by accelerating expenses, for example, paying bills early or by making certain prepayments.
- Businesses should consider making expenditures that qualify for the liberalized business property expensing option. For tax years beginning in 2018, the expensing limit is $1,000,000, and the investment ceiling limit is $2,500,000. Expensing is generally available for most depreciable property (other than buildings), and off-the-shelf computer software. For property placed in service in tax years beginning after December 31, 2017, expensing also is available for qualified improvement property (generally, any interior improvement to a building's interior, but not for enlargement of a building, elevators or escalators, or the internal structural framework), for roofs, and for HVAC, fire protection, alarm, and security systems. The expensing deduction is not prorated for the time that the asset is in service. Thus, property acquired and placed in service in the last days of 2018, rather than at the beginning of 2019, can result in a full expensing deduction for 2018.
- Businesses also can claim a 100% bonus first year depreciation deduction for machinery and equipment—bought used (with some exceptions) or new—if purchased and placed in service this year. This includes purchase of new and used heavy vehicles used over 50% for business and exceeding the 6,000 lb. gross vehicle weight rating requirement. The 100% write-off is permitted without any proration based on the length of time that an asset is in service during the tax year. As a result, the 100% bonus first-year write-off is available even if qualifying assets are in service for only a few days in 2018.
- A corporation (other than a “large” corporation) that anticipates a small net operating loss (NOL) for 2018 (and substantial net income in 2019) may find it worthwhile to accelerate just enough of its 2019 income (or to defer just enough of its 2018 deductions) to create a small amount of net income for 2018. This may permit the corporation to base its 2019 estimated tax installments on the relatively small amount of income shown on its 2018 return, rather than having to pay estimated taxes based on 100% of its much larger 2019 taxable income.
- To reduce 2018 taxable income, consider disposing of a passive activity in 2018 if doing so will allow you to deduct suspended passive activity losses.
- Transfer a portion of your business interest into irrevocable family trusts by using a portion of your lifetime gifting exclusion – now at $11.2 million per person. These large estate planning gift exclusions are set to expire Jan 1, 2026. Therefore, this very sizable tax benefit which could save 40% or more in gift and estate taxes could be a “use-it or lose it” benefit. Explore this now.
- Take advantage of ordinary losses to lower your income tax. Example: offset ordinary losses with qualified plan Roth conversions from 401(k) and IRA plans. In the right situation, valuable Roth conversions can be done without out-of-pocket taxes today.
- Manage your 2019 income via nonqualified deferred compensation plan elections. For 2019, C corporate tax rates are 21% and ordinary income rates at 37%. The tax arbitrage can be very attractive. Unsure if you have access to a nonqualified deferred compensation plan? Give us a call.
- Fully fund your Health Savings Accounts (HSA) and explore adding HSA with a company match for your employees. HSA contributions up to $6,900 (plus a $1,000 catch-up contribution) go in pre-tax and come out free of tax for eligible health care expenditures such as health insurance premiums and medical, dental, and vision expenses for your whole family. HSA contributions are powerful and unique.