As the end of the year approaches, it is a good time to think of planning moves that may help lower your tax bill for this year and possibly next.
Year-end planning for 2018 takes place against the backdrop of a new tax law — the Tax Cuts and Jobs Act (TCJA) — that was passed last December and that made major changes to the tax rules for individuals and businesses. For individuals, there are new, lower income tax rates, an increased standard deduction, new limitations on certain itemized deductions and the elimination of personal exemptions, a significantly increased exemption for the alternative minimum tax (AMT) and the estate tax, and many other changes. Also, in the foreground is the possibility of new tax legislation being passed before or after year-end.
Continue reading for some tax-saving ideas based on current rules, and please contact your tax advisor to discuss your particular situation and any moves to consider between now and year-end.
Year-End Tax Planning Moves for Individuals
- Beginning in 2018, many taxpayers who claimed itemized deductions year after year may no longer find it beneficial 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, and $12,000 for married filing separately), and many itemized deductions have been cut back or abolished. No more than $10,000 of state and local taxes, including property tax, may be deducted; miscellaneous itemized deductions (e.g., investment advisor and tax preparation fees) and unreimbursed employee expenses are no longer deductible; and personal casualty and theft losses are deductible only if they’re 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 to the extent they exceed 7.5% of your adjusted gross income, state and local taxes up to $10,000, your charitable contributions, plus interest deductions on a restricted amount of qualifying residence debt, but payments of those items won’t save taxes if they don’t cumulatively exceed the new, higher standard deduction.
- Some taxpayers may be able to plan for the new reality by applying a “bunching” strategy to pull or push discretionary medical expenses and charitable contributions into the year where they will result in a greater tax benefit. For example, if a taxpayer knows he or she will be able to itemize deductions this year but not next year, the taxpayer may be able to make two years’ worth of charitable contributions this year, instead of spreading out donations over 2018 and 2019 (but watch for the AGI limitation on charitable contributions if considering this strategy).
- The use of appreciated publicly-traded securities held more than one year for planned charitable giving may provide additional tax savings by avoiding the capital gains tax that would be owed if these investments were sold.
- Consider using a credit card to pay deductible expenses before the end of the year. Doing so will increase your 2018 deductions even if you don’t pay your credit card bill until after the end of the year.
- If you expect to owe state and local income taxes when you file your return next year and you will be itemizing in 2018, consider paying estimated tax payments of state and local taxes (or increase withholdings) before year-end to pull the deduction of those taxes into 2018. This strategy may also be used for property taxes but remember that state and local tax deductions, whether property taxes or income taxes, are limited to $10,000 per year, so this strategy is not a good one if to the extent it causes your 2018 state and local tax payments to exceed $10,000.
- If 2018 medical expenses not reimbursed by insurance (and not paid with a pre-tax account) exceed 7.5% of AGI, you can deduct the excess amount. This threshold is scheduled to return to 10% beginning in 2019. Bunching or accelerating medical expenses may save tax depending on your personal situation.
- Take required minimum distributions (RMDs) from your IRA or 401(k) plan (or other employer-sponsored retirement plan). RMDs from IRAs must begin by April 1 of the year following the year you reach age 70-½. (That start date also applies to company plans, but 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 70-½ in 2018, you can delay the first required distribution to 2019, but if you do, you will have to take a double distribution in 2019-the amount required for 2018 plus the amount required for 2019. Think twice before delaying 2018 distributions to 2019, as bunching income into 2019 might push you into a higher tax bracket or have a detrimental impact on various income tax deductions that are reduced at higher income levels. However, it could be beneficial to take both distributions in 2019 if you will be in a substantially lower bracket that 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 from your IRAs. Such distributions are made directly to charities from your IRAs, and the amount of the contribution is neither included in your gross income nor deductible on Schedule A, Form 1040. But the amount of the qualified charitable distribution reduces the amount of your required minimum distribution, resulting in tax savings but subject to limitation.
- Higher-income earners must be wary of the 3.8% surtax on certain unearned income (the Net Investment Income Tax, or NIIT). The surtax is 3.8% of the lesser of:
- Net investment income (NII), or
- The excess of modified adjusted gross income (MAGI) over a threshold amount ($250,000 for joint filers or surviving spouses, $125,000 for a married individual filing a separate return, and $200,000 in any other case).
As year-end nears, a taxpayer’s approach to minimizing or eliminating the 3.8% surtax will depend on his or her estimated MAGI and NII for the year. Some taxpayers should consider ways to minimize (e.g., through deferral) additional NII for the balance of the year, others should try to see if they can reduce MAGI other than NII, and other individuals will need to consider ways to minimize both NII and other types of MAGI.
- Passive activity income is also subject to the NIIT. To avoid passive activity treatment, you must materially participate in the activity which typically means you must participate more than 500 hours or meet certain other tests (including special rules for real estate). For activities in which you materially participate, be sure to have contemporaneous records of your time spent related to the activity.
- The 0.9% additional Medicare tax also may require higher-income earners to take year-end actions. It applies to individuals for whom the sum of their wages received with respect to employment and their self-employment income is in excess of an unindexed 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 it into account in figuring estimated tax. There could be situations where 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, he or she would owe the additional Medicare tax, but there would be no withholding by either employer for the additional Medicare tax since wages from each employer don’t exceed $200,000. Also, if you are nearing the threshold for triggering the additional Medicare tax or your employment income varies significantly from year to year, income timing strategies may help you avoid or minimize it.
- Long-term capital gain from sales of assets held for over one year is taxed at 0%, 15% or 20%, depending on taxable income. 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 the 0% rate applies to long-term capital gains you took earlier this year—for example, you are a joint filer who made a profit of $5,000 on the sale of stock bought in 2009, and other taxable income for 2018 is $70,000—then before year-end, try not to sell assets yielding a capital loss because the first $5,000 of such losses won’t yield a benefit this year. And 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.
- Gains from the sale of real estate investments may be eligible for deferral using one of several strategies, including installment sale treatment, Section 1031 (“like-kind”) exchange, or investment in a Qualified Opportunity Fund (QOF) established under the TCJA. Additional guidance regarding QOF investments is still forthcoming and the rules are complex, so if you need tax help please contact your tax advisor.
- Postpone income until 2019 and accelerate deductions into 2018 if doing so will enable you to claim larger deductions, credits, and other tax breaks for 2018 that are phased out over varying levels of adjusted gross income (AGI). These include deductible IRA contributions, child tax credits, higher education tax credits, and deductions for student loan interest. Postponing income also is desirable for those taxpayers who anticipate being in a lower tax bracket next year due to changed financial circumstances. Note, however, that in some cases, it may pay to actually accelerate income into 2018. 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.
- Maximize tax-advantaged retirement plan contributions which, in addition to saving income tax, can reduce your MAGI for purposes of the NIIT.
- 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).
- It may be advantageous to try to arrange with your employer to defer, until early 2019, a bonus that may be coming your way. This could cut as well as defer your tax.
- Review your income tax withholdings before year-end to see if Form W-4 should be revised based on your expected income tax liability if you anticipate a shortfall.
- If you become eligible in December of 2018 to make health savings account (HSA) contributions, you can make a full year’s worth of deductible HSA contributions for 2018.
- 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 made in 2018 to each of an unlimited number of individuals. You can’t carry over unused exclusions from one year to the next. Such transfers may save family income taxes where income-earning property is given to family members in lower income tax brackets who are not subject to the kiddie tax. Also, the estate tax exemption amount was doubled from an inflation-adjusted $5 million in 2017 to $10 million in 2018 resulting in an exemption amount of $11.18 million for 2018. The exemption amount will return to an inflation-adjusted $5 million in 2026.
- Gifts made to Section 529 plans are eligible for a special rule allowing five years of annual gift tax exclusions to be used to make a $75,000 contribution (or $150,000 for both spouses) in 2018. Under the TCJA, Section 529 plan funds may also be used for K-12 tuition up to $10,000 annually per student beginning in 2018.
- If you were in an area affected by a federally declared disaster area, and you suffered uninsured or unreimbursed disaster-related losses, keep in mind you can choose to claim them on either the return for the year the loss occurred (in this instance, the 2018 return normally filed next year), or the return for the prior year (2017). Also, you may want to settle an insurance or damage claim in 2018 in order to maximize your casualty loss deduction this year.
If you are also interested in learning about our Year-End Tax Planning Moves for Businesses & Business Owners, click here.