With year-end approaching, now is the time to take steps to reduce your 2018 tax bill. Here are some year-end tax planning strategies to consider, taking into account changes included in the Tax Cuts and Jobs Act (TCJA).
Year-End Tax Planning Moves for Individuals
Game the Increased Standard Deduction Allowances.
The TCJA almost doubled the standard deduction amounts. For 2018, the amounts are $12,000 for singles and those who use married filing separate status (up from $6,350 for 2017), $24,000 for married joint filing couples (up from $12,700), and $18,000 for heads of household (up from $9,350). If your total annual itemized deductions for 2018 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 2018. Although the TCJA put new limits on itemized deductions for home mortgage interest, you are probably unaffected if you had a mortgage in place prior to 2018.
Accelerating other expenditures could cause your itemized deductions to exceed your standard deduction in 2018. 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 that are needed. For 2018, medical expenses are deductible to the extent they exceed 7.5% 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 2018 is only 15% for most people, 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-2018 years, selling winning stocks this year will not result in any tax hit. In particular, sheltering net short-term capital gains with long term capital losses is a good deal because net short-term gains would otherwise be taxed at higher ordinary income rates. Additionally, $3,000 of any capital losses in excess of capital gains can be used to offset any other income you incur which could possibly be taxed at a higher tax rate than the capital gain rate.
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 taxable income brackets that are not tied to the ordinary income brackets. Here are the brackets for 2018:
||Head of Household
|Beginning of 15% bracket
|Beginning of 20% bracket
Under the zero bracket scenario, a taxpayer could conceivably pay zero tax on their capital gains and qualified dividends if the bulk of their income comes from these two sources.
Give Away Appreciated Securities.
If you want to make gifts to charities, they can be made in conjunction with an overall revamping of your taxable account stock and equity mutual fund portfolios. Gifts of appreciated securities should be made to IRS-approved charities. The charitable deduction is equal to the full current fair market value of the shares at the time of gift (assuming you itemize) and you save taxes on capital gains. If your securities are trading at a loss, you should sell these 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.
Make Charitable Donations from Your IRA.
IRA owners and beneficiaries who have reached age 701
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 donations 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. The tax-free treatment of QCDs equates to an immediate 100% federal income tax deduction and reduces your adjusted gross income. A lower adjusted gross income could have other tax advantages, too. 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
. 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
in 2018, you can delay your 2018 required distribution until April 1, 2019. However, waiting until 2019 will result in two distributions in 2019, the amount required for 2018 plus the amount required for 2019. While deferring income is normally a sound tax strategy, here it results in bunching income into 2019. Thus, think twice before delaying your 2018 distribution to 2019, bunching income into 2019 might throw you into a higher tax bracket or have a detrimental impact on your tax deductions.
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. 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 IRA account’s earnings. Additionally, planning opportunities exist for contributions to a non-deductible IRA followed by an immediate conversion to a Roth IRA with no tax implications. Taxpayers with net operating losses from their business should also consider this Roth conversion strategy since in certain circumstances this too could result in no tax liabilities.
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.
Watch out for the AMT.
The TCJA significantly reduced the odds that you will owe AMT for 2018 by significantly increasing the AMT exemption amounts and the income levels at which those exemptions are phased out. Even if you still owe AMT, you will probably owe considerably less than under prior law. Nevertheless, it’s still critical to evaluate year-end tax planning strategies in light of the AMT rules.
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 2018, 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 2018 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.
Take Advantage of Flexible Spending Accounts (FSAs).
If your company has a healthcare and/or dependent care FSA, before year-end you must specify how much of your 2018 salary to convert into tax-free contributions to the plan if you haven’t contributed already. Be careful 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 medical expenses for the year. Medical items or procedures to consider include buying 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 $6,850 for a family coverage or $3,450 for individual coverage—plus an extra $1,000 if you will be 55 or older by the end of 2018. 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.
Don’t Overlook Estate Planning.
The unified federal estate and gift tax exemption for 2018 is a historically large $11.18 million, or effectively $22.36 million for married couples. Even though these big exemptions may mean you are not currently exposed to the federal estate tax, your estate plan may need updating to reflect the current tax rules. Additionally, making gifts to family members by the end of the year of $15,000 per person will exempt you from use of any of the estate and gift exemption. Taxpayers need to be aware of state tax liabilities regarding estates. Currently Illinois has only a $4 million dollar exemption and other states have estate tax laws which are far different than the Federal law. Estate planning for potential state taxes has become even more essential.
Year-End Tax Planning Moves for Small Businesses
Establish/Utilize Expense Reimbursement Plans.
Given that employee business expenses have been eliminated as an itemized deduction, creating and utilizing an accountable reimbursement plan for your business is more important than ever. Business expenses incurred by employees that are reported via the plan will be deductible by the business and the employees will be get reimbursed for the expenses incurred.
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 are self-employed and set up a SEP-IRA, you can contribute up to 20% of your self-employment earnings, with a maximum contribution of $55,000 for 2018. If you are employed by your own corporation, up to 25% of your salary can be contributed with a maximum contribution of $55,000.
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 2018 tax year is 10/15/19 if you extend your 2018 return to that date. Other types of plans generally must be established by 12/31/18 if you want to make a deductible contribution for the 2018 tax year, but the deadline for the contribution itself is the extended due date of your 2018 return. However, to make a SIMPLE-IRA contribution for 2018, you must have set up the plan by October 1.
Take Advantage of Liberalized Depreciation Tax Breaks.
Thanks to the TCJA, 100% first-year bonus depreciation is available for qualified new and used property that is acquired and placed in service in calendar year 2018. That means your business might be able to write off the entire cost of some or all of your 2018 asset additions on this year’s return. So, consider making additional acquisitions between now and year-end.
Claim 100% Bonus Depreciation for Heavy SUVs, Pickups, or Vans.
The 100% bonus depreciation provision can have a major 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. 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 large write-off on this year’s return.
Claim Bigger 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 2018 and used over 50% for business, the TCJA dramatically increased the so-called luxury auto depreciation limitations
. For passenger vehicles that are acquired and placed in service in 2018, the luxury auto depreciation limits are as follows: $18,000 for the first year if bonus depreciation is claimed, $16,000 for the second year, $9,600 for third year and $5,760 for the fourth year and thereafter until the vehicle is fully depreciated.
These allowances are much more generous than under prior law. Note that the $18,000 first-year luxury auto depreciation limit only applies to vehicles that cost $58,000 or more. Vehicles that cost less are depreciated over six tax years using depreciation percentages based on their cost.
More Generous Section 179 Deduction Rules.
For qualifying property placed in service in tax years beginning in 2018, the TCJA increased the maximum Section 179 deduction to $1 million (up from $510,000 for tax years beginning in 2017). The Section 179 deduction phase-out threshold amount was increased to $2.5 million (up from $2.03 million). The following additional beneficial changes were also made by the TCJA.
Property Used for Lodging.
For property placed in service in tax years beginning in 2018 and beyond, the TCJA removed the prior-law provision that disallowed Section 179 deductions for personal property used predominately to furnish lodging or in connection with the furnishing of lodging. Examples of such property would apparently 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.
As under prior law, Section 179 deductions can be claimed for qualifying real property expenditures, up to the maximum annual Section 179 deduction allowance ($1 million for tax years beginning in 2018). There is no separate limit for qualifying real property expenditures, so Section 179 deductions claimed for real property reduce the maximum annual allowance dollar for dollar. 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.
For tax years beginning in 2018 and beyond, the TCJA expanded the definition of real property eligible for
the Section 179 deduction to include qualified expenditures for roofs, HVAC equipment, fire protection and alarm systems, and security systems for nonresidential real property. To qualify, these items must be placed in service in tax years beginning after 2017 and after the nonresidential building has been placed in service.
Maximize the New Deduction for Pass-through Business Income.
The new deduction based on Qualified Business Income (QBI) from pass-through entities was a key element of the TCJA. For tax years beginning in 2018–2025, the deduction 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 non-corporate taxpayers (individuals, trusts, and estates). The IRS regulations for the QBI deduction are very complex. Please consult with us to determine your maximum benefit from this new law.
Cash Method Accounting.
More "small businesses" are able to use the cash (as opposed to accrual) method of accounting in 2018 and later years than were not 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 Dec. 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 used to be $5 million). Cash method taxpayers may find it a lot easier to shift income, for example by holding off billings till next year or by accelerating expenses by paying bills early or by making certain prepayments.
De Minimis Safe Harbor 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 don't 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 can't 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's no AFS, the cost of a unit of property can't exceed $2,500. Where the UNICAP rules aren't an issue, consider purchasing such qualifying items before the end of 2018.
A recent U.S. Supreme Court Case (Wayfair) involving a South Dakota business’s sales tax obligation from internet sales, has brought more scrutiny to the economic nexus (as opposed to physical nexus) approach for apportioning income for multi-state businesses. Please consult us for all sales involving multi-state business activity where you have no physical presence.
Contact KRD for your Tax and Accounting Issues Today
This letter only covers some of the year-end tax planning moves that could potentially benefit you and your business. Please contact us if you have questions, want more information, or would like us to help in designing a year-end planning package that delivers the best tax results for your particular circumstances.