The Tax Cuts and Jobs Act (TCJA) eliminated many long-standing tax benefits taxpayers have relied upon, and some of the more traditional year-end tactics are no longer applicable. However, some of the newer provisions of the law have led to planning opportunities.
Now is a good time to re-visit your tax estimate. If updates are needed, let us know immediately so we can properly advise you on specific actions that should be taken by year-end.
A. THE VALUE OF ITEMIZED DEDUCTIONS HAS BEEN DIMINISHED.
One of the biggest components of the TCJA was the change to the standard deduction figure for all filers. The standard deduction jumped up to $12,000 for single filers, $18,000 for heads of household, and the joint filer standard deduction increased to $24,000.
In addition to these standard deduction increases, the following changes were made to amounts deductible by individual taxpayers:
- State and local taxes (SALT) are now capped at $10,000.
- Miscellaneous itemized deductions subject to the 2% floor of Adjusted Gross Income were eliminated.
- The floor for claiming medical expenses is 7.5% for ALL taxpayers (not just those 65 or older). The floor returns to 10% in 2019.
- Home Equity Loan indebtedness is no longer deductible if not related to the improvement, construction, or refinance of your primary residence.
- Deductible mortgage interest limited to $750,000 of qualifying acquisition debt. Homes that had a mortgage contract before December 17, 2017 and closed by April 1, 2018 will still have the grandfathered limit of $1,000,000 of acquisition debt.
- Casualty and theft losses are now limited to only federally-declared disaster areas.
- The Pease limitation was repealed. This reduced itemized deductions if taxpayer’s Adjusted Gross Income exceeded $261,500 for single filers and $311,300 for joint filers (2017). Starting in 2018, itemized deductions will no longer be reduced if income reaches a certain level.
B. REVIEW YOUR CHARITABLE GIVING
While the TCJA did increase the deduction limit of charitable gifts from 50% to 60% of Adjusted Gross Income, the deduction itself was unaffected by the act. However, due to the SALT limitation and the new standard deduction, charitable giving may now be an afterthought to many taxpayers. According to a June 2018 report by the American Enterprise Institute, they believe charitable giving by individuals will decrease by 4% (about $17 billion) in 2018 alone. We are not sure if this was the intent of law or not, but if you take away the economic benefit of charitable giving, some may no longer participate.
- Review your tax estimate to see if you are able to itemize before you make year-end gifts.
- If you cannot itemize, see if bringing forward gifts from 2019 could put you into a situation where you could itemize (assuming cash flow permits this). This is a lumping strategy, where two years’ worth of contributions are combined into one year to take advantage of the deduction. This strategy also assumes that in the year you do not make contributions you will take the standard deduction.
- Consider making a large contribution to a donor advised fund. You’ll take the deduction in the year the gift was made, but distributions out of the fund will not be tax deductible. This strategy allows for your favorite charities to receive contributions in a more consistent manner.
- Consider making charitable gifts from your IRA if you are over the age of 70 1/2. The Qualified Charitable Distribution was made permanent by the PATH Act in 2015. These contributions qualify against Minimum Required Distributions. There is a $100,000 per Individual limit.
C. YEAR-END TAX SELLING
The TCJA created separate tax brackets for long-term capital gains. They are no longer tied to the ordinary tax rate schedules. Gains are taxed at:
- 0% if income is less than $38,600 for single filers and $77,200 for joint filers,
- 15% if income is less than $425,800 for single filers and $479,000 for joint filers, and
- 20% if income exceeds $425,800 for single filers and $479,000 for joint filers.
A 3.8% surtax on investment income is added on gains that are part of modified adjusted gross Income is excess of $200,000 for a single filer, and $250,000 for joint filers. Considering state income taxes, the tax on capital gains can exceed 30%.
A situation you want to avoid is paying tax on capital gains in 2018, but having non-deductible losses in 2019 because losses exceed gains. Taking capital losses to offset capital gains can also avoid the surtax on investment income.
- Review portfolios before year-end for tax selling opportunities.
- Look into spreading gains over two years to avoid the maximum 20% rate and 3.8% surtax.
- Take long-term gains if you are in the 0% tax bracket.
D. REPORTING FOREIGN BANK ACCOUNTS
In efforts to end the disconnect between the filing dates for foreign bank account reporting (FBAR) and income tax returns, the due date for FinCEN Report 114 will now be April 15th. A six-month extension is allowed. These are required to be e-filed separately from the e-filing of the individual income tax return.
As a reminder, U.S. persons are required to file an FBAR if:
- They have financial interest in or signature authority over at least one financial account located outside the United States, and
- They have financial foreign accounts with an aggregate value which exceeds $10,000 at any time during the calendar year.
Individuals with foreign bank accounts should download the tax organizer in January and fill out the page related to FBAR reporting.
E. EXPECT A TAX RETURN WITH A NEW LOOK WHEN FILING NEXT YEAR
One of the main goals of the TCJA was to simplify the federal tax filing. Legislators were fixated on providing the opportunity for every American to file their tax returns on a postcard. Well, if you haven’t glanced at the draft Form 1040 for 2018 yet, we recommend you do. In their attempt to get the filing on a postcard, they created a very confusing system that requires jumping from various statements (in addition to the forms we all know), which are summarized on this faux postcard 1040.
These statements are merely chopped up components of the original 2-page 1040 that are now spread over 6 statements (each on their own separate page).
To us, this is tax confusion, not tax simplification.
2018 Year End Items of Note
1. RESTRUCTURE YOUR DEBTS WHERE POSSIBLE TO ENSURE DEDUCTIBILITY AND REDUCE FINANCIAL RISK.
- Pay down nondeductible debt first.
- Consider paying down debt that produces deductions that are part of blocked passive activity losses. Lock in fixed rates.
Caution: When refinancing grandfathered acquisition debt, you must meet several limitations if you want to stay above the new $750,000 debt limit. Grandfathered debt will not be recognized if a refinance:
- Exceeds the principal of the previous loan balance;
- Is extended after the original term completed,
- Has principal that is not amortized over its term, and
- Is extended longer than the current term remaining of the original long with a maximum of 30 years (i.e. If 25 years remain on a 30 year mortgage, the refinance cannot exceed 25 years. In the likelihood you have a balance with a term longer than 30 years you cannot extend beyond 30 if you meet the requirements for refinancing grandfathered debt).
2. REVIEW YOUR GIFTING OPPORTUNITIES:
- The present interest annual exclusion gift: $15,000 per donee for 2018.
- Unlimited transfer directly to educational institutions for tuition. These amounts are not considered taxable gifts. If amounts are not paid directly to the educational institution they are considered gifts.
- Unlimited transfer directly to medical care providers for medical expenditures. These amounts are not considered taxable gifts. If amounts are not paid directly to the medical care provider they are considered gifts.
- Gifts to 529 plans: These are considered gifts that reduce you’re annual exclusion ($15,000 max per donee in 2018). However, there is an exception that allows 5 years of gifts In 1 years – a maximum of $75,000 in 2018.
3. THE FOLLOWING TAX BENEFITS HAVE EXPIRED, AND HAVE NOT BEEN EXTENDED:
- Tuition and fees deduction
- Exclusion of discharged principal residence indebtedness Mortgage premium insurance deduction
- Credit for residential energy-efficient property
- Credit for construction of energy-efficient homes Several other alternative fuel and energy credits
With a lame duck Congress, these tax benefits will not be extended before the end of the year. Taxpayers should not rely upon these tax breaks at this time. It is worth noting, however, Congress extended these tax benefits for the 2017 tax year with the Bipartisan Budget Act of 2018 that was signed in February 2018, two months after year-end. These may be part of another budget bill early in 2019.
2018 Year End Tax Planning: Routine Follow-ups
1. REVIEW YOUR 2018 TAX ESTIMATES.
Update what 2018 will look like.
- Estimate your marginal tax rates (income tax rate on the next dollar of income).
- Determine whether your wage or self-employment income will be above the FICA limit ($128,700 for 2018).
- Determine whether you are eligible for the passthrough deduction under IRC Section 199A. Qualifying taxpayers are eligible for a deduction equal to 20% of Qualified Business Income. Taxpayers who are close should determine what additional steps should be taken at year end to qualify for this tax break.
2. DEVELOP STRATEGIES FOR TAKING 2018 DEDUCTIONS.
Know where additional deductions will produce little or no tax benefit.
- If your childcare expenses are already above the tax credit or salary reduction limits.
- If your rental losses are already blocked by the passive loss rules.
- If your losses or deductions will throw you into a 0%, 10%, or 12% tax bracket.
- If you won’t have enough deductions to itemize and instead will use the standard deduction (Single = $12,000; Married Filing Jointly = $24,000).
- Think about your charitable giving strategy. It may make more sense to lump two years’ worth of charitable contributions into one year to take advantage of itemizing.
If any of these situations exist, it may be preferable to delay taking the deduction until 2019.
3. LOOK FOR SITUATIONS WHERE TAKING INCOME IN 2018 WILL RESULT IN NO ADDITIONAL TAX BEING DUE.
- Realizing capital gains where you will have excess (non-deductible) capital losses.
- Realizing passive income where you have blocked passive activity losses.
- Realizing investment income where you have blocked investment interest deductions. Where you are in a zero or low (10% or 12%) income tax bracket.
- Making a Roth IRA conversion.
4. MAKE SURE THAT YOU ARE MAKING MAXIMUM USE OF THE FOLLOWING TAX BENEFITS:
- $3,000/year capital loss deduction allowance.
- $25,000 rental loss allowance for owners with active participation in the ownership and management of rental real estate. (Warning: This benefit is phased out as Adjusted Gross Income increases from $100,000 to $150,000.)
- The $2,000 per individual child (must be under the age of 17) tax credit, and $500 for other dependents (not children under age 17). Phase out begins at $400,000 of modified adjusted gross income.
- $5,000 per year dependent care exclusion ($2,500 for single filers).
- Deductible IRA contributions (Maximum $5,500 per individual). Individuals over age 50 are able to make an additional “catch-up” contribution of $1,000. Non-working spouses may have deductible IRA’s available if AGI tests are met. Note that deduction phase-out ranges are being increased annually for individuals who have pension coverage. The AGI phase-out point for individuals with pension coverage is $63,000 for single filers and $101,000 for joint filers with pension coverage. The phase-out point for spouses without pension coverage starts at $189,000 of AGI when the other spouse has pension coverage.
- $100,000 per year exclusion of charitable distributions from IRA accounts by individuals aged 70 1⁄2 or older.
- The Section 179 expensing allowance for personal property used in a trade or business. The maximum deduction is $1,000,000 and the phase-out-threshold begins at $2,500,000 million of asset additions. The expense allowance is completely phased out if $3,500,000 of purchases are made. Off- the-shelf software also qualifies for this allowance.
- The optional standard mileage reimbursement rate for 2018 is 54.5 cents per mile.
5. INDIVIDUALS SHOULD MAKE SURE THAT TAX DEPOSITS ARE ADEQUATE.
- To avoid underpayment penalties, your total withholding plus estimated tax deposits must exceed the lesser of: (a) 2017’s tax or (b) 90% of your eventual 2018 tax.
- If your prior year Adjusted Gross Income was above $150,000, you will avoid underpayment penalties if you deposit 110% of 2017’s tax. Taxpayers with incomes up to $150,000 can avoid penalties by depositing 100% of the prior year’s tax as noted above.
- Don’t forget to review estimated taxes for your children. New for 2018, the kiddie tax is based on trust tax rates. This will make filings easier, but will subject income to higher tax rates at lower income levels.
6. REVIEW YOUR TAX BASIS IN PARTNERSHIPS AND S-CORPORATIONS.
- Losses from S-corporations can be non-deductible if a shareholder does not have tax basis in either the stock or debt of the company. Partnership losses can be limited if losses allocated exceed the taxpayer’s basis in the partnership.
- Partners and shareholders of these entities that are projected to have pass-through losses should review their basis in the investment to make sure that the desired amount of loss will, in fact, be deductible. Making additional investments before year-end to increase basis may be necessary to make this happen.
7. PAY ATTENTION TO FINANCIAL HOUSEKEEPING.
- If you are married to a foreign national, make sure your spouse has an ITIN (Individual Tax Identification Number). E-filing is not allowed without one.
- Apply for Social Security numbers for dependents.
- Change Social Security name records for name changes due to marriage or divorce. (Note: Names used on tax returns must agree exactly to the spelling used by the Social Security Administration, including the use of abbreviations and initials.)
- Obtain documentation for charitable contributions. Gifts of $250 or more must be substantiated by a written acknowledgment from the donee organization.
- Obtain appraisals for non-cash contributions exceeding $5,000.
- Get auto usage records compiled. Businesses should make sure that the personal use value of company autos is included in the employee’s W-2.
- Make sure that documentation for meal expenses is adequate to withstand an IRS audit.
- Do not dispose of the year’s appointment book if you intend to rely on it to support business deductions. Entertainment expenses are no longer deductible.
- Get taxpayer ID numbers for 1099 and W-2 recipients (including daycare providers) by having them complete Form W-9.
- Document participation in business activities if you feel that this may be an issue in applying the passive loss rules (or if you are claiming exemption from the Net Investment Income tax on the sale of partnership interests or S-corporation stock). The general cutoff point for material participation is 500 hours per year. The cutoff for status as a Qualified Real Estate Professional is 750 hours.
- Update your tax basis records for investments, especially for mutual funds with dividend reinvestment. Also update basis records for improvements done to real estate.
- If you have received any gifts of investment property during the year, ask the donor for the carryover basis information.
- Get business activities segregated into separate bank accounts for 2019.
- If your deductions will change radically in 2019, be sure to adjust your withholding accordingly using Form W-4.
- Shareholders who have advanced money to their incorporated businesses should evidence the transaction with a note and should charge an adequate rate of interest.
- The value of health insurance paid on behalf of 2%+ S corporation shareholders should be included in W-2 totals as wages.
- Clean out the basement!!!! Financial records that relate to tax years more than three years prior can generally be disposed. (The big exception relates to the cost of assets. Keep asset basis records for as long as you own the property).
8. REVIEW 2019 BENEFIT PLAN OPTIONS WITH YOUR EMPLOYER.
- 401(k) plan contribution rate and investment choices. (Don’t forget to elect the bonus contributions if you’re 50 or older.)
- Non-qualified deferred compensation plan elections.
- Dependent care assistance salary reductions.
- Compensation paid in the form of mass transit passes. (The new tax law eliminated the deduction for employers, but retained the pre-tax benefit for employees.)
- Medical reimbursement plan salary reductions. Payments and reimbursements for any year may not exceed $5,050 for an eligible employee and $10,250 if the arrangement also covers family members. (Small employer’s only – 50 or less full time equivalent employees)
- Health insurance deductible options Health savings account contributions Flex spending account contributions
Having health insurance coverage with a high deductible policy entitles you to make contributions to a Health Savings Account (HSA). Minimum qualifying policy deductibles are $1,350 for single coverage or $2,700 for family coverage. The maximum HSA contribution for 2018 is $3,450 for single coverage (or $6,900 for family coverage). Bonus contributions of $1,000 will be allowed for those individuals age 55 or more. Individuals eligible for Medicare cannot make HSA contributions.
The maximum annual contribution limit for a flex spending account for 2018 is $2,650. Participants can carry over up to $500 in unspent contributions if the plan has not adopted the 2 1⁄2 month grace period rule. (This allows 2 1⁄2 months after year-end to spend unused funds.) The $500 carryover will not reduce the current year’s FSA contribution. Caution: Taking advantage of the carryover rule will prevent HSA contributions.
If you plan on making HSA contributions for 2018, clear out the flex spending account before year-end.
9. DISCUSS CHANGES TO TAX TREATEMENT OF UNREIMBURSED BUSINESS EXPENSES WITH YOUR EMPLOYER BEFORE YEAR-END.
- The TCJA eliminated miscellaneous itemized deductions subject to a 2% of Adjusted Gross Income floor. Employees who incurred business expenses that were not reimbursed under an accountable plan are no longer able to deduct these as an itemized deduction. See whether or not these can be reimbursed under an accountable plan with your employer moving forward.
10. ZERO OUT PERSONAL SERVICE CORPORATION INCOME WITH EXPENSE PAYMENTS AND BONUSES AT YEAR END.
- When taxable income is retained in a Personal Service Corporation (PSC), it is subject to a 21% income tax. Corporations that have not elected S status must zero out income to avoid eventual double tax when corporate earnings are distributed.
11. S-CORPORATION OWNER/EMPLOYEES SHOULD REVIEW THEIR COMPENSATION.
- S-Corporations shareholders who are also employees are required to declare reasonable compensation from the business. The IRS has not defined what is reasonable, but recent court cases show the service applies a facts and circumstances calculation based on the trade or business and location of the entity. The formalities of setting reasonable salary levels should be strictly observed to avoid potential distribution reclassification as wages by the IRS.
13. MAKE SURE THAT ALL INVESTMENT ACCOUNTS HAVE A PROPER SOCIAL SECURITY NUMBER AND ARE NOT SUBJECT TO BACKUP WITHHOLDING.
- The backup withholding rate is 28%. The existence of backup withholding can cause the filing of a child’s individual return that may not be required.
14. C-CORPORATIONS THAT PLAN TO RETAIN EARNINGS SHOULD MAKE ESTIMATED TAX DEPOSITS EVEN IF NO TAX WAS INCURRED IN 2017.
- Underpayment penalties are usually avoided if a taxpayer at least matches the prior year’s tax with estimated tax payments. This penalty exception does not apply if a corporation has no tax liability in the prior year.
15. IF YOU MAINTAIN AN IRREVOCABLE LIFE INSURANCE TRUST, MAKE SURE THAT CRUMMEY POWER DOCUMENTATION IS KEPT IN YOUR FILE AND IS UP TO DATE.
- In the absence of this documentation, the IRS can apply the transfer of funds to the trust against your unified estate and gift tax credit.
Looking to 2019 and beyond
Traditional tax planning includes looking ahead to assess and plan for future tax liabilities. With the Democrats taking control of the House of Representatives and the Republicans retaining control of the Senate, we cannot predict how federal tax legislation will be handled moving forward.
We believe there will be more activity at the state level, where states continue to juggle growing debt and pension burdens while trying to keep their constituents happy. This is Mission Impossible.