Written by Scott A. Bishop, MBA, CPA/PFS, CFP® and Michael Churchill, CPA/MSPA, CFP® | Friday, November 15th, 2019
What are the appropriate checklists for year-end tax planning?
From our experience, tax planners often develop checklists to guide taxpayers toward year-end strategies that might help reduce taxes. Throughout the year, we publish many timely tax-related articles (summarized here). In August this year, we also published our Top 10 Tax Planning Ideas for2019. The tax filing seasons are now behind us. We have put together a year-end checklist of things that you should review. We have grouped the list into several different categories, such as “Filing Status” or “Employee Matters,” for ease of reading. As year-end approaches review each category that applies to your situation and consult with your tax advisor.
Filing Status and Exemptions:
If you’re married (or will be married by the end
of the year), compare the tax liability for
yourself and your spouse based on all filing statuses that you might
select which may include married filing jointly or married filing separately.
Determine which status results in a lower tax bill. Generally speaking, filing
jointly is the more advantageous method, however, there are reasons for which
couples may file separately such as keeping separate accounting for tax
bills. If you are in a community
property state, addition disclosure may be required on each tax return.
Exemptions for yourself, spouse and kids are no
longer available under the Tax Cuts and Jobs Act of 2017, however, the standard
deduction has doubled. It would be smart to analyze the numbers to determine if
these changes result in higher taxes so that you are not surprised when you
file your taxes. Some taxpayers may end up with a higher tax bill if their
withholdings are not updated with their employer.
Family Tax and Education Planning:
It may be advantageous to direct income to other
family members in lower brackets. Review your planning and determine whether
you can and should direct income to other family members such as your minor children who are in lower
tax brackets to minimize overall
taxes. Caution, however, because the kiddie tax rules apply to those who are:
Ages 19 and under, and
Ages 19 to 23 who are dependent full-time
students and whose earned income doesn’t exceed one- half of their support.
There was one important change to the Kiddie Tax rules under the Tax Cuts and Jobs Act of 2017. Prior to 2018, parents could elect to treat their kids’ income to be taxed at the parent’s rates. Under current law, the kids’ unearned income such as interest and dividends would now be taxed at Trust tax rates which may be significantly higher than their parents! Check to see if this change results in your children paying higher taxes.
Under the new tax law, the child tax credit was
increased from $1,000 to $2,000 per eligible child and the phaseout amounts
were increased so that more households would qualify for the full credit. Given the elimination of the exemptions
previous discussed, this change in the law ended up offsetting the punitive
effects that would have otherwise existed due to the increase in taxes on
families with multiple children that no longer received exemptions.
Don’t forget to use any remaining balances in
your flexible spending account balances that will be lost if not used.
Understand the rules of your benefits package. In some cases, employers may
allow small rollover amounts to the following year that will be lost if not
used in the following year as well.
If your insurance plan qualifies for a Health
Savings Account or HSA, take advantage of the triple tax savings benefit by
contributing to it. HSAs receive a tax deduction for the contribution, tax
deferral on all earnings and growth of the account,
and tax-free distributions if used for qualified
medical expenses. It’s a win-win-win.
Take advantage of tax credits for higher education costs paid during the tax year if you’re eligible to do so by utilizing the American Opportunity (Hope) credit or the Lifetime Learning Credit. These credits are based on the tax year rather than the academic year. Therefore, you should try to bunch expenses to maximize the education credits. These credits are also subject to phaseouts and may not be available for higher-income earners. Because of the phaseout potential, it’s important to taxpayers to take advantage of all possible deductions that are above-the-line (before AGI and Itemized or Standard Deductions) to see if they can reduce or eliminate any phaseout.
If you have qualified student loans (and meet
all necessary requirements), you may be entitled to take a deduction for the
interest you paid during the year. The maximum amount you can deduct is $2,500.
This tax benefit is subject to phaseouts so your benefit may be reduced or
Make sure that you take distributions from your
children’s Section 529 Plans that can be for qualified
education expenses that occurred during the calendar year. Keep good receipts.
Some plans may require proof submitted in order to be reimbursed.
Estate Planning Matters:
Consider making nontaxable gifts of up to
$15,000 (2019) by using the annual gift tax exclusion. Split gifts with your
spouse to double the amount of gifting you can make to any person. To maximize
estate tax savings, give assets that are likely to appreciate significantly
after the gift is made. Avoid giving assets that have depreciated in value.
It’s better to take the losses yourself to offset any gains you may have on
assets elsewhere. Use all losses during your life to avoid losing the benefit.
Consider max funding 529 plans as early as
possible for your kids by accelerating 5 years’ worth of gifts in one contribution of $75,000 or $150,000 with
split gifting for maximum possible tax deferral. Don’t worry about not using
all the 529 assets for a child, you can always change the beneficiaries.
Under the Tax Cuts and Jobs Act of 2017, the
unified estate exemption has been dramatically increased to $11,400,000 per
taxpayer in 2019, up from $5,490,000 in 2017. Because the increase is set to
disappear and revert in 2026 to prior levels, now is the time to update your
estate plan and maximize the use of your estate tax exemption.
Trust tax brackets are far more progressive when
compared to individual tax brackets, meaning, the rates at which income is
taxed grows higher much faster. The highest rate of tax at 37% starts at only
$12,750 of income for trusts that retain income without distributing it to
their beneficiaries. Consider taking advantage of the “65 Day Rule” election
and distribute income up to 65 days after the new year to the beneficiaries so
that the taxes are paid at their brackets which could result in the income
being taxed at lower rates.
Before a spouse passes away due to illness or other reasons, ROTH conversions (discussed in detail more latter) are “worth” more while your spouse is still alive before you will inherit their assets due to the largely expanded tax brackets of married joint taxpayers. In other words, converting before the death of a spouse may be less expensive from a tax perspective rather than after a spouse dies and the surviving spouse inherits the IRA from their deceased spouse.
Employee / Employment Matters:
Self-employed individuals (and businesses who qualify) using the cash method of accounting need to understand that collections on their accounts receivable prior to year-end will be included in their taxable income. Conversely, payments made on account payable will be deducted from taxable income if paid prior to the year-end. It’s important to pay close attention to your year-end billing cycles to avoid any unnecessary accelerated collection efforts and to pay expenses if there is an appropriate cash flow available.
You can delay recognition of tax on capital
gains by using installment sale agreements to
spread out any payments received from a sale to future taxable periods.
A BIG change under the Tax Cuts and Jobs Act of 2017 for employees is that they can no longer deduct their unreimbursed employee expenses on Schedule A as an itemized deduction if these expenses exceed 2 percent of adjusted gross income (AGI). This itemized deduction was eliminated. For taxpayers who relied on this deduction in prior years, they should see to renegotiating their employment contract with their employer to avoid losing valuable deductions. Employers can still deduct documented reimbursements from their employees such as miles and other costs as part of their employees’ jobs.
Business Owner – income and expenses:
As mentioned earlier, under the cash method of
accounting, expenses are deducted in the year they are paid. Manage your
year-end expenses and consider accelerating expenses (such as repair work and
the purchase of supplies and equipment) in the current year to lower your tax
bill if cashflow is available to do so. In some cases, even using your
line-of-credit may make sense to pay expenses. However, use caution in driving
up debt if your AR collection cycle is not short enough to immediately reset
your line-of-credit in the following year because the interest charged might
outweigh the benefit received.
Increase your employee withholding of state and
federal taxes to help avoid exposure to
estimated tax underpayment penalties.
If you have significant business losses this year, pay close attention. The Tax Cuts and Jobs Act of 2017 eliminated the ability to carryback net operating losses for years after 2017 to prior years. Furthermore, the new law has added an excess business loss limitation for non-corporate taxpayers (S Corps and Partnerships and Single-Member LLCs and Sole Proprietors) of $250,000 for single filers and $500,000 for joint filers on their tax returns. Any losses not utilized in the current year will be carried forward to future years.
In certain circumstances, it may be possible for the full cost of last-minute purchases of equipment to be deducted currently by taking advantage of Section 179 deductions. The new tax law has expanded the Section 179 deduction and increased the Bonus Depreciation deduction amount to 100% for 2019. However, even though these benefits offer larger deductions, you may want to spread out your depreciation over several years to take full advantage of the new 199A qualified business deduction for businesses taxed as Partnerships, S Corps, and Disregarded Entities such as Single Member LLCs and Sole Proprietorships. Visit with your tax advisor and run the numbers to strategize on the best approaches to purchasing depreciable equipment. More importantly, never buy to just get a deduction. Make sure your purchase makes economic sense.
There is a new business deduction available to pass-thru businesses such as S Corps, Partnerships, Single Member LLCs, and Sole Proprietors. Section 199A was added under the new law to bring down the effective tax rate for pass-thru business to compete against the new 21% flat tax rate for corporate taxpayers. There are many nuances to this new deduction and strategies that taxpayers need to be aware of when planning at year-end to ensure they receive this valuable benefit. For example, using defined benefit plans to fund your retirement can give you large deductions that lower your taxable income below the phaseout requirements of 199A. It’s important to work with an experienced tax professional who understands this new benefit because the calculation and formula to receive your 20% benefit are not simple to derive and not all businesses qualify and have more restrictions such as specified services businesses like lawyers, doctors, accountants, and financial advisors to name a few.
Under the Tax Cuts and Jobs Act of 2017, your
interest expense deduction for your business could be limited. If your business
is leveraged and operates on a lot of debt, these new limitations could impact
your tax bill.
There are new IRS Regulations on audits that you and your legal team should consider for Partnerships and LLCs. May sure you have visited with your attorney to update your business documents to refer to the requirements and how to address the new rules on audited changes.
Generally, you can contribute to your retirement plan at any time up to the filing deadline, including extensions. You must have a plan in place to do so, and not all plans can be set up after the prior year has ended.
For small businesses or independent contractors, you can consider setting up a retirement plan (401k, SEP-IRA, SIMPLE IRA or a Defined Benefit Plan). These plans allow you to defer taxes on income from $13,000 to $56,000 in 2019 and more for Defined Benefit (or Cash Balance) plans. In 2020, the range will increase to $13,500 and $57,000. Catchup contributions remain the same for those over 50 years of age at $6,000 for 2019 and $6,500 for 2020.
If you own an interest in a partnership or S corporation, know your tax basis. If you don’t have any basis in your business, you cannot deduct a loss this year. If you are planning on taking distributions, don’t over distribute in excess of your basis or you could end up paying unintended taxes on excess basis distributions.
Beware of aggressive tax strategies for shifting income to other businesses or recharacterizing W-2 employees to 1099 contractors. The IRS is aware of all the possible “games” that can be played with trying to benefit more from the new laws. Proceed with caution.
The IRS recently published Notice 2018-76 which provides taxpayers guidance on the deductibility of Meals and Entertainment expenses. The Tax Cuts and Jobs Act of 2017 eliminated the ability to deduction any entertainment expenses such as event tickets. However, the IRS notice provides guidance that meals, food, and beverages, are still able to be deducted at 50% as long as the taxpayer maintains the appropriate record of the expense (who, what, where, when, and why).
Financial Planning and Investments:
Pay attention to the changes in the capital
gains tax rates for individuals and try to sell only assets held for more than
12 months. Capital gains rates are no longer determined by your marginal tax
rate, but rather your income levels and don’t forget about the Net Investment
Income Tax of 3.8% for those who make over $250,000 of income.
Review your Adjust Gross Income (AGI) and then
review your passive and portfolio investment
income to see
if you are going to get “hit” with the Net Investment Income Tax, commonly
referred to as the 3.8% Obamacare Tax. There may be ways you
can reduce your AGI below that threshold that triggers this tax.
Consider selling the stock if you have capital losses this year that you need to offset with capital gain
income (sometimes called
If you plan to sell some of your investments
this year, consider selling the investments
that produce the smallest gain.
If you are having a lower-income year and expect to be in a lower tax bracket, consider converting a portion of your Traditional IRA to a Roth IRA. Conversions will create taxable income, but the goal is to lock in permanent tax savings at lower rates when you previously received a tax deduction in prior years at higher rates. Important observation – if you are a business owner who is eligible for a 199A qualified business deduction, be sure to run the analysis of the conversion before pulling the trigger to ensure the conversion doesn’t end up reducing or eliminating your otherwise business deduction.
Other possible ROTH conversion tax consequences could include increasing Medicare premiums,
triggering the Net Investment Income Tax, the Alternative Tax (AMT), phaseouts
and Roth contributions thresholds. Always complete a tax analysis first before converting it. You don’t want any surprises.
You may also want to consider breaking up your
conversion amount by making smaller conversions throughout the year to dollar
average the taxable income. For example, if you convert lump sum at the
beginning of the year, versus converting a little each month, and the markets
are higher at the beginning of the year and slowly decline through the year,
dollar averaging will result in a lower tax than the lump sum method.
As stated in the prior point, the new 199A deduction needs to be balanced and coordinated with all other income items like W-2
wages, retirement distributions or conversions, or your deductions for pensions
or other qualified plans or IRAs. A multifactor analysis is needed to maximize
your 199A deduction.
If you made any IRA Rollovers during the tax year, make sure you didn’t make any common IRA rollover mistakes like forgetting to complete your 60-day rollover in a timely manner.
Make sure you take ALL required minimum distributions (RMDs) from your IRA or 401(k) plan (or other employer-sponsored retirement plans). RMDs from IRAs must be taken no later than April 1st of the year following the year in which you reach the age of 70 ½. If you don’t take your RMDs timely, the penalty can be 50%! Also, don’t forget to withhold the appropriate amount for taxes and/or make sure that you make an estimated tax payment to cover your RMD to avoid underpayment and interest penalties.
If you are over age 70 ½ and charitably
inclined, consider taking advantage of a Qualified Charitable Distribution (QCD) that
will result in a tax-free distribution from your IRA directly to a charity. This type of distribution
will NOT be added to your adjusted gross income that may affect other
deductions due to phaseouts or potentially cause your Medicare premiums to
increase. For those that will no longer itemize given the tax law changes, a
QCD is an excellent way to give to charity.
Don’t forget to split inherited IRAs before the
end of the year. If an IRA owner, died during the year and had multiple
individual beneficiaries named on a beneficiary form, they can each use their
own life expectancy for calculating required minimum distributions (the stretch
IRA) if the inherited IRAs are split into separate shares before the end the
year. If this is not done timely, the beneficiaries will be stuck using the age
of the oldest beneficiary, even if they split their shares in a later
year. Again, the split must be
done by the end of the year after the IRA owner’s death.
NEWS ALERT!!! There is a current bill in the US Senate waiting for a vote called the SECURE ACT which will take away the ability for inherited IRAs to be stretched for the beneficiary’s life known as the “STRETCH.” This benefit will be replaced with a mandatory 10-year distribution rule where the entire IRA must be distributed within 10 years. Since it is not law yet, the current rules still apply as mentioned above.
Net Unrealized Appreciation or NUA. It may be beneficial to roll out low basis employer stock, pay tax on the original cost basis, and receive capital gains treatment on the appreciated gain when you sell your stock; however, don’t forget to complete this transaction before year-end by taking a lump-sum distribution. You keep the employer stock and roll over the rest to an IRA so you’re only taxed on the original cost basis this year. Failing to complete the transition (leaving no remaining funds in your employer plan) by year-end will result in disqualifying the NUA transaction.
Personal Residence and other Real Estate
Under the new tax law, bunching itemized deductions doesn’t have the impact as it once did; however, it’s still a great strategy. If you bunch deductions together every other year, the better your overall tax bill we are over the same two-year period.
Make your early January mortgage
payment (i.e., payment
due no later than January
15 of next year) in December so that you can deduct the accrued
interest for the current year that is paid in the current year.
Under the new law, the limit of your mortgage
interest deduction for principal amounts of $1M has been reduced for new
mortgages to $750K. Mortgages in effect prior to the new act are still grandfathered. If you are
considering refinancing or taking on new mortgages, be sure to remember this
Did you know that your RV, if mortgaged, may
qualify for an interest deduction? Check with your tax professional to see if
your RV qualifies because you can deduct up to two mortgages on your tax return.
Under the new tax law, State and Local Taxes,
also known as SALT taxes, are now limited to
$10,000 max per
tax year itemized. This change will affect taxpayers who once were able to
itemize versus taking the new standard deduction amount.
If you looking to sell your principal residence,
you may qualify to exclude all or part of the capital gain from the sale on
your federal income tax. If you meet the requirements, you can exclude up to
$250,000 ($500,000 for married couples filing jointly). Generally, you can
exclude the gain only if you used the home as your principal residence for at
least two out of the five years preceding the sale. In addition, you can
generally use this exemption only once every two years. However, even if you
don’t meet these tests, you may still be able to qualify for a reduced
exclusion if you meet the relevant conditions. Taxpayers must have lived at the
residence to qualify. For example, just because you marry your spouse and they
move in doesn’t mean they automatically are fully entitled to their $250,000
capital gain exclusion. More rules apply if you use the residence in a trade or
business or as a rental prior to the sale. Speak to a tax professional before
selling your home that has greatly increased in value since your purchase.
Consider structuring the sale of investment
property as an installment sale to defer gains
to later years.
If you are looking to sell real estate other
than your primary home, consider the tax benefits of utilizing a 1031 Exchange to defer, and possibly
eliminate, both the capital gains taxes and the recapture of any depreciation taken.
Maximize the tax benefits you derive from your second
home by modifying your personal use of
the property in accordance with applicable tax
Retirement Planning and Contributions:
Make the maximum deductible contribution to your
IRA or consider a Roth IRA if you are eligible. Even if you are not eligible for
a ROTH IRA, you may still be able to contribute through a “Back Door” ROTH IRA
contribution by contributing to a non-deductible IRA and then converting it to
a ROTH IRA.
Try to avoid premature IRA payouts to avoid the 10 percent early withdrawal penalty unless you meet an exception. Exceptions may include first time home buyers, higher education expenses, disability or medical needs. For more exceptions, visit with your tax advisor.
Even if your spouse is not working, make the
maximum deductible contribution to their IRA or ROTH, if eligible. If you meet
all the requirements, you may be able to deduct annual contributions of $6,000
to your traditional IRA and $6,000 to your spouse’s IRA for 2019 and 2020. If
you’re at least age 50, make a catch contribution of $1,000 as well. Keep in
mind, however, if you are covered by an employee plan, your Traditional IRA
deduction may be limited depending
on your income.
Set up a retirement plan for yourself if you are
a self-employed taxpayer such as a solo 401K,
SEP IRA, or Simple IRA to contribute even more to your retirement.
If your children work for your business or somewhere else, consider making IRA contributions on their behalf. Consider a Roth IRA over Traditional IRAs for your children as it may be more beneficial than a Traditional IRA because they will have a longer deferral period AND they won’t have RMDs later in life or distributions that are taxed. Make sure you coordinate this strategy with your estate gifting strategy as this will be considered a completed gift. If your children are at least 18 years old, and no longer your dependent or a full-time student, they may even qualify for the Savers Tax Credit worth up to $1,000.
If possible, minimize
the income tax on Social Security benefits
by lowering your income below the applicable threshold.
You can minimize the tax drag on your qualified plans by fully funding in January your contributions and waiting to the last possible moment to take any RMDs. This is a time-sensitive and tricky strategy, so be careful.
As previously stated, the tax deduction bunching
strategy isn’t as impactful as it once was because of the SALT $10,000
limitation, Mortgage Interest Limitation, and elimination of Miscellaneous
Itemized Deductions. However, the strategy does still benefit those who are
charitably inclined or have large mortgages. Bunch all charitable donations
(cash or even old clothes) into one year if you are able. Remember to keep all
your receipts from the recipient charity.
Higher-income taxpayers can pre-fund their charitable giving in one year to maximize their tax benefits. Use investment accounts like Donor Advised Funds to assist with the logistics of receiving larger charity contributions to be distributed to 501(c)(3)s at later dates.
Give appreciated stock and property rather than
cash when giving to charities. This may help you permanently eliminate income
tax on the built-in gain of your stocks or property, while at the same time, maximizing your
Use a credit card to make contributions to
ensure that they can be deducted in the current year.
If you are over age 70 ½, you can also consider
doing a Qualified Charitable Distribution (QCD) that will be a tax-free
distribution from your IRA to a charity that will NOT hit your tax return (and
possibly impact other deductions). For those that will no longer itemize given
the new tax law changes, a QCD is an excellent tax-efficient way to give to charity.
Miscellaneous Tax Matters:
Take advantage of the adoption tax credit for any qualified adoption expenses you paid. In 2019, you may be able to claim up to $14,080 per eligible child. If the child has “special needs,” you may qualify for the full credit regardless of the number of adoption expenses paid. The credit begins to phase out once your modified AGI exceeds $211,160 and it’s eliminated when your modified AGI reaches $251,160.
Under the new law, itemized miscellaneous
deductions have been eliminated. You can no longer deduct your tax prep fees or
even your investment advisor fees. However, these fees may still be deductible
as part of your business. Unreimbursed employee expenses are no longer allowed.
Even casualty losses unless deemed a federal disaster may no longer be allowed.
It’s much harder to itemize under the new law, but again, don’t forget to bunch
deductions if you are able.
Medical expenses are still deductible under the
new law and you might maximize them
by bunching such expenses in the same year, to the extent possible, to meet the
threshold percentage of your AGI.
The “bunching” strategy
for itemized deductions still may benefit taxpayers. If you can double
up on your itemized medical, charitable, SALT, investment interest and mortgage
interest expenses in a tax year, you may achieve a higher deduction than the
new standard deduction amounts.
Under the new law, Alimony will no longer be
deductible for NEW divorces starting in 2019. Although the deduction will be allowed
for older divorce
decrees, some divorced
taxpayers may find it
worthwhile to change their decrees.
Although you may hear politicians say that the
individual mandate has been eliminated, however, it technically still exists in
law and only the penalty has been reduced to ZERO starting in 2019.
Consider investing in Qualified Opportunity Zones (QOZ). These QOZ’s (many times in funds) can provide tax deferral and a partial tax exclusion benefit when investors use their gains from earlier investment transactions and reinvest the gains into QOZ’s. These rules are complex and the funds from other gains need to be re-invested within 180 days of the prior transaction. When done properly, investors receive a 15% step-up in basis and thus exclude some of their prior gains after 7 years (only 10% after 5 years). When investing in QOZ’s, make sure to evaluate the investment on its own merits and not solely on the tax benefits. If invested by the end of 2019, you will receive the full 15% (10% + 5%) step up in basis under current law, and if held for 10 years or more, any gain on the new QOZ will be excluded from taxes. Alert: Congress is aware of the short timeframe on the opportunity zones. They are considering extensions to give investors more time to meet the 7-year requirement.
Disclaimer: Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by STA Wealth Management, LLC (“STA”), or any non-investment related content, made reference to directly or indirectly in this newsletter will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this newsletter serves as the receipt of, or as a substitute for, personalized investment advice from STA. To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/ her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing. STA is neither a law firm nor a certified public accounting firm and no portion of the newsletter content should be construed as legal or accounting advice. A copy of the STA’s current written disclosure Brochure discussing our advisory services and fees is available upon request. If you are an STA client, please remember to contact STA, in writing, if there are any changes in your personal/financial situation or investment objectives for the purpose of review ng/evaluating/revising our previous recommendations and/or services, or if you would like to impose, add, or to modify any reasonable restrictions to our investment advisory services.
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