This blog was prepared with the
assistance of Peter Weitsen, CPA, partner at WithumSmith+Brown, PC.
Nearly
two years after the 2017 Tax Cuts and Jobs Act was signed into law, taxpayers
are still getting used to the effects it has had on tax rules, tax breaks and
tax planning—including deductions and investments.
Here
are some ways to plan and manage your taxes to minimize your tax bill under the
law. Keep in mind that the law is set to expire on December 31, 2025, so some—but
not all—of the tax-planning and management advice will change if the rules are
not extended.
Charitable contributions are no longer deductible for taxpayers who
use the standard deduction. That is not to say that you should stop donating to
charities—it’s still an honorable thing to do. And if you give enough, it may
still make sense to itemize and take a deduction. In fact, under the new law
you can deduct charitable cash contributions up to 60% of your adjusted gross
income, compared with 50% before (and up to 30% on gifts of stock or other appreciated
assets). You might want to bunch the contributions together every other year and
itemize in those years while taking the standard deduction in the years in
between—or you can contribute to a so-called donor advised fund, which allows a
donor to bunch smaller gifts into a much larger amount.
An
alternative would be for employers to offer employees an informal salary-reduction
plan similar to the flexible health-care funding plan. The employer would
reduce the employee’s salary by an amount designated by the employee and would
make charitable contributions up to that amount as directed by the employee. This
way the employee would get a tax break via a reduced salary and the employer
would still have the same cost. Both would save on payroll taxes.
Keep
in mind that to the extent gross salary is reduced, it could affect how much in
401(k) contributions is allowed and how much in matching contributions is
available. It could also affect unemployment compensation…disability benefits…and/or
possibly eventual Social Security benefits.
Unreimbursed miscellaneous employee
expenses are also no
longer deductible except for a few exceptions, such as taxpayers who are Armed Forces
reservists or qualified performing artists. Employers can offer employees a
similar salary reduction plan as suggested for charitable contributions above as
long as the expenses are fully documented.
Standard deduction. The standard
deduction nearly doubled in 2018…and for 2019, it is $12,200 for singles and
$24,400 for joint filers. For 2020, it goes up to $12,400 for single filers and
$24,800 for joint filers. If you itemize, mortgage interest is still deductible (with new
limits) as well as up to $10,000 of state and local taxes. Also included are
medical costs in excess of 10% of adjusted gross income. However, it might make
sense to pay down the mortgage and bring the total itemized deduction below the
standard deduction amount while reducing your interest charges long-term.
Interest and dividend income. How you invest is also a tax concern.
Interest is taxed at a greater rate than “qualified” dividends and long-term
capital gains—both of which have a zero bracket for taxable income of joint
filers up to $78,750 in 2019 and $80,000 in 2020.
If
you are in a high tax bracket and have corporate bonds or bank certificates of
deposit (CDs), consider investing in tax-exempt bonds. The bond yield might be
lower than the corporate bonds but could be greater after considering the tax
savings.
Perennial Advice
The
following advice was useful before the law took effect and continues to be
helpful…
Capital gains. Harvest losses where possible. This
means you sell an investment at a loss and use the loss to offset taxes gains.
Also, immediately buy similar shares to maintain your stock market risk
profile. You must be careful not to engage in a wash sale, which disallows
losses if the same or substantially the same securities are purchased within 30
days prior to or after the sale. For example, selling pharmaceutical stocks and
purchasing an exchange traded fund for that sector is not the same. Neither is selling
various stocks and purchasing stocks in other companies in the same industry.
Capital losses can be offset against capital gains and the unused portion can
be carried forward indefinitely and to the extent they do not offset current
year gains, $3,000 can be deducted annually against other income.
In
any years that you realized short-term gains and have stocks with long-term losses
in your portfolio, consider realizing those losses to offset the short-term
gains.
If
you have a low-income year and your capital gains would not be taxed, you
should consider selling enough shares to realize a tax-free gain and
immediately repurchase those same shares and establish a higher tax basis. Wash
sale rules only apply to losses, not gains.
Take advantage of tax benefits such as sheltering capital gains with
Qualified Opportunity Zone benefits, providing either a deferral of the gain or
making the gain completely tax free. To qualify, the gain must be reinvested
within 180 days and the tax law requirements must be fully complied with.
Withholding and estimated tax payments. If you receive income, such as salary, subject
to withholding, try to adjust your W-4 exemption statement to have the least
amount required to be withheld. Overpaying will not get you any medals and will
give the government interest-free funds for a period up to 15 months. Do the
same with estimated tax payments. Of course, don’t reduce the amounts so much
that you end up facing a big tax bill plus interest and penalties after you
file your tax return.
If
you are receiving retirement account distributions, you might have a choice in
some instances to have withholding or not. Consider taking the full
distributions during the year and have the withholding applied to the last distributions
of the year. This will delay the tax payments as long as possible. Withholding
is always considered to have occurred ratably during the year, so there will be
no underestimated tax penalty due to the bunching of the payments toward year
end.
Retirement accounts. Tax-deferred IRA accounts and tax-free
Roth IRA accounts should be maximized as part of an overall financial plan.
Depending on your age, it might be more appropriate to invest in Roth accounts,
which are funded with after-tax contributions and then are not taxed any
further, rather than traditional IRAs or 401(k) accounts, which face taxes on
earnings when they are withdrawn.
Contributions
to the retirement accounts from existing savings should be made as early in the
year as possible to start the tax-deferred or tax-free accumulation. If made
from current earnings, they would need to be made as the funds became
available.
If
you are receiving required minimum distributions (RMDs) and will be
contributing to plans that you are still eligible to maintain, such as a solo 401(k)
plan for self-employed individuals, consider delaying the current year’s
contributions to the beginning of the following year. Otherwise it will be part
of the prior year’s December 31 balance, thereby increasing the following
year’s RMD, which will be taxed.
If
your contributions are made with payroll deductions, this cannot be done. If
you are employed and over age 70½ and are a less-than-5% owner, you do not have
to start RMDs from your employer’s 401(k).
If
you had a low-income year or a large business loss, consider taking a
distribution from your traditional IRA and rolling over the funds into a Roth IRA.
Do this to the extent you can to avoid being taxed at higher rates than the
minimum brackets.
Employer tax-favored plans. To the extent possible, maximize as
much of these benefits as you can. These include flexible spending health-care
plans, health savings accounts, 401k plans especially with employer matching
contributions, commuting reimbursement payments, and informal matching
charitable contribution or expense reimbursement plans (described above).
Estate and gift taxes. Estate taxes have virtually been
eliminated for most single people that will leave a 2019 estate under $11.4
million and married couples under $22.8 million. Therefore, planning to reduce
those taxes has been drastically reduced. However, making gifts can still be a
good strategy for family wealth planning and as a method to transfer wealth
early on so that the younger family members would get the benefits of the cash
flow and future capital appreciation. There is still a $15,000 annual gift tax
exclusion for gifts to each person you want to make gifts to (and double that
if there is a consenting spouse).
Further,
for those with family businesses where there are some children that work in the
business and some that don’t, gifting can be a method to facilitate transfers
and eliminate some of the cumbersome gyrations that occur during probate when
arrangements have not been made. This could eliminate the need for valuations…negotiations
by children among themselves on the value and payment terms…or even having the
wrong siblings remaining as co-owners and perhaps thorns in the side of the
siblings that operate the business on a daily basis.
Life insurance. The use of a trust has been
recommended as a possible estate-tax reduction maneuver. However, if there is
substantial coverage, using the trust could still be a mechanism to assure that
the funds will remain in the blood line while providing the surviving spouse or
guardians with adequate cash flow.
State and local taxes. This article primarily applies to
federal taxes, but the same processes apply to state and local taxes. If the
state follows the federal rules, not much planning is necessary, but for states
that do not, you should plan as much as possible.
Moving
to a low-tax state can also reduce overall taxes. Of course, unless you are
rich enough, the tax savings usually would not be worth the change in location
and lifestyle.
Year-round tax management. Look at last month’s year-end tax-planning posting for additional ideas.
The
key is to use as many resources as you can and apply as much as you can to your
situation. In many cases it requires mixing and matching and combining tax
benefits to maximize your tax position.
Tax
planning and management are not an “April 15” event. They require continuous
year-round attention. Do so and you will keep your taxes to the lowest legal
amount.
