Year-End Tax Planning Moves to Make
We have reached the end of the first year of the Tax Cuts and Jobs Act (TCJA), the most significant tax legislation in the Unites States in more than 30 years. Over the past several months, we have analyzed the significant tax law changes brought by TCJA, which has provided a host of planning opportunities. Here is an overview of some of the changes and issues you need to know about, as well as some actions you may be able to take before year-end, to maximize your tax savings for 2018.
Year-End Tax Planning Moves for Individuals
Lower Tax Rates and Investment Gains
The TCJA introduced for 2018 ordinary tax rates which are generally lower than 2017. The top rate was lowered from 39.6% to 37%, and the overall rate thresholds were increased. Many taxpayers who have been in the top tax rate margin in past years may find themselves in a lower tax margin for 2018.
Additionally, the TCJA did not change the preferential rates for capital gains. Long-term capital gains from sales of assets held for over one year are taxed at 0%, 15% or 20%, depending on the taxpayer's taxable income. The maximum 20% rate applies to joint filers with 2018 taxable income above $479,000.
You may want to evaluate your portfolio before year end to determine if it makes sense to either accelerate some capital gains (for instance, if you expect to be subject to a higher capital gains rate in future years) or harvest some losses (to lower your capital gains rate for 2018).
Itemized Deductions and the Increased Standard Deduction
Beginning in 2018, many taxpayers who have previously claimed itemized deductions will no longer be able 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 marrieds filing separately), and many itemized deductions have been cut back or abolished. The deduction for state and local taxes is now limited to $10,000, and all miscellaneous itemized deductions (e.g., tax preparation fees) and unreimbursed employee expenses are no longer deductible. You can still itemize medical expenses to the extent they exceed 7.5% of your adjusted gross income, 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 work around the new reality by applying a “bunching strategy” to accelerate discretionary medical expenses and charitable contributions into the year where they will do some tax good. For example, if a taxpayer knows he or she will be able to itemize deductions this year but not next year, the taxpayer will benefit by making two years' worth of charitable contributions this year, instead of spreading out donations over 2018 and 2019. Other strategies for maximizing your charitable contributions in 2018 are the donations of appreciated securities or the use of a donor advised fund.
The New Child Tax Credit
Under the TCJA, personal exemptions have been eliminated starting in 2018. In place of the exemption deduction, the child tax credit has been increased from $1,000 to $2,000 per qualifying child under age 17. The tax law also introduced a new credit of $500 for each dependent who does not meet the qualifying age requirement.
The credit phaseout threshold of adjusted gross income for married couple filing jointly was increased from $110,000 to $400,000. As a result, if you were prohibited from taking the credit due to these income limitations in the past, you may now find you are eligible in 2018. If you find that your income level may be close to the phaseout threshold for 2018, it may be a good time to consider postponing income until 2019, or accelerating more deductions into 2018. This could be accomplished by using a credit card to pay deductible expenses before the end of the year, or by deferring the payout of a year end bonus to early 2019. If you are interested in other ideas, please feel free to call us.
Qualified Charitable IRA Distributions
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, which can result in tax savings. It also decreases your adjusted gross income, which may allow you to be eligible for more deductions and credits.
Gifts and Estates
Consider making gifts sheltered by the annual gift tax exclusion before the end of the year. 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.
Year-End Tax Planning Moves for Businesses & Business Owners
The Qualified Business Income Deduction
For tax years beginning after 2017, taxpayers other than C corporations may be entitled to a deduction of up to 20% of their qualified business income. For 2018, if taxable income exceeds $315,000 for a married couple filing jointly, or $157,500 for all other taxpayers, the deduction may be limited based on whether the taxpayer is engaged in a service-type trade or business (such as law, accounting, health, or consulting), the amount of W-2 wages paid by the trade or business, and/or the unadjusted basis of qualified property (such as machinery and equipment) held by the trade or business. The limitations are phased in for joint filers with taxable income between $315,000 and $415,000 and for all other taxpayers with taxable income between $157,500 and $207,500.
Taxpayers may be able to achieve significant savings by deferring income or accelerating deductions so as to come under the dollar thresholds (or be subject to a smaller phaseout of the deduction) for 2018. Depending on their business model, taxpayers also may be able increase the new deduction by increasing W-2 wages before year-end. This could include wages paid to a spouse or to children. Although additional payroll reporting and taxes may create a burden, the increased deduction may well offset this additional cost. The rules are quite complex, so don't make a move in this area without consulting your tax adviser.
More “small businesses” are able to use the cash (as opposed to accrual) method of accounting in 2018 and later years than were 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).
There are many advantages to using the cash method for tax purposes. 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, for example, paying bills early or by making certain prepayments. They also may be able to avoid such tax rules as uniform capitalization of inventory, or use of the percentage of completion method for contractors.
Depreciation and Expensing Allowance
Businesses should consider making expenditures that qualify for the liberalized business property expensing option. For tax years beginning in 2018, the expensing limit is $1,000,000, and the investment ceiling limit is $2,500,000. Expensing is generally available for most depreciable property (other than buildings), and off-the-shelf computer software. For property placed in service in tax years beginning after Dec. 31, 2017, expensing is also available for qualified improvement property (generally, any interior improvement to a building's interior, but not for enlargement of a building, elevators or escalators, or the internal structural framework), for roofs, and for HVAC, fire protection, alarm, and security systems.
The generous dollar ceilings that apply this year mean that many small and medium-sized businesses that make timely purchases will be able to currently deduct most, if not all, of their outlays for machinery and equipment. What's more, the expensing deduction is not prorated for the time that the asset is in service during the year. The fact that the expensing deduction may be claimed in full (if you are otherwise eligible to take it), regardless of how long the property is held during the year, can be a potent tool for year-end tax planning. Thus, property acquired and placed in service in the last days of 2018, rather than at the beginning of 2019, can result in a full expensing deduction for 2018.
Businesses also can claim a 100% bonus first-year depreciation deduction for machinery and equipment—bought used (with some exceptions) or new—if purchased and placed in service this year. The 100% write off is permitted without any proration based on the length of time that an asset is in service during the tax year. As a result, the 100% bonus first-year write off is available even if qualifying assets are in service for only a few days in 2018.
Meals and Entertainment
Entertainment expenses are no longer deductible starting in 2018. Meals are still partially deductible, with a few minor changes. Consider tracking your meals and entertainment costs in separate accounts.
Qualified Opportunity Zones
Qualified Opportunity Zones are a new vehicle for deferring gains from the sale of real property or securities. Opportunity Zones are low income communities identified by each state which meet certain criteria. Investing in Opportunity Zones can result in tax savings from both the temporary deferral of the original gain until 2026, and the permanent exclusion of any post-acquisition gains if the investment is disposed after a ten year holding period.
There are currently Opportunity Zones designated in each state. Many Qualified Opportunity Funds have been formed and are available for investment. If you are interested in deferring taxable gains while helping disadvantaged communities, this may be a win-win. Please feel free to reach out to us if you want additional information.
As we said above, the TCJA has brought about many changes to the tax landscape. Additionally, we are still awaiting guidance for some of the major provisions, so there is still some uncertainty. However, the above should give you some ideas of how the new tax law will affect you and your business. If you have any questions at all, or would like to set up an appointment, please do not hesitate to call.
- Your Tax Advising Team, The Doty Group, P.S.