2019 Year-End Tax Planning Tips & Traps

As the end of the year is fast approaching, we should consider any last-minute strategies that might help reduce your 2019 tax bill. Last year was the first year to be impacted by the Tax Cuts and Jobs Act of 2017 (TCJA). While there was plenty of clarifying guidance on application of the TCJA, there were was no significant new legislation in 2019 affecting individual taxes. But situations do change from year to year, thus requiring a fresh look at how to approach year-end tax planning. The following are strategies that may benefit you and that we should discuss before December 31.

Bunching Deductions into 2019

As you may know, TCJA significantly increased the standard deduction for all taxpayers. This means that many individuals who previously received a tax benefit by itemizing deductions no longer do because taking the standard deduction is more advantageous. For 2019, the standard deduction is $12,200 for single taxpayers, $24,400 for married taxpayers filing a joint return, $18,350 for taxpayers filing as head of household, and $12,200 for married taxpayers filing separately.

In addition, there is a $10,000 limitation ($5,000 in the case of married taxpayers filing separately) on the combined amount of state income taxes and property taxes that may be deducted when itemizing. Unfortunately, this $10,000 limitation applies to single as well as married taxpayers and is not indexed for inflation.

If the total of your itemized deductions in 2019 will be close to your standard deduction amount, alternating between bunching itemized deductions into 2019 and taking the standard deduction in 2020 (or vice versa) could provide a net-tax benefit over the two-year period. For example, if you give a certain amount to charities each year, and if it’s financially feasible, you might consider doubling up this year on your contributions rather than spreading the contributions over a two-year period. If these amounts, along with your mortgage interest and medical expenses exceed your standard deduction, then you should double up on the expenses this year and take the standard deduction next year.

Similar opportunities may be available for bunching property tax payments and state income tax payments, subject to TCJA’s $10,000 limitation on deductions for such payments. This strategy can be especially attractive for single taxpayers because the standard deduction is so much lower for single individuals. It’s important to remember, however, that the deduction for property taxes applies only to property taxes that have been assessed. Thus, if the assessment for 2019 property taxes occurred in 2018 and the taxes are due in 2019, you can deduct in 2019 the taxes assessed for 2019 that you have paid as well as the property taxes assessed for 2020, assuming you also pay the 2020 taxes in 2019.

Finally, if any of your real estate or income taxes can be allocated to a trade or business, they are not subject to the $10,000 limitation.

Medical Expenses and Health Savings Accounts

For 2019, your medical expenses are only deductible as an itemized deduction to the extent they exceed 10 percent of your adjusted gross income. Depending on what your taxable income is expected to be in 2019 and 2020, and whether itemizing deductions would be advantageous for you in either year, you may want to accelerate any optional medical expenses into 2019 or defer them until 2020. The right approach depends on your income for each year, expected medical expenses, as well as your other itemized deductions.

However, health saving accounts (HSAs) present an attractive alternative. If you are eligible to set up such an account, you can deduct the amount you contribute to the account in computing adjusted gross income. Thus, the contributions are deductible whether you itemize deductions or not. Distributions from an HSA are tax free to the extent they are used to pay for qualified medical expenses (i.e., medical, dental, and vision expenses). For 2019, the annual contribution limits are $3,500 for an individual with self-only coverage and $7,000 for an individual with family coverage.

Mortgage Interest Deduction

If you sold your principal residence during the year and acquired a new principal residence, the deduction for any interest on your acquisition indebtedness (i.e., mortgage) could be limited. The TCJA limits the interest deduction on mortgages of more than $750,000 obtained after December 14, 2017. The deduction is limited to the portion of the interest allocable to $750,000 ($375,000 in the case of married taxpayers filing separately). For mortgages acquired before December 15, 2017, the limitation is the same as it was under prior law: $1,000,000 ($500,000 in the case of married taxpayers filing separately). However, as discussed below, if you operate a business from your home, an allocable portion of your mortgage interest is not subject to these limitations.

You can potentially deduct interest paid on home equity indebtedness, but only if you used the debt to buy, build, or substantially improve your home. Thus, for example, interest on a home equity loan used to build an addition to your existing home is typically deductible, while interest on the same loan used to pay personal living expenses, such as credit card debts, is not.

Home Office Expenses

When the TCJA eliminated the miscellaneous itemized expense deduction, it eliminated the ability of employees to deduct home office expenses. However, taxpayers with their own business can still file a Schedule C and take a home office expense deduction if part of the home is used for that business. State income taxes, property taxes, and home mortgage interest allocable to your business can also be deducted and such deductions are not subject to the limitations that apply to individual taxpayers who do not operate a Schedule C business from their home.

Revised Kiddie Tax Rules

One of the changes made by TCJA involves what is known as the “kiddie tax.” The kiddie tax applies to a child’s net unearned income (e.g., dividends, interest, and capital gain distributions) over $2,200. While such income used to be taxed at the parent’s marginal income tax rate and took into consideration the unearned income of any siblings, TCJA simplified the calculation so that the child’s unearned income is taxed at trust and estate tax rates. Although the trust and estate tax rates are similar to the individual tax rates, the tax brackets are much lower, meaning higher rates of tax apply to lower levels of income.

For 2019, the top marginal tax rate for a couple filing a joint return is 37% for taxable income over $612,350. For income subject to the estate and trust tax rates, the 37% tax rate begins at taxable income over $12,750. There is a way to save some taxes here, however, if your child is under the age of 18 at the end of 2019 and didn’t have earned income that was more than half of the child’s support, or a full-time student at least age 19 and under age 24 and the end of 2019 and didn’t have earned income that was more than half of the child’s support. For such children, you can elect to include the child’s income on your tax return. However, we would need to evaluate whether adding such income to your tax return would subject you to the net investment income tax of 3.8 percent.

Child-Related Expenses and Credits

While the TCJA eliminated the personal and dependent exemption deductions that applied to tax years before 2018, it increased the child tax credit available for years after 2017 and increased the income level at which taxpayers are eligible for the credit. For 2019, if you file a joint return and your modified adjusted gross income (MAGI) is $400,000 or less, you are eligible for a $2,000 child tax credit for each qualifying child. If you are filing as single, head of household, or married filing separately, the MAGI limitation for claiming a child tax credit is $200,000 or less. For income above those levels, a pro rata credit may be available depending on total MAGI. Taxpayers with income below certain thresholds may be eligible for a refundable child tax credit.

Additionally, if you paid someone to take care of your child or a dependent so you can work or look for work, you may be entitled to a tax credit for up to 35 percent of the expenses paid. The amount of employment-related expenses used to calculate the credit is generally limited to $3,000 for one qualifying individual or $6,000 for two or more qualifying individuals. Various qualifications must be met in order to be eligible for the credit, but if you incurred such expenses, you may qualify. Additionally, if you paid someone to come to your home and care for a child or dependent, you may be a household employer subject to employment taxes.

If you incurred expenses to adopt a child, you may be eligible for a tax credit of up to $14,080 for some or all of those expenses. The determination of the tax year in which qualified adoption expenses are allowable as a credit depends on whether the expenses were paid before the year in which the adoption became final or whether they were paid during or after the year in which the adoption became final.

Education-Related Deductions and Credits

While the tuition and fees deduction that had previously been available expired at the end of 2017 along with the miscellaneous itemized deduction for work-related education expenses, other education-related tax deductions, credits, and exclusions from income may apply for amounts paid in 2019. Tax-free distributions from a qualified tuition program of up to $10,000 are now allowed for elementary or secondary school tuition. In addition, if your modified adjusted gross income level is below certain thresholds, the following are available for 2019:

· an exclusion from income for education savings bond interest;

· a deduction for student loan interest; and

· a lifetime learning credit of up to $2,000 for tuition and fees paid for the enrollment or attendance of yourself, your spouse, or your dependents for courses of instruction at an eligible educational institution.

Charitable Contribution Deductions

As a result of the increase in the standard deduction, some taxpayers are no longer getting a benefit from itemizing their deductions, such as charitable contributions, as they once were. However, as noted above, you can still help charities and get a tax benefit if you contribute enough to get over the standard deduction amount or bunch itemized deductions that would otherwise be spread over multiple years into one year.

Additionally, you can reap a larger tax benefit by donating appreciated assets, such as stock, to a charity. Generally, the higher the appreciated value of an asset, the bigger the potential value of the tax benefit. Donating appreciated assets not only entitles you to a charitable contribution deduction but you also avoid the capital gains tax that would otherwise be due if you sold the stock. For example, if you own stock with a fair market value of $1,000 that was purchased for $250 and your capital gains tax rate is 15 percent, the capital gains tax would be $113 ($750 gain x 15%). If you donate that stock instead of selling it, and are in the 24 percent tax bracket, you get an ordinary income deduction worth $240 ($1,000 FMV x 24%). You also save $150 in capital gains tax that you would otherwise pay if you sold the stock. Thus, the after-tax cost of the gift of appreciated stock is $647 ($1,000 – $240 – $113) compared to the after tax cost of a donation of $1,000 cash which would be $760 ($1,000 – $240). However, it’s important to also keep in mind that tax deductions for appreciated property are limited to 50 percent of your adjusted gross income.

Finally, taxpayers 70 1/2 years old and older who own an individual retirement account (IRA) are required to take minimum distributions from that account each year and include those amounts in taxable income. If you are in this category, a special rule allows you to make a charitable contribution directly from your IRA to a charity. This has several benefits. First, since charitable contributions deductions are usually only available to individuals who itemize, individuals who take the standard deduction instead can benefit from this rule. Second, making the contribution directly to a charity counts towards your required minimum distribution but that amount is not included in income and thus reduces your taxable income and adjusted gross income (AGI). A lower AGI is advantageous because it increases your ability to take medical expense deductions that you might not otherwise be able to take. For example, medical expenses are only deductible to the extent those expenses exceed 10 percent of your AGI and a lower AGI means you can deduct more medical expenses. In addition, as AGI increases, more of your social security income is subject to tax. Finally, the 3.8 percent net investment income tax applies to the extent your AGI exceeds a certain level.

Rental Real Estate

If you own rental real estate, you may be eligible for a special tax break – TCJA’s Section 199A deduction – which is based on a percentage of income earned by the rental real estate activity. In order to be eligible for the deduction, the activity must be considerable, regular, and continuous in scope. In determining whether your rental real estate activity meets those criteria, relevant factors include, but are not limited to, the following:

· the type of rented property (commercial real property versus residential property);

· the number of properties rented;

· you or your agent’s day-to-day involvement;

· the types and significance of any ancillary services provided under the lease; and

· the terms of the lease (for example, a net lease versus a traditional lease and a short-term lease versus a long-term lease).

Under a safe harbor issued by the IRS, a rental real estate activity will be treated as a business eligible for the special deduction if certain requirements are satisfied, such as:

· separate books and records are maintained to reflect the income and expenses for each rental real estate enterprise;

· for rental real estate enterprises that have been in existence less than four years, 250 or more hours of rental services are performed per year with respect to the rental real estate enterprise (with slightly less stringent requirements for rental real estate enterprises that have been in existence for at least four years);

· contemporaneous records have been maintained, including time reports, logs, or similar documents, regarding the following: (i) hours of all services performed; (ii) description of all services performed; (iii) dates on which such services were performed; and (iv) who performed the services; and

· certain compliance requirements are met.

If you think you may be eligible for this deduction, we should get together to nail down any last steps you may need to take to fall within the safe harbor. Alternatively, even if you don’t meet the safe harbor requirements, you may still be eligible for this deduction.

In addition, if you rent out a vacation home that you also use for personal purposes, we should review the number of days it was used for business versus pleasure to see if there are ways to maximize tax savings with respect to that property.

Retirement Planning

By investing in a qualified retirement plan you’ll not only receive a current tax deduction, thereby reducing current year income tax, but you can sock away money for your retirement years. If your employer has a 401(k) plan and you are under age 50, you can defer up to $19,000 of income into that plan. Catch-up contributions of $6,000 are allowed if you are 50 or over.

If you have a SIMPLE 401(k), the maximum pre-tax contribution for 2019 is $13,000. That amount increases to $16,000 if you are 50 or older.

If certain requirements are met, contributions to an individual retirement account (IRA) may be deductible. If you are under 50, the maximum contribution amount for 2019 is $6,000. If you are 50 or older but less than 70 1/2, the maximum contribution amount is $7,000. Contributions exceeding the maximum amount are subject to a 6 percent excise tax. Even if you are not eligible to deduct contributions, contributing after-tax money to an IRA may be advantageous because it will allow you to later convert that traditional IRA to a Roth IRA. Qualified withdrawals from a Roth IRA, including earnings, are free of tax, while earnings on a traditional IRA are taxable when withdrawn.

If you already have a traditional IRA, we should evaluate whether it is appropriate to convert it to a Roth IRA this year. You’ll have to pay tax on the amount converted as ordinary income, but subsequent earnings will be free of tax and the decrease in tax rates that are effective this year makes such a conversion less costly than it would have been in previous years. Of course, this option only makes sense if the tax rates when the money is withdrawn from the Roth IRA are anticipated to be higher than the tax rates when the traditional IRA is converted. And if you have a traditional 401(k), 403(b), or 457 plan that includes after-tax contributions, you can generally rollover these after-tax amounts to a Roth IRA with no tax consequences. A rollover of a SIMPLE 401(k) into a Roth IRA may also be available. As with all tax rules, there are qualifications that apply to these rollovers that we should discuss before any actions are taken.

Finally, if you make qualified retirement savings contributions during 2019 you can claim a retirement savings credit of up to $1,000 (single or head of household) or $2,000 (joint filers) if your adjusted gross income does not exceed $64,000 (married filing jointly), $48,000 (head of household), or $32,000 (all other taxpayers).

Reevaluating Your Stock Portfolio

Year end is a good time to review your stock portfolio to see if you might want to divest yourself of stocks that have lost value since you originally bought them. We should evaluate whether you might benefit from selling off appreciated stocks, particularly those that would generate a short-term capital gain, and using the resulting gain to limit your exposure to a long-term capital loss on stocks you may want to dump, since the deduction of long-term capital gains is limited. And any net capital gain you may reap will be taxed at the substantially reduced capital gain tax rate.

The tax rate for net capital gain is generally no higher than 15 percent for most taxpayers. Some or all of your net capital gain may be taxed at 0 percent if your income is not above $39,375 (single), $78,750 (joint), or $52,750 (head of household). However, a 20 percent tax rate on net capital gain does apply to the extent that your ordinary taxable income is over $434,550 (single), $488,850 (joint), $244,425 (married filing separately), or $461,700 (head of household). Additionally, the following types of capital gains have different tax rate structures: (1) the taxable part of a gain from selling certain qualified small business stock is taxed at a maximum 28 percent rate; (2) the net capital gain from selling collectibles (such as coins or art) is taxed at a maximum 28 percent rate; and (3) the portion of certain unrecaptured gain from selling real property is taxed at a maximum 25 percent rate. If you have been involved in any such transactions during the year, we should review your options for reducing the tax on those transactions.

Substantial Increases in Deductions or Nontaxable Income Could Result in AMT Exposure

While fewer taxpayers are subject to the alternative minimum tax (AMT) as a result of the TCJA increasing exemption amounts and raising the exemption phaseout levels, the AMT is not completely dead. Certain adjustments to your taxable income, or certain exclusions from gross income, for regular tax purposes are not allowed for AMT purposes and will increase your AMT income (AMTI), thus potentially subjecting you to the AMT. Typical items which may reduce regular income but are not allowed for AMTI purposes include the standard deduction, the state and local income tax deduction, and the deduction for property taxes. In addition, the exercise of incentive stock options can result in AMT income, whereas such income is not recognized for regular tax purposes. Thus, if you have exercised any incentive stock options or have had a substantial increase in certain deductions in 2019, but have not previously been subject to the AMT, there is the possibility that you could be subject to the AMT for 2019.

If you work from home, one strategy for avoiding the AMT is to allocate part of your mortgage interest or property taxes to your Schedule C business. To the extent you can claim items on your Schedule C, they aren’t added back in calculating AMTI.

While all taxpayers are eligible for an exemption from the AMT, the amount of the exemption depends on your filing status. For 2019, the exemption amounts for individuals, other than those subject to the kiddie tax, are (1) $111,700 in the case of a joint return or a surviving spouse; (2) $71,700 in the case of an individual who is unmarried and not a surviving spouse; and (3) $55,850 in the case of a married individual filing a separate return. However, these exemptions are phased out by an amount equal to 25 percent of the amount by which your alternative minimum taxable income (AMTI) exceeds: (1) $1,020,600 in the case of married individuals filing a joint return and surviving spouses and (2) $510,300 in the case of all other individuals.

Planning for the 3.8 Percent Net Investment Income Tax

A 3.8 percent tax applies to certain net investment income of individuals with income above a threshold amount. The threshold amounts are $250,000 (married filing jointly and qualifying widow(er) with dependent child), $200,000 (single and head of household), and $125,000 (married filing separately). In general, investment income includes, but is not limited to: interest, dividends, capital gains, rental and royalty income, non-qualified annuities, and income from businesses involved in trading of financial instruments or commodities. Thus, while the top tax rate for qualified dividend income is generally 20 percent, the top rate on such income increases to 23.8 percent for a taxpayer subject to the net investment income tax (NIIT).

If it appears you may be subject to the NIIT, the following actions may help avoid the tax and we should discuss whether any of these options make sense in light of your financial situation.

· Donate or gift appreciated property. As discussed above, by donating appreciated property to a charity, you can avoid recognizing the appreciation for income tax purposes and for net investment income tax purposes. Or you may gift the property so that the donee can sell it and report the income. In this case, you’ll want to gift the property to individuals that have income below the $200,000 (single) or $250,000 (couples) thresholds.

· Replace stocks with state and local bonds. Interest on tax-exempt state and local bonds are exempt from the NIIT. In addition, because such interest income is not included in adjusted gross income, it can help keep you below the threshold for which the NIIT applies.

· If you are in the real estate business, we should review the criteria for being classified as a real estate professional in addition to the criteria necessary for meeting the safe harbor requirements mentioned above for obtaining the qualified business income deduction. If you meet the requirements for being a real estate professional, your rental income is considered nonpassive and thus escapes the NIIT.

· If you intend to sell any appreciated assets, consider whether the sale can be structured as an installment sale so the gain recognition is spread over several years.

· Since capital losses can offset capital gains for NIIT purposes, consider whether it makes sense to sell any losing stocks, but keeping in mind the transaction costs associated with selling stocks.

· If you have appreciated real property to dispose of and are not considered a real estate professional, a like-kind exchange may be more advantageous. By deferring the gain recognition, you can avoid recognizing income subject to the NIIT.

Because the NIIT does not apply to a trade or business unless (1) the trade or business is a passive activity with respect to the taxpayer, or (2) the trade or business consists of trading financial instruments or commodities, we may want to look at ways in which a venture you are involved with could qualify as a trade or business. However, such classification could have Form 1099 reporting implications whereas personal payments are not reportable if your activity is not considered a trade or business.

Additional Medicare Tax

An additional Medicare tax of 0.9 percent is imposed on wages, compensation, and self-employment income in excess of a threshold amount. The threshold amounts are $250,000 (joint return or surviving spouse), $125,000 (married individual filing a separate return), and $200,000 (all others). However, the threshold amount is reduced (but not below zero) by the amount of the taxpayer’s wages. Thus, a single individual who has $145,000 in self-employment income and $130,000 of wages is subject to the .9 percent additional tax on $75,000 of self-employment income ($145,000 – $70,000 (the $200,000 threshold – $130,000 in wages)). No tax deduction is allowed for the additional Medicare tax.

For married couples, employers do not take a spouse’s self-employment income or wages into account when calculating Medicare tax withholding for an employee. If you and your spouse will exceed the $250,000 threshold in 2019 and have not made enough tax payments to cover the additional .9 percent tax, you can file Form W-4 with the IRS before year end to have an additional amount deducted from your paycheck to cover the additional .9 percent tax. Otherwise, underpayment of tax penalties may apply.

Timing Income and Deductions

If there is going to be a dramatic swing in your taxable income or your life circumstances between 2019 and 2020, it may make sense to either: (1) accelerate income into 2019 and defer deductions into 2020, or (2) accelerate deductions into 2019 and defer income into 2020.

· Accelerating Income into 2019. Options for accelerating income include: (1) harvesting gains from your investment portfolio, keeping in mind the 3.8 percent NIIT; (2) converting a retirement account into a Roth IRA and recognizing the conversion income this year; (3) taking IRA distributions this year rather than next year; (4) if you are self-employed and have clients that owe you money, try to get them to pay before year end; and (5) settling any outstanding lawsuits or insurance claims that will generate income this year.

· Deferring Deductions into 2020. If you anticipate a substantial increase in taxable income next year, it may be advantageous to push deductions into 2020 by: (1) postponing year-end charitable contributions, property tax payments, and medical and dental expense payments, to the extent deductions are available for such payments, until next year; and (2) postponing the sale of any loss-generating property.

· Deferring Income into 2020. If it looks like you may have a significant decrease in income next year, either from a reduction in income or an increase in deductions, it may make sense to defer income into 2020 or later years. Some options for deferring income include: (1) if you are due a year-end bonus, having your employer pay the bonus in January 2020; (2) if you are considering selling assets that will generate a gain, postponing the sale until 2020; (3) if you are considering exercising stock options, delaying the exercise of those options; (4) if you are planning on selling appreciated property, consider an installment sale with larger payments being received in 2020; and (5) consider parking investments in deferred annuities.

· Accelerating Deductions into 2019. If you expect a decrease in income next year, accelerating deductions into the current year can offset the higher income this year. Some options include: (1) prepaying property taxes in December, keeping in mind the $10,000 limitation on deducting state income and property taxes and the fact that the property taxes must have been assessed in order to be deductible; (2) if you owe state income taxes, making up any shortfall in December rather than waiting until your state income tax return is due (and similarly keeping in mind the $10,000 limitation); (3) making your January mortgage payment in December; (4) making any large charitable contributions in 2019, rather than 2020; (5) selling some or all loss stocks; and (6) if you qualify for a health savings account, setting one up and making the maximum contribution allowable.

Foreign Bank Account Reporting

The IRS has become increasingly aggressive at tracking down individuals who have not reported foreign bank accounts. If you have an interest in a foreign bank account, it must be disclosed; failure to do so carries stiff penalties. You must file a Report of Foreign Bank and Financial Accounts (FBAR) if: (1) you are a U.S. resident or a person doing business in the United States; (2) you had one or more financial accounts that exceeded $10,000 during the calendar year; (3) the financial account was in a foreign country; and (4) you had a financial interest in the account or signatory or other authority over the foreign financial account. If you are unclear about the requirements or think they could possibly apply to you, please let me know at your earliest convenience.

Other Considerations

Here are some additional items to consider:

Flexible Spending Accounts: Generally, you will lose any amounts remaining in a health flexible spending account at the end of the year unless your employer allows you to use the account until March 15, 2020, in which case you’ll have until then. You should check with your employer to see if the employer gives employees the optional grace period to March 15.

Life Events. Life events can significantly impact your taxes. For example, if you are using head of household or surviving spouse filing status for 2019, but will change to a filing tax status of single for 2020, your tax rate will go up. Thus, accelerating income into 2019 and pushing deductions into 2020 may also yield tax savings.

Individual Healthcare Penalty. For 2019, the tax penalty on individuals who fail to carry health insurance, which was enacted as part of the Affordable Care Act, has been eliminated.

Moving Expense Reimbursement. If you received a reimbursement from your employer for moving expenses incurred in 2019, the reimbursement is taxable income. While taxpayers could previously deduct employment-relating moving expenses, this deduction is no longer available for moves taking place in years 2018-2025, unless you are a member of the U.S. Armed Forces on active duty and move pursuant to a military order to a permanent change of station.

Casualty and Theft Losses. If you incurred a casualty loss in a presidentially declared disaster area in 2019, it may be deductible. Any other casualty loss, along with all theft losses, are not deductible.

Section 199A Passthrough Tax Break. Enacted as part of TCJA, the Section 199A tax break allows a 20 percent deduction for qualified business income from sole proprietorships, S corporations, partnerships, and LLCs taxed as partnerships. If you qualify for the deduction, which is available to both itemizers and nonitemizers, it is taken on your individual tax returns as a reduction to taxable income. The new tax break is subject to some complicated restrictions and limitations, but the rules that apply to individuals with taxable income at or below $160,700 ($321,400 for joint filers; $160,725 for married individuals filing separately) are simpler and more permissive than the ones that apply above those thresholds.

If you would like to review your current investment portfolio or discuss any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.

2018 Year-End Tax Planning Tips

Yep, it’s that time of year again. While the stock markets were busy correcting in October, making for a very volatile month, our thoughts turn to year-end tax planning.

Now is the time to take steps to cut your 2018 tax bill. Here are some relatively foolproof year-end tax planning strategies to consider, taking into account changes included in the Tax Cuts and Jobs Act (TCJA).

Year-end 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 itemizable 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 your home mortgage payment due on January 1. Accelerating that payment into this year will give you 13 months’ worth of interest deductions in 2018. Although the TCJA put new limits on itemized deductions for home mortgage interest, you are most likely unaffected (mostly affects some interest on home equity loans and lines of credit).

Also, consider state and local income and property taxes that are due early next year. Prepaying those bills before year-end can decrease your 2018 federal income tax bill because your itemized deductions will be that much higher. However, the TCJA decreased the maximum annual amount you can deduct for state and local taxes to $10,000 ($5,000 if you use married filing separate status). So, beware of this new limitation, and don’t be in a hurry to pre-pay property taxes by year-end if there’s a better chance that you might be able to deduct them in 2019.

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. Be sure to ask us about a donor advised fund, which can accelerate donation deductions this year, while taking your time (perhaps years) to “grant” amounts to your favorite charities. Also, consider accelerating elective medical procedures, dental work, and vision care. For 2018, medical expenses are deductible to the extent they exceed 7.5% of Adjusted Gross Income (AGI), assuming you itemize.

Warning: The state and local tax prepayment drill can be a bad idea if you owe Alternative Minimum Tax (AMT) for this year. That’s because write-offs for state and local income and property taxes are completely disallowed under the AMT rules. Therefore, prepaying those expenses may do little or no good if you are an AMT victim. While changes in the tax law reduced the number of people subject to the AMT, you may want to contact us if you are unsure about your exposure to the AMT.

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 folks, 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 that you have capital losses that were recognized earlier this year, or capital loss carryovers from pre-2018 years, selling winners this year will not result in any tax hit. In particular, sheltering net short-term capital gains with capital losses is a sweet deal because net short-term gains would otherwise be taxed at higher ordinary income rates.

What if you have some loser investments that you would like to unload? Biting the bullet and taking the resulting capital losses this year would shelter capital gains, including high-taxed short-term gains, from other sales this year.

If selling a bunch of losers would cause your capital losses to exceed your capital gains, the result would be what’s known as a net capital loss for the year. No problem! That net capital loss can be used to shelter up to $3,000 of 2018 ordinary income from salaries, bonuses, self-employment income, interest income, royalties, and whatever else ($1,500 if you use married filing separate status). Any excess net capital loss from this year is carried forward to next year and beyond.

In fact, having a capital loss carryover into next year could turn out to be a pretty good deal. The carryover can be used to shelter both short-term and long-term gains recognized next year and beyond. This can give you extra investing flexibility in those years because you won’t have to hold appreciated securities for over a year to get a preferential tax rate. Since the top two federal rates on net short-term capital gains recognized in 2019 and beyond are 35% and 37% (plus the 3.8% NIIT, if applicable), having a capital loss carryover into next year to shelter short-term gains recognized next year and beyond could be a very good thing.

One thing to keep in mind when either “harvesting” losses or holding on to winners to avoid capital gains: don’t let the tax “tail” wag the investment “dog”. Selling a loser for the sake of recognizing tax losses may not be prudent if the investment is temporarily undervalued. Conversely, holding onto an investment just to avoid capital gains taxes or to enjoy long term capital gains treatment may cost you more in lost gains than the taxes you’ll save. Be smart about it.

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 brackets that are not tied to the ordinary income brackets. Here are the brackets for 2018:

Single

Joint

Head of Household

0% bracket

$0–38,600

$0–77,200

$0–51,700

Beginning of 15% bracket

38,601

77,201

51,701

Beginning of 20% bracket

425,801

479,001

452,401

Note: The 3.8% NIIT can hit LTCGs and dividends recognized by higher-income individuals. This means that many folks will actually pay 18.8% (15% + 3.8% for the NIIT) and 23.8% (20% + 3.8%) on their 2018 LTCGs and dividends.

While your income may be too high to benefit from the 0% rate, you may have children, grandchildren, or other loved ones who will be in the 0% bracket. If you’re planning to give them cash, alternatively consider giving them appreciated stock or mutual fund shares that they can sell and pay 0% tax on the resulting long-term gains. Gains will be long-term as long as your ownership period plus the gift recipient’s ownership period (before the sale) equals at least a year and a day.

Giving away stocks that pay dividends is another tax-smart idea. As long as the dividends fall within the gift recipient’s 0% rate bracket, they will be federal-income-tax-free.

Warning: If you give securities to someone who is under age 24, the Kiddie Tax rules could potentially cause some of the resulting capital gains and dividends to be taxed at the higher rates that apply to trusts and estates. That would defeat the purpose. Please contact us if you have questions about the Kiddie Tax and refer to our post on the topic: Is Tax Simplification Just A Kiddie’s Play?

Also, one can be doing pretty well income-wise and still be within the 0% rate bracket for LTCGs and qualified dividends. Consider the following examples:

·       Your married adult daughter files jointly and claims the $24,000 standard deduction for 2018. She could have up to $101,200 of AGI (including LTCGs and dividends) and still be within the 0% rate bracket. Her taxable income would be $77,200, which is the top of the 0% bracket for joint filers.

·       Your divorced son uses head of household filing status and claims the $18,000 standard deduction for 2018. He could have up to $69,700 of AGI (including LTCGs and dividends) and still be within the 0% rate bracket. His taxable income would be $51,700, which is the top of the 0% bracket for heads of household.

·       Your single daughter claims the $12,000 standard deduction for 2018. She could have up to $50,600 of AGI (including LTCGs and dividends) and still be within the 0% rate bracket. Her taxable income would be $38,600, which is the top of the 0% bracket for singles.

Give Away Winning Shares, or Sell Losing Shares and Give Away the Resulting Cash. If you want to make gifts to some favorite relatives and/or charities, they can be made in conjunction with an overall revamping of your taxable (non-IRA) stock and equity mutual fund portfolios. Gifts should be made according to the following tax-smart principles.

Gifts to Relatives. Don’t give away losing shares (currently worth less than what you paid for them). Instead, you should sell the shares and book the resulting tax-saving capital loss. Then, you can give the sales proceeds to your relative.

On the other hand, you should give away winning shares to relatives. It’s somewhat likely they will pay lower tax rates than you would pay if you sold the same shares. As explained earlier, relatives in the 0% federal income tax bracket for LTCGs and qualified dividends will pay a 0% federal tax rate on gains from shares that were held for over a year before being sold. (For purposes of meeting the more-than-one-year rule for gifted shares, you can count your ownership period plus the gift recipient’s ownership period.) Even if the winning shares have been held for a year or less before being sold, your relative will probably pay a much lower tax rate on the gain than you would.

Gifts to Charities. The principles for tax-smart gifts to relatives also apply to donations to IRS-approved charities. You should sell losing shares and benefit from 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.

On the other hand, you should donate winning shares instead of giving away cash. Why? Because donations of publicly traded shares that you have owned for over a year result in charitable deductions equal to the full current market value of the shares at the time of the gift (assuming you itemize). Plus, when you donate winning shares, you escape any capital gains taxes on those shares. This makes this idea another double tax-saver: you avoid capital gains taxes, while getting a tax-saving donation deduction (assuming you itemize). Meanwhile, the tax-exempt charitable organization can sell the donated shares without owing anything to the IRS.

Finally, if you’re over age 70-1/2, you are subject to annual required minimum distributions (RMD) on your traditional IRA accounts. Consider making a direct contribution from your IRA to your favorite charity for any amount and it applies towards your annual RMD obligation. That way, the income is never taxed, and reduces your overall AGI, which can benefit you in many ways (e.g., possibly lower medicare premiums, less taxation of social security benefits, less exposure to deduction phaseouts that are based on your AGI).

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 account’s earnings.

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. Even billionaires can now do Roth conversions! If you have a lower than normal maximum tax bracket, you may want to consider a Roth conversion before year end.

Take Advantage of Principal Residence Gain Exclusion Break. Home prices are on the upswing in many areas. More good news: Gains of up to $500,000 on the sale of a principal residence are completely federal-income-tax-free for qualifying married couples who file joint returns. $250,000 is the gain exclusion limit for qualifying unmarried individuals and married individuals who file separate returns. To qualify for the gain exclusion break, you normally must have owned and used the home as your principal residence for a total of at least two years during the five-year period ending on the sale date. You’ll definitely want to take these rules into consideration if you’re planning on selling your home in today’s improving real estate environment.

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. Because the AMT rules are complicated, you may want some assistance. We can help.

Don’t Overlook Estate Planning. The unified federal estate and gift tax exemption for 2018 is a historically huge $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. Also, you may need to make some changes for reasons that have nothing to do with taxes, especially if your estate plan is more than a few years old. Don’t put off this very important life planning task.

Year-end Planning Moves for Small Businesses

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 10/15/2019 if you extend your 2018 return to that date. Other types of plans generally must be established by 12/31/2018 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. So, you might have to wait until next year if the SIMPLE-IRA option is appealing.

Contact us for more information on small business retirement plan alternatives, and be aware that if your business has employees, you may have to cover them too.

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. Contact us for details on the 100% bonus depreciation break and what types of assets qualify.

Claim 100% Bonus Depreciation for Heavy SUVs, Pickups, or Vans. The 100% bonus depreciation provision can have a hugely 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. The GVWR of a vehicle can be verified by looking at the manufacturer’s label, which is usually found on the inside edge of the driver’s side door where the door hinges meet the frame. 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 juicy 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 Year 1 if bonus depreciation is claimed.
· $16,000 for Year 2.
· $9,600 for Year 3.
· $5,760 for Year 4 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. Contact us for details.

Cash in on 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.

Time Business Income and Deductions for Tax Savings. If you conduct your business using a pass-through entity (sole proprietorship, S corporation, LLC, or partnership), your shares of the business’s income and deductions are passed through to you and taxed at your personal rates. Assuming the current tax rules will still apply in 2019, next year’s individual federal income tax rate brackets will be the same as this year’s (with modest bumps for inflation). In that case, the traditional strategy of deferring income into next year while accelerating deductible expenditures into this year makes sense if you expect to be in the same or lower tax bracket next year. Deferring income and accelerating deductions will, at a minimum, postpone part of your tax bill from 2018 until 2019.

On the other hand, if you expect to be in a higher tax bracket in 2019, take the opposite approach. Accelerate income into this year (if possible) and postpone deductible expenditures until 2019. That way, more income will be taxed at this year’s lower rate instead of next year’s higher rate. Contact us for more information on timing strategies.

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).

Because of the various limitations on the QBI deduction, tax planning moves (or non-moves) can have the side effect of increasing or decreasing your allowable QBI deduction. So, individuals who can benefit from the deduction must be really careful at year-end tax planning time. We can help you put together strategies that give you the best overall tax results for the year.

Claim 100% Gain Exclusion for Qualified Small Business Stock. There is a 100% federal income tax gain exclusion privilege for eligible sales of Qualified Small Business Corporation (QSBC) stock that was acquired after 9/27/10. QSBC shares must be held for more than five years to be eligible for the gain exclusion break. Contact us if you think you own stock that could qualify.

Conclusion

This post 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.

Is Tax Simplification Just A Kiddie’s Play?

You’ve probably heard by now that the IRS plans to issue a post-card sized 2018 tax form to allow taxpayers with the simplest of returns to file on. While “tax simplification” is an admirable goal, is it really possible when the objectives of the tax code are to meet and balance social, political and revenue goals/needs? Let’s just say that, as a CPA who prepares tens of returns each year, I have no worries about job security in my lifetime.

Tax simplification is one of the biggest misnomers coming out of Washington, where Congress purportedly makes it easier for all of us to fill out our tax returns by adding several thousand pages of new rules, rates and lists of things we can and cannot deduct under new lists of circumstances. The most recent version, which includes a complicated deduction for individuals participating in S corporations, partnerships, LLCs and sole proprietorships (with regulations running no fewer than 184 pages); new rules governing the deduction of alimony payments; what new payments can be made, tax-free, out of 529 plans; and restrictions on state and local tax deductions for federal tax purposes, are excellent examples of more complexity, not less.

But one actual reduction in complexity came with reform to the so-called “Kiddie Tax.” Under the old law (warning: get ready for some real complexity), a dependent child under the age of 18, or under 19 who provides less than 50% of his/her support, or a full-time student under the age of 24 would divide his/her income into two buckets: earned and unearned (investment) income. If parents claimed the child as a dependent on their tax return, the child’s standard deduction would be the greater of $1,050 or the child’s earned income (W-2), plus $350 (limited to the standard deduction amount of the parents). If the unearned income was more than $2,100, the investment income—but not the earned income—would be taxed at the tax rate of the highest-income parent. Did you get all that?

Under the new 2017 tax act, each child’s tax is calculated using the tax rates that apply to trusts, rather than the parents’ tax rates. Unlike individuals, trusts have just four brackets for ordinary income: 10% (up to $2,550), 24% ($2,551-$9,150), 35% ($9,151-$12,500) and 37%, with the top rate applied to all income over $12,500. For long-term capital gains, different rates apply.

Of course, that means that children get to the highest tax rate with far less income than, for example, married individuals (where the top rate kicks in above $600,000 in taxable income) or heads of household ($500,000). But at least the calculation is simpler—certainly a rarity in our history of tax “simplification.”

For children with expected investment income greater than $2,550, and especially over $9,150, it’s worth examining whether the “income shifting” planning that is currently in place, still makes sense.  Setting up and funding custodial accounts for minors, going forward, definitely won’t be as simple as it once was.

If we can be of help with setting up custodial accounts or planning kiddie income, or if you would like to review your current investment portfolio or discuss any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first. If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.

source:

https://www.irs.gov/irb/2018-10_IRB#RR-2018-06

The MoneyGeek thanks guest writer Bob Veres for his contribution to this post

Is A Donor Advised Fund Right for You?

Executive Summary: Setting up a Donor Advised Fund (DAF) for 2017 (before December 31, 2017) and front loading charitable deductions can save you thousands of dollars in taxes immediately, while directing distribution to charities in/for future years. Even if you decide not to establish a DAF, you should consider whether accelerating next year’s charitable contributions to 2017 makes sense for you, especially if you are phased out of itemizing deductions starting next year.

As you’ve heard by now, President Donald Trump has signed the Tax and Jobs Act of 2017, which mostly makes sweeping changes to tax rates and eliminates many deductions starting in 2018. For most households, this means no itemized deductions due to an increased standard deduction ($12,000 for single, $24,000 for married), a limit on the deduction of taxes ($10,000 of income, sales and property taxes combined) and elimination of most miscellaneous itemized deductions.

Many of you give generously to charities every year regardless of the prospect of deducting those contributions. While the changes to the deductiblity of contributions is little changed, the fact that you likely won’t be able to itemize, means that you’ll receive no tax benefit going forward if your contributions plus other itemized deductions don’t exceed your standard deduction.

This means that 2017 may be a year that you’ll want to consider a Donor Advised Fund (DAF) to take advantage of what might be your last year for itemizing, and take a large 2017 deduction for your contribution. The deadline for establishing a DAF is December 31, 2017, though for all intents and purposes, December 29 is the last business day of the year and may be the true deadline.

A DAF is simply an account that you establish with the charitable entity of a well-known custodian (Schwab, Fidelity, Vanguard or TD Ameritrade for example) and to which you make a lump sum contribution to fund future years’ contributions. For example, if you give $2,000 a year to charity, you could fund it with $10,000 today, and direct $2,000 a year to your charities each year while the fund grows tax free. Better yet, if you fund the DAF with long-term appreciated stocks or funds, you’ll get a full deduction for the fair market value of the securities, and never have to report the capital gain on your tax return.

This is right for you if:

  1. You’re willing and able to irrevocably contribute at least $5,000 (some custodians have higher minimums) to a managed account where you direct future contributions to the charities of your choice;
  2. You expect to be phased out of itemized deductions starting in 2018 due to the increased standard deduction and other changes to itemized deductions (see above) or,
  3. You would benefit more from an acceleration of charitable deductions to 2017 (than in future years) due to high income or lower tax rates in the years ahead.

Even if you decide not to establish a DAF, you should consider whether accelerating next year’s charitable contributions to 2017 makes sense for you.

The most common ‘strategy’ for creating a donor-advised fund is relatively straightforward – donor-advised funds are a good fit any time there’s a desire to contribute (and get the tax deduction) now, but make the actual grant to the final charity at some later date. In fact, the whole point of a donor-advised fund is to separate the timing of when the tax deduction occurs from when the charity ultimately receives the money.

Once established, you can add funds to a DAF in future years, and you can take as long as you want to distribute the funds to various charities. Some custodians maintain minimum donations you can make to a charity at any one time, say $50.

The important caveat to remember in all donor-advised fund strategies is that once funds go to the donor-advised fund, they must go to some charity, and cannot be retracted for the donor. The charitable gift to a donor-advised fund is still irrevocable, even if the assets have not yet passed through to the underlying charity. Nonetheless, for those who are ready to make the charitable donation – and want to receive the tax deduction now – the donor-advised fund serves as a useful vehicle to execute charitable giving strategies over time. And it certainly doesn’t hurt that any growth along the way will ultimately accrue tax-free for the charity as well.

If you would like to review your current investment portfolio or discuss setting up a Donor Advised Fund, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first. If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.

Tax Bill Provisions to Consider Before You Jingle All the Way

And the award for the busiest profession during the 2017 year-end holiday season goes to…..tax preparers and planners…..the crowd goes wild and applauds loudly. “I’d like to take this opportunity to thank our President, our senate and our House of Representatives for this “gift”. Without their last minute help and effort, no one could have made this Christmas to New Year’s period any busier for us.”

Laughing all the way…

The new tax law hasn’t been fully ratified by the U.S. House and Senate yet, but all indications are that the Tax Cuts and Jobs Act of 2017 will be sent to the President’s desk in the next two days. As you probably know, the House and Senate versions were somewhat different. What does the new bill look like?

Tax simplification? “Fuggetaboutit!” (think Italian mobster)

Despite the promise of tax “reform” or “simplification,” the bill actually adds hundreds of pages to our tax laws. And the initial idea of reducing the number of tax brackets was apparently tossed aside in the final version; the new bill maintains seven different tax rates: 10%, 12%, 22%, 24%, 32%, 35% and 37%. Most people will see their bracket go down by one to four percentage points, with the higher reductions going to people with higher income. And the tax brackets, going forward, will be indexed to inflation, meaning that the “real” income brackets will remain approximately the same from year to year.

The new brackets break down like this:

Individual Taxpayers

Income $0-$9,525 – 10% of taxable income
$9,526-$38,700 – $952.50 + 12% of the amount over $9,526
$38,701-$82,500 – $4,453 + 22% of the amount over $38,700
$82,501-$157,500 – $14,089.50 + 24% of the amount over $82,500
$157, 501-$200,000 – $32,089.50 + 32% of the amount over $157,500
$200,001-$500,000 – 45,689.50 + 35% of the amount over $200,000
$500,001+ – $150,689.50 + 37% of the amount over $500,000

Joint Return Taxpayers

Income $0-$19,050 – 10% of taxable income
$19,051-$77,400 – $1,905 + 12% of the amount over $19,050
$77,401-$165,000 – $8,907 + 22% of the amount over $77,400
$165,001-$315,000 – $28,179 + 24% of the amount over $165,000
$315,001-$400,000 – $64,179 + 32% of the amount over $315,000
$400,001-$600,000 – $91,379 + 35% of the amount over $400,000
$600,000+ – $161,379 + 37% of the amount over $600,000

Taxes for trusts and estates were also changed to:

$0-$2,550 – 10% of taxable income
$2,551-$9,150 – $255 + 24% of the amount over $2,550
$9,151-$12,500 – $1,839 + 35% of the amount over $9,150
$12,501+ – $3,011.50 + 37% of the amount over $12,500

Tax geeks like me note that the current 10% tax bracket is little changed, and the 15% bracket is now 12%, while the 25% and 28% tax bracket are replaced with 22% and 24% and a new 32% rate. Notice that in the lower brackets, the joint return (mostly for married couples) are double the individual bracket thresholds, eliminating the so-called “marriage penalty.” However in the higher brackets, the 35% rate extends to individuals up to $500,000, but married couples with $600,000 in income fall into that bracket. In the top bracket, the marriage penalty is more significant; individuals fall into it at $500,000, while couples are paying a 37% rate at $600,000 of adjusted gross income. That means more two-income couples will be calculating their taxes filed jointly and separately to arrive at the lowest resulting tax.

Making spirits bright…

Other provisions: the standard deduction is basically doubled, to $12,000 (single) or $24,000 (joint), $18,000 (head of household), and persons who are over 65, blind or disabled can add $1,300 to their standard deduction (currently $1,250).

The bill calls for no personal exemptions for 2018 and beyond (currently $4,050). For married couples with more than two children, this means that the new standard deduction ($24,000 in 2018) will be less than their current total standard deduction plus personal exemptions ($24,850 with three children in 2017). And the Pease limitation, a gradual phaseout of itemized deductions as taxpayers reached higher income brackets, has been eliminated. The Pease limitation added up to 3% to a high income taxpayer’s rates.

Despite the hopes of many taxpayers, the dreaded alternative minimum tax (AMT), remains in the bill. The individual exemption amount is $70,300; for joint filers it’s $109,400. But for the first time, the AMT exemption amounts will be indexed to inflation, so fewer taxpayers will be ensnared by the AMT. Even without this change, fewer taxpayers would be subject to the AMT because, as described below, the maximum deduction for (state and local income, sales, property) taxes is reduced beginning in 2018, and for most taxpayers, it was the deduction of those taxes that made them subject to the AMT.

Interestingly, the new tax bill retains the old capital gains and qualified dividend tax brackets—based on the prior brackets. The 0% capital gains rate will be in place for individuals with $38,600 or less in income ($77,200 for joint filers), and the 15% rate will apply to individuals earning between $38,600 and $452,400 (between $77,400 and $479,000 for joint filers). Above those amounts, capital gains and qualified dividends will be taxed at a 20% rate.

Misfortune seemed his lot…

In addition, the rules governing Roth conversion recharacterizations will be repealed. Under the old law, if a person converted from a traditional IRA to a Roth IRA, and the account lost value over the next year and a half, they could simply undo (recharacterize) the transaction, no harm no foul. Under the new rules, recharactization would no longer be allowed. This makes more accurate tax projections essential going forward, along with a good working crystal ball.

Before the tax act, fewer than 30% of taxpayers itemized their deductions. With the higher standard deductions, many more people will no longer file Schedule A, Itemized Deductions. Their deductions will simply not be enough to exceed the standard deduction, especially given the other changes in the tax bill. This makes year-end planning and projecting even more essential.

For many taxpayers who can itemize deductions, their taxable income number will likely be higher under the new tax plan, because many itemized deductions have been reduced or eliminated. Among them: there will be a $10,000 limit on how much any individual can deduct for state and local income, sales, and property tax payments. Before you rush to write a check to the state or your local government, know that a provision in the bill states that any 2018 state income taxes paid by the end of 2017 are not deductible in 2017, and instead will be treated as having been paid at the end of calendar year 2018. It’s not clear yet what happens if your 2017 state withholding exceeds your state liability. Normally, you would deduct the full amount on your current return and report the excess (refund) as income in the following year. But prior year state income tax refunds are no longer includible in income starting in 2018. Nothing is mentioned about paying and deducting already issued property tax bills due early in 2018, so it makes sense to figure out whether paying them in 2017 or 2018 yields a higher tax benefit. If you are in the AMT for 2017, prepaying any taxes will not yield a benefit.

The mortgage interest deduction will be limited to $750,000 of principal for new mortgages (down from a current $1 million limit); any mortgage interest payments on principal amounts above that limit will not be deductible. However, the charitable contribution deduction limit will rise from 50% of a person’s adjusted gross income to 60% under the new bill. If you think you’ll be ineligible to itemize starting in 2018, it makes sense to evaluate accelerating some planned 2018 charitable contributions to 2017, including any non-cash contributions.

Miscellaneous itemized deductions such as safe deposit box fees, unreimbursed employee business expenses, tax preparation fees, investment expenses and other deductions (currently subject to a reduction by 2% of adjusted gross income) are no longer deductible in any amount beginning in 2018. Here again, it make sense to see if prepaying some of those expenses makes sense (it does not if you’re in the AMT for 2017). Any prepayment amount and timing must be reasonable in the eyes of the IRS.

What about estate taxes? The bill doubles the estate tax exemption from, currently, $5.6 million (projected for 2018) to $11.2 million; $22.4 million for couples. Meanwhile, Congress maintained the step-up in basis, which means that people who inherit low-basis stock or real estate will see the embedded capital gains go away upon receipt, because the assets will have a cost basis equal to their fair market value on the date of death.

Public “C” Corporations saw their highest marginal tax rate drop from 35% to 21%, the largest one-time rate cut in U.S. history for the nation’s largest companies.

And pass-through entities like partnerships, S corporations, limited liability companies and sole proprietorships will receive a 20% deduction on taxes for “qualified business income,” which explicitly does NOT include wages or investment income. This is one of the more complicated areas of the tax bill, and will require working closely with your accountant or CPA to assess whether your pass-through entity will save money converting to a C Corporation.

As things stand today, all of these provisions are due to “sunset” after the year 2025, at which point the entire tax regime will revert to what we have now.

Assuming the tax bill is signed into law this week, and it likely will, you’ll have just over a week to project your 2017 and 2018 taxes, and decide which deductions (or income) you may want to defer to 2018 or accelerate into 2017. Only by projecting both years and finding the least combined liability will you know what planning tactics makes sense for you. We can help.

Oh what fun it is…

If you would like to review your current taxes, investment portfolio or discuss any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first. If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.

Sources:

https://www.washingtonpost.com/news/wonk/wp/2017/12/15/the-final-gop-tax-bill-is-complete-heres-what-is-in-it/?utm_term=.4b0efca718e8

https://www.forbes.com/sites/kellyphillipserb/2017/12/17/what-the-2018-tax-brackets-standard-deduction-amounts-and-more-look-like-under-tax-reform/#42b575bf1401

https://www.kitces.com/blog/final-gop-tax-plan-summary-tcja-2017-individual-tax-brackets-pass-through-strategies/

https://www.bna.com/2017-Individual-Tax/

https://www.nytimes.com/interactive/2017/12/15/us/politics/final-republican-tax-bill-cuts/

The MoneyGeek thanks guest writer Bob Veres for his contribution to this post

Details of Proposed Tax Reform

The House Ways and Means Committee released draft tax reform legislation on Thursday. Titled “The Tax Cuts and Jobs Act”, H.R. 1, incorporates many of the provisions listed in the Republicans’ September tax reform framework while providing new details. Budget legislation passed in October would allow for the tax reform bill to cut federal government revenue by up to $1.5 trillion over the next 10 years, and still be enacted under the Senate’s budget reconciliation rules, which would require only 51 votes in the Senate for passage. The Joint Committee on Taxation issued an estimate of the revenue effects of the bill on Thursday showing a net total revenue loss of $1.487 trillion over 10 years.

The bill features new tax rates, a lower limit on the deductibility of home mortgage interest, the repeal of most deductions for individuals, and full expensing of depreciable assets by businesses, among its many provisions.

Lawmakers had reportedly been discussing lowering the contribution limits for 401(k) plans, but the bill does not include any changes to those limits.

The Senate Finance Committee is reportedly working on its own version of tax reform legislation, which is expected to be unveiled next week. It is unclear how much that bill will differ from the House bill released on Thursday.

Here are some of the highlights of the House bill:

Individuals

Tax rates: The bill would impose four tax rates on individuals: 12%, 25%, 35%, and 39.6%, effective for tax years after 2017. The current rates are 10%, 15%, 25%, 28%, 33%, 35%, and 39.6%. The 25% bracket would start at $45,000 of taxable income for single taxpayers and at $90,000 for married taxpayers filing jointly. By comparison, for 2017, the current 25% rate starts at $37,951 of taxable income for single taxpayers and $75,901 for married taxpayers, so more income gets taxed at lower rates under the proposed tax bill.

The 35% bracket would start at $200,000 of taxable income for single taxpayers and at $260,000 for married taxpayers filing jointly. By comparison, for 2017, the current 35% rate starts at $416,701 of taxable income for both single taxpayers and married taxpayers, so more income gets taxed at higher rates at much lower levels under the proposed tax bill. And the 39.6% bracket would apply to taxable income over $500,000 for single taxpayers and $1 million for joint filers (currently $418,400 for single, $470,700 for married taxpayers.)

Standard deduction and personal exemption: The standard deduction would increase from $6,350 to $12,200 for single taxpayers and from $12,700 to $24,400 for married couples filing jointly, effective for tax years after 2017. Single filers with at least one qualifying child would get an $18,300 standard deduction. These amounts will be adjusted for inflation after 2019. However, the personal exemption would be eliminated.

Deductions: Most deductions would be repealed, including the medical expense deduction, the alimony deduction, and the casualty loss deduction (except for personal casualty losses associated with special disaster relief legislation). The deduction for tax preparation fees would also be eliminated (which most taxpayers never qualified to deduct anyway).

However, the deductions for charitable contributions and for mortgage interest would be retained. The mortgage interest deduction on existing mortgages would remain the same; for newly purchased residences (that is, for debt incurred after Nov. 2, 2017), the limit on deductibility would be reduced to $500,000 of acquisition indebtedness from the current $1.1 million. The overall limitation of itemized deductions would also be repealed.

Some rules for charitable contributions would change for tax years beginning after 2017. Among those changes, the current 50% limitation would be increased to 60%.

The deduction for state and local income or sales taxes would be eliminated, except that income or sales taxes paid in carrying out a trade or business or producing income would still be deductible. State and local real property taxes would continue to be deductible, but only up to $10,000. These provisions would be effective for tax years beginning after Dec. 31, 2017.

Credits: Various credits would also be repealed by the bill, including the adoption tax credit, the credit for individuals over age 65 who have retired on disability, the credit associated with mortgage credit certificates, and the credit for plug-in electric vehicles.

The child tax credit would be increased from $1,000 to $1,600, and a $300 credit would be allowed for nonchild dependents. A new “family flexibility” credit of $300 would be allowed for other dependents. The $300 credit for nonchild dependents and the family flexibility credit would expire after 2022.

The bill greatly changes the landscape for claiming college saving and spending deductions and credits. The American opportunity tax credit, the Hope scholarship credit, and the lifetime learning credit would be combined into one credit, providing a 100% tax credit on the first $2,000 of eligible higher education expenses and a 25% credit on the next $2,000, effective for tax years after 2017. Contributions to Coverdell education savings accounts (except rollover contributions) would be prohibited after 2017, but taxpayers would be allowed to roll over money in their Coverdell ESAs into a Sec. 529 plan.

The bill would also repeal the deduction for interest on education loans and the deduction for qualified tuition and related expenses, as well as the exclusion for interest on U.S. savings bonds used to pay qualified higher education expenses, the exclusion for qualified tuition reduction programs, and the exclusion for employer-provided education assistance programs.

Other taxes: The bill would repeal the alternative minimum tax (AMT).

The estate tax would be repealed after 2023 (with the step-up in basis for inherited property retained). In the meantime, the estate tax exclusion amount would double (currently it is $5,490,000, indexed for inflation). The top gift tax rate would be lowered to 35%.

Passthrough income: A portion of net income distributions from passthrough entities (partnerships and S corporations) would be taxed at a maximum rate of 25%, instead of at ordinary individual income tax rates, effective for tax years after 2017. The bill includes provisions to prevent individuals from converting wage income into passthrough distributions. Passive activity income would always be eligible for the 25% rate.

For income from nonpassive business activities (including wages), owners and shareholders generally could elect to treat 30% of the income as eligible for the 25% rate; the other 70% would be taxed at ordinary income rates. Alternatively, owners and shareholders could apply a facts-and-circumstances formula.

However, for specified service activities, the applicable percentage that would be eligible for the 25% rate would be zero. These activities are those defined in Sec. 1202(e)(3)(A) (any trade or business involving the performance of services in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, or any trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees), including investing, trading, or dealing in securities, partnership interests, or commodities. Essentially, any passthrough entity that’s considered a personal service corporation under current law would be excluded from this 25% maximum tax rate provision.

Business provisions

A flat corporate rate: The bill would replace the current four-tier schedule of corporate rates (15%, 25%, 34%, and 35%, with a $75,001 threshold for the 34% rate) with a flat 20% rate (25% for personal services corporations). Remember, shareholders of non-passthrough entities (better known as C corporations), get their income taxed twice-once at the corporate level when earned, and once again when distributed to shareholders. The corporate AMT is repealed along with the individual AMT.

Higher expensing levels: The bill would provide 100% expensing of qualified property acquired and placed in service after Sept. 27, 2017, and before Jan. 1, 2023 (with an additional year for longer-production-period property). It would also increase tenfold the Sec. 179 expensing limitation ceiling and phaseout threshold to $5 million and $20 million, respectively, both indexed for inflation. Essentially, most small businesses would be able to expense all qualified property and not have to depreciate them over their useful lives.

Cash accounting method more widely available: The bill would increase to $25 million the current $5 million average gross receipts ceiling for corporations generally permitted to use the cash method of accounting and extend it to businesses with inventories. Such businesses also would be exempted from the complicated and arcane uniform capitalization (UNICAP) rules. The exemption from the percentage-of-completion method (forcing you to recognize income as you progress towards completion of a project rather than at the end) for long-term contracts of $10 million in average gross receipts would also be increased to $25 million.

NOLs, other deductions eliminated or limited: Deductions of net operating losses (NOLs) would be limited to 90% of taxable income. NOLs would have an indefinite carryforward period, but carrybacks would no longer be available for most businesses. Carryforwards for losses arising after 2017 would be increased by an interest factor. Other deductions also would be curtailed or eliminated:

  • Instead of the current provisions under Sec. 163(j) limiting a deduction for business interest paid to a related party or basing a limitation on the taxpayer’s debt-equity ratio or a percentage of adjusted taxable income, the bill would impose a limit of 30% of adjusted taxable income for all businesses with more than $25 million in average gross receipts.
  • The Sec. 199 domestic production activities deduction would be repealed.
  • Deductions for entertainment, amusement, or recreation activities as a business expense would be generally eliminated, as would employee fringe benefits for transportation and certain other perks deemed personal in nature rather than directly related to a trade or business, except to the extent that such benefits are treated as taxable compensation to an employee (or includible in gross income of a recipient who is not an employee).

Like-kind exchanges limited to real estate: The bill would limit like-kind exchange treatment to real estate, but a transition rule would allow completion of currently pending Sec. 1031 exchanges of personal property.

Business and energy credits curtailed: Offsetting some of the revenue loss resulting from the lower top corporate tax rate, the bill would repeal a number of business credits, including:

  • The work opportunity tax credit (Sec. 51).
  • The credit for employer-provided child care (Sec. 45F).
  • The credit for rehabilitation of qualified buildings or certified historic structures (Sec. 47).
  • The Sec. 45D new markets tax credit. Credits allocated before 2018 could still be used in up to seven subsequent years.
  • The credit for providing access to disabled individuals (Sec. 44).
  • The credit for enhanced oil recovery (Sec. 43).
  • The credit for producing oil and gas from marginal wells (Sec. 45I)

Other credits would be modified, including those for a portion of employer Social Security taxes paid with respect to employee tips (Sec. 45B), for electricity produced from certain renewable resources (Sec. 45), for production from advanced nuclear power facilities (Sec. 45J), and the investment tax credit (Sec. 46) for eligible energy property. The Sec. 25D residential energy-efficient property credit, which expired for property placed in service after 2016, would be extended retroactively through 2022 but reduced beginning in 2020.

Bond provisions: Several types of tax-exempt bonds would become taxable:

  • Private activity bonds would no longer be tax-exempt. The bill would include in taxpayer income interest on such bonds issued after 2017.
  • Interest on bonds issued to finance construction of, or capital expenditures for, a professional sports stadium would be taxable.
  • Interest on advance refunding bonds would be taxable.
  • Current provisions relating to tax credit bonds would generally be repealed. Holders and issuers would continue receiving tax credits and payments for tax credit bonds already issued, but no new bonds could be issued.

Insurance provisions: The bill would introduce several revenue-raising provisions modifying special rules applicable to the insurance industry. These include bringing life insurers’ NOL carryover rules into conformity with those of other businesses.

Compensation provisions: The bill would impose new limits on the deductibility of certain highly paid employees’ pay, including, for the first time, those of tax-exempt organizations.

  • Nonqualified deferred compensation would be subject to tax in the tax year in which it is no longer subject to a substantial risk of forfeiture. Current law would apply to existing nonqualified deferred compensation arrangements until the last tax year beginning before 2026.
  • The exceptions for commissions and performance-based compensation from the Sec. 162(m) $1 million limitation on deductibility of compensation of certain top employees of publicly traded corporations would be repealed. The bill would also include more employees in the definition of “covered employee” subject to the limit.
  • The bill would impose similar rules on executives of organizations exempt from tax under Sec. 501(a), with a 20% excise tax on compensation exceeding $1 million paid to any of a tax-exempt organization’s five highest-paid employees, including “excess parachute payments.”

Foreign income and persons

Deduction for foreign-source dividends received by 10% U.S. corporate owners: The bill would add a new section to the Code, Sec. 245A, which replaces the foreign tax credit for dividends received by a U.S. corporation with a dividend-exemption system. This provision would be effective for distributions made after 2017. This provision is designed to eliminate the “lock-out” effect that encourages U.S. companies not to bring earnings back to the United States.

The bill would also repeal Sec. 902, the indirect foreign tax credit provision, and amend Sec. 960 to coordinate with the bill’s dividends-received provision. Thus, no foreign tax credit or deduction would be allowed for any taxes (including withholding taxes) paid or accrued with respect to any dividend to which the dividend exemption of the bill would apply.

Elimination of U.S. tax on reinvestments in U.S. property: Under current law, a foreign subsidiary’s undistributed earnings that are reinvested in U.S. property are subject to current U.S. tax. The bill would amend Sec. 956(a) to eliminate this tax on reinvestments in the United States for tax years of foreign corporations beginning after Dec. 31, 2017. This provision would remove the disincentive from reinvesting foreign earnings in the United States.

Limitation on loss deductions for 10%-owned foreign corporations: In a companion provision to the deduction for foreign-source dividends, the bill would amend Sec. 961 and add new Sec. 91 to require a U.S. parent to reduce the basis of its stock in a foreign subsidiary by the amount of any exempt dividends received by the U.S. parent from its foreign subsidiary, but only for determining loss, not gain. The provision also requires a U.S. corporation that transfers substantially all of the assets of a foreign branch to a foreign subsidiary to include in the U.S. corporation’s income the amount of any post-2017 losses that were incurred by the branch. The provisions would be effective for distributions or transfers made after 2017.

Repatriation provision: The bill would amend Sec. 956 to provide that U.S. shareholders owning at least 10% of a foreign subsidiary will include in income for the subsidiary’s last tax year beginning before 2018 the shareholder’s pro rata share of the net post-1986 historical earnings and profits (E&P) of the foreign subsidiary to the extent that E&P have not been previously subject to U.S. tax, determined as of Nov. 2, 2017, or Dec. 31, 2017 (whichever is higher). The portion of E&P attributable to cash or cash equivalents would be taxed at a 12% rate; the remainder would be taxed at a 5% rate. U.S. shareholders can elect to pay the tax liability over eight years in equal annual installments of 12.5% of the total tax due.

Income from production activities sourced: The bill would amend Sec. 863(b) to provide that income from the sale of inventory property produced within and sold outside the United States (or vice versa) is allocated solely on the basis of the production activities for the inventory.

Changes to Subpart F rules: The bill would repeal the foreign shipping income and foreign base company oil-related income rules. It would also add an inflation adjustment to the de minimis exception to the foreign base company income rules and make permanent the lookthrough rule, under which passive income one foreign subsidiary receives from a related foreign subsidiary generally is not includible in the taxable income of the U.S. parent, provided that income was not subject to current U.S. tax or effectively connected with a U.S. trade or business.

Under the bill, a U.S. corporation would be treated as constructively owning stock held by its foreign shareholder for purposes of determining CFC status. The bill would also eliminate the requirements that a U.S. parent corporation must control a foreign subsidiary for 30 days before Subpart F inclusions apply.

Base erosion provisions: Under the bill, a U.S. parent of one or more foreign subsidiaries would be subject to current U.S. tax on 50% of the U.S. parent’s foreign high returns—the excess of the U.S. parent’s foreign subsidiaries’ aggregate net income over a routine return (7% plus the federal short-term rate) on the foreign subsidiaries’ aggregate adjusted bases in depreciable tangible property, adjusted downward for interest expense.

The deductible net interest expense of a U.S. corporation that is a member of an international financial reporting group would be limited to the extent the U.S. corporation’s share of the group’s global net interest expense exceeds 110% of the U.S. corporation’s share of the group’s global earnings before interest, taxes, depreciation, and amortization (EBITDA).

Payments (other than interest) made by a U.S. corporation to a related foreign corporation that are deductible, includible in costs of goods sold, or includible in the basis of a depreciable or amortizable asset would be subject to a 20% excise tax, unless the related foreign corporation elected to treat the payments as income effectively connected with the conduct of a U.S. trade or business. Consequently, the foreign corporation’s net profits (or gross receipts if no election is made) with respect to those payments would be subject to full U.S. tax, eliminating the potential U.S. tax benefit otherwise achieved.

Exempt organizations

Clarification that state and local entities are subject to unrelated business income tax (UBIT): The bill would amend Sec. 511 to clarify that all state and local entities including pension plans are subject to the Sec. 511 tax on unrelated business income (UBI).

Exclusion from UBIT for research income: The act would amend the Code to provide that income from research is exempt from UBI only if the results are freely made available to the public.

Reduction in excise tax paid by private foundations: The bill would repeal the current rules that apply either a 1% or 2% tax on private foundations’ net investment income with a 1.4% rate for tax years beginning after 2017.

Modification of the Johnson Amendment: Effective on the date of enactment, the bill would amend Sec. 501 to permit statements about political campaigns to be made by religious organizations.

If you would like to review your current investment portfolio or discuss any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first. If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.

Source: AICPA

Tax Reform or Accountant’s Re-employment Act?

For as long as I can remember, tax reduction and simplification have been on the table for congress and past presidents. So why not President Trump? File your next tax return on a postcard (not likely)? I might be a bit cynical, but the only result of the next tax act I see will be extending my employment as a tax planner and preparer for the foreseeable future.

I sincerely doubt I’ll see significant tax simplification in my lifetime, so my fellow CPA’s and Turbotax employees can probably breathe a sigh of relief-their jobs are likely safe for years to come.

You can be forgiven if you’re skeptical that Congress will be able to completely overhaul our tax system after multiple failures to overhaul our health care system, but professional advisors are studying the newly-released nine-page proposal closely nonetheless. We only have the bare outlines of what the initial plan might look like before it goes through the Congressional sausage grinder:

First, we would see the current seven tax brackets for individuals reduced to three — a 12% rate for lower-income people (up from 10% currently), 25% in the middle and a top bracket of 35%. The proposal doesn’t include the income “cutoffs” for the three brackets, but if they end up as suggested in President Trump’s tax plan from the campaign, the 25% rate would start at $75,000 (for married couples–currently $75,900), and joint filers would start paying 35% at $225,000 of income (currently $416,700).

The dreaded alternative minimum tax, which was created to ensure that upper-income Americans would not be able to finesse away their tax obligations altogether, would be eliminated under the proposal. But there is a mysterious notation that Congress might impose an additional rate for the highest-income taxpayers, to ensure that wealthier Americans don’t contribute a lower share than they pay today.

The initial proposal would nearly double the standard deduction to $12,000 for individuals and $24,000 for married couples, and increase the child tax credit, now set at $1,000 per child under age 17. (No actual figure was given.)

At the same time, the new tax plan promises to eliminate many itemized deductions, without telling us which ones other than a promise to keep deductions for home mortgage interest and charitable contributions. The plan mentions tax benefits that would encourage work, higher education and retirement savings, but gives no details of what might change in these areas.

The most interesting part of the proposal is a full repeal of the estate tax and generation-skipping estate tax, which affects only a small percentage of the population but results in an enormous amount of planning and calculations for those who ARE affected. Anyone with enough money to be subject to the estate tax, has probably paid lawyers and accountants enough for planning to avoid paying a single dollar of it.

The plan would also limit the maximum tax rate for pass-through business entities like partnerships and limited liability companies (LLC’s) to 25%, which might allow high-income business owners to take their gains through the entity, rather than as personal (1040) income and avoid the highest personal tax brackets.

Finally, the tax plan would lower America’s maximum corporate (C-Corporation) tax rate from the current 35% to 20%. To encourage companies to repatriate profits held overseas, the proposal would introduce a 100% exemption for dividends from foreign subsidiaries in which the U.S. parent owns at least a 10% stake, and imposes a one-time “low” (not specified) tax rate on wealth already accumulated overseas.

What are the implications of this bare-bones proposal? The most obvious, and most remarked-upon, is the drop that many high-income taxpayers would experience, from the current 39.6% top tax rate to 35%. That, plus the elimination of the estate tax, in addition to the lowering of the corporate tax (potentially leading to higher dividends) has been described as a huge relief for upper-income American investors, which could fuel the notion that the entire exercise is a big giveaway to large donors. But the mysterious “surcharge” on wealthier taxpayers might taketh away what the rest of the plan giveth.

But many Americans with S corporations, LLCs or partnership entities (known as pass-through entities because their income is reported on the owners’ personal returns and therefore no company level tax is paid) would potentially receive a much greater windfall, if they could choose to pay taxes on their corporate earnings at 25% rather than nearly 40% currently. (No big surprise: The Trump organization is a pass-through entity.)

A huge unknown is which itemized deductions would be eliminated in return for the higher standard deduction. Would the plan eliminate the deduction for state and local property and income taxes, which is especially valuable to people in high-tax states such as New York, New Jersey and California, and in general to higher-income taxpayers who pay state taxes at the highest rate? Note that on average, only about 35% of Americans itemize their deductions on Schedule A, most of them higher income taxpayers.

Currently, about one-third of the 145 million households filing a tax return — or roughly 48 million filers — claim state and local tax deductions. Among households with income of $100,000 or more, the average deduction for state and local taxes is around $12,300. Some economists have speculated that people earning between $100,000 and around $300,000 might wind up paying more in taxes under the proposal than they do now. Taxpayers with incomes above $730,000 would hypothetically see their after-tax income increase an average of 8.5 percent.

Big picture, economists are in the early stages of debating how much the plan might add to America’s soaring $20 trillion national debt. One back-of-the-envelope estimate by a Washington budget watchdog estimated that the tax cuts might add $5.8 trillion to the debt load over the next 10 years. According to the Committee for a Responsible Federal Budget analysis, Republican economists have identified about $3.6 trillion in offsetting revenues (mostly an assumption of increased economic growth), so by the most conservative calculation the tax plan would cost the federal deficit somewhere in the $2.2 trillion range over the next decade.

Others, notably the Brookings Tax Policy Center (see graph) see the new proposals actually raising tax revenues for individuals (blue bars), while mostly reducing the flow to Uncle Sam from corporations.

CA - 2017-9-30 - Tax Reform Proposal_2

These cost estimates have huge political implications for whether a tax bill will ever be passed. Under a prior agreement, the Senate can pass tax cuts with a simple majority of 51 votes — avoiding a filibuster that might sink the effort — only if the bill adds no more than $1.5 trillion to the national debt during the next decade.

That means compromise. To get the impact on the national debt below $1.5 trillion, Congressional Republicans might decide on a smaller cut to the corporate rate, to something closer to 25-28%, while giving typical families a smaller 1-percentage point tax cut (gee…thanks?). Under that scenario, multi-national corporations might be able to bring back $1 trillion or more in profit at unusually low tax rates, and most families might see a modest tax cut that will put a few hundred extra bucks in their pockets.

Alternatively, Congress could pass tax cuts of more than $1.5 trillion if the Republicans could flip enough Democratic Senators to get to 60 votes. The Democrats would almost certainly demand large tax cuts for lower and middle earners, potentially lower taxes on corporations and higher taxes on the wealthy. Would you bet on that sort of compromise?

We shall see, and I’ll keep you posted on tax developments. For now, put away that post card–you’re probably going to need an envelope and more postage.

If you would like to review your current investment portfolio or discuss any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first. If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.

Sources:
https://www.yahoo.com/finance/news/trump-overpromising-tax-cuts-205013012.html
https://www.aei.org/publication/the-big-six-tax-reform-framework-can-you-dynamically-score-a-question-mark/
https://www.washingtonpost.com/blogs/plum-line/wp/2017/09/27/trumps-new-tax-plan-shows-how-unserious-republicans-are-about-governing/?tid=sm_tw&utm_term=.d37e0bcf718d
https://www.yahoo.com/finance/news/hidden-tax-hikes-trumps-tax-cut-plan-202041809.html
https://www.yahoo.com/finance/news/republicans-700-million-problem-could-173027048.html
https://www.yahoo.com/finance/news/trumps-tax-plan-just-got-180000645.html
The MoneyGeek thanks guest writer Bob Veres for his contribution to this post

 

%d bloggers like this: