Jim Lange’s 2019 Year-End Tax Report
by Glenn Venturino, CPA and James Lange, CPA/Attorney
With year-end approaching, let’s look at some tax-planning considerations that can help lower your 2019 tax bill.
One piece of tax legislation that didn’t pass but should be taken into consideration for your year-end planning is The SECURE Act. For 2019 year-end tax planning purposes, the most immediate consideration is that more taxpayers than ever before will be good candidates for Roth IRA conversions. Please see our book, Retirement Plan Owner’s Guide to Beating the New Death Tax, which describes Roth IRA conversion in the shadow of the SECURE Act. Please see Chapter 5, p. 36.
While 2019 is shaping up to be a quiet year for new tax legislation, we are in the second year of the 2017 Tax Cuts and Jobs Act (TCJA). The TCJA was the first major overhaul of the tax code in over 30 years.
The TCJA brought significant tax reform changes for both individuals and businesses that are relevant now. Many of the new changes that took place in 2018 were anything but simple. One change that affected millions of taxpayers was the elimination or drastic reduction of certain itemized deductions on Schedule A.
In filing season 2019, many more taxpayers claimed the new higher standard deduction in lieu of itemizing their tax deductions for tax year ended 2018. While this change did simplify the tax return filing for many, there are still plenty of tax-savvy ideas to consider. With many taxpayers no longer itemizing deductions additional focus should shift to AGI (adjusted gross income) tax planning. Reducing your AGI can increase tax deductions, increase certain tax credits, and reduce exposure to other taxes. Let’s examine the tax environment with regard to itemized deductions.
Itemized Deductions: We have a higher standard deduction allowance in 2019 ($12,200 for individuals, $24,400 for married filing jointly, $27,000 if 65 or over). There are also significant limitations on what we may include for itemized deductions. For those taxpayers who never itemized or were not close to being able to itemize, the increase in itemized deductions is favorable. For others, particularly if you pay high real estate taxes and state and local income taxes, the change in itemized deductions generally hurt you.
Gaming the Standard Deduction Allowance Vs. Itemizing Deductions
Bunching Strategy. Bunching your itemized deductions is a technique that involves accumulating deductions, so they are high in one year and low in the following year. If your tax deductions normally fall short of itemizing, or even if you can marginally itemize, you can benefit from the “bunching” strategy. It’s very typical for most taxpayers to wait until tax time to add up everything and use the higher of the standard deduction or their itemized deductions. It should be easier for most taxpayers to project their total itemized deductions before the end of 2019 due to the elimination of certain itemized deductions and limitations on others (SALT). By being proactive, you can time the payments of tax-deductible items to maximize your itemized deductions in one year while using the standard deduction the following year.
Bunching Charitable Donations. Consider bunching charitable donations every other year while taking the standard deduction in the off years. This strategy may be an effective way to receive a greater tax benefit from your charitable giving. Another popular vehicle for maximizing your charitable donations is the use of a donor-advised fund (DAF). The donor-advised fund functions as a conduit. The taxpayer gets an immediate tax deduction when the money is directed into the fund. The donor can decide which charities will receive the money and when they will receive the money even if it is in a future year. In a high-income year, front-loading the fund with a larger contribution can be quite nice. By the way, the assets within the fund also enjoy tax-free growth.
We have found that charities are very active with their solicitations during the holiday season and would be happy to receive gifts near year-end or early in the new year. If you think you’ll be itemizing your deductions in 2019, but not next year, consider making last-minute cash and non-cash charity donations before year-end. If you don’t have the extra cash available today, you can use a credit card before year-end and still qualify for a 2019 tax deduction. If the gift is appreciated stock, the tax benefits are even greater.
One planning technique that may be more advantageous in 2019 and beyond is the use of Qualified Charitable Distributions for taxpayers who are 70 and ½ or older. See the section titled “Charitable Giving” for details on using this strategy.
A Helpful Tip. If you are currently using QCDs, please make sure you receive acknowledge letters for any single donation of $250 or more from the charitable organizations before filing your tax return. The IRS requires the letter under the Substantiation and Disclosure requirements for the donation to be tax-deductible.
Alert. This is especially important to seniors who no longer itemize their deductions. If your 2019 Required Minimum Distributions (RMDs) will come entirely from qualified plans such as 403(b)s and 401(k)s, consider an IRA rollover, or partial rollover, where applicable before December 31, 2019. You will not be eligible to take advantage of Qualified Charitable Distributions in 2020 unless this action is taken. Determine an IRA rollover amount that will be large enough to meet your qualified charitable giving goal.
Important Early Thought for 2020. If you are considering using your RMDs from your IRA to make qualified charitable distributions, try and be proactive. Advanced planning with your tax advisor and investment advisor (if you have one) will ease the process while achieving your charitable giving goal and maximizing the income tax savings.
Medical Expenses. The medical expense deduction is taking a bigger haircut in 2019 as your total out-of-pocket costs must exceed 10% of your adjusted gross income. Most taxpayers don’t typically incur significant deductible out-of-pocket medical expenses due to medical insurance coverage.
Your net medical expense deduction is linked directly to your adjusted gross income. Eligible expenses include health insurance premiums, long-term care premiums (limits apply), prescription drugs, medical, dental and eye-care services. If you have incurred higher medical expenses during the year and you believe you’ll be able to itemize your deductions in 2019, then consider paying any last-minute medical expenses before December 31, 2019. If one spouse has larger medical expenses and lower-income than the other, analyze if filing separately reduces your overall tax bill.
State and Local Tax Deductions. The overall deductible limit for 2019 remains at $10,000. This limit applies to a combined total that will include state and local income taxes, real estate taxes, sales tax, personal property tax, etc. There is not a lot of wiggle room in this category. A large portion of this deduction is typically filled with a combination of income tax withholdings from employee wages and larger real estate tax costs. If you don’t have employee wages but are expecting higher taxable income from other sources of taxable income (i.e., self-employment income, capital gain income/investment income) paying an increased 4th quarter estimate by December 31, 2019, can generate additional tax savings. But, if your state and local deductions are more than $10,000, unlike prior years, there is no advantage of paying your estimates early.
Qualified Business Income Deduction for Business Owners. The TCJA introduced a new complicated 20 percent tax deduction (also known as the Section 199A deduction) for eligible business owners such as sole proprietorships, LLCs, S Corporations, Partnerships and Trusts. The deduction is also available to certain real estate rental property owners. The details of this deduction are beyond the scope of this letter. In January 2019, the Department of Treasury and the IRS issued final regulations providing some additional clarity and safe harbors for taxpayers to follow. It is a valuable tax deduction for those who qualify. They will enjoy an extra reduction of taxable income without additional capital outlay. Certain deduction limits are imposed when taxable income exceeds threshold amounts. Keeping taxable income below these thresholds will preserve more of the qualifying deduction.
Defer Income and/or Accelerate Expenses. Many taxpayers don’t have much control in choosing whether to defer or accelerate income from year to year. However, the new tax law provides businesses and business owners (including pass-through entities), with incentives and deductions to lower their overall tax costs. Smart timing of income and expenses can be fruitful while poor timing may result in paying a larger tax bill. Being able to estimate income for 2020 can help with the decision of either accelerating income before the end of 2019 or deferring the income into 2020. The same is true for deductions. Try and use this flexibility to your advantage.
Tax Loss Harvesting. If your capital gains are larger than your losses, you might want to do some “loss harvesting.” This means selling certain investments that will generate a loss—converting them from unrealized losses to realized losses. You can use an unlimited amount of capital losses to offset capital gains. Large long-term capital gain income has often triggered Alternative Minimum Tax (AMT) in past years. On a good note, if 2018 is a roadmap for 2019, AMT has virtually disappeared. For those higher-income taxpayers, lowering current year investment income by loss harvesting will generate even greater savings. These taxpayers can potentially lower the net investment income tax (the additional 3.8% tax) assessed on net investment income above certain levels.
Roth IRA Conversions. In general, we like Roth IRA conversions for taxpayers who can make a conversion and stay in the same tax bracket they are currently in and have the funds to pay for the Roth conversion from outside of the IRA. Unfortunately, the qualification “in general” is likely critically important. It is best to run the numbers to determine the most appropriate conversion amount for the current year and to plan for possible future conversions in your situation. We often develop a long-term Roth IRA conversion plan that usually involves multiple years of partial conversions.
When a conversion plan is developed, we often recommend a conversion up to certain income limits to avoid additional Medicare premium cost increases or to avoid high rates of income tax on amounts of Roth conversion income over certain amounts.
In certain situations, utilizing a parent’s IRA and lower tax rates to do Roth conversions can be beneficial. The adult child (eventual beneficiary) having sufficient financial resources can make a monetary gift to the parent to pay the tax on the conversion. Since the parent wouldn’t be receiving annual RMDs from the converted portion of the IRA, the child can make annual gifts to replace the lost income distributions to cover living expenses. Without future IRA income, the parent’s Social Security income in future years can be received tax-free. Friendly Caution: Keep in mind that you are expecting your child to make those monetary gifts to you each year.
Going forward, Roth conversions under the current tax laws may present a better opportunity to do conversions at the lower tax rates. The historical benefits of Roth IRAs and Roth conversions that grow in value have not changed. It is more important than ever to develop a Roth conversion plan considering your unique situation. If you are interested in this strategy, please contact us. Again, we refer you to the DVD we had mailed to you, Unintended Benefits of Trump’s New Tax Law.
Modifications to Depreciation Limits on Automobiles. The annual depreciation limits have been expanded very generously for these business assets. Generous depreciation deductions will lower overall taxable business income and while reducing adjusted gross income. As stated earlier, many tax benefits under the current landscape are tied to reducing your adjusted gross income.
Friendly Reminder to Elders: Now is a good time to make sure you have met your 2019 Required Minimum Distribution amount. You have until December 31, 2019 to fulfill the requirement. The IRS has the power to assess harsh penalties for failure to meet the requirement. In recent years, the IRS has been more forgiving in abating penalties based on individual facts and circumstances. Ideally, you don’t want to leave the decision in the hands of the IRS on whether they are in a forgiving mood or not.
One of our main goals is to help clients identify specific opportunities that coordinate tax reduction with their investment portfolios. To achieve this goal, we continually stay current about potential year-end tax strategies and keep abreast of future strategies that our clients might want to consider in helping reduce their income taxes. We hope you are continually implementing long-term tax reduction strategies. If you are interested in our help with year-end planning, you should know we are crushed with year-end planning work for our clients now. The last I checked, there is some availability for year-end planning before year-end.
As a comprehensive financial services firm, Lange Financial Group, LLC is committed to helping our clients improve their long-term financial success. Of course, since every situation is different, not all strategies outlined will be appropriate for you. Please discuss all potential tax strategies with your tax preparer. Remember, this is not advice for preparing your taxes. Our goal is to identify ways to reduce your taxes!
My entire team at Lange Financial Group, LLC is available to provide you with updated information that can help with all your financial planning needs. If you would like us to mail a copy of this important report to any of your friends or associates, please call Alice Davis at 412-521-2732.
It should be noted that our frequently recommended three best tax shelters that create income-tax-free growth are particularly appropriate in today’s tax environment. These three tax shelters are:
- Roth IRA conversions, please see our book, Retirement Plan Owners’ Guide to Beating the New Death Tax, which describes Roth IRA conversion in the shadow of the SECURE Act. Please see Chapter 5, p. 36.
- Section 529 plans (college plans for grandchildren and children). We would recommend Joe Hurley’s book, Saving for College, or his website, savingforcollege.com.
- Life insurance.
As always, if you have any questions about your specific situation before our next scheduled meeting, please feel free to call your tax preparer.
Certified Public Accountant
Attorney at Law
P.S.: What follows is year-end tax planning advice that we licensed and are providing for you. We covered what we believe are the most important points for most taxpayers, but frankly didn’t go into as much detail in many areas as the following reprinted materials.
Once again in 2019, many higher-income taxpayers had larger tax bills due to the 3.8% Medicare contribution tax on net investment income. The focus must be on reducing your adjusted gross income to help mitigate the additional tax costs. Try and manage your adjusted gross income by keeping it as close to the threshold as possible. Going well below the threshold provides no additional benefit as it relates to computing the 3.8% surtax. With a few strategic moves, you may be able to reduce your adjusted gross income enough to mitigate the impact of these new taxes.
The Medicare contribution tax is imposed only on “net investment income” and only to the extent that total Modified Adjusted Gross Income (MAGI) exceeds $200,000 for single individuals and $250,000 for taxpayers filing joint returns. The amount subject to the tax is the lesser of:
- Net investment income; or
- The excess of MAGI over the applicable threshold amount listed above.
In addition to the complexity of calculating “net investment income” subject to the tax, another difficulty will be determining what constitutes net investment income that is subject to the tax. The chart below summarizes what qualifies as investment income under the new law.
Type of Income
|Subject to 3.8% Medicare Contribution Tax?|
|Interest and Dividends||X|
|Royalties and net rental income||X|
|Installment sales proceeds||X|
|Gain from the sale of a personal residence in excess of the IRC 121 exclusion||X|
|Passive income from S corporations||X|
|Passive activity income||X|
|Income from a trade or business that trades in financial instruments or commodities||X|
|Non-passive income from S corporations||X|
|Income from qualified pension, profit-sharing plan and stock bonus plans||X|
|Social Security income||X|
Source: The Essential Planning Guide To The Income & Estate Tax Increases, pg. 61
Let’s examine ways to reduce your adjusted gross income before the end of 2019.
Many taxpayers, especially wage earners, have less control over their adjusted gross income when compared to self-employed taxpayers or even those in retirement. The following year-end moves can be ideal if any of these situations apply. If you have earned income from self-employment or an employee, one of the best ways to manage adjusted gross income is through retirement plan contributions. There are many alternatives to choose from that enable individuals to make retirement plan contributions. Now is an ideal time to make sure you maximize your retirement plan contributions for 2019 and start thinking about your strategy for 2020. Examine your year-to-date elective deferral contributions on your most recent pay stub. While your intentions may have been to maximize current year contributions to your 401(k) or 403(b), you may find out that you have not hit the maximum amounts as anticipated. There is still time to have your employer increase your contributions from your remaining paychecks to reach the maximum level of contributions allowable for 2019.
Higher 401(k)/403(b) Contribution Limits. The elective deferral (contribution) limit for employees who participate in 401(k), 403(b), most 457 plans, and the federal government’s Thrift Savings Plan will increase to $19,500 in 2020. The 2020 catch-up contribution limit for employees age 50 and over who participate in 401(k), 403(b), most 457 plans, and the federal government’s Thrift Savings Plan will increase to $6,500.
Planning Note: We are big proponents of using Roth 401(k) and Roth 403(b) plans for elective deferral contributions. Considering the current increased tax rate structure on certain investment income and the new Section 199A for business owners an increased focus on reducing both adjusted gross and taxable income can be beneficial. Higher-income taxpayers should consider switching back to making tax-deductible retirement plan contributions instead of funding their Roth accounts. An ideal strategy may be to split your contributions during the year if you’re in overlapping tax brackets. For example, consider making tax-deductible contributions to reduce your income to the bottom level of your upper tax bracket and fund the remaining portion of your current year retirement account with non-deductible Roth contributions in a lower bracket. If you’re interested in this strategy, be sure to discuss with your professional tax preparer. With possibly the lowest historic tax rates, we often recommend hedging against higher future tax rates by splitting your annual retirement plan contributions using both tax-deductible and non-deductible Roth contributions.
Make a Tax-Deductible IRA Contribution. For those taxpayers who qualify, you can make a tax-deductible contribution of $6,000 with a catch-up (for taxpayers 50 or older) of an additional $1,000. The contribution can be made until April 15, 2020 and still be a deduction on your 2019 tax return.
Planning Note: Due to the fact that the IRA contribution can be made after the end of the calendar year, calculating the actual tax savings provides a great advantage and shouldn’t be overlooked.
While it Lasts. For those of you who don’t qualify for a regular Roth IRA contribution (because your income is too high) and who have no other traditional IRAs, you can take advantage of a nice loophole in the code (Backdoor Roth). Consider making a traditional IRA contribution and converting it immediately to a Roth IRA. You will run into complications with this strategy if you have other traditional IRAs. Once again, if this strategy fits your situation, make your 2019 contribution as soon as possible and repeat the process with your 2020 IRA contribution in early January 2020. If you are married, you can apply this strategy to your spouse even if they don’t work and assuming you have enough earned compensation to qualify.
Caution: If you are planning to do a rollover from a qualified plan to an IRA account prior to the end of the year, the above strategy will be unsuccessful, and the conversion will result in unexpected taxable income. It will not matter if the IRA contribution and the immediate Roth conversions occurred earlier in the year before the rollover date.
For those of you who can afford it, I encourage establishing and funding a Roth IRA for your children or even grandchildren and get a tax-free retirement fund started for their benefit. The longer period of tax-free growth provides a greater benefit. Like any IRA, the child or grandchild must have earned income to qualify fora contribution.
New Proposed Legislation in the Pipeline.
- Repealing the maximum age of 70 ½ for making traditional IRA contributions.
- Increasing the beginning Required Minimum Distribution age from 70 ½ to age 72.
- Allowing penalty-free IRA withdrawals for the birth or adoption of a new child.
- Drastically reducing the payout period for most beneficiaries inheriting retirement assets.
Tax Loss Harvesting. If your capital gains are larger than your losses, you might want to do some “loss harvesting.” This means selling certain investments that will generate a loss—converting them from unrealized losses to realized losses. You can use an unlimited amount of capital losses to offset capital gains. However, you are limited to only $3,000 of net capital losses that can offset other income, such as interest, dividends, and wages. Any remaining unused capital losses can be carried forward into future years indefinitely. Tax-loss harvesting will generate even greater savings for higher-income taxpayers that are subject to an additional 3.8% net investment income tax on net capital gains. (Don’t forget to review your “Trust Investment Accounts” for loss harvesting as the higher tax rates apply at much lower levels of taxable income). Being tax-savvy by reviewing your investment portfolio(s) for loss harvesting should be done annually prior to the end of the current tax year.
The Hidden Tax Trap. How many times have you heard your tax preparer tell you that the reason you owe more money this year versus last year or the reason your refund is smaller this year versus last year is due to Capital Gain Distributions. Very typically, the bulk of these taxable distributions will not be known until late November and December. You may not have sold any securities at a gain during the year, but these taxable distributions are the result of mutual fund portfolio managers recognizing gains in the funds they manage that get passed onto the fund investors. Due to a robust 2019 stock market, early indicators reveal significant capital gain distributions may be forthcoming. It is very important that you or your investment advisor review your investment portfolio(s) for any “Loss Harvesting” opportunities. While the market is in a good place today, you do have until the end of December to sell securities at a loss.
Please note that if you sell an investment with a loss and then buy it right back, the IRS disallows the deduction. The “wash sale” rule says you must wait at least 30 days before buying back the same security to be able to claim the original loss as a deduction. However, you can buy a similar security to immediately replace the one you sold—perhaps a stock in the same sector. This strategy allows you to maintain your general market position while capitalizing a tax break.
If you are planning to write-off a non-business bad debt, be sure to establish that it is bona fide debt and document unsuccessful efforts to collect. Form over substance matters in these instances.
Utilize Installment Sales. If appropriate, reporting taxable gains using an installment sale will allow you to the spread the gain over several years rather than recognizing the entire gain in the year of sale. In many instances, this type of gain is also subject to the 3.8% Medicare surtax on “net investment income” thus managing your adjusted gross income can save additional taxes. Keep in mind that Medicare Part B premiums are determined by looking at your tax return from two years prior to the current year. An installment sale may enable you to spread the gain over several years while never crossing the threshold that would trigger increased Medicare premiums in any one year. Alternatively, if you have entered into an installment sale arrangement, you may have an option to elect out of the installment sales tax treatment. This election allows you to recognize the entire gain in the year of sale even though payments you receive will be over multiple tax years. Consider this option if it’s the appropriate tax strategy.
Maximize your HSA Contribution. If you are enrolled in a Health Savings Account (HSA) plan, it is not too late to maximize your 2019 tax-deductible contribution to the account. In fact, you have until April 15, 2020 to fund your HSA account and still get a 2019 tax deduction. Similar to an IRA contribution, the exact amount of tax savings can be calculated. It is the only section in the Internal Revenue Code (the Triple Crown if you will) that allows a tax deduction on the way in, tax-free growth and tax-free qualifying distributions. For those who can afford it, fully funding the HSA account and never using the funds to pay for current medical expenses (using other monies to pay for medical expenses incurred) can allow for a big pot of tax-free money to accumulate over time to be used for future medical costs. These funds can come in handy during retirement when you normally experience more medical expenses while having less annual income. Also, once you reach age 65, you can use the money for reasons other than medical expenses. These distributions used for non-medical purposes will be penalty-free but subject to income taxes. It sounds like an extra IRA account, without being subject RMD rules. Certainly not a bad thing to have.
Funding Self-Employed Retirement Plans. If you are self-employed, you have other retirement savings options. We will review these alternatives with you when you come in for your appointment. One of my favorites for many one-person self-employed businesses is the one person 401(k) plan.
Most self-employed retirement plans allow for contributions to be made as late as October 15th of the following year. Having this deferred funding benefit allows you to calculate various levels of savings based on various contribution amounts. The 2019 maximum contribution allowable for these plans can be as high as $62,000 for taxpayers age 50 and older.
Increase Tax-Favored Income. Converting taxable interest to tax-exempt interest will serve to reduce adjusted gross income and modified adjusted gross income. For example, moving money from CDs or money market accounts will not create any taxable income. Alternatively, selling corporate bonds may produce a taxable gain and reduce or offset the benefits.
Reduce Business or Rental Real Estate Income. Make full use of depreciation including bonus depreciation and Section §179 expensing allowances for property and equipment placed in service before the end of the year. You have more control in attaining the desired profit or loss level if properly analyzed. The 2017 Tax Cut and Jobs Act has increased the annual limits for Section §179 expensing and bonus depreciation. The new tax law permits full expensing of certain improvements to nonresidential rental property. Improvements such as a full roof replacement on an existing building may be expensed in the year of purchase by any taxpayer eligible to deduct under Section §179. These type expenditures have historically been subject to much longer depreciation recovery periods. Expensing certain asset purchases under the de minimis expensing rules, while easy and convenient, may actually work against other deductions on your tax return such as the new Qualified Business Income deduction.
Capital Gains and Losses. Looking at your investment portfolio can reveal several different tax-saving opportunities. Review your year-to-date sales of stocks, bonds and other investments. This allows you to determine the net amount of capital gains or losses you have realized to date. Also, review the unsold investments in your portfolio to determine whether these investments have an unrealized gains or losses. (Unrealized means you still own the investment while realized means you’ve sold the investment).
Most taxpayers can obtain the tax basis of their investments. In most instances, the basis refers to the price that you paid to acquire the investment. Some investments allow you to reinvest your dividends and/or capital gains to purchase additional shares. These additional shares add to the cost basis of the original purchase.
Generally, it is best to offset short-term gains with long-term losses rather than the opposite of offsetting long-term gains with short-term losses. If your capital gains are larger than your losses, you can begin looking for tax-loss selling candidates. This strategy called “loss harvesting” converts the unrealized losses to realized losses. Tax-loss harvesting and portfolio rebalancing are a natural fit. If you’re more of a buy and hold mutual fund investor, your capital gains may be in the form of mutual fund distributions. These distributions are typically paid out towards the end of the tax year and sometimes can be quite substantial. Implementing the “loss harvesting” strategy after these additional gains are included provides for more accurate tax planning. The tax code allows you to apply to up to $3,000 of net capital losses to reduce ordinary income items such as interest, dividends and wages. Any remaining unused capital losses can be carried forward into future years indefinitely.
Please note that if you sell an investment with a loss and then buy it right back, the IRS disallows the deduction. The “wash sale” rule says you must wait at least 30 days before buying back the same security in order to be able to claim the original loss as a deduction. However, you can buy a similar security to immediately replace the one you sold—perhaps a stock in the same sector. This strategy allows you to maintain your general market position while utilizing a tax break.
Dealing with Stock Loss Carryovers in the Year of Death for a Surviving Spouse. From a tax point of view, it is important for the surviving spouse to consult with his/her tax advisor on strategies that would use the deceased spouse’s carryovers on the joint tax return filed for the year of death. The surviving spouse could sell their own securities or other capital assets at a gain to use the deceased spouse’s expiring capital loss carryover. If there is time, evaluating the sick spouse’s portfolio before the date of death may also be helpful.
Zero Percent Tax on Long-Term Capital Gains. If you are in the 10% or 12% tax bracket, the tax rate for long-term capital gains is zero percent! In order to qualify for this tax break, your 2019 taxable income cannot exceed $39,475 for singles and $78,950 for married joint filers.
Please note that the 0% tax rate only applies until your taxable income reaches the end of the 12% tax bracket. For example, let us assume that a married couple with wages of $70,000, long-term capital gains of $45,000 and deductions of $16,700 leaving them with $98,300 of taxable income. The first $25,650 of long-term capital gain is tax-free, but once their taxable income passes the $78,950 limit, the remaining long-term capital gain of $19,350 is taxed at 15%.
If you are eligible for the 0% capital gains tax rate, here is a cool maneuver to take advantage of the federal tax-free rate. Sell some appreciated stocks recognizing just enough gain to push your income to the top of the 12% tax bracket. With the sale proceeds, purchase new shares in the same company that were just sold. The newly purchased shares will have a higher cost basis than the shares you sold. If you should eventually decide to sell these new shares, they will have a new higher tax basis. Please also note that you do not have to wait 30 days before you can buy the stock back when there is a taxable gain. This technique is referred to as “gains-harvesting.” The 30-day period only applies to securities sold at a loss.
Consider this strategy. If you’re ineligible for the 0% capital gains tax rate, but you have adult children (not subject to the Kiddie tax rules) in the 0% bracket, consider gifting appreciated stock to them. Your adult children will pay a lot less in capital gains tax than if you sold the stock yourself and gifted the cash to them. This is especially true if you are subject to both the Medicare surtax on net investment income, and you’re in the 37% tax bracket. In this scenario, you are paying 23.8% on your long-term capital gains. Modest amounts of low basis stocks can still be gifted and sold by younger children while avoiding the new Kiddie tax rules in effect.
But be careful—you can’t “go back in time” if you subsequently discover you would have fared better had you identified different shares before you made a particular sale. If you don’t specify which shares you are selling at the time of the sale, the tax law treats the shares you acquired first as the first ones sold. In other words, it uses a FIFO (First-In, First-Out) method. This may not produce the optimal result that you had wished for.
Hidden Gem. When a parent’s income is too large to claim education tax credits (the American Opportunity and Lifetime Learning), shifting income to the kid’s return can generate tax savings. In this tax-planning strategy, the parent is eligible to claim the child as a dependent but chooses not to do so. The child indicates that he or she can be claimed as a dependent on someone else’s tax return thus by default not claiming a personal exemption. Due to income limitations, the parent(s) wouldn’t be eligible to claim the education tax credit on their tax return and the personal exemption deduction is currently suspended they are basically giving up no tax benefits associated with the child. The child in turn claims the education credit on their own tax return up to $2,500, depending on which education credit they’re eligible for. This holds true even if the parent pays for the college tuition and qualified expenses. Ideally you would shift enough income from the parent to the child to be offset by the education tax credit. Caution: Take into accounts the changes to the Kiddie Tax rules when calculating the optimal amount of income to shift.
Step-Up-In-Basis Rules. Another very important but often overlooked item is a step-up-in-basis, which occurs when a taxpayer inherits certain assets. The new cost basis is the fair market value as of the date of death, which is often much greater than the original basis that the decedent had in this investment. However, the step-up-in-basis rule does not apply to certain investments, such as IRAs and other tax-deferred accounts.
Remember that if someone gifts you an appreciated asset while they are alive, then the recipient’s basis is the same as the basis of the giver.
Taxes on Social Security Income. Social Security income may be taxable, depending on the amount of other income a taxpayer receives. If a taxpayer only receives Social Security income, the benefits are generally not taxable, and it is possible that the taxpayer may not even need to file a federal income tax return.
If a taxpayer receives other income in addition to Social Security income, and one-half of the Social Security income plus the other income exceeds a base amount, then up to 85% of the Social Security income may be taxable. The base amount is $25,000 for a single filer and $32,000 for married taxpayers filing a joint return.
A complicated formula is necessary to determine the amount of Social Security income that is subject to income tax. IRS publication 915 contains a worksheet that is helpful in making this determination.
Social Security income is included in the calculation of MAGI for purposes of calculating the Medicare contribution tax, as discussed earlier. Therefore, taxpayers having significant net-investment income will have a reason to delay receiving Social Security benefits.
Assuming a reasonable or long-life expectancy, it is generally beneficial for an individual who is eligible to receive Social Security on or after age 62 to delay payments until full retirement age. Assuming a full retirement age of 66, an individual who elects to receive Social Security benefits at age 62 will see benefits reduced by 25%. However, if the same individual delays receiving Social Security benefits until after full retirement age, a delayed retirement credit may be available. The chart below shows the percentage increases when an individual delays receipt of retirement benefits.
Increase in Social Security Benefits for Delayed Retirement
|Year of Birth||Yearly Rate of Increase||Monthly Rate of Increase|
|1933-1934||5.5%||11/24 of 1%|
|1935-1936||6.0%||1/2 of 1%|
|1937-1938||6.5%||13/24 of 1%|
|1939-1940||7.0%||7/12 of 1%|
|1941-1942||7.5%||5/8 of 1%|
|1943 or later||8.0%||2/3 of 1%|
Source: The Essential Planning Guide to The Income & Estate Tax Increases, page 38
An interesting wrinkle in long-term planning related to the taxation of Social Security is the synergy of developing a good long-term Social Security maximization plan and a good long-term Roth IRA conversion plan. We often enjoy tremendous benefits using the following combination strategy under the right circumstances.
One effective strategy is holding off on Social Security and making Roth IRA conversions in the years after you retire and you don’t have wages, but before age 70 when you will have Required Minimum Distributions (RMD) and full Social Security. Make those Roth IRA conversions while your marginal income tax bracket is at an all-time low. Please note a Roth IRA conversion increases income which could increase Social Security taxes.
Estate and Gift Tax Opportunities. The game of estate planning for most clients has changed from trying to reduce gift or estate tax to trying to reduce income taxes. For 2019, each taxpayer can pass $11,400,000 (minus past taxable gifts that he/she has made) to children or other beneficiaries without having to pay gift or estate taxes. If you are married, you will be able to pass $22,800,000 without any federal gift or estate taxes. There is a 35% estate tax on gifts or estates of deceased persons exceeding the limits. This is the exemption amount for federal estate tax, not for PA inheritance tax, which is a flat 4.5% to lineal heirs (children and grandchildren).
Many people believe that with the estate tax exemption set at over $11,000,000 per person, they don’t need to worry about shrewd, tax-wise ways to give wealth. However, these people might want to rethink their strategy. Congress can change the law (and has changed the law in the past), and your wealth could grow faster than expected, thereby subjecting you to estate tax. Nevertheless, before you gift something away, you need to consider the income tax effects of making certain gifts. Giving away the wrong asset can cost your family some unnecessary taxes. However, if you have an estate that is worth less than $3,000,000, I would recommend focusing on long-term planning to reduce income taxes, not estate taxes. Planning appropriately for your IRA, Roth IRA, Roth IRA conversions and your retirement plan should be your biggest concern.
In 2019, you and your spouse can each give $15,000 per calendar year ($30,000 for couples) to as many individuals as you’d like without reducing your lifetime gift tax exemptions. Depending on your circumstances, it may be smart to make a gift before the end of this year. Gifts to medical or educational providers are not included in the $15,000 limit. In fact, there is no limit on qualified gifts if the checks are made directly to a school or medical facility.
If you are going to make a gift, it is important to determine which asset is the best one to gift. It is usually best to gift high-basis assets or cash, especially if the taxpayer is in poor health. In most cases, it is best not to give low-basis assets because the basis of gifted assets is the same for the recipient as it is for the donor, and the gifted assets will not usually receive a step-up-in-basis when a taxpayer passes.
Before making sizable gifts to children or other family members, keep in mind that in some cases, these gifts may unfortunately backfire. For example, a gift might make a student ineligible for college financial aid, or the earnings from the gift might trigger tax on a senior’s Social Security benefits.
Congress has created several tax breaks over the last few years to help pay for education. One of the most popular types of savings plans is the 529 plan. Withdrawals (including earnings) used for qualified education expenses (tuition, books and computers) are income-tax-free.
The amount you can contribute to a Section 529 plan on behalf of a beneficiary qualifies for the annual gift-tax exclusion. However, the tax law allows you to give the equivalent of five years’ worth of contributions upfront with no gift-tax consequences. The gift is treated as if it were spread out over the 5-year period. For instance, you and your spouse might together contribute the maximum of $150,000 (5 x $30,000) on behalf of a grandchild this year without paying any gift tax.
Miscellaneous Year-End and Other Tax Reduction Strategies. Most taxpayers cannot control the timing of received income, but many of us can determine when to pay or not pay deductible expenses. Prepare tax projections for 2019 and possibly 2020 to determine which tax bracket you are in and where you can get the most bang for your buck. Let’s say for example, your deductions and exemptions are greater than your income, and you will have a negative taxable income, with a tax liability of zero. This is often the case with seniors who receive tax-free Social Security income. In this case, it would be a good strategy to increase your income from negative taxable income to zero taxable income, because the tax on zero taxable income is still zero! One of the best ways to do this is to do a partial Roth IRA conversion up to the amount that brings your negative taxable income up to zero. Depending on your tax bracket, you may wish to convert even more, especially if you expect to be in a higher income tax bracket in the future. If a Roth conversion is not appropriate or desirable, then taking additional retirement account distributions in one year while lowering the amount in the following year may save tax dollars. This strategy is comparable to bunching itemized deductions while using income instead of expenses.
Paying taxes is bad enough. Paying a penalty is even worse. If you face an estimated tax shortfall for 2019, and you haven’t received your 2019 Required Minimum Distribution payment, consider having the extra tax withheld on the IRA distribution. Withheld taxes are treated as if you paid them evenly to the IRS throughout the year. This can make up for any previous underpayments, which could save you penalties.
If you turned age 70 ½ during 2019, you still have until April 1, 2020, to withdrawal your first RMD. This is a one-time opportunity in case you forgot. Remember—if you do not take out your RMD by this date, you will be faced with a 50% penalty on the failed distribution amount. Before holding off until April 1, 2020, to take your first RMD, review the tax implications especially if you’re likely to be subject to the Medicare surtax on net investment income. (NOTE: If your first RMD is due by April 1, 2020, you will be responsible for taking out two RMDs in 2020. This will often put you in a higher tax bracket in 2020. Therefore, a two-year tax projection is usually recommended before deciding whether it’s more tax advantageous to take your first RMD by the end of the current tax year or choosing to defer the first payment into the following tax year and paying taxes on two RMD payments in year two).
Harvesting Ordinary Income. Harvesting ordinary income is another part of an overall successful year-end plan. Many older taxpayers incur extra-ordinary high medical expenses. Without proper planning, thousands of dollars of medical expenses can be incurred with no tax benefit. Harvesting ordinary income should at least equal itemized deductions plus exemptions; and the targeted tax liability at least equals tax credits available. Furthermore, harvesting ordinary income may be considered in order to “fill up” your marginal tax bracket.
Making Trust Distributions. Net investment income tax also applies to trusts and estates. With compressed tax brackets for trusts compared to individual tax brackets, making permitted discretionary distributions to beneficiaries can reduce overall taxes. By making the proper election, trusts can distribute current year income up to 65 days into the following year and still have the income taxed to the beneficiary in the current tax year.
Pennsylvania 529 Plan Contribution Deduction. Don’t miss out on the state tax deduction for contributions to a Section 529 College Saving Program. A taxpayer can reduce their PA taxable income up to $15,000 per plan beneficiary (kids, grandkids, nieces, nephews, etc.). Married couples can deduct up to $30,000 per beneficiary per year, provided each spouse has taxable income of at least $15,000. If your child is currently in college and you are writing checks to the college for tuition or qualified expenses, you should open the 529 plan immediately. You can deposit the college expense money into the account and immediately write the check to the college. You have just generated an immediate 3.07% rate of return on the deposit. Now that’s a winner.
529 Plan changes. The 2017 TCJA provides that distributions up to $10,000 used for tuition at an elementary or secondary public, private or religious school, K-12 are permitted. Prior law limited 529 money to be used to pay college and/or graduate school costs. Make sure the specific State plan has been amended to allow distributions to elementary and high school tuition.
Kiddie Tax Planning. Considering hiring your child as an employee. It is prudent to review the child labor laws in your state and the Fair Labor Standards Act. Maintain good records that substantiate wage payments. A child can use their standard deduction to shelter up to $12,200 of wages from federal income tax. There is also Social Security tax savings in certain situations. The child becomes eligible to contribute up to $6,000 to a Roth IRA. The wage income may enable the child to escape the kiddie tax rules that would otherwise be imposed on unearned income.
In prior years, shifting income to children was a popular strategy to reduce overall family tax costs. The new kiddie tax rules will often create can more tax than what the parent would have paid on their own tax return.
Utilize Your Home Office. It may be the right year to switch back to deducting the actual cost of home office expenses as opposed to using the simplified method. If you are one of the many who will be using the standard deduction in 2019, enjoying some tax benefits of deducting a portion of your real estate and mortgage interest as a home office deduction can help ease the pain.
Dependent Care Expenses. If you are paying out-of-pocket dependent care expenses (not enrolled in an employer plan) for two or more qualifying dependents, the annual expense is $6,000. The expenses do not need prorated between the qualifying individuals. If you incurred $5,800 for one child and $200 for the second child, the full $6,000 of expenses are eligible for the $1,200 tax credit. Keep in mind that if one spouse is a student or disabled, earned income is deemed to be $250 per month with one child and $500 per month with two or more qualifying individuals. In certain instances, taking on-line courses can be considered students.
Employee Business Expenses. With the elimination of deductions formerly reported on Form 2106 Employee Business Expense, encourage your employer for reimbursement of the substantiated expenses that are no longer tax-deductible.
Charitable Giving. Under the current tax system, a focus on controlling adjusted gross income can provide tax savings. The Path Act of 2015 made permanent the popular Qualified Charitable Distribution (QCD) rules for making charitable contributions from an IRA. Taxpayers age 70 ½ and older can transfer up to $100,000 directly from their IRA over to a charity, satisfying all or part of the RMD with the IRA-to-charity maneuver. Please read the June 2016 Lange Report at https://paytaxeslater.com/lange-report/lange-report-june-2016/ for a great summary of how seniors can get more out of their charitable giving.
This is a great time of the year to clean out your basement and garage. However, please remember that you can only write off these non-cash charitable donations to a charitable organization if you itemize your deductions. Please do yourself a favor and follow the substantiation rules to tilt the scale in your direction if the deduction is questioned by the IRS. Determining the value of non-cash donations can sometimes be challenging. You can find estimated values for your donated clothing at http://turbotax.intuit.com/personal-taxes/itsdeductible/. It can never hurt to have pictures of the donated items (cell phone cameras make this much easier). The more detailed the receipt, the better. Please send cash donations to your favorite charity no later than December 31, 2019, and be sure to hold on to your canceled check or credit card receipt as proof of your donation. If you contribute $250 or more, you also need an acknowledgment from the charity. Many taxpayers kindly help various charities making non-cash donations.
Tax tip for coaches who still itemize their charity deductions: Many taxpayers have children who participate in youth, intermediate or even high school level sports. If dad or mom volunteer their time as coaches, assistant coaches, timekeepers, etc., they can be eligible for an income tax deduction for various out-of-pocket expenses incurred. For example, miles driven on their cars while performing their role as a coach are deductible charity miles. Many teams travel out of town to compete. You are entitled to deduct certain travel expenses as a charitable deduction. See the IRS website Newsroom for “Tips for Taxpayers Who Travel for Charity Work” for a list of qualifying deductions.
My favorite substantial charitable gift is leaving a portion of your IRA or retirement plan to a charity of your choice after you and your spouse die.
If you want to give money to a charity and get the deduction this year, but don’t know which charity you want to benefit, you should consider donor-directed funds that could be set up by a group like The Pittsburgh Foundation.
As mentioned earlier, if you plan to make a significant gift to charity this year, consider gifting appreciated stocks or other investments that you have owned for more than one year. Review your tax brackets to help determine how you can maximize the deduction. Doing so boosts the savings on your tax returns. Your charitable contribution deduction is the fair market value of the securities on the date of the gift, not the amount you paid for the asset, and therefore, you never have to pay taxes on the profit!
Do not donate stocks that have lost value. If you do, you can’t claim a loss. In this case, it is best to sell the stock with the loss first and then donate the proceeds, allowing you to take both the charitable contribution deduction and the capital loss.
Inherited IRAs. Be careful if you inherit a retirement account. In many cases, a decedent’s largest asset is his or her retirement account. When a beneficiary receives this distribution, it is often a very large sum of money, and there is no step-up-in-basis on retirement accounts. If you inherit a retirement account, such as an IRA or other qualified plans, the money is usually taxable upon receipt. In addition to this immediate taxation, the extra money could push you up into a higher tax bracket, causing you to pay more taxes than you might have if this taxable income was spread over several years.
The solution to this problem is to establish an Inherited IRA, allowing you to spread out the distributions over your lifetime which should reduce and defer your income taxes significantly. Sounds easy, right? Unfortunately, the tax laws regarding the inheritance of retirement accounts are very complicated. Be sure to take the necessary steps in order to avoid any unnecessary income taxes.
Helpful Tip. Inherited IRAs for non-spouse beneficiaries can never be converted to a Roth IRA. Inherited employer plan assets (401k), 403(b), etc. can be directly transferred to a properly titled, inherited Roth IRA. Income tax will be due on the conversion and paid by the beneficiary. Required distributions will also occur. If the child beneficiary is in a lower tax bracket at the time of inheritance, what a wonderful way to get a Roth IRA started at a lower tax cost while enjoying future tax-free growth. Step to take: you may want to help direct mom and/or dad after they retire to keep some of their retirement plan dollars in a qualified plan rather than rolling everything into a traditional IRA.
Identity Theft Affidavit: Consider filing IRS Form 14039 (available on the IRS website) before the 2019 tax filing season arrives. Identity theft has been steadily on the rise. The IRS will provide you a 6-digit PIN number to use when filing your income tax return. The PIN will help the IRS verify a taxpayer’s identity and accept their electronic or paper tax return. The PIN will prevent someone else from filing a tax return with your SSN as the primary or secondary taxpayer (spouse).
IRS Scams. Threatening emails and phone calls purporting to be from the IRS have been proliferating—don’t get caught in a scam. Please read the article in the October 2016 Lange Report for helpful facts at https://paytaxeslater.com/lange-report/lange-report-october-2016/.
Final Thoughts. When it comes to tax planning and paying income taxes, it’s usually not what you know, but rather what you don’t know that can leave you with unhappy tax results. We are here to help close that knowledge gap. We look forward to seeing you soon.
About Glenn Venturino, CPA: Glenn has been an integral part of the Lange Accounting Group, LLC for over 32 years. As our longest standing Lange team member, Glenn manages the tax department and oversees many of the day-to-day operational functions such as payroll, employee benefits, financial reporting, and billing. As a CPA, Glenn has built a substantial accounting practice having working relationships with hundreds of individual clients and various small businesses.
About James Lange, CPA/Attorney: Jim is President of Lange Financial Group, LLC and has 30+ years of experience working with retirees and those about to retire. Jim can be reached at (412) 521-2732.
The views expressed are not necessarily the opinion of Lange Financial Group, LLC and should not be construed, directly or indirectly, as an offer to buy or sell any securities mentioned herein. This article is for informational purposes only. This information is not intended to be a substitute for specific individualized tax, legal or investment planning advice as individual situations will vary. For specific advice about your situation, please consult with a financial professional.
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