by Glenn Venturino, CPA and James Lange, CPA/Attorney
Table of Contents
- Very Big Picture
- Federal Individual Income Tax Rates for 2018
- Increased Standard Deduction Versus Itemizing Deductions
- Medicare Tax
- Capital Gains and Losses
- Zero Percent Tax on Long-Term Capital Gains
- Step-Up-In-Basis Rules
- Taxes on Social Security Income
- Estate and Gift Tax Opportunities
- Miscellaneous Year-End Tax Reduction Strategies
- Charitable Giving
- Inherited IRAs
- Instructions for Prepaying Your 2018 City of Pittsburgh and Allegheny County Real Estate Taxes
The Republican tax bill has passed and immediate action is required to cut your taxes. This newsletter will concentrate on what action steps individual taxpayers can take between now and year-end to reduce their taxes. We will start with big picture advice and then get into specifics. This is the most important year-end tax letter that we have ever sent because it has the most opportunities to cut you taxes then previous years.
Very Big Picture
If you are currently itemizing your deductions, we would generally encourage you to pay them this year for four reasons:
- You may lose them because of the many itemized deductions that will no longer be deductible.
- There will be a higher standard deduction so even if they are still allowable, they might not do you any good.
- Your tax rate might be lower.
- If you are currently deducting miscellaneous itemized deductions, it is critical to pay them before year end as these deductions are being eliminated. That would also apply to fees that you would pay to your CPA and/or financial advisor. That would also include professional expenses employees incur, such as various expenses that college professors pay out of pocket related to their work.
CAUTION: We are speaking in generalities, and it will be different for every taxpayer and we haven’t talked about the impact of Alternative Minimum Tax (AMT) which might offset some of the advantages that I’m talking about. Everybody really is a snowflake but I’m trying to give some guidance and some general principles that will help a lot, if not most, taxpayers.
Federal Individual Income Tax Rates for 2018
|Not over $9,525||10% of the taxable income|
|Over $9,525 but not over $38,700||$952.50 plus 12% of the excess over $9,525|
|Over $38,700 but not over $82,500||$4,453.50 plus 22% of the excess over $38,700|
|Over $82,500 but not over $157,500||$14,089.50 plus 24% of the excess over $82,500|
|Over $157,500 but not over $200,000||$32,089.50 plus 32% of the excess over $157,500|
|Over $200,000 but not over $500,000||$45,689.50 plus 35% of the excess over $200,000|
|Over $500,000||$150,689.50 plus 37% of the excess over $500,000|
|Married Individuals Filing Joint Returns and Surviving Spouses|
|Not over $19,050||10% of the taxable income|
|Over $19,050 but not over $77,400||$1,905 plus 12% of the excess over $19,050|
|Over $77,400 but not over $165,000||$8,907 plus 22% of the excess over $77,400|
|Over $165,000 but not over $315,000||$28,179 plus 24% of the excess over $165,000|
|Over $315,000 but not over $400,000||$64,179 plus 32% of the excess over $315,000|
|Over $400,000 but not over $600,000||$91,379 plus 35% of the excess over $400,000|
|Over $600,000||$161,379 plus 37% of the excess over $600,000|
Increased Standard Deduction versus Itemizing Deductions.
This change will potentially affect many taxpayers. As the standard deduction amount increases for taxpayers in 2018 to $12,000 for individuals and $24,000 for married couples filing jointly, many taxpayers that up to now have itemized their deductions will no longer be able to benefit from those deductions
Qualifying medical expenses are still deductible in 2018 subject to limitations. Under the Tax Cuts and Jobs Act of 2017, medical expense deductions are temporarily expanded by retroactively reducing the 10%-of-AGI (adjusted gross income) threshold to 7.5 of AGI for both 2017 and the upcoming 2018 tax year for all taxpayers. What to do. If you don’t believe you’ll be able to itemize your deductions in 2018, then you should definitely consider paying any last minute medical expenses before December 31, 2017 and realize the tax benefit. On the other hand, if you still expect to itemize your medical expenses in 2018 then the decision can become more difficult. Several factors to consider before making the choice. Will my adjusted gross income be higher in 2017 compared to what is anticipated for 2018. Also, will you be in a higher tax bracket in 2017 or 2018. If you have a handle on these factors the decision-making process become better.
State and Local Tax Deductions.
The change in these deductions will have a significant impact on many taxpayers. The overall deductible limit for 2018 is limited to $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. This deduction limitation of $10,000, in our opinion, will be the primary reason why more taxpayers will be using the 2018 standard deduction versus actual itemized deductions.
If you think that you fall in this category, and will not be itemizing deductions in 2018, consider paying your 4th quarter 2017 state and local estimated income tax payment prior to December 31, 2017. Keep in mind though, if you are likely to subject to Alternative Minimum Tax (AMT) in 2017 making these additional tax payments will result in no tax benefit.
ALERT. Based on the language in the tax bill, Congress preemptively foresaw the temptation of taxpayers to prepay all of their 2018 state and local tax income liability by December 31, 2017. Such payments will not be deductible on your 2017 tax return but rather on your 2018 tax return subject to limitations.
Some taxpayers take the state sales tax deduction in lieu of state and local income taxes on Schedule A because of their individual circumstances. If you don’t think you’ll be itemizing your deductions in 2018, this idea is for you. If you live in states that charge sales tax on vehicle purchases, and you’re currently considering purchasing a new vehicle, purchase it before December 31, 2017. You’ll get the deduction on your 2017 tax return and potentially save a few tax dollars.
Real Estate Taxes.
We are highly recommending that taxpayers consider prepaying their 2018 real estate taxes prior to December 31, 2017 if it makes sense based on their individual tax situation. Keep in mind though, if you are likely to be subject to Alternative Minimum Tax (AMT) in 2017, making these additional tax payments will result in no tax benefit. Due to the increased standard deduction in 2018 many taxpayers will not see the tax benefits that they normally get each year when paying and deducting their real estate taxes.
The theme here is similar. If you don’t think you’ll be itemizing your deductions in 2018 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 2017 tax deduction. Those of you still itemizing your deductions in 2018, a 2017 tax deduction may be more valuable to you due to lower tax rates across the board in 2018.
You could also make a contribution to a charitable annuity account and take the deduction this year and then make distributions from the account to the different charities next year or in future years. You have many options like the Pittsburgh Foundation, The Pittsburgh Jewish Foundation, Vanguard, Fidelity, etc.
One planning technique that becomes even more advantageous looking ahead is the use of Qualified Charitable Distributions. See the section titled “Charitable Giving” for details on using this strategy.
Miscellaneous Itemized Deductions.
For tax years beginning after December 31, 2017, and before January 1, 2026 no miscellaneous itemized deductions shall be allowed. If you normally pay the Alternative Minimum Tax (AMT) every year you may not have been enjoying the tax benefits of these deductions. For those taxpayers who aren’t subject to AMT every year here some last-minute moves to consider before the end of 2017: Keep in mind credit card purchases are the same as using cash.
*** Unreimbursed employee expenses. Pay 2018 membership fees and professional dues. Purchase professional books, journals, etc. Stock up on computer and office supplies. Purchase any computer or office equipment that you were planning on doing in the very near future. If you have a business trip planned in early 2018, make arrangements to pay any cost that can be done in advance such as airline tickets or lodging. The same holds true for a business seminar or annual conference that can be paid early. Job education expense expenses. If you use your car for business purposes and normally deduct actual costs rather than the standard mileage rate get your vehicle serviced before year end. With winter approaching for many of us, consider buying the new tires that you need before year end.
*** If you have you any unpaid tax preparation fees pay them before December 31.
*** Retirement and Estate planning fees.
*** Investment fees or expenses.
Defer Income and/or Accelerate Expenses.
With tax rates lower in 2018 it may make sense to defer income into 2018 and accelerate expenses into the end of 2017. 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. Deferring income into 2018 may take advantage of these preferential tax rates and deductions.
While on the surface, the decision to defer income into 2018 seems reasonable considering lower tax rates next year. Due to the loss of certain itemized deductions and capped limits on other deductions the tax savings may be less than anticipated
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 can often be the trigger that causes the Alternative Minimum Tax (AMT). Reducing your current year long-term capital gains before year-end can potentially reduce your exposure to AMT. 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.The new tax bill increases the AMT exemption for taxpayers. The increase is an effort to reduce the number of taxpayers who paid AMT in previous years. The increased exemption should be of particular help when it comes to long-term capital gain income in 2018 and beyond.
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. With the lowered tax rates for the next at least several years, Roth RIA conversion strategies become very attractive. In fact, I plan on writing a book on the new opportunities that IRA and retirement plan owners have with Roth IRA conversion under the new law. 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.
ALERT. Based on the language in the tax bill, Congress has removed the ability for taxpayers to do any “recharacterizations” of Roth IRA conversions after 12/31/2017. The ability to “re-characterize” a Roth IRA back to a Traditional IRA was historically useful if the value of the Roth IRA had decreased since the conversion had taken place so you did not have to pay taxes on a larger amount of money if the value had gone down. Hopefully anyone who did a conversion in 2017 will not have this problem since the stock market went up significantly in 2017. However there may be other reasons that a 2017 recharacterization would be appropriate, and they must be done by 12/31/17.
When a conversion plan is developed, we often recommend a conversion up to certain income limits to avoid additional Medicare premiums or to avoid high rates of income tax on amounts of Roth conversion income over certain amounts. So even if the investments from a 2017 Roth conversion are positive, you may nonetheless be in a situation where doing a partial recharacterization would be appropriate, such as when 2017 capital gains or other income are more than originally expected. Under prior law, a 2017 conversion could be recharacterized by October 15, 2018 but now it appears that any 2017 recharacterizations must be done by 12/31/17.
Under prior law, some people may even have planned on establishing multiple Roth IRA accounts with the intention of keeping the best performing one and recharacterizing the others. If you took this action in 2017, it is extremely important that the recharacterizations be done by 12/31/2017 otherwise you will have to pay tax on all the conversions.
Going forward, Roth conversions under the new tax laws in 2018 may present a better opportunity to do conversions at the lower rates provided. 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.
Qualified Real Property.
Improvements to non-residential real property has been amended to include items such as roofs, heating, ventilation, air-conditioning property, fire protection systems and security alarm systems. These improvements will be eligible for immediate expensing under the new tax law. It probably makes sense to delay these improvements until after the end of 2017 rather than before year-end.
Modifications to Depreciation Limits on Luxury Automobiles.
The annual depreciation limits have been expanded quite generously for these business assets. It may be in your best interest to hold off until the new year to purchase one of these vehicles used for business.
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 to help reduce their taxes. We hope you are continually implementing long-term tax reduction strategies. We hope you will use us as a resource. We urge you to begin your final year-end tax planning now!
As a comprehensive financial services firm, Lange Financial Group, LLC is committed to helping our clients improve their long-term financial success. This special report covers many year-end tax strategies for 2017. 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 send a copy of this important report to any of your friends or associates, please call Alice Davis at 412-521-2732.
As always, if you have any questions about your specific situation before our next scheduled meeting, please feel free to call your preparer.
Certified Public Accountant
Attorney at Law
Once again in 2017, 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, we might 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.
Let’s examine ways to reduce your adjusted gross income before the end of 2017.
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 2017, and start thinking about your strategy for 2018. 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 2017. Just recently the Internal Revenue Service announced cost‑of‑living adjustments affecting dollar limitations for pension plans and other retirement-related items for tax year 2018. Highlights include the following:
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 remains unchanged at $18,500. The 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 remains at $6,000. Looking ahead, if you’re currently set up to have the maximum salary deferral in 2017, you’ll need to increase it $500 for 2018.
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 and the focus on reducing adjusted gross income, 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.
Make a Tax-Deductible IRA Contribution.
For those taxpayers who qualify, you can make a tax-deductible contribution of $5,500 with a catch-up (for taxpayers 50 or older) of an additional $1,000. The contribution can be made until April 15, 2018 and still be a deduction on your 2017 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. 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 2017 contribution as soon as possible and repeat the process with your 2018 IRA contribution in early January 2018. If you are married, you can apply this strategy to your spouse even if they don’t work assuming your earned compensation is sufficient.
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 owner must have earned income for you to make a contribution.
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 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. 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 an HSA (health savings account) plan, it is not too late to maximize your 2017 tax deductible contribution to the account. In fact, you have until April 16, 2018 to fund your HSA account and still get a 2016 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 that allows a tax deduction on the way in and tax-free on the way out for 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.
Consider Like Kind Exchange.
No gains are recognized if property held for use in a trade or business or for investment is exchanged solely for property of a like kind to be held either for use in a trade or business or for investment. Any gain realized, but not recognized, adjusts the basis of like-kind property received in the exchange. Caution, make sure you are aware of the rules when doing a like kind exchange.
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. This is really cool because it allows you to calculate various levels of savings based on various contribution amounts. The 2017 maximum contribution allowable for these plans can be as high as $60,000 if catch-up contributions are permitted 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 Path Act of 2015 allows for more favorable treatment of certain building improvements in 2017. These type expenditures have historically been subject to much longer depreciation recovery periods.
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 are able to obtain the tax basis of their investments. In most instances, 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.
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 have to 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.
Zero Percent Tax on Long-Term Capital Gains
If you are in the 10% or 15% tax bracket, the tax rate for long-term capital gains is zero percent! In order to qualify for this tax break, your 2017 taxable income cannot exceed $37,950 for singles and $75,900 for married joint filers.
Please note that the 0% tax rate only applies until your taxable income exceeds the current 15% tax bracket. For example, let us assume that a married couple with wages of $70,000, long-term capital gains of $40,000 and deductions of $14,700 leaving them with $95,300 of taxable income. The first $20,600 of long-term capital gain is tax-free, but once their taxable income passes the $75,900 limit, the remaining long-term capital gain of $19,400 is taxed at 15%.
If you are eligible for the 0% capital gains tax rate, here is a cool maneuver. It might be appropriate to sell some appreciated stocks to take advantage of the zero percent capital gains rates. Sell just enough so your gain pushes your income to the top of the 15% tax bracket, then buy new shares in the same company. The newly purchased shares will have a higher cost basis than the shares you sold. If you should eventually sell these shares, it will be with a new higher tax basis. This allows you to take advantage of the 0% tax rate now. 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 days period only applies to securities sold at a loss.
If you’re ineligible for the 0% capital gains tax rate, but you have adult children 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 39.6% tax bracket. In this scenario, you are paying 23.8% on your long-term capital gains.
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 high to claim education tax credits, (the American Opportunity and Lifetime Learning), and the parent is also subject to Alternative Minimum Tax, shifting the 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 on the parent’s tax return. Although the parent is giving up the child as a dependent on their tax return, the child “can’t” claim a personal exemption for themselves on their own tax return. By waiving the dependency deduction, the parent also gives up the right to claim the college tax credit on their return. Keep in mind the parent wouldn’t be eligible to take the tax credit on their tax return so no loss there.
The kid is now able to claim the education credit on their own tax return up to $2,500 depending on which education credit they’re eligible for. This is even true if the parent pays for the college tuition and qualified expenses. Ideally you would shift enough long-term capital gain income from the parent to the child to be offset by the $2,500 education tax credit. Caution: You always should make sure that adding income to your kid’s tax return will not affect eligibility for any kind of student aid. Usually in this scenario, the family unit has too much income and too many assets to be eligible for any income based financial aid.
Even shifting income from a parent to a minor child can help save taxes. This can work well with high income taxpayer parents who are already subject to the 3.8% surtax on investment income. Even though the shifted income may be subject to the “kiddie tax” rules (effectively taxing the income at the parent’s income tax rate on the child’s tax return), it wouldn’t be included in the parent’s net investment income calculation. Hence, it wouldn’t be subject to the additional 3.8% surtax on investment income.
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.
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.
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.
On November 2, 2015, President Obama signed the Bipartisan Budget Act (BBA) of 2015 into law. This law eliminated two of the most effective methods available for maximizing Social Security benefits: Apply and Suspend and filing a Restricted Application for benefits. For an excellent and concise explanation of these new rules please see my The Little Black Book of Social Security Secrets at https://www.paytaxeslater.com/ss. We do “run the numbers” and provide personalized solutions for both Social Security maximization and Roth IRA conversions for our assets under management clients.
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 2017, each taxpayer can pass $5,490,000 (minus past taxable gifts that he/she has made) to children or other beneficiaries without having to pay gift or estate taxes. (This exemption increases to $5,600,000 in 2018 under current law, but this amount is set to increase significantly under the Tax Cut and Jobs Act). If you are married, you will be able to pass $11,200,000 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 $5,000,000 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—although that will be less likely with Republican control of the government. Nevertheless, before you gift something away, you need to consider the income tax effects of making a particular gift. 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 2018, 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 as long as the check is 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 these gifts may actually backfire in some cases. 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 a number of 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 up front 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 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 2017 and possibly 2018 to determine which tax bracket you are in and where you can get the most bang for your buck. The projections may also help minimize AMT and reduce the Medicare surtaxes. 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 similar to bunching itemized deductions but using income instead of expenses.
Paying taxes is bad enough. Paying a penalty is even worse. If you face an estimated tax shortfall for 2017, and you haven’t received your 2017 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 2017, you still have until April 1, 2018 to take out 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 amount that you should have taken out, but didn’t. Before holding off until April 1, 2018 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, 2018, you will be responsible for taking out two RMDs in 2018. This will often put you in a higher tax bracket in 2018. 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 being taxed 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 extraordinary 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. In light of 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 $14,000 per plan beneficiary (kids, grandkids, nieces, nephews, etc.). Married couples can deduct up to $28,000 per beneficiary per year, provided each spouse has taxable income of at least $14,000. 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.
Deferring Losses. Another idea would be to defer business losses into next year if the loss deduction is more valuable in 2018 than 2017. If you’re an S Corporation shareholder with current year business losses, you may want to choose to not increase the basis in your S Corporation stock for 2017. Without sufficient stock basis, the losses would not be deductible in 2017 thus suspended to tax year 2018. Electing whether to fully expense eligible business assets purchased in 2017 under code Section 179 or depreciating the asset(s) over several years should be evaluated for the greatest tax benefit. Once again, with business tax rates being reduced rather dramatically in 2018 you will need to evaluate your tax situation carefully.
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 phones cameras make this much easier). The more detailed the receipt, the better. Please send cash donations to your favorite charity by December 31, 2017, and be sure to hold on to your cancelled check or credit card receipt as proof of your donation. If you contribute $250 or more, you also need an acknowledgement from the charity. Many taxpayers kindly help out various charities making non-cash donations.
Tax tip for coaches: 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 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. 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.
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 plan, 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 out over a period of time.
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 and all of the rules need to be followed in order to avoid any unnecessary income taxes.
Instructions for prepaying your 2018 City of Pittsburgh and Allegheny County Real Estate Taxes.
For the Allegheny County Taxes the mailing address is:
John K Weinstein, County Treasurer
Room 108 Courthouse Building
436 Grant Street
Pittsburgh, PA 15219
Attention Mary Lee
You will include a note indicating that you are prepaying your 2018 Real Estate Taxes. The amount you will pay will be the same as you paid in 2017. If you know your lot and block number or your account number include it on the memo line of the check. If you don’t know that information they will be able to obtain your name and address on the check that you’re sending and apply the payment properly.
For the City & School Real Estate Taxes the mailing address is:
Real Estate Tax Division
414 Grant Street
Pittsburgh, PA 15219
Attention Collen Salmon
Follow the same instruction as above.
Identity Theft Affidavit: Consider filing IRS Form 14039 (available on the IRS website) before the 2016 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 30 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 Jim Lange, CPA/Attorney: James Lange 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.
Some Content Provided by MDP, Inc. Copyright MDP, Inc.
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