With year-end approaching, now’s the time to take steps to cut your 2019 tax bill. Here are some year-end tax planning strategies to consider, assuming next year’s general election doesn’t result in retroactive tax changes that could affect your 2020 tax year.
Year-end Tax Planning Moves for Individuals
Standard Deduction Allowances
For 2019, the standard deduction amounts are $12,200 for singles and those who use married filing separate status, $24,400 for married joint filing couples, and $18,350 for heads of household. If your total annual itemized deductions for 2019 will be close to your standard deduction amount, consider making additional expenditures before year-end to exceed your standard deduction. That will lower this year’s tax bill.
The easiest deductible expense to accelerate is included in your house payment due on January 1. Accelerating that payment into this year will give you 13 months’ worth of interest in 2019. State and Local Tax deductions should be easy to achieve for an itemized deduction since there is a deductible cap of $10,000.
Accelerating other expenditures could cause your itemized deductions to exceed your standard deduction in 2019. For example, consider making bigger charitable donations this year and smaller contributions next year to compensate. Also, consider accelerating elective medical procedures, dental work, and vision care. For 2019, medical expenses are deductible to the extent they exceed 10% of Adjusted Gross Income (AGI), assuming you itemize.
Carefully Manage Investment Gains and Losses in Taxable Accounts
If you hold investments in taxable brokerage firm accounts, consider the tax advantage of selling appreciated securities that have been held for over 12 months. The maximum federal income tax rate on long-term capital gains recognized in 2019 is only 15% for most people, although it can reach a maximum of 20% at higher income levels. The 3.8% Net Investment Income Tax (NIIT) also can apply at higher income levels.
To the extent you have capital losses that were recognized earlier this year or capital loss carryovers from pre-2019 years, selling securities with capital gains this year will not result in any tax liability to the extent of losses. In particular, sheltering net short-term capital gains with long term capital losses is good planning since short-term capital gains would otherwise be taxed at higher ordinary income tax rates.
Having a capital loss carryover into next year and beyond could turn out to be beneficial. The carryover can be used to shelter both short-term and long-term gains recognized next year and beyond. This can give you extra investing flexibility in those years because you won’t have to hold appreciated securities for over a year to get a preferential tax rate. Additionally, all business asset capital gains can be offset with these carryover capital losses.
Take Advantage of 0% Tax Rate on Investment Income
For 2019, singles can take advantage of the 0% income tax rate on long-term capital gains and qualified dividends from securities held in taxable brokerage firm accounts if their taxable income is $39,375 or less. For heads of household and joint filers, that limit is increased to $52,750 and $78,750, respectively.
While your income may be too high to benefit from the 0% rate, you may have children, grandchildren, or other loved ones who will be in the 0% bracket. If so, consider giving them appreciated stock or mutual fund shares that they can sell and pay 0% tax on the resulting long-term gains. Gains will be long-term, as long as your ownership period plus the gift recipient’s ownership period (before the sale) equals at least a year and a day. Please note that gifts of appreciated securities have a carryover investment basis.
Giving away stocks that pay dividends is another tax-smart idea. As long as the dividends fall within the gift recipient’s 0% rate bracket, they will be federal-income-tax-free.
Warning: If you give securities to someone who is under age 24, the Kiddie Tax rules could potentially cause some of the resulting capital gains and dividends to be taxed at the higher rates that apply to trusts and estates. That would defeat the purpose. Please contact us if you have questions about the Kiddie Tax.
Give away Appreciated Securities and Sell Losing Securities with a Give Away of the Resulting Cash
If you want to make gifts to some favorite relatives and/or charities, they can be made in conjunction with an overall revamping of your taxable account stock and equity mutual fund portfolios. Gifts should be made according to the following tax-smart principles.
Gifts to Relatives. Don’t give away depreciated securities (currently worth less than what you paid for them). Instead, you should sell the securities and book the resulting tax-saving capital loss. Then, you can give the sales proceeds to your relative.
On the other hand, you should give away appreciated securities to relatives. Most likely, they will pay lower tax rates than you would pay if you sold the same shares. As explained earlier, relatives in the 0% federal income tax bracket for long-term capital gains and qualified dividends will pay a 0% federal tax rate on gains from shares that were held for over a year before being sold. (For purposes of meeting the more-than-one-year rule for gifted shares, you can count your ownership period plus the gift recipient’s ownership period.) Even if the appreciated shares have been held for a year or less before being sold, your relative will probably pay a much lower tax rate on the gain than you would.
Gifts to Charities. The principles for tax-smart gifts to relatives also apply to donations to IRS-approved charities. You should sell depreciated securities and collect the resulting tax-saving capital losses. Then, you can give the sales proceeds to favored charities and claim the resulting tax-saving charitable deductions (assuming you itemize). Following this strategy delivers a double tax benefit: tax-saving capital losses plus tax-saving charitable donation deductions.
On the other hand, you should donate appreciated securities instead of giving away cash. Donations of publicly traded shares that you have owned over a year result in charitable deductions equal to the full current market value of the shares at the time of the gift (assuming you itemize). Plus, when you donate appreciated shares, you escape any capital gains taxes on those shares. This makes this idea another double tax-saver: you avoid capital gains taxes while getting a tax-saving donation deduction (assuming you itemize). Meanwhile, the tax-exempt charitable organization can sell the donated shares without owing anything to the IRS.
Make Charitable Donations from Your IRA
IRA owners and beneficiaries who have reached age 701/2 are permitted to make cash donations totaling up to $100,000 per individual IRA owner per year—$200,000 per year maximum on a joint return if both spouses make donations of $100,000, to IRS approved public charities directly out of their IRAs. These so-called Qualified Charitable Distributions, or QCDs, are federal-income-tax-free to you, but you get no itemized charitable write-off on your Form 1040. The tax-free treatment of QCDs equates to an immediate 100% federal income tax deduction and reduces your adjusted gross income. A lower adjusted gross income could have other tax advantages, too. To qualify for this special tax break, the funds must be transferred directly from your IRA to the charity.
Convert Traditional IRAs into Roth Accounts
The best profile for the Roth conversion strategy is when you expect to be in the same or higher tax bracket during your retirement years. The current tax liability from a conversion done this year may turn out to be a relatively small price to pay for completely avoiding potentially higher future tax rates on the account’s earnings. In effect, a Roth IRA can insure part or all of your retirement savings against future tax rate increases. A Roth conversion is also an excellent tax strategy to offset a net operating loss from your business and effectively pay little or no income tax on the conversion.
A few years ago, the Roth conversion privilege was a restricted deal. It was only available if your modified AGI was $100,000 or less. That restriction is gone.
Year-end Tax Planning Moves for Small Businesses
Establish a Tax-favored Retirement Plan
If your business doesn’t already have a retirement plan, now might be the time to take the plunge. Current retirement plan rules allow for significant deductible contributions. For example, if you’re self-employed and set up a SEP-IRA, you can contribute up to 20% of your self-employment earnings, with a maximum contribution of $56,000 for 2019. If you’re employed by your own corporation, up to 25% of your salary can be contributed with a maximum contribution of $56,000.
Other small business retirement plan options include the 401(k) plan (which can be set up for just one person), the defined benefit pension plan, and the SIMPLE-IRA. Depending on your circumstances, these other types of plans may allow bigger deductible contributions.
The deadline for setting up a SEP-IRA for a sole proprietorship and making the initial deductible contribution for the 2019 tax year is 10/15/20 if you extend your 2019 return to that date. Other types of plans generally must be established by 12/31/19 if you want to make a deductible contribution for the 2019 tax year, but the deadline for the contribution itself is the extended due date of your 2019 return. However, to make a SIMPLE-IRA contribution for 2019, you must have set up the plan by October 1. So, you might have to wait until next year if the SIMPLE-IRA option is appealing.
Contact us for more information on small business retirement plan alternatives, and be aware that if your business has employees, you may have to cover them too.
Take Advantage of Generous Depreciation Tax Breaks
100% first-year bonus depreciation is available for qualified new and used property that is acquired and placed in service in calendar-year 2019. That means your business might be able to write off the entire cost of some or all of your 2019 asset additions on this year’s return. So, consider making additional acquisitions between now and year-end. Contact us for details on the 100% bonus depreciation break and what types of assets qualify.
Claim 100% Bonus Depreciation for Heavy SUVs, Pickups, or Vans. The 100% bonus depreciation provision can have a hugely beneficial impact on first-year depreciation deductions for new and used heavy vehicles used over 50% for business. That’s because heavy SUVs, pickups, and vans are treated for tax purposes as transportation equipment that qualifies for 100% bonus depreciation. However, 100% bonus depreciation is only available when the SUV, pickup, or van has a manufacturer’s Gross Vehicle Weight Rating (GVWR) above 6,000 pounds. The GVWR of a vehicle can be verified by looking at the manufacturer’s label, which is usually found on the inside edge of the driver’s side door where the door hinges meet the frame. If you are considering buying an eligible vehicle, doing so and placing it in service before the end of this tax year could deliver a large tax deduction for the 2019 tax year.
Claim First-year Depreciation Deductions for Cars, Light Trucks, and Light Vans. For both new and used passenger vehicles (meaning cars and light trucks and vans) that are acquired and placed in service in 2019, the luxury auto depreciation limits are as follows:
- $18,100 for Year 1 if bonus depreciation is claimed.
- $16,100 for Year 2.
- $9,700 for Year 3.
- $5,760 for Year 4 and thereafter until the vehicle is fully depreciated.
Note that the $18,100 first-year luxury auto depreciation limit only applies to vehicles that cost $58,500 or more. Vehicles that cost less are depreciated over six tax years using percentages based on their cost.
Generous Section 179 Deduction Rules
For qualifying property placed in service in tax years beginning in 2019, the maximum Section 179 deduction is $1.02 million. The Section 179 deduction phase-out threshold amount is $2.55 million of assets acquired during the year.
Property Used for Lodging. The Section 179 deduction may be claimed for personal property used predominately to furnish lodging or in connection with the furnishing of lodging. Examples of such property include furniture, kitchen appliances, lawn mowers, and other equipment used in the living quarters of a lodging facility or in connection with a lodging facility such as a hotel, motel, apartment house, dormitory, or other facility where sleeping accommodations are provided and rented out.
Qualifying Real Property. Section 179 deductions can be claimed for qualifying real property expenditures. Qualifying real property means any improvement to an interior portion of a nonresidential building that is placed in service after the date the building is first placed in service, except for expenditures attributable to the enlargement of the building, any elevator or escalator, or the building’s internal structural framework. The definition also includes roofs, HVAC equipment, fire protection and alarm systems, and security systems for nonresidential real property. To qualify, these items must be placed in service after the nonresidential building has been placed in service.
Maximize the Deduction for Pass-through Business Income
For 2019, the deduction for Qualified Business Income (QBI) can be up to 20% of a pass-through entity owner’s QBI, subject to restrictions that can apply at higher income levels and another restriction based on the owner’s taxable income. The QBI deduction also can be claimed for up to 20% of income from qualified Real Estate Investment Trust (REIT) dividends and 20% of qualified income from publicly-traded partnerships.
For QBI deduction purposes, pass-through entities are defined as sole proprietorships, single-member LLCs that are treated as sole proprietorships for tax purposes, partnerships, LLCs that are treated as partnerships for tax purposes, and S corporations. The QBI deduction is only available to non-corporate taxpayers (individuals, trusts, and estates).
Because of the various limitations on the QBI deduction, tax planning strategies can have the side effect of increasing or decreasing your allowable QBI deduction. So, individuals who can benefit from the deduction must be really careful at year-end tax planning time. We can help you put together strategies that give you the best overall tax results for the year.
Cash Method Accounting
Beginning in 2018, more “small businesses” are able to use the cash (as opposed to accrual) method of accounting in later years than were not allowed to do so in earlier years. To qualify as a “small business” a taxpayer must, among other things, satisfy a gross receipts test. Effective for tax years beginning after Dec. 31, 2018, the gross-receipts test is satisfied if, during a three-year testing period, average annual gross receipts don’t exceed $26 million (the dollar amount used to be $5 million). Cash method taxpayers may find it a lot easier to shift income, for example by holding off billings until next year or by accelerating expenses by paying bills early or by making certain prepayments. Additionally, business who meet the $26 million dollar threshold have a great opportunity to avoid paying tax on large accounts receivable.
De Minimis Safe Harbor Election
Businesses may be able to take advantage of the de minimis safe harbor election (also known as the book-tax conformity election) to expense the costs of lower-cost assets, materials and supplies, assuming the costs don’t have to be capitalized under the Code Sec. 263A uniform capitalization (UNICAP) rules. To qualify for the election, the cost of a unit of property can’t exceed $5,000 if the taxpayer has an applicable financial statement (AFS; e.g., a certified audited financial statement along with an independent CPA’s report). If there’s no AFS, the cost of a unit of property can’t exceed $2,500. Where the UNICAP rules aren’t an issue, consider purchasing such qualifying items before the end of 2019.
Watch out for Business Interest Expense Limit
Thanks to an unfavorable TCJA change, a taxpayer’s deduction for business interest expense for the year is limited to the sum of (1) business interest income, (2) 30% of adjusted taxable income, and (3) floor plan financing interest paid by certain vehicle dealers. This limit is a permanent change that can potentially affect all types of businesses—corporate and non-corporate alike. The rules for businesses conducted as partnerships, LLCs treated as partnerships for tax purposes, and S corporations are especially complicated.
Fortunately, many businesses are exempt from the interest expense limit rules under the small business exception. Under this exception, a taxpayer is generally exempt from the limit if average annual gross receipts are $25 million or less for the three-tax-year period ending with the preceding tax year. The gross receipts threshold is adjusted annually for inflation. For 2019, the threshold is $26 million.
Certain real estate and farming businesses with average annual gross receipts above the threshold also are exempt if they choose to limit their depreciation deductions.
Claim 100% Gain Exclusion for Qualified Small Business Stock
There is a 100% federal income tax gain exclusion privilege for eligible sales of Qualified Small Business Corporation (QSBC) stock that was acquired after 9/27/10. QSBC shares must be held for more than five years to be eligible for the gain exclusion break. Contact us if you think you own stock that could qualify.
Economic Nexus
A recent U.S. Supreme Court Case (Wayfair) involving a South Dakota business’s sales tax obligation from internet sales, has brought more scrutiny to the economic nexus (as opposed to physical nexus) approach for apportioning income for multi-state businesses. Please consult us for all sales involving multi-state business activity where you have no physical presence.
Don’t Overlook Estate Planning
Thanks to the Tax Cuts and Jobs Act (TCJA), the unified federal estate and gift tax exemption for 2019 is a historically huge $11.4 million, or effectively $22.8 million for married couples. Even though these big exemptions may mean you’re not currently exposed to the federal estate tax, your estate plan may need updating to reflect the current tax rules. Lifetime gifting to take advantage of the new exemption amounts is essential. For small gifts, there is an annual exclusion of $15,000 per person which won’t impact the exemption at all. Please note that Illinois, however, is still a $4 million estate tax exemption.
In 2026, the estate and gift tax exemption is scheduled to revert to the much-lower pre-TCJA level. Depending on political developments, that could happen much sooner than 2026. However, late last year, the IRS issued proposed regulations that would protect estates that make large gifts while the ultra-generous TCJA exemption is in place. These rules haven’t been finalized, so place your bets and act accordingly. We can help you assess the various risks.
Conclusion
This letter only covers some of the year-end tax planning ideas that could potentially benefit you, your loved ones, and your business. Please contact us if you have questions, want more information, or would like us to help in designing a year-end planning package that delivers the best tax results for your particular circumstances.
