With fall in the air, it is time to turn your attention to year-end tax planning. During the first tax filing season under the 2019 Tax Cuts and Jobs Act (TCJA), several clear strategies and tactics emerged. However, subsequent years bring potential twists that must be considered. Let’s take a closer look at year-end tax planning strategies that can reduce your 2019 income tax liability.
Accelerating Expenses While Deferring Income
For taxpayers who don’t expect to be in a higher tax bracket the following year, deferring income into the next tax year and accelerating expenses into the current one is a time-tested technique. For example, independent contractors and other self-employed individuals can postpone sending invoices until late December to push the associated income into 2020. Additionally, regardless of employment status, all taxpayers can defer income by taking capital gains after January 1st. However, by waiting to sell, you risk the possibility that your investment might become less valuable.
There may be other reasons that taking the income this year can be more beneficial. For example, future tax rates may increase; depending upon 2020 election results, it’s possible they may rise significantly by 2021, especially for those with higher incomes. In 2026, the higher tax rates placed for 2017 are scheduled to return.
Also, taxpayers who qualify for the qualified business income (QBI) deduction for pass-through entities (sole proprietors, partnerships, limited liability companies and S corporations) could reduce the size of the deduction if they reduce their income. While still available, however, it might make more sense to maximize the QBI deduction, which is scheduled to end after 2025.
Time Your Itemized Deductions
The standard deduction was boosted substantially by the TCJA. For 2019, it was $24,000 for married couples and $12,200 for single filers. Some taxpayers find it challenging to claim more in itemized deductions as opposed to standard deductions, with many previously popular itemized deductions eliminated or limited. Timing, or “bunching,” those deductions may make it easier.
The term “bunching” means delaying or accelerating deductions into a tax year to exceed the standard deduction and claim itemized deductions. For example, you could bunch your charitable contributions if it means you can get a tax break for one tax year. You can bunch donations in alternative years if you normally make your donations at the end of the year — for example, donate in January and December of 2020, and January and December of 2022.
Multiple contributions may be made in a single year if you have a donor-advised fund (DAF), which can accelerate the deduction. Then, you can decide when the funds are distributed to the charity. If your objective, for instance, is to give annually in equal increments, doing so will allow your chosen charities to receive a reliable stream of yearly donations, something that is critical to their financial stability. You can deduct the total amount in a single tax year.
If you donate appreciated assets to a DAF or a nonprofit that you’ve held for more than one year, you’ll avoid long-term capital gain taxes that you’d have to pay if you sold the property and also obtain a deduction for the assets’ fair market value (subject to certain restrictions). If you’re subject to the 3.8% net investment income tax or the top long-term capital gains tax rate (20% for 2019), this tactic pays off even more.
However, what if you’re looking to divest yourself of assets on which you have a loss? From a tax perspective, rather than donate the asset, the better option is to sell it and take advantage of the loss and then donate the proceeds.
Timing also comes into play for medical expenses. The threshold for deducting unreimbursed medical expenses was lowered by the TCJA to 7.5% of the adjusted gross income (AGI) for 2017 and 2018, but it rises to 10% of the AGI for 2019. By bunching qualified medical expenses into one year, you could be eligible for the deduction.
Assuming local law permits you to pay in advance, property tax payments can also be bunched. However, this approach might bring your total state and local tax deduction over the $10,000 limit, which means that you would effectively forfeit the deduction on the excess.
You need to consider your tax bracket status when timing deductions, as with income deferral and expense acceleration. When you’re in a higher tax bracket, itemized deductions are worth more. If you expect to land in a higher bracket in 2020, you will save more by timing your deductions for that year.
Loss Harvesting vs Capital Gains
The year 2019 has been turbulent for some investments. Thus, your portfolio may be ripe for loss harvesting — that is, selling underperforming investments on a dollar-for-dollar basis before year-end to realize losses you can use to offset taxable gains you also realized this year. If your losses exceed your gains, you generally can apply up to $3,000 of the excess to offset ordinary income. However, any unused losses may be carried forward indefinitely throughout your lifetime, providing the opportunity for you to use the losses in a subsequent year.
Maximize Your Retirement
Individual taxpayers, as always, should consider making their maximum allowable contributions for the year to IRAs, 401(k) plans, deferred annuities and other tax-advantaged retirement accounts. You can contribute up to $19,000 to 401(k)s and $6,000 for IRAs for 2019. Those age 50 or older are eligible to make an additional catch-up contribution of $1,000 to an IRA and, as long as the plan allows, $6,000 for 401(k)s and other employer-sponsored plans.
How to Account for 2019 TCJA Changes
Most, not all, provisions of the TCJA took effect in 2018. For example, the repeal of the individual mandate penalty for those without qualified health insurance isn’t effective until this year. Additionally, the TCJA eliminates the alimony payments deduction for couples divorced in 2019 or later, and alimony recipients are no longer required to include the payments in their taxable income.
The future of tax planning is uncertain. Many of the most significant TCJA provisions are set to expire within six years. If you have questions or need help with your year-end tax planning, contact us today.