2018 Year End Tax Planning
October 30, 2018 - By: SC&H Group
SC&H Group is hosting a Year-End Tax Planning Webinar November 28th to take a deeper dive into the following information. Register today to learn more about how to prepare for year-end deadlines and the outlook for 2019 tax strategies.
With 2018 coming to a close, now is the best time to begin planning for moves to help lower your tax bill for this year, and possibly the years that follow. Year end tax planning for 2018 takes place against the backdrop of new laws that made major changes in the tax rules for individuals and businesses.
For individual filers, there are new lower-income tax rates, a substantially increased standard deduction, newly limited itemized deductions, and the elimination of personal exemptions. There was also an increased child tax credit and a watered down alternative minimum tax (AMT) now exists.
For business owners and businesses, the corporate tax rate was cut to 21%. Corporate AMT was also removed. Further changes include new limits on business interest deductions and significantly liberalized expensing and depreciation rules. There’s also a new 20% deduction for non-corporate taxpayers with qualified business income from pass-through entities.
Despite this atmosphere of change, the time-tested approach of deferring income and accelerating deductions to minimize taxes still applies for many taxpayers. The same applies with the greater benefit of “bunching” expenses into this year or the next to get around deduction restrictions. We have compiled a list of actions based on the current tax rules that may help you and your business save tax dollars if you act before the year-end. Not all actions apply to everyone, but many will prove beneficial to your situation.
Year End Tax Planning Moves for Individuals
Minimize or eliminate the 3.8% surtax on unearned income – higher income earners must be wary of this surtax that applies to certain unearned income. The 3.8% surtax is the lesser of either your net investment income (NII), or the excess of modified adjusted gross income (MAGI). For the MAGI, the income must be over a threshold of $250,000 for joint filers or surviving spouses, $125,000 for a married individual filing separately, or $200,000 in any other case. A taxpayer’s approach to minimizing or eliminating the surtax will depend on their estimated MAGI and NII for the year. Some taxpayers should consider ways to minimize additional NII for the balance of the year, while others should try to reduce MAGI. Others still will need to consider ways to minimize both.
Offset realized capital gains on losses – consider offsetting losses you take by year-end. However, you must be cautious of wash sale rules that eliminate this benefit. Wash sale rules disallow a deduction when an individual sells or trades a security at a loss and, within 30 days before or after this sale, buys a “substantially identical” stock or security.
Postpone income and accelerate deductions – postponing income into 2019 and accelerating deductions into 2018 is a smart move if doing so will enable you to claim larger deductions, credits, and other tax breaks for 2018 that are phased out over varying levels of adjusted gross income (AGI). These include deductible IRA contributions, child tax credits, higher education tax credits, and deductions for student loan interest. Postponing income is desirable for taxpayers who anticipate being in a lower tax bracket next year due to changed financial circumstances. In some cases, it may pay to accelerate income into 2018, as when a person will have a more favorable filing status this year than next or expects to be in a higher tax bracket next year.
Convert traditional IRA funds into Roth IRA – consider making these changes if you are eligible to do so. Keep in mind; such a conversion will increase your adjusted gross income (AGI) for 2018. Doing so many possibly reduce tax breaks geared to AGI or modified AGI.
Defer bonuses – it may well be advantageous to try and arrange with your employer to defer a bonus coming your way until the early parts of 2019. The reasoning behind this is that deferring a bonus could also defer and cut your tax owed. Seek to have employee business expenses paid pre-tax if your employer is willing to make changes in that realm.
Itemize what you still can – beginning in 2018, many taxpayers will no longer benefit from claiming itemized deductions. Basic standard deductions were increased ($24,000 joint filing, $12,000 for singles, $18,000 for household heads, $12,000 married filing separately) and many itemized deductions were cut back or abolished. No more than $10,000 of state and local taxes may be deducted and unreimbursed employee expenses are also no longer deductible. You can still itemize medical expenses to the extent they exceed 7.5% of your adjusted gross income, state and local taxes up to $10,000, charitable contributions, and interest deductions on a restricted amount of qualifying residence debt. Payments of those items won’t save taxes if they don’t cumulatively exceed the new, higher standard deduction. State laws are different and much lower standard deductions will apply to Maryland and other state taxpayers.
Bunching strategy – some taxpayers may be able to work around the new laws by applying a bunching strategy to pull or push discretionary medical expenses and charitable contributions into the year that they will have the best impact on your tax costs. If a taxpayer knows they will be able to itemize deductions this year but not next, the taxpayer may be able to make two years worth of charitable contributions this year. Donor advised funds are a perfect tool to accomplish this strategy over a number of years.
Pay deductible expenses before 2019 – consider using a credit card to pay off deductible expenses before the end of the year. Doing so will increase your 2018 deductions, even if you don’t pay your credit card bill until after the end of the year.
Increase withholding of state and local tax – if you expect to owe state and local income taxes when you file your return next year and you will be itemizing in 2018, consider asking your employer to increase withholding of state and local tax. Or pay estimated tax payments of state and local taxes before year-end to pull the deduction of those taxes into 2018. Remember, state and local tax deductions are limited to $10,000 per year, which means this strategy is not a good one if it causes your state and local tax payments to exceed $10,000.
Take required minimum distributions from your IRA or 401(k) – In order to take the required minimum distribution from an IRA, you must begin by April 1 following the year you reach the age 70-½. Failure to take a required withdrawal can result in a penalty of 50% of the amount of the RMD not withdrawn. If you turn 70-½ in 2018, you can delay the first required distribution to 2019, but if you do, you will have to take a double distribution in 2019. This is the amount required in 2018 plus the amount required in 2019. Bunching income into 2019 might push you into a higher tax bracket or have a detrimental impact on various income tax deductions that are reduced at higher income levels. It may be beneficial to take both distributions in 2019 if you will be in a substantially lower bracket.
Make charitable donations/distributions from your IRA – if you are aged 70-½ or older by the end of 2018 and have a traditional IRA you can make donations from your IRA. Such distributions are made directly to charities from your IRA and the amount of the contribution is neither included in your gross income nor deductible on Schedule A, Form 1040. The amount of the qualified charitable distribution reduces the amount of your required minimum distribution, resulting in tax savings.
Contribute as much as you can to traditional IRAs in 2018 – if you will be younger than 70-½ at the end of 2018 and you anticipate you will not itemize deductions, contribute as much as you can to one or more established traditional IRAs before the end of the year. When you reach the age of 70-½ follow the instructions in the previous step and make charitable donations from your IRA to reap both benefits. Doing all of this will allow you to convert nondeductible charitable contributions you make into deductible IRA contributions in 2018.
Take an eligible rollover distribution from a qualified retirement plan – do this before the end of 2018 if you are facing a penalty for underpayment of estimated tax, especially if your employer is unable to increase your withholdings. Income tax will be withheld from the distribution and will be applied toward the taxes owned for 2018. You can then roll over the gross amount of the distribution (i.e. the net amount you received plus the amount of withheld tax) to a traditional IRA. No part of the distribution will be included in income for 2018, but the withheld tax will be applied pro rata over the full 2018-tax year to reduce previous underpayments.
Increase next year’s FSA – consider increasing the amount you set aside in 2019 in your employer’s health flexible spending account (FSA). If you feel like you set aside too little this year, increasing FSA will provide a balance for next year.
Make HSA contributions – if you become eligible in December 2018 to make health savings account (HSA) contributions, you can make a full year’s worth of HSA contributions for 2018.
Make monetary gifts before the end of the year – if you are looking to make monetary gifts sheltered by the annual gift tax exclusion, make them before the end of 2018 and save gift and estate taxes. The exclusion applies to gifts of up to $15,000 made in 2018 to each of an unlimited number of individuals. You can’t carry over unused exclusions from one year to the next. Such transfers may save family income taxes where income-earning property is given to family members in lower income brackets who are not subject to the kiddie tax.
Year End Tax Planning Moves for Businesses & Business Owners
Use cash-based accounting as a small business – more small businesses are able to use the cash accounting method as opposed to an accrual method in 2018 than were previously allowed to in earlier years. To qualify as a small business, a taxpayer must satisfy a gross receipts test. Effective in 2018, the gross-receipts test is satisfied if, during a three-year testing period, average annual gross receipts don’t exceed $25 million (previously $5 million). Cash method taxpayers will find it easier to shift income by holding off billing until next year – or by accelerating expenses, paying bills early, or making specific prepayments.
Use liberalized business property expensing – for tax years beginning in 2018, the Section 179 expensing limit is $1 million, and the investment ceiling is $2.5 million. Expensing is generally available for most depreciable property, and off-the-shelf computer software. Expensing is available for qualified improvement property, for roofs, and for HVAC, fire protection, alarm, and security systems. The generous dollar ceilings that apply this year mean many small and medium sized businesses that make timely purchases will be able to deduct most of their outlays for machinery and equipment. The expensing deduction is not prorated for the time the asset is in service during the year. The expensing deduction may be claimed in full regardless of how long the property is held during the year, which can be a potent tool for year-end tax planning.
100% bonus first year depreciation deduction – machinery and equipment bought new or used (with some exceptions) can claim a 100% first year depreciation deduction. The write off is permitted without any proration based on the length of time an asset is in service during the tax year. As a result, the bonus first year write off is available even if qualifying assets are in service for only a few days.
De minimis safe harbor election – some businesses may be able to take advantage of what’s also know as the book-tax conformity election to expense the costs of lower-cost assets and materials and supplies, assuming the costs don’t have to be capitalized under uniform capitalization (UNICAP) rules. To qualify for the election, the cost of a unit property can’t exceed $5,000 if the taxpayer has an applicable financial statement.
Non-corporation businesses entitled to 20% deduction – as a business owner, assuming the business is not designated as a corporation, taxpayers may be entitled to a deduction of up to 20% of their qualified business income. If taxable income exceeds $315,000 for a married couple or $157,500 for all other taxpayers, the deduction may be limited based on whether the taxpayer is engaged in a service-type business (law, accounting, health care, financial services, consulting).
Defer income or accelerate deductions for 2018 – taxpayers may be able to achieve significant savings by deferring income or accelerating deductions so as to come under the dollar thresholds or be subject to a smaller phase-out of the deduction. Depending on the business model, taxpayers may ne able to increase the new deduction by increasing W-2 wages before year-end. The rules to do so are quite complex. Don’t make a move in this area without consulting your tax adviser.
Defer debt cancellation until 2019 – for businesses to reduce 2018 taxable income.
Dispose of a passive activity in 2018 – to reduce 2018 taxable income if doing so will allow you to deduct suspended passive activity losses.
While not all of the changes and recommendations will apply for individuals and businesses come 2019’s tax filing, these are just some of the most prevalent and recommended steps to take in order to avoid tax implications. It’s always a good idea to meet with tax advisors before the end of the year to develop a plan that is uniquely tailored to your financial situation in 2018 and 2019.