The Tax Cuts and Jobs Act (TCJA) brought many new rules for individual tax filers, and there are quite a few ways taxpayers can use these changes to their advantage. With the end of the year quickly approaching, it’s the ideal time to start looking at how these changes will affect your taxes and start making moves to help lower your 2019 tax burden.
What’s Changed for Individuals?
The TCJA brought many changes for individuals, including:
- Lower income tax rates
- Increased child tax credit
- Watered-down alternative minimum tax (AMT)
As we have seen in previous years, deferring income and accelerating deductions to minimize taxes will work for most taxpayers, and many folks will still benefit from bunching expenses into this year or the next to get around deduction restrictions.
In addition to these methods, here is a list of actions to consider before the end of the year to save on your tax bill.
Reduce Surtax on Unearned Income
Higher-income earners must be wary of the 3.8% surtax on certain unearned income. The surtax is 3.8% of the lesser of: (1) net investment income (NII), or (2) the excess of modified adjusted gross income (MAGI) over a threshold amount ($250,000 for joint filers or surviving spouses, $125,000 for a married individual filing a separate return, and $200,000 in any other case). As year-end nears, a taxpayer’s approach to minimizing or eliminating the 3.8% surtax will depend on their estimated MAGI and NII for the year. Some taxpayers should consider ways to minimize (such as through deferral) additional NII for the balance of the year, others should try to see if they can reduce MAGI other than NII, and other individuals will need to consider ways to minimize both NII and other types of MAGI.
Be Wary of Medicare Tax
The 0.9% additional Medicare tax may also require higher-income earners to take year-end actions. The tax applies to individuals with wages received from employment or self-employment in excess of a threshold amount ($250,000 for joint filers, $125,000 for married couples filing separately, and $200,000 in any other case). Employers must withhold the additional Medicare tax from wages in excess of $200,000 regardless of filing status or other income. Self-employed persons must take it into account in figuring estimated tax. There could be situations where an employee may need to have more withheld toward the end of the year to cover the tax. For example, if an individual earns $200,000 from one employer during the first half of the year and a like amount from another employer during the balance of the year, he or she would owe the additional Medicare tax; however, there would be no withholding by either employer for the additional Medicare tax since wages from each employer do not exceed $200,000.
Consider Capital Gains
Long-term capital gain from sales of assets held for over one year is taxed at 0%, 15% or 20%, depending on the taxpayer’s taxable income. The 0% rate generally applies to the excess of long-term capital gain over any short-term capital loss to the extent that it, when added to regular taxable income, is not more than the maximum zero rate amount ($78,750 for a married couple). For example, if the 0% rate applies to long-term capital gains you took earlier this year, you are a joint filer who made a profit of $5,000 on the sale of stock bought in 2009 and other taxable income for 2019 is $70,000, then before year-end, try not to sell assets yielding a capital loss because the first $5,000 of such losses won’t yield a benefit this year. And if you hold long-term appreciated-in-value assets, consider selling enough of them to generate long-term capital gains sheltered by the 0% rate.
Postponing Income and Accelerating Deductions
Individuals should consider postponing income until 2020 and accelerating deductions into 2019 if doing so will enable them to claim larger deductions, credits, and other tax breaks for 2019 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 also desirable for taxpayers who anticipate being in a lower tax bracket next year due to changed financial circumstances. Note, however, that in some cases, it may pay to actually accelerate income into 2019. For example, in cases where a person will have a more favorable filing status this year than next (like head of household vs. individual filing status) or expects to be in a higher tax bracket next year.
Convert to a Roth IRA
If you believe a Roth IRA is better than a traditional IRA, consider converting traditional-IRA money invested in beaten-down stocks (or mutual funds) into a Roth IRA in 2019, if eligible to do so. Keep in mind, however, that such a conversion will increase your AGI for 2019, and possibly reduce tax breaks geared to AGI (or modified AGI).
It may be advantageous to try to arrange with your employer to defer, until early 2020, a bonus that may be coming your way. This could cut as well as defer your tax.
Changes in Itemized Deductions
Many taxpayers won’t be able to itemize because of the high basic standard deduction amounts that apply for 2019 ($24,400 for joint filers, $12,200 for singles and for marrieds filing separately, $18,350 for heads of household), and because many itemized deductions have been reduced or abolished. No more than $10,000 of state and local taxes may be deducted; miscellaneous itemized deductions (tax preparation fees and unreimbursed employee expenses) are not deductible; and personal casualty and theft losses are deductible only if they’re attributable to a federally declared disaster and only to the extent the $100-per-casualty and 10%-of-AGI limits are met. You can still itemize medical expenses but only to the extent they exceed 10% of your adjusted gross income, state and local taxes up to $10,000, your charitable contributions, plus interest deductions on a restricted amount of qualifying residence debt. However, payments of those items won’t save taxes if they don’t cumulatively exceed the standard deduction amount that applies to your filing status.
Some taxpayers may be able to work around these deduction restrictions by applying a bunching strategy to pull or push discretionary medical expenses and charitable contributions into the year where they will do some tax good. For example, if a taxpayer knows he or she will be able to itemize deductions this year but not next year, the taxpayer will benefit by making two years’ worth of charitable contributions this year, instead of spreading out donations over 2019 and 2020.
Use a Credit Card
Consider using a credit card to pay deductible expenses before the end of the year. Doing so will increase your 2019 deductions even if you don’t pay your credit card bill until after the end of the year.
Consider State and Local Tax Withholdings
If you expect to owe state and local income taxes when you file your return next year and you will be itemizing in 2019, consider asking your employer to increase withholding of state and local taxes (or pay estimated tax payments of state and local taxes) before year-end to pull the deduction of those taxes into 2019. But remember that state and local tax deductions are limited to $10,000 per year, so this strategy is not a good one to the extent it causes your 2019 state and local tax payments to exceed $10,000.
Take Required Minimum Distributions from Your Retirement Plan
Take required minimum distributions (RMDs) from your IRA or 401(k) plan (or other employer-sponsored retirement plan). RMDs from IRAs must begin by April 1 of the year following the year you reach age 70½. That start date also applies to company plans, but non-5% company owners who continue working may defer RMDs until April 1 following the year they retire. Failure to take a required withdrawal can result in a penalty of 50% of the amount of the RMD not withdrawn. Thus, if you turn age 70½ in 2019, you can delay the first required distribution to 2020, but if you do, you will have to take a double distribution in 2020 the amount required for 2019 plus the amount required for 2020. Think twice before delaying 2019 distributions to 2020, as bunching income into 2020 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. However, it could be beneficial to take both distributions in 2020 if you will be in a substantially lower bracket that year.
Utilize Qualified Charitable Distributions
If you are age 70½ or older by the end of 2019 and have a traditional IRA, and particularly if you can’t itemize your deductions, consider making 2019 charitable donations via qualified charitable distributions from your IRA. Such distributions are made directly to charities from your IRAs, and the amount of the contribution is neither included in your gross income nor deductible on Schedule A, Form 1040. But the amount of the qualified charitable distribution reduces the amount of your required minimum distribution, which can result in tax savings.
Make Maximum Contributions to Your Retirement Plan
If you are younger than age 70½ at the end of 2019, you anticipate that in the year that you turn 70 and/or in later years you will not itemize your deductions, and you don’t have any traditional IRAs, establish and contribute as much as you can to one or more traditional IRAs in 2019. If these circumstances apply to you, except that you already have one or more traditional IRAs, make maximum contributions to one or more traditional IRAs in 2019. Then, when you reach age 70½, make your charitable donations by way of qualified charitable distributions from your IRA. Doing all of this will allow you to, in effect, convert nondeductible charitable contributions that you make in the year you turn 70½ and later years, into deductible-in-2019 IRA contributions and reductions of gross income from age 70½ and later year distributions from the IRAs.
Take an Eligible Rollover Distribution
Take an eligible rollover distribution from a qualified retirement plan before the end of 2019 if you are facing a penalty for underpayment of estimated tax and having your employer increase your withholding is unavailable or won’t sufficiently address the problem. Income tax will be withheld from the distribution and will be applied toward the taxes owed for 2019. You can then timely roll over the gross amount of the distribution (the net amount you received plus the amount of withheld tax, to a traditional IRA). No part of the distribution will be includible in income for 2019, but the withheld tax will be applied pro rata over the full 2019 tax year to reduce previous underpayments of estimated tax.
Increase Payments to Your Health Flexible Spending Account
Consider increasing the amount you set aside for next year in your employer’s health flexible spending account (FSA) if you set aside too little for this year.
Make Health Savings Account Contributions
If you become eligible in December of 2019 to make health savings account (HSA) contributions, you can make a full year’s worth of deductible HSA contributions for 2019.
Take Advantage of the Annual Gift Tax Exclusion
Make gifts sheltered by the annual gift tax exclusion before the end of the year if doing so may save gift and estate taxes. The exclusion applies to gifts of up to $15,000 made in 2019 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 tax brackets who are not subject to the kiddie tax.
Maximize the Casualty Loss Deduction
If you were in federally declared disaster area, and you suffered uninsured or unreimbursed disaster-related losses, keep in mind you can choose to claim them either on the return for the year the loss occurred (in this instance, the 2019 return normally filed next year), or on the return for the prior year (2018). Additionally, you may want to settle an insurance or damage claim in 2019 in order to maximize your casualty loss deduction this year.
All of the above tax strategies have significant tax-saving power; however, they are not a one-size-fits-all solution for every individual. It’s important to remember that every situation is unique, and tax strategies will vary based on your particular circumstances. If you think you may benefit from one of these strategies, please reach out to our tax experts to learn more.