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Also see: Year-End Tax Planning Guide for Businesses.
An In-Depth Look: Practitioner's 2019 Year-End Tax Planning Guide for INDIVIDUALS. (Includes Sample Client Letter)
(Parker Tax Publishing Updated December 2019)
The first installment of Parker's annual two-part series on year-end tax planning recaps 2019's major changes affecting individual taxpayers and the implications of those changes for year-end tax moves. The online version of the article includes a link to a sample year-end client letter for individuals.
Introduction
As the year winds to a close, it's time to start thinking of any last-minute strategies that could benefit clients. While there was no new tax legislation of note this year, the ramifications of the Tax Cuts and Jobs Act of 2017 (TCJA) are still around and will be for years, absent any new legislation to unwind its provisions. Probably one of the most important areas of year-end tax planning is ensuring that your client has had enough income taxes withheld, or has made enough estimated tax payments, to avoid any underpayment of tax penalties. Last year saw a number of taxpayers taken by surprise when their returns showed taxes due rather than the refund they were expecting. Many of those situations resulted from the TCJA reducing tax rates and thus withholding taxes while also reducing deductions taxpayers had taken in prior years (e.g., unreimbursed business expenses and limitations on state and local taxes) thus leaving taxpayers with higher taxable income.
Practice Aid: Use Parker's Sample Client Letter as a template or just sign your name at the bottom. See Our Client Letter for Individuals.
The following options are worth reviewing to determine if they could reduce a client's tax bill for 2019.
Bunching Deductions into 2019
As a result of the TCJA increasing the standard deduction for all taxpayers, many taxpayers are not getting a tax benefit from itemizing their deductions. And even those that are, experience significant limitations on what they can deduct, given the $10,000 ($5,000 for married filing separately) limitation on the state income and property tax deduction and the elimination of miscellaneous itemized deductions such as unreimbursed employee business expenses.
However, if a client is near the threshold of receiving a benefit from itemizing deductions rather than taking the standard deduction, it may make sense to bunch expenses for which an itemized deduction is available into alternating years. Such expenses might include property taxes, mortgage interest, charitable contributions, or medical expenses. For example, if a single taxpayer, whose standard deduction in 2019 is $12,200 has mortgage interest of $5,000 for 2019, as well as $5,000 in state and local income and property tax deductions, and the taxpayer typically makes charitable donations of $2,000 per year, bunching two years' worth of charitable deductions into 2019 and taking the standard deduction in 2020 would yield a bigger tax savings than just taking the standard deduction each year.
Medical Expenses and Health Savings Accounts
If a client has significant medical expenses but is unable to meet the threshold for deducting such expenses because they don't exceed 10 percent of the taxpayer's adjusted gross income, a health saving account (HSA) could be an attractive alternative. If the client is eligible to set up such an HSA, he or she can deduct the amount contributed to the account in computing adjusted gross income and not have to worry about exceeding the medical expense deduction threshold. Because the annual contribution limits for 2019 are $3,500 for an individual with self-only coverage and $7,000 for an individual with family coverage, this could result in significant tax savings.
Home Office Expenses
Because the TCJA eliminated the miscellaneous itemized expense deduction, employees can no longer deduct home office expenses. However, taxpayers with their own business can still file a Schedule C and take a home office expense deduction if part of the home is used for that business. Besides deducting mortgage interest allocable to the portion of the home used for business, an allocable portion of state income taxes and property taxes, that may otherwise be limited to $10,000, are also deductible, along with utilities and any applicable home improvements relating to the space being used. Nailing down the percentage of the home used for business before year end will provide a more accurate estimate of the taxpayer's taxable income for 2019.
Kiddie Tax
Taxpayers subject to the "kiddie tax" are now taxed at the trust and estate tax rates. Although the trust and estate tax rates are similar to the individual tax rates, the tax brackets are much lower, meaning higher rates of tax apply to lower levels of income. Taxpayers with children subject to this tax can elect to include the child's income on their tax return. However, whether that is advisable needs to be evaluated in light of the parent's other net investment income with an eye toward whether adding the child's investment income to the parent's income could subject the parent to the 3.8 percent net investment income tax.
Child-Related Expenses and Credits
Taxpayers with children and child-related expenses can qualify for significant deductions and credits. When the TCJA eliminated the personal and dependent exemption deductions, it increased the child tax credit and the income levels over which a taxpayer becomes ineligible for the credit. Thus, for 2019, taxpayers filing a joint return with modified adjusted gross income (MAGI) of $400,000 or less, are eligible for a $2,000 child tax credit for each qualifying child. Taxpayers filing as single, head of household, or married filing separately, are eligible for the child tax credit if their MAGI is $200,000 or less. For taxpayers with income above those levels, a pro rata credit may be available depending on total MAGI. Taxpayers with income below certain thresholds may be eligible for a refundable child tax credit.
Child and dependent care expenses can also take up a big chunk of a parent's budget and the dependent-care credit of up to 35 percent of employment-related expenses can result in substantial tax savings. The amount of employment-related expenses used to calculate the credit is generally limited to $3,000 for one qualifying individual or $6,000 for two or more qualifying individuals. Expenses that may qualify for the credit include costs of a day camp (but not an overnight camp), costs paid to a dependent care provider to transport a child to or from a place where care is provided, costs of providing room and board for a dependent child's caregiver, payroll taxes for caregivers, and fees paid to an agency to find a child care provider.
Education-Related Deductions and Credits
Another big area where deductions and credits should not be overlooked is education. While the tuition and fees deduction and the miscellaneous itemized deduction for work-related education expenses are no longer available, other education-related tax deductions, credits, and exclusions from income may apply for amounts paid in 2019. This includes the exclusion from income for distributions from a qualified tuition program of up to $10,000, the exclusion from income for education savings bond interest; the deduction for student loan interest of up to $2,500; and the lifetime learning credit of up to $2,000.
Charitable Contribution Deductions
With respect to charitable donations, clients may reap a larger tax benefit by donating appreciated assets, such as stock, to a charity. Generally, the higher the appreciated value of an asset, the bigger the potential value of the tax benefit. Donating appreciated assets not only entitles the taxpayer to a charitable contribution deduction but also avoids the capital gains tax that would otherwise be due if the taxpayer sold the stock.
Additionally, because taxpayers 70 1/2 years old and older who own an individual retirement account (IRA) must take minimum distributions from that account each year and include those amounts in taxable income, a special provision allows such taxpayers to make a charitable contribution directly from their IRAs to a charity. This has several benefits. First, since charitable contributions deductions are usually only available to individuals who itemize, a taxpayer who takes the standard deduction can benefit from this rule. Second, by making a contribution directly to a charity, the donation counts towards the taxpayer's required minimum distribution but that amount is not included in income and thus reduces taxable income and adjusted gross income (AGI). A lower AGI is advantageous because it increases the taxpayer's ability to take medical expense deductions that might not otherwise be available. In addition, the reduction in AGI decreases the amount of the taxpayer's social security income subject to income tax and possibly the 3.8 percent net investment income tax if the taxpayer has a lot of investment income.
Rental Real Estate
Finally, one of the most important new deductions that came about as the result of the TCJA is the Code Sec. 199A deduction. For individuals who own rental real estate, this deduction may apply if certain criteria are met. For example, the taxpayer's rental activity must be considerable, regular, and continuous in scope. In determining whether the taxpayer's rental real estate activity meets those criteria, relevant factors include, but are not limited to, the following:
(1) the type of rented property (commercial real property versus residential property);
(2) the number of properties rented;
(3) the taxpayer's or taxpayer's agent's day-to-day involvement;
(4) the types and significance of any ancillary services provided under the lease; and
(5) the terms of the lease (for example, a net lease versus a traditional lease and a short-term lease versus a long-term lease).
Under a safe harbor issued by the IRS, a rental real estate activity will be treated as a business eligible for the special deduction if certain requirements are satisfied, such as:
(1) separate books and records are maintained to reflect the income and expenses for each rental real estate enterprise;
(2) for rental real estate enterprises that have been in existence less than four years, 250 or more hours of rental services are performed per year with respect to the rental real estate enterprise (with slightly less stringent requirements for rental real estate enterprises that have been in existence for at least four years);
(3) contemporaneous records have been maintained, including time reports, logs, or similar documents, regarding the following: (i) hours of all services performed; (ii) description of all services performed; (iii) dates on which such services were performed; and (iv) who performed the services; and
(4) certain compliance requirements are met.
For taxpayers that may be eligible for this deduction, it's important to determine if the safe harbor is met and, if not, determine whether it can be met by year end. Alternatively, even if the taxpayer doesn't meet the safe harbor requirements, actions can still be taken to ensure that the taxpayer falls within the "trade or business" guidelines for taking the deduction.
Net Investment Income Tax
For high net-worth clients, the 3.8 percent net investment income tax may apply and steps for reducing its impact should be considered. Some of the options include:
(1) donating or gifting appreciated property rather than selling it;
(2) replacing stocks with state and local bonds that generate tax-exempt interest;
(3) determining if an outright sale of appreciated assets can instead be structured as an installment sale;
(4) giving consideration to selling stocks with values below their cost this year to generate a loss in the current year; and
(5) determining whether a planned sale of real estate can be structured as a like-kind exchange.
Retirement Planning
Finally, it's always advisable to revisit a client's retirement planning to see if there is any extra income that can be put aside for retirement, while cutting current year taxes.
Where a taxpayer's employer has a 401(k) plan and the taxpayer is under age 50, up to $19,000 of income can be deferred into that plan. Catch-up contributions of $6,000 are allowed if the taxpayer is 50 years or older. With a SIMPLE 401(k), the maximum pre-tax contribution for 2019 is $12,500, and $15,500 if the taxpayer is 50 or older. Contributions to an individual retirement account (IRA) may also be deductible. For taxpayers under 50, the maximum contribution amount for 2019 is $6,000. If the taxpayer is 50 or older but less than 70 1/2, the maximum contribution amount is $7,000. Contributions exceeding the maximum amount are subject to a 6 percent excise tax. Even if a taxpayer is not eligible to deduct contributions to an IRA, contributing after-tax money to an IRA may be advantageous because it will allow the taxpayer to later convert that traditional IRA to a Roth IRA and subsequently withdraw the money free of tax.
For taxpayers with a traditional IRA, it may be worth evaluating whether it is appropriate to convert it to a Roth IRA this year. Of course, this option only makes sense if the tax rates when the money is withdrawn from the Roth IRA are anticipated to be higher than the tax rates when the traditional IRA is converted. And if a taxpayer has a traditional 401(k), 403(b), or 457 plan that includes after-tax contributions, those amounts can generally be rolled over to a Roth IRA with no tax consequences. A rollover of a SIMPLE 401(k) into a Roth IRA may also be available. As with all tax rules, there are qualifications that apply to these rollovers that must be considered before any actions are taken.
A taxpayer that makes qualified retirement savings contributions during 2019 could be eligible for a retirement savings credit of up to $1,000 (single or head of household) or $2,000 (joint filers) if taxpayer income is below certain thresholds.
Finally, self-employed individuals or small business owners can contribute as much as 25 percent of net earnings from self-employment, up to $56,000, for 2019.
Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.
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