Year-end tax planning opportunities
About one year ago, the Tax Cuts and Jobs Act (“TCJA”) of 2017 officially passed – creating significant change for many U.S. families. Below is an update to my December 20, 2017 article on tax reform and planning opportunities you should consider before December 31, 2018.
STANDARD VS. ITEMIZED DEDUCTION
The standard deduction increased dramatically from 2017 and is now $24,000 for married couples filing jointly and $12,000 for single filers. The deduction for state, local and property taxes is capped at $10,000 annually. The mortgage interest deduction on primary and secondary residences applies to loans under $750,000. Medical expenses exceeding 7.5% of income are deductible if you’re itemizing.
What this means to you: There’s a good chance you may no longer want to itemize. Taxpayers who historically itemized deductions on Schedule A may find it more advantageous to take the higher standard deduction in 2018. For example, assume you are a married couple, and your state, local, and property tax deduction in 2017 was $15,000. Other itemized deductions equaled $5,000, resulting in total itemized deductions of $20,000. In 2018, there is a $10,000 cap on state and local taxes. Coupled with $5,000 of other itemized deductions, you only have $15,000 of itemized deductions for 2018. In this case, you are better off taking the $24,000 standard deduction.
The biggest lever at your disposal is charitable contributions. Let’s take the above example one step further. Assume you want to donate $20,000 to your favorite four charities over the next few years. You could set-up a donor advised fund before 12/31/18 and fund it with $20,000 to get the tax deduction in 2018. This would bring your total 2018 itemized deductions to $35,000 ($15,000 above plus $20,000 charitable) – far better than the $24,000 standard deduction. For additional reading on donor advised funds, consult my earlier blog post on 5 ways to maximize charitable giving.
TAX RATES & ROTH CONVERSIONS
Even though the number of tax brackets remains unchanged at seven, the top tax rate is 37% (down from 39.6%). The new 2018 tax rates are: 10%, 12%, 22%, 24%, 32%, 35% and 37%.
What this means to you: You are likely in a lower tax bracket this year compared to 2017, especially if you’re a married couple filing jointly. Individual taxpayers with taxable income above $157,500 may see a slightly higher tax bill.
If you are retired and have a low income year, consider making a backdoor Roth conversion before year-end. Married couples with under $77,200 of 2018 taxable income pay 0% federal capital gains tax on the Roth conversion. Please consult your tax professional and/or financial advisor, as the backdoor Roth conversion process can be tricky. You need to include your Roth conversion as income in the taxable income calculation; going above the $77,200 threshold in this example increases the federal capital gains tax rate from 0% to 15%.
Although the personal exemption of $4,050 per person was eliminated through the TCJA, the child tax credit doubled to $2,000 per child ($1,400 of which is a refundable tax credit). This distinction between refundable and non-refundable tax credits is important. Non-refundable tax credits cannot reduce your tax liability beyond zero, while refundable tax credits can give you an additional refund – even if your tax liability was zero before the credit.
New rules also include a $500 nonrefundable tax credit for dependents who are not qualified (e.g. over age 17, such as a college-aged child or dependent adult parent). This $500 dependent credit and the $2,000 child tax credit are limited if you’re a married couple earning over $400,000.
What this means to you: Expect a $4,000 tax credit that will directly reduce your tax liability if you are a married couple earning less than $400K with 2 children under age 17. If you don’t have any dependents, you won’t benefit from this enhanced child tax credit but may appreciate the higher standard deduction and lower tax rate.
If your employer is allowing you to make changes to 2019 elections via open enrollment, fund a dependent care FSA to reimburse yourself for daycare, preschool, and before and after-care costs for school-age children. You can elect up to $5,000 per family, but only elect the amount of expenses you can reasonably estimate. FSAs come with a “use it or lose it” provision, so balances do not carry over into the following tax year.
On a related note, don’t forget to exhaust 2018 FSA balances before year-end. You may be able to file the reimbursement claim in the first quarter of 2019, but most FSA plans require that you incur the eligible expense prior to December 31st.
You may have previously used Coverdell Education Savings Accounts (ESAs) to save for private elementary and high school expenses. The TCJA of 2017 now allows families to save for private elementary, high school AND college expenses in a single, tax-advantaged account – a 529 savings plan. Historically, college expenses were the only “qualified” withdrawals of 529 plans.
What this means to you: Consider funding a 529 saving plan before year-end. Beginning in 2018, you can withdraw up to $10,000 annually per student from the 529 plan for private elementary or high school expenses. Want to learn more about funding K-12 expenses with a 529 plan? Consult this article.
Qualified withdrawals for higher education expenses at the college or university level are not capped, and a 529 savings plan is a great tool to save for these future costs.
If you are insistent on sending your child to a private university, you may prefer the Private College 529 Plan instead. Private College 529 is the only prepaid 529 plan not run by a state. Read more about the nuances between 529 savings and prepaid plans in this Kiplinger article.
If your family doesn’t have health insurance, you will no longer pay a penalty under the Affordable Care Act for lack of coverage – beginning January 1, 2019.
What this means to you: Healthy people who were previously forced under the Affordable Care Act to have health insurance coverage may drop it. Premiums are likely to rise if your family gets coverage through the individual exchange. Healthcare sharing plans are not insurance but may represent a viable alternative for some families concerned with rising premiums.
If you own a small business such an a Limited Liability Company (LLC), S Corporation or partnership, please keep reading. There could be a 20% qualified business deduction available, particularly if your taxable income is lower than $157,5000 as a single filer or $315,000 as a married couple filing jointly.
What this means for you: Are you already a small business owner? Read this article for details of 2018 business deductions spurred by the 2017 tax law change. If you are considering entrepreneurship in 2019, get a head start on your business plan. Pamela Slim’s Escape from Cubicle Nation and Michael Gerber’s The E-Myth Revisited are great books for soon-to-be entrepreneurs.
Finally, here are proactive steps you should consider before year’s end.
1. Accelerate deductions. Work diligently to take as many deductions as possible in 2018, especially if you’re a cash-basis business owner. Saving more in tax-deferred retirement accounts such as 401k and 403b plans also lowers taxable income.
2. Defer income. If your employer is paying a year-end bonus to you, request that they wait and pay it in January 2019. On the other extreme, small-business owners on a cash basis method of accounting should postpone December 2018 billings to January if possible. Tax deferral is usually a good thing. :-)
3. Time charitable contributions carefully. If you plan to take the standard deduction this year, postpone significant charitable contributions to 2019 (or vice versa). Making a contribution to a donor advised fund allows you to take an immediate tax deduction – regardless of when the charity actually receives your grant request. If using non-cash assets, be careful that your contribution doesn’t exceed 30% of adjusted gross income.
This list isn’t exhaustive. Consult your trusted tax adviser if you have one, as each strategy may not be relevant to every family.