10 year-end tax planning tips as 2020 approaches
Tax reform made 2018 a particularly difficult year as taxpayers and the Internal Revenue Service raced to contend with sweeping changes. But, with the dust settling and significant IRS guidance available, taxpayers and tax professionals can approach the end of 2019 with more certainty. Here are the 10 most important 2019 year-end tax-planning considerations for individuals.
1. Know whether your client will take the standard deduction
It’s critical for your clients to know whether they expect to take the standard deduction before making decisions on year-end spending that would normally generate itemized deductions. Tax reform doubled the standard deduction while repealing or limiting numerous itemized deductions, leaving millions fewer taxpayers claiming actual itemized deductions.
If your clients' itemized deductions are unlikely to total at least $12,200 (or $24,400 if married and filing jointly), they will not get any deduction for things like charitable gifts or elective health care procedures.
2. Make opportunity zone investments before year-end
Opportunity zones were created to encourage investment in specific geographic areas by offering generous tax incentives. If your clients have sold or are considering selling assets this year that would generate large capital gains, keep in mind that the gain can be deferred if they invest an equal amount in an opportunity zone fund within 180 days of the sale. If they hold the investment for 10 years, they won’t recognize any gain on the new investment itself. They still have to recognize the original gain they have deferred by Dec. 31, 2026, at the latest, but if they make their investment by the end of the year, an extra 5 percent will be forgiven.
They can get up to 10 percent of the deferred gain forgiven entirely if they hold the investment for five years or 15 percent if they hold it for seven years, meaning 2019 presents the last opportunity to qualify for the extra 5 percent step up in basis. There are over 8,000 opportunity zones throughout the U.S. in areas ripe for investment, and numerous funds are soliciting investors.
3. Defer tax
Deferral remains a cornerstone of good tax planning. Why pay tax today when you can put it off until tomorrow and enjoy the time value of money? Deferring tax is about accelerating deductions and postponing income. Your clients may be able to control the timing of items of income and expense. Consider deferring bonuses, consulting income or self-employment income.
On the deduction side, they may be able to accelerate state and local income taxes, interest payments and real estate taxes, but remember the $10,000 cap on deducting tax.
4. Maximize “above-the-line” deductions
Above-the-line deductions are especially valuable because so many taxpayers will no longer itemize deductions. They also reduce the taxpayer's adjusted gross income, and AGI affects whether they’re eligible for many tax benefits.
Common above-the-line deductions include traditional individual retirement account and health savings account contributions, self-employment taxes, certain health insurance costs and any bank penalties clients may have had to pay for early account withdrawals.
Note that tax reform repealed some popular above-the-line deductions, such as moving expenses (except for members of the military) and alimony payments (for divorces finalized after 2018).
5. Leverage retirement account tax savings
It’s not too late for your clients to maximize contributions to a retirement account. Traditional retirement accounts like 401(k)s and IRAs still offer some of the best tax savings in the Tax Code. Contributions reduce taxable income at the time a taxpayer makes them, and they don’t pay taxes until they take the money out at retirement.
The 2019 contribution limits are $19,000 for a 401(k) and $6,000 for an IRA (not including catch-up contributions for those 50 years old and older). Remember that 2019 contributions to an IRA can be made as late as April 15, 2020.
6. Make up a tax shortfall with increased withholding
Many taxpayers were unpleasantly surprised by smaller refunds or unexpected bills when they filed their 2018 returns because of changes to tax rules and withholding schedules. This year, make sure your clients' withholding and estimated taxes align with what they actually expect to pay while they have time to fix a problem.
If your clients find themselves in danger of being penalized for underpaying tax, they can make up the shortfall through increased withholding on their salary or bonuses. A larger estimated tax payment at the end of the year can still expose them to penalties for underpayments in previous quarters, but withholding is considered to have been paid ratably throughout the year, so increasing it for year-end wages can save them on penalties.
7. Don’t squander the gift tax exclusion
Your clients can give up to $15,000 to as many people as they wish in 2019, free of gift or estate tax. They get a new annual gift tax exclusion every year, so they shouldn't let it go to waste. If they combine gifts with their spouse, they can use their exemptions together to give up to $30,000 per beneficiary each year. So if they have three married children, they could give each couple $60,000 and remove $180,000 from your estate in a single year. They can give even more tax-free if they have grandchildren.
8. Plan for the new version of the “kiddie tax”
Tax reform repealed the old “kiddie tax,” which generally taxed the unearned income of children at parents’ marginal rates. Now a child’s unearned income is taxed at trust and estate rates. The change cuts both ways. For some low- and middle-income families whose children receive unearned income like scholarships or military survival benefits, the trust and estate rates are much less favorable than their parents’ tax brackets. For some high-income families, the ability to use the trust tax brackets may allow their children to enjoy more capital gains and qualified dividends in the zero and 15 percent brackets.
Consider whether it may benefit your clients to transfer assets earning investment income to children, but beware of the gift tax consequences and watch for changes in law. The House has passed legislation restoring the old kiddie tax regime, and retroactive enactment is a possibility.
9. Don’t count on charitable gift state and local tax workarounds
Your client's state may be one of several to enact charitable giving laws designed to circumvent the $10,000 cap on the state and local tax deduction enacted as a part of tax reform. These laws offer state tax credits in exchange for contributions to charitable programs that provide state services, essentially turning state tax payments into charitable contributions for federal tax purposes. But the IRS has shut the door on these workarounds. If your clients have made such a contribution, new rules negate any potential benefit by requiring them to reduce their charitable deduction by the tax credits received in return. However, there is some relief. They can treat the contributions as state tax payments so that they can continue to deduct them up to the $10,000 cap.
10. Leverage low interest rates and generous exemptions
The historically low interest rates and lifetime gift and estate tax exemption presents a powerful estate planning opportunity. Many estate and gift tax strategies hinge on the ability of assets to appreciate faster than the interest rates prescribed by the IRS. There’s a small window of opportunity to employ estate-planning techniques while interest rates are still low and the lifetime gift exemption is at an all-time high. Tax reform doubled the gift and estate tax exemptions, but like the rest of the individual provisions, this change is set to expire in a few years.