New opportunities for year-end tax planning abound with new tax law
Taxpayers have now had close to a year to evaluate the new provisions of the Tax Cuts and Jobs Act. However, they have had much less time to look at proposed regulations interpreting those provisions and are still awaiting some proposed regulations and any final regulations.
There have been suggestions that the 2019 tax filing season might be delayed due to the inability of the Internal Revenue Service to process all of the changes in time. Even with a lot of questions remaining, taxpayers should be thinking about taking steps prior to year-end to take advantage of the new provisions in the law.
Increased standard deduction and reduced itemized deductions.
With the standard deduction nearly doubling to $12,000 for single filers and $24,000 for joint filers, while a number of common itemized deductions have been reduced or eliminated, particularly the state and local tax deduction, the interest deduction, the casualty loss deduction and the miscellaneous itemized deductions over the 2-percent-of-adjusted-gross-income floor, many more taxpayers are projected to be better off with the standard deduction than the itemized deduction. Already in prior years, about two-thirds of taxpayers claimed the standard deduction. Now that percentage is expected to increase to more than three-fourths of all taxpayers. Many more taxpayers in 2018 may no longer receive a tax benefit from itemized deductions that they had received in the past.
Taxpayers must compare not only the new standard deduction to the amount of itemized deductions to which they were entitled in the past but also to the amount of itemized deductions to which they expect to be entitled in 2018 and beyond.
Taxpayers who regularly claimed itemized deductions in the past may now want to bunch those deductions into one year and claim the standard deduction in the other year. One itemized deduction that is easily bunched is charitable contributions. A taxpayer can still give annually to their favorite charities by making the donations in January and December of one year while skipping the following year or through the use of donor-advised funds, where the donation is claimed in one year while the distributions to charities can be spread over several years.
If the standard deduction is now still a better option with the level of charitable giving, taxpayers over age 70-½ can consider making the charitable contributions from an IRA, offsetting required minimum distributions that otherwise would have been required to be taken into income.
Taxpayers with line of credit interest should consider documenting the cost of home improvements that would support claiming at least a portion of that interest as qualified mortgage interest.
With respect to the $10,000 limit on the state and local tax deduction, taxpayers with real estate taxes should consider whether it is possible to allocate any real estate taxes to a business tax return. While some higher-tax states have adopted laws to help taxpayers preserve their deductions through charitable contributions to state charities or through payroll deductions, the IRS is attacking those approaches and it is not clear that such approaches will hold up.
The Tax Cuts and Jobs Act was enacted so late in 2017 that the new 2018 withholding tables were not required to be put into effect until March 2018, creating a potential over-withholding situation for some taxpayers.
While the new withholding tables adjusted for lower tax rates, the increased standard deduction, and the elimination of exemptions, those tables did not adjust for the loss of itemized deductions. This has created the potential for under-withholding in 2018 for millions of taxpayers unless they have adjusted their estimated tax payments or withholding accordingly.
Taxpayers should review their estimated tax payments and withholding as soon as possible to adjust for the new reality. While increasing estimated tax payments late in the year will provide only a benefit based on the date they were paid, increasing withholding will provide a benefit as if it had been paid throughout the year. Taxpayers facing possible under-withholding should therefore consider revising their Form W-4s for the remainder of the year to add a dollar amount to compensate for any anticipated under-withholding.
The 20 percent deduction for pass-through businesses
By this point in the year, most pass-through business owners are aware of and excited about the new 20 percent deduction available to them. However, even with proposed regulations released, there remains a lot of uncertainty about how to take maximum advantage of the deduction. Does my activity qualify as a trade or business? What is my qualified business income after considering investment income and compensation-like income? Am I a specified service trade or business or have some level of specified service trade or business income? What are the W-2 wages of the business? What is the qualified property of the business? Would I be better off aggregating businesses or breaking up businesses?
The issues can be complicated and the answers in many instances remain unclear. Pass-through business owners should be working with their trusted tax advisor to develop the best strategy to maximize the deduction. Also complicating planning is that the 20 percent deduction, like many of the individual tax provisions in the new law, expires after 2025, which must be considered in any significant restructuring.
Some taxpayers may elect to do nothing until the answers to some of these issues become clear, perhaps in final regulations or later. Other taxpayers may, however, be able to take steps for the remainder of the year, with expert advice, to increase their deduction for 2018.
The new partnership audit rules
The new partnership audit rules are effective for 2018. These require designation of a partnership representative, smaller partnerships considering electing out of the rules, or partnerships pushing out liability for audit adjustments under the new rules from the partnership to the partners. These actions should be taken as soon as possible before an IRS audit materializes, remembering that the audit rules are designed to increase the number of IRS audits of partnerships.
Child Tax Credit and Social Security numbers
The Tax Cuts and Jobs Act now requires any child for whom the new higher Child Tax Credit is claimed to have a Social Security number. For the refundable portion of the Child Tax Credit, the Social Security number must be issued to a U.S. citizen or authorize the individual to work in the U.S.
A Taxpayer Identification Number is no longer sufficient; however, it is sufficient for the new $500 credit for a qualifying dependent. The Social Security number can be issued up until the filing date for the tax return.
529 plans and ABLE accounts
Look at new options to pay elementary and secondary tuition from 529 plans and new opportunities to provide increased funding for ABLE accounts from 529 plans or the beneficiary’s income. The attractiveness of ABLE accounts still suffers, however, from the fact that the funds revert to the state on the death of the beneficiary. Special needs trusts may remain a more attractive alternative.
Do the usual
In addition to some of the special issues for 2018, taxpayers should still look at the usual year-end planning:
Review your investment portfolio to realize gains and losses before year-end. From a tax perspective, the ideal year-end situation is a $3,000 net capital loss that can be offset against more highly taxed ordinary income. However, it must always be considered whether it is better to realize capital losses to offset capital gains in 2018, taxed at a maximum rate of 20 percent, or to postpone those losses into future years when, if there are no capital gains, they might offset ordinary income that would otherwise be taxed as high as 37 percent.
Maximize contributions to 401(k) plans and 529 plans. Take required minimum distributions if the taxpayer reached age 70-½ prior to 2018.
If taxpayers have exercised incentive stock options during 2018, consider selling the stock before year-end if the values have significantly declined since the exercise date. Otherwise, the taxpayer could be hit with a large Alternative Minimum Tax that it might be difficult to pay.
The TCJA did include a provision permitting non-highly-compensated employees to make an election to defer tax on stock options for up to five years.
The many changes in the Tax Cuts and Jobs Act have created a number of planning opportunities for 2018 tax returns. There remain a number of outstanding issues for which guidance is still being sought from the IRS, and the IRS will continue to issue additional guidance between now and year-end.
Tax advisors and their clients should monitor these developments as they occur and take actions before year-end that will prove helpful in taking full advantage of the provisions of the new law.