By Barry H. Williams, CPA, JD
Year-end tax planning looks at the tax year that is about to end with the general objective of reducing taxes that will be paid. It has the additional aim of reducing long-term tax liability when making current-year end decisions. Strategies largely fall into two areas: reducing the amount of income that would be subject to tax and increasing tax deductions. Some strategies that have been traditionally used, and are still available, require an understanding of the implications of the Tax Cuts and Jobs Act of 2017 (TCJA). The TCJA impacted many tax returns beginning in 2018, and will continue to do so into the future.
To begin your tax planning for the 2019 tax year-end and beyond, first consider the effect the TCJA had upon your 2018 tax year. You might say there were two broad groups of taxpayers last year: those that asked “Why did my refund go down?” and those who were happy that their refunds increased or stayed the same. To assist you in understanding the impact of the changes in the tax law, the IRS developed Tax Reform Basics for Individuals and Families (IRS Publication 5307).
An important change taxpayers need to be aware of are the new tax rates. There are now seven income tax brackets, ranging from 10% to 37%. Also, the standard deduction nearly doubled. The basic standard deduction for 2019 is now $12,200 for singles and married people filing separate returns; $18,350 for heads of household; and $24,400 for married couples filing a joint tax return – all of which resulted in a reduction in the number of taxpayers who itemize their deductions. Some deductions are now limited or discontinued, too, such as the state and local tax deduction and miscellaneous itemized deduction for job-related costs. Certain other expenses are no longer available. Personal and dependency exemptions have been suspended, which means that an exemption can no longer be claimed for a tax filer, spouse, and dependents.
Before the start of a new tax year, check your withholding and estimated tax payments. With the TCJA, you may have had your tax liability reduced, but it was offset by a reduction in your withholding (if you are an employee) or estimated tax payments (if self-employed). Following passage of the TCJA, the IRS reduced the amount of money withheld from taxpayers’ paychecks, giving them the money during the year instead of leaving it for tax refunds. This is important: owing money on your tax return can result in the assessment of an underpayment penalty.
The IRS has a tax withholding estimator that can help you determine the amount that should be withheld from your paycheck and will help you adjust your withholding if needed. This will not be a retroactive solution if you determine you will owe money, but you still have some time to make an estimated tax payment if necessary. IRS Publication 505 (2019), Tax Withholding and Estimated Tax, is available to assist you in answering any questions you may have regarding the payment of tax.
Once you understand your tax position regarding income and deductions, you can then focus on the tax reduction strategies of deferring income, increasing deductions through bunching strategies, or increasing tax deductible expenditures. When focusing on deferring income, taxpayers can shelter some income through employer-provided retirement plans, such as 401(k)s, 403(b)s, 457(b)s, federal thrift savings plans, and traditional individual retirement accounts (IRAs). Contributions to employer-sponsored plans have a limit for 2019 of $19,000 if you are under age 50, but increases to $25,000 if you are age 50 or older. Total annual contributions to traditional and Roth IRAs, combined, cannot exceed $6,000 for 2019 if you are under age 50 and $7,000 for 2019 if you are age 50 or older. However, with traditional IRAs, income limitations apply that you need to meet or the tax deduction may be limited.
Because the TCJA increased the standard deduction and placed ceilings on the amount of certain types of itemized deductions, one way to achieve savings is to use a bunching strategy. This involves the accumulation of deductible charitable contributions and/or deductible medical expenses into one tax year, with the goal to exceed the amount of standard deduction. For example, a married couple who has $10,000 of charitable contributions every year could defer the year one amount to year two, and then accelerate what they intend to give in year three into year two. Putting all three years’ contributions in year two could produce $30,000 in itemized deductions that would exceed the standard deduction amount for married couples filing jointly ($24,400). The key to success with a bunching strategy is multiyear tax planning and the discipline to complete the plan.
Another area that you want to be sure to remember during year-end tax planning is life-changing events:
- Did you get married or divorced during the tax year?
- Do you now have a child that will allow you to take a child tax credit?
- Conversely, did your child reach the age at which you will be unable to claim the credit?
- Did the purchase of a new home open up any related tax benefits?
- Did you/will you retire during the year, changing the type and amount of income that you receive?
Once you determine if you have the ability to achieve tax savings from one of the above strategies or other strategies you undertake, consider whether you have any capital gains or qualified dividend in 2019. Long-term capital gains from the sale of an asset held for more than a year and qualified dividends tax rate is 0%, 15%, or 20% for 2019, depending on your income. During tax planning, you need to consider the implications of your strategies upon your capital gains and qualified dividend tax rates as well as the net investment income tax (NIIT). The NIIT is an additional 3.8% tax that may apply to interest, dividends, short- and long-term capital gains, rents and royalties, and passive business income.
As you move forward with your short-term and long-term tax planning, make certain to understand all the pros and cons associated with each opportunity and how they impact your situation. This discussion provides merely an overview of the basic concepts and options that may fit into your strategy. A CPA can help you understand other tax planning opportunities, the complexities of the TCJA, and its implications for the successful achievement of your financial goals. You can find a CPA near you by using PICPA’s CPA Locator.
Barry H. Williams, CPA, JD, is dean of the McGowan School of Business at King’s College, Wilkes-Barre, Pa. Williams holds a JD from Widener University, a master’s degree in taxation from Villanova University, and is a licensed CPA in Pennsylvania and Florida.
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