2018 Year-end tax planning
By Kyle Lodder, CPA
As the end of the year approaches, it is a good time to think of planning moves that will help lower your tax bill for this year and possibly the next.
Year-end planning for 2018 takes place against the backdrop of a new tax law—the Tax Cuts and Jobs Act—that make major changes in the tax rules for individuals and businesses.
For individuals, there are new, lower income tax rates, a substantially increased standard deduction, severely limited itemized deductions and no personal exemptions, an increased child tax credit, and a watered-down alternative minimum tax (AMT), among many other changes.
For businesses, the corporate tax rate is cut to 21%, the corporate AMT is gone, there are new limits on business interest deductions, and significantly expanded expensing and depreciation rules. And there’s a new deduction for non-corporate taxpayers with qualified business income from pass-through entities or sole proprietorships.
We have compiled a checklist of actions based on current tax rules that may help you save tax dollars if you act before year-end. Not all actions will apply in your particular situation, but you (or a family member) will likely benefit from many of them. We are happy to discuss specific actions that you can take before year-end to optimize your particular situation. In the meantime, please review the following list and contact us at your earliest convenience so that we can advise you on which tax-saving moves to make:
Year-End Tax Planning Moves – International implications
First things first… there are some specific international tax law changes to consider before year-end. Here are some of the highlights.
U.S. individual and business taxpayers that have an ownership interest in a non-U.S. corporation may be subject to a new set of anti-tax deferral rules, namely the Global Intangible Low-Taxed Income (GILTI) regime. Refer to our post here regarding this specific matter. It’s possible that many taxpayers owning non-U.S. corporations may be subject to U.S. tax this year, whereas he or she has never owed tax in the past. For this reason, it’d be advisable to get in touch with us before year-end to consider year-end planning moves to optimize your tax situation.
The new law made several changes to the taxation of “subpart F income” of U.S. shareholders of certain non-U.S. corporations. Among other things, the new law expands the definition of U.S. shareholders and the applicability of Subpart F income.
The new law provides a 100% deduction for the foreign source portion of dividends received by domestic corporations from certain foreign corporations. Domestic corporations may want to consider their worldwide tax obligations amongst their global entity structure, and consider paying out a certain amount of dividends prior to year-end.
Property taxes on foreign real estate will no longer be deductible on the individual tax return.
Thankfully, the deemed repatriation income inclusion was a one-time transition tax mainly impacting the prior year filings, so this shouldn’t apply to most taxpayers this coming year.
Year-End Tax Planning Moves for Individuals
Higher-income earners must watch out for the 3.8% surtax on certain unearned income. The surtax is 3.8% of the lesser of: (1) net investment income (NII), or (2) the excess of modified adjusted gross income (MAGI) over a threshold amount ($250,000 for joint filers or surviving spouses, $125,000 for a married individual filing a separate return, and $200,000 in any other case). As year-end nears, a taxpayer’s approach to minimizing or eliminating the 3.8% surtax will depend on his estimated MAGI and NII for the year. Some taxpayers should consider ways to minimize (e.g., through deferral) additional NII for the balance of the year, others should try to see if they can reduce MAGI other than NII, and other individuals will need to consider ways to minimize both NII and other types of MAGI. This is particularly true for U.S. citizens living abroad, since this surtax generally isn’t eligible to be eliminated by the foreign tax credit.
The 0.9% additional Medicare tax also may require higher-income earners to take year-end actions. It applies to individuals for whom the sum of their wages received with respect to employment and their self-employment income is in excess of an unindexed threshold amount ($250,000 for joint filers, $125,000 for married couples filing separately, and $200,000 in any other case). Employers must withhold the additional Medicare tax from wages in excess of $200,000 regardless of filing status or other income. Self-employed persons must take it into account in figuring estimated tax.
Long-term capital gain from sales of assets held for over one year is taxed at 0%, 15% or 20%, depending on the taxpayer’s taxable income. The 0% rate generally applies to the excess of long-term capital gain over any short-term capital loss to the extent that it, when added to regular taxable income, is not more than the “maximum zero rate amount” (e.g., $77,200 for a married couple). If the 0% rate applies to long-term capital gains you took earlier this year—for example, you are a joint filer who made a profit of $5,000 on the sale of stock bought in 2009, and other taxable income for 2018 is $70,000—then before year-end, try not to sell assets yielding a capital loss because the first $5,000 of such losses won’t yield a benefit this year. And if you hold long-term appreciated-in-value assets, consider selling enough of them to generate long-term capital gains sheltered by the 0% rate.
Postpone income until 2019 and accelerate deductions into 2018 if doing so will enable you to claim larger deductions, credits, and other tax breaks for 2018 that are phased out over varying levels of adjusted gross income (AGI). These include deductible IRA contributions, child tax credits, higher education tax credits, and deductions for student loan interest. Postponing income also is desirable for those taxpayers who anticipate being in a lower tax bracket next year due to changed financial circumstances. Note, however, that in some cases, it may pay to actually accelerate income into 2018. For example, that may be the case where a person will have a more favorable filing status this year than next (e.g., head of household versus individual filing status), or expects to be in a higher tax bracket next year.
If you believe a Roth IRA is better than a traditional IRA, consider converting traditional IRA money invested in beaten-down stocks (or mutual funds) or converting during a market down-turn into a Roth IRA if eligible to do so. Keep in mind, however, that such a conversion will increase your AGI for 2018, and possibly reduce tax breaks geared to AGI (or modified AGI).
It may be advantageous to try to arrange with your employer to defer, until early 2019, a bonus that may be coming your way. This could cut as well as defer your tax.
Beginning in 2018, many taxpayers who claimed itemized deductions year after year will no longer be able to do so. That’s because the basic standard deduction has been increased (to $24,000 for joint filers, $12,000 for singles, $18,000 for heads of household, and $12,000 for marrieds filing separately), and many itemized deductions have been cut back or abolished. No more than $10,000 of state and local taxes may be deducted; miscellaneous itemized deductions (e.g., tax preparation fees) and unreimbursed employee expenses are no longer deductible; and personal casualty and theft losses are deductible only if they’re attributable to a federally declared disaster and only to the extent the $100-per-casualty and 10%-of-AGI limits are met. You can still itemize medical expenses to the extent they exceed 7.5% of your adjusted gross income, state and local taxes up to $10,000, your charitable contributions, plus interest deductions on a restricted amount of qualifying residence debt, but payments of those items won’t save taxes if they don’t cumulatively exceed the new, higher standard deduction.
Some taxpayers may be able to work around these higher itemized deduction thresholds by applying a “bunching strategy” to pull or push discretionary medical expenses and charitable contributions into the year where they will do some tax good. For example, if a taxpayer knows he or she will be able to itemize deductions this year but not next year, the taxpayer may be able to make two years’ worth of charitable contributions this year, instead of spreading out donations over 2018 and 2019.
Another option is to contribute a large sum to a donor advised fund to obtain a large one-year charitable donation deduction, while directing that the funds be distributed evenly to your charity of choice over a number of years as you wish.
Consider using a credit card to pay deductible expenses before the end of the year. Doing so will increase your 2018 deductions even if you don’t pay your credit card bill until after the end of the year.
If you expect to owe state and local income taxes when you file your return next year and you will be itemizing in 2018, consider asking your employer to increase withholding of state and local taxes (or pay estimated tax payments of state and local taxes) before year-end to pull the deduction of those taxes into 2018. But remember that state and local tax deductions are limited to $10,000 per year, so this strategy is not a good one if to the extent it causes your 2018 state and local tax payments to exceed $10,000.
Take required minimum distributions (RMDs) from your IRA or 401(k) plan (or other employer-sponsored retirement plan). RMDs from IRAs must begin by April 1 of the year following the year you reach age 70-½. (That start date also applies to company plans, but non-5% company owners who continue working may defer RMDs until April 1 following the year they retire.) Failure to take a required withdrawal can result in a penalty of 50% of the amount of the RMD not withdrawn. Thus, if you turn age 70-½ in 2018, you can delay the first required distribution to 2019, but if you do, you will have to take a double distribution in 2019—the amount required for 2018 plus the amount required for 2019. Think twice before delaying 2018 distributions to 2019, as bunching income into 2019 might push you into a higher tax bracket or have a detrimental impact on various income tax deductions that are reduced at higher income levels. However, it could be beneficial to take both distributions in 2019 if you will be in a substantially lower bracket that year.
If you are age 70-½ or older by the end of 2018, have traditional IRAs, and particularly if you can’t itemize your deductions, consider making 2018 charitable donations via qualified charitable distributions from your IRAs. Such distributions are made directly to charities from your IRAs, and the amount of the contribution is neither included in your gross income nor deductible on Schedule A, Form 1040. But the amount of the qualified charitable distribution reduces the amount of your required minimum distribution, resulting in tax savings.
Consider increasing the amount you set aside for next year in your employer’s health flexible spending account (FSA) if you set aside too little for this year.
If you become eligible in December of 2018 to make health savings account (HSA) contributions, you can make a full year’s worth of deductible HSA contributions for 2018.
Make gifts sheltered by the annual gift tax exclusion before the end of the year and thereby save gift and estate taxes. The exclusion applies to gifts of up to $15,000 made in 2018 to each of an unlimited number of individuals. You can’t carry over unused exclusions from one year to the next. Such transfers may save family income taxes where income-earning property is given to family members in lower income tax brackets who are not subject to the kiddie tax.
If you were in an area affected by Hurricane Florence or any other federally declared disaster area, and you suffered uninsured or unreimbursed disaster-related losses, keep in mind you can choose to claim them on either the return for the year the loss occurred (in this instance, the 2018 return normally filed next year), or the return for the prior year (2017).
If you were in an area affected by Hurricane Florence or any other federally declared disaster area, you may want to settle an insurance or damage claim in order to maximize your casualty loss deduction this year.
Year-End Tax-Planning Moves for Businesses & Business Owners
For tax years beginning after 2017, taxpayers other than corporations may be entitled to a deduction of up to 20% of their qualified business income. For 2018, if taxable income exceeds $315,000 for a married couple filing jointly, or $157,500 for all other taxpayers, the deduction may be limited based on whether the taxpayer is engaged in a service-type trade or business (such as law, accounting, health, or consulting), the amount of W-2 wages paid by the trade or business, and/or the unadjusted basis of qualified property (such as machinery and equipment) held by the trade or business. The limitations are phased in for joint filers with taxable income between $315,000 and $415,000 and for all other taxpayers with taxable income between $157,500 and $207,500.
Taxpayers may be able to achieve significant savings by deferring income or accelerating deductions so as to come under the dollar thresholds (or be subject to a smaller phase-out of the deduction) for 2018. Depending on their business model, taxpayers also may be able increase the new deduction by increasing W-2 wages before year-end. The rules are quite complex, so we advise you to contact us for planning before making any changes.
More “small businesses” are able to use the cash (as opposed to accrual) method of accounting in 2018 and later years than were allowed to do so in earlier years. To qualify as a “small business” a taxpayer must, among other things, satisfy a gross receipts test. Effective for tax years beginning after Dec. 31, 2017, the gross-receipts test is satisfied if, during a three-year testing period, average annual gross receipts don’t exceed $25 million (the dollar amount used to be $5 million). Cash method taxpayers may find it a lot easier to legally shift income, for example by holding off billings till next year or by accelerating expenses, for example, paying bills early or by making certain prepayments.
Businesses should consider making expenditures that qualify for the expanded business property expensing option. For tax years beginning in 2018, the expensing limit is $1,000,000, and the investment ceiling limit is $2,500,000. Expensing is generally available for most depreciable property (other than buildings), and off-the-shelf computer software.
Businesses also can claim a 100% bonus first year depreciation deduction for machinery and equipment—bought used (with some exceptions) or new—if purchased and placed in service this year.
A corporation (other than a “large” corporation) that anticipates a small net operating loss (NOL) for 2018 (and substantial net income in 2019) may find it worthwhile to accelerate just enough of its 2019 income (or to defer just enough of its 2018 deductions) to create a small amount of net income for 2018. This will permit the corporation to base its 2019 estimated tax installments on the relatively small amount of income shown on its 2018 return, rather than having to pay estimated taxes based on 100% of its much larger 2019 taxable income.
To reduce 2018 taxable income, consider deferring a debt-cancellation event until 2019.
To reduce 2018 taxable income, consider disposing of a passive activity in 2018 if doing so will allow you to deduct suspended passive activity losses.
These are just some of the year-end steps that can be taken to save taxes. Again, by contacting us, we can tailor a particular plan that will work best for you.
If you require additional information on any aspect of these complex rules, please contact Kyle Lodder at 360.599.4340 or firstname.lastname@example.org. Kyle Lodder is a Certified Public Accountant and is the owner of Lodder CPA PLLC, a U.S. international tax firm.
The material appearing in this communication is for informational purposes only and should not be construed as legal, accounting, or tax advice or opinion provided by Lodder CPA PLLC. This information is not intended to create, and receipt does not constitute, a legal relationship, including, but not limited to, an accountant-client relationship. Although these materials have been prepared by a professional, the user should not substitute these materials for professional services, and should seek advice from an independent advisor before acting on any information presented. Lodder CPA PLLC assumes no obligation to provide notification of changes in tax laws or other factors that could affect the information provided.