Holiday meal planning, rummaging through the attic for decorations, and…tax planning? This time of year can be full of obligations and lead to hectic schedules, but we don’t want your year-end tax planning to be forgotten. Here are a few reminders to consider as we approach December 31st. As always, please consult your tax advisor to see how these ideas may apply to your specific situation.
Are you maximizing your tax deductions for charitable contributions?
The Tax Cuts and Jobs Act of 2017 significantly increased the standard deduction available to taxpayers on Form 1040. For most taxpayers, this simplified recordkeeping for the filing of their taxes. For the charitably inclined, however, it potentially limited the tax deduction available for charitable gifts. Carefully planning the timing of your contributions could create the opportunity to itemize and deduct charitable contributions in certain years, while using the standard deduction in other years when no contributions are made. For example, you could “bunch” your planned charitable contributions for the next several years into one tax year, so that your itemized deductions exceed the standard deduction in that tax year. This could be done via direct gifts to charities or through a donor advised fund (DAF). A DAF is a giving vehicle that allows a taxpayer to transfer funds and obtain an immediate tax deduction while recommending grants to specific charities in future years.
In addition to timing, the choice of asset can be important when maximizing deductions for charitable contributions. Cash is a simple and easy way to make a contribution but consider the tax advantages to contributing appreciated stock. The deduction for the contribution of appreciated stock you have held for more than one year to a public charity is the fair market value of the stock at the date of donation rather than its cost basis. Importantly, the donor never has to recognize and pay income tax on the capital gain. Contributing appreciated stock can also be a useful tool when diversifying away from a concentrated stock position that includes a large unrealized gain.
Please note: Charitable contributions that are mailed must be postmarked by December 31st, while hand-delivered contributions must be received by the charity by December 31st. Contributions made via credit card are considered made when charged, regardless of when the bill is paid. Stock transfers are considered complete on the actual date of transfer (not when instructions are given). To allow for adequate time for transfers to be completed by December 31st, please let your South State Wealth Advisor know of any anticipated charitable stock transfers by December 15th.
Do you have a Required Minimum Distribution (RMD) for 2019?
In the year you turn age 70½, annual required minimum distributions from your retirement accounts must begin. This includes IRAs, 401(k)s, 403(b) or 457 accounts. The minimum distribution is calculated dividing the fair market value as of December 31st of the prior year using a life expectancy factor from an IRS table. The IRS penalty for a distribution that does not meet the required minimum is one of the most onerous in the tax code at 50% for every dollar not withdrawn.
For inherited IRAs, the general rule for a non-spouse beneficiary is that a minimum distribution must be taken each year during beneficiary’s lifetime beginning in the year after the death of the original owner. If the original owner died before reaching 70 ½, the beneficiary also can opt to withdraw the entire IRA balance within five years after the death of the original account holder.
Please note: For those over 70 ½ that are charitably inclined, an opportunity exists to have up to $100,000 paid directly from your retirement account to a qualified charity. This Qualified Charitable Distribution (QCD) would count towards satisfying your required minimum distribution, while not being included in your adjusted gross income (AGI) on your Form 1040. As mentioned earlier, with the increased standard deduction, many taxpayers find themselves not itemizing, and thus not receiving a direct tax deduction for their charitable contributions. This QCD allows the taxpayer to get a tax benefit even if they now use the standard deduction.
Do you have any changes in your taxable income or deductions that would impact our management of realized capital gains and loss?
As we approach year end, our portfolio managers are reviewing our clients’ accounts to quantify the net impact of any capital transactions throughout the year. When an account has realized capital gains, an opportunity exists to purposefully recognize capital losses by selling a security at a value less than the cost basis in what we call tax-loss harvesting. This tax-loss harvesting can be used to reduce taxes on the other reportable capital gains. While balancing the year-to-date realized capital gains with the market conditions and the potential rebalancing of the overall asset allocation are factors in tax-loss harvesting, it is also important for us to know of any unusual income, losses, or deductions you might have in the near future. Please contact your wealth advisor if you have taxable income variations for 2019 and 2020, including any large capital loss carryforwards.
Have you maximized tax-deferred Retirement plan contributions?
For taxpayers with W-2 wages, deferral of income into employer sponsored retirement plans such as 401(k), 403(b) and 457 plans can be an easy way to reduce current taxable income. If you have not maximized your contributions for 2019, your deferrals can be increased for paychecks received by December 31, 2019. The contribution limit for 2019 is $19,000 with an allowed $6,000 catch up contribution for those 50 or older.
Retirement plans for the self-employed business owner are also beneficial in reducing current taxable income. Traditional IRA contributions for the 2019 tax year must be made by the filing date of your tax return, without consideration of any requested extensions. However, for SEP IRAs and Keogh plans, the deadline for making a 2019 contribution does include any extension of the due date of the tax return. This allows for tax planning even after the close of the year.
Please note: For married taxpayers, if the working spouse is not a participant in a qualified retirement plan, the nonworking spouse may also qualify to make an IRA contribution to a plan in his/her own name, without being subject to phase outs for deductibility.
Are you on track with your quarterly Estimated Tax payments and wage withholding?
For 2019, estimated income taxes paid must be at least 110 percent (100 percent for taxpayers with AGI less than $150,000) of the 2018 tax liability or 90% of the actual 2019 tax liability to avoid the penalties under the safe harbor. Estimated taxes are typically due in equal quarterly payments on April 15th, June 15th, September 15th, and January 15th. Taxpayers can be subject to underpayment penalties for failure to pay estimated income taxes in a timely fashion.
Determining proper estimated tax payments is not traditionally a year-end planning item; however, if you find yourself with a shortfall in your 2019 tax payments, there might be a planning opportunity.
While an end-of-the-year estimated tax payment will be sufficient to bring your total taxes paid up to your estimated tax liability, you will generally still be subject to an underpayment penalty because the underpayment deficiency began running on the earlier quarterly due date of those estimated payments. However, for taxpayers with income that can be subject to IRS withholdings, such as wages, required minimum distributions, and social security income, an opportunity exists to adjust your withholdings prior to December 31st to cover any shortfall in your estimates. Income tax withholdings are deemed to be paid equally on the estimated tax payment dates throughout the year. Therefore, the taxpayer can make-up any deficiency at the end of the year by having up to 100% of the income withheld.
In this low tax environment, should you consider a Roth Conversion for your IRA?
Since 2010, taxpayers have had the opportunity to rollover, or “convert” a traditional IRA (including other qualified retirement accounts first rolled over to a traditional IRA) to a Roth IRA, regardless of their total income. A Roth IRA differs from traditional retirement plans because the distributions from the Roth are not subject to income tax and required minimum distributions are not required to start at age 70 ½. Also, the contributions to a Roth are not deductible against your current taxable income.
The conversion of a traditional IRA to a Roth IRA is a taxable event. Ordinary income equal to the total value of the amount converted, less any basis you have in the account from previous nondeductible contributions, will be recognized in the year of the rollover. Please note the ability to essentially “undo” a Roth conversion by October 15th of the following year if the value of the Roth decreased is no longer available.
A Roth conversion can be beneficial if you have the funds available outside of your retirement accounts to pay the taxes and one or more of the following apply:
- You don’t need to take distributions by age 70½ and might not need the funds during your lifetime
- You expect to be in a higher tax bracket in future than you are now
- You think the value of your IRA investments is at a low point
- You have losses or other deductions in a tax year that could offset the ordinary income recognized on conversion
The advice of both your financial advisor and tax advisor should be sought when analyzing a rollover to a Roth IRA as it is a comprehensive analysis that would include weighing several factors, including income tax planning, estate tax planning, and cash flow planning.
Have you considered tax planning to maximize your Qualified Business Income deduction if you own a pass-through business?
The Tax Cuts and Jobs Act of 2017 created a new deduction for business owners with pass-through income under Section 199A of up to 20% on qualified business income. While a full discussion of the calculation of this deduction is beyond the scope of this article, it is worth noting that taxable income limitations, as well as wage limitations, play a role in determining the overall deduction available to each taxpayer.
Please contact your tax advisor to see if any planning opportunities exist before December 31st for you to maximize this deduction.
Update on ways to mitigate $10,000 limit on deduction for state taxes
The state taxes (income, property, and sales) allowed as an itemized deduction under The Tax Cuts and Jobs Act of 2017 was limited to a total of $10,000. Many states had or created programs that allowed payments to qualified state-created charities to be treated as if made directly to the state as income tax payments. The impact of this was to recast those payments as deductible charitable contributions rather than state taxes that may be nondeductible if the taxpayer’s total state taxes exceeded $10,000.
In June 2019, the IRS issued final regulations that reduced a taxpayer’s charitable deduction dollar for dollar for any state tax credit allowed. Please note that in South Carolina, the Exceptional Needs program can still accept appreciated stock for payment of state income taxes. While you will not receive a federal charitable income tax deduction, you can utilize the appreciated value of the stock to pay your state income taxes without having to recognize the capital gain on the stock.
Have you considered funding a 529 Savings account or making other gifts to utilize your annual gift tax exclusion?
The IRS allows each taxpayer to make a gift to an individual up to an “annual exclusion” amount without having to pay gift tax or having the gift count against your lifetime estate and gift tax exemption. The gift tax annual exclusion amount for 2019 is $15,000 per donee. While determining your proper gifting strategy should be part of an overall estate plan review, one popular way for taxpayers to utilize their annual gift exclusion is through the funding of a 529 savings plan, as contributions to these plans are considered gifts for estate and gift tax purposes. A donor even has the option to elect to make five (5) years’ worth of annual exclusion amounts in a single year’s contribution and allow those funds to grow tax-free until needed.
A 529 plan is a tax advantaged way to save for college, and now elementary and secondary school. The earnings accumulate tax-deferred while qualified withdrawals for certain educational expenses are free from federal income taxes. The donor can be the owner of the account and therefore still have control of the funds and retain the ability to change the designated beneficiary. Many states, including South Carolina, also allow income tax deductions for contributions made to their state sponsored plans.
Please note: Tuition paid directly to a school is not considered a gift and would not utilize your annual exclusion amount. This could be beneficial when trying to maximize your nontaxable transfers each year. However, the state income tax deduction allowed for the 529 plan contribution would be lost when the tuition is paid directly. Taxpayers should weigh the benefits of paying tuition directly to the educational institution versus using a 529 account for a student currently enrolled in school.
A unique “opportunity” for those who have significant realized capital gains
Investors with taxable gains from the sale of virtually any type of property (e.g. stocks, real estate, business assets) may potentially defer those gains by reinvesting the gain (rollover gains) into a Qualified Opportunity Zone within 180 days of the sale. The gain must be invested in real estate property or a business located in a designated QOZ, which are generally low-income areas. Original gains are deferred for up to 10 years, and any additional gains generated through the investment in the QOZ may be permanently excluded from income if held for at least 10 years.
Your South State Wealth Advisor would be happy to work with you and your tax advisor to fully explore any of the topics mentioned above.