Every year, as we prepare to turn the calendar page to December, it’s a good idea to think about what we can do before the end of the year to minimize taxes. This year, with the Tax Cuts and Jobs Act (TCJA) having taken effect on January 1, it’s an even better idea. Much has changed in 2018; many deductions have disappeared, as have personal exemptions. On the bright side for many, the standard deduction has doubled. With all of the changes in the tax landscape upending some rules we took for granted, it’s worth making the effort before year’s end to minimize your tax burden. Here are some end of year tax planning tips to make April 15, 2019 less painful.
1. Bunch Deductions Together
Single taxpayers with total itemized deductions of $12,000 or less, or married taxpayers filing jointly with total deductions of $24,000 or less will probably want to use the new (increased) standard deduction. The upside of this is simpler tax return preparation, and maybe paying less in taxes. The downside is that if you take the standard deduction, you cannot take advantage of other, itemized deductions, like those for charitable donations, home mortgage interest, state and local taxes (SALT) and others.
However, through the process of “bunching,” you may still be able to take advantage of some itemized deductions and the new, higher standard deduction. This strategy involves grouping deductions in one year, and then taking the standard deduction the next year, and potentially the year after that.
Let’s say you and your spouse donate $15,000 per year to your favorite charity. Let’s suppose that doing so in this year would bring your itemized deductions to $25,000, making it more profitable for you to itemize than to take the standard deduction—but only just. If you are able to make a donation of $45,000 this year, you will reduce your taxable income by a much more significant amount in 2018. Then you skip making the donations in 2019 and 2020. You can claim the standard deduction in those years, taking full advantage of that amount. This can save you thousands of dollars in taxes.
If you are a senior citizen, some of the deductions you can “bunch” may be for medical expenses. For 2018 and 2019, the threshold for being able to claim medical expenses is 7.5% of AGI, down from 10%. If your medical expenses exceed 7.5% of your adjusted gross income, you can deduct the excess. You can also retroactively claim the deduction for tax year 2017 if you are eligible.
2. Take Advantage of Tax-Deferred Retirement Accounts and HSAs
By making pretax contributions to a 401(k) or 403(b) in 2018, you can reduce taxes both now and in the future. A taxpayer in the 32% tax bracket would save $320 in federal income tax this year for every $1,000 in contributions to a 401(k) or similar plan. Because tax is paid on withdrawals from the account, and taxpayers tend to be in a lower tax bracket in retirement, there is a tax savings on the back end as well.
You can contribute $18,500 to your account in 2018, unless you are 50 or older; in that case, your contribution limit is $24,500. You must make your contributions by December 31, 2018 for it to count in 2018. If you have an IRA or a Simplified Employee Pension (SEP) IRA, you can make contributions up until April 15, 2019 that will count for 2018. Contribution limits for these accounts are $5,500 for those under 50, and $6,500 for those 50 and over.
Don’t forget about your Health Savings Account (HSA)! This account is good for much more than paying the deductible for your high-deductible health care plan.
Don’t forget about your Health Savings Account (HSA)! This account is good for much more than paying the deductible for your high-deductible health care plan. An HSA packs a one-two punch when it comes to reducing your taxable income. First, your contributions, made with pretax dollars, reduce your taxable income in the current year. Second, earnings are federal tax-free and may be free of state tax as well; any withdrawals you make to pay for qualified medical expenses are tax-free, too.
3. Take and Make Wise Distributions
If you have a retirement account, like a traditional IRA or 401(k) that requires you to take required minimum distributions (RMD), you must take your 2018 RMD by December 31. (If you turned 70 1/2 in 2018, you have until April 1, 2019 to take your RMD.) This is one deadline you do NOT want to miss; if you don’t take an RMD from a tax-deferred retirement account when you are supposed to, you will be hit with a penalty of up to 50% of the shortfall.
If you are age 70 1/2 or older, however, and you want to donate to a charity, you have another option for your distribution: a qualified charitable distribution (QCD). A QCD allows funds to be transferred directly from the custodian of your IRA to a qualified charity. This can count toward your annual RMD up to $100,000. What’s more, this distribution does not count against charitable contribution deduction limits, AND it is not included in your gross income! For qualified taxpayers with a significant amount of income, this can be a real boon, but the rules around QCDs are complex, so be sure to discuss your intentions with your tax advisor.
4. Take Advantage of QBI Deductions
If you own a small business that is a “pass-through” business for tax purposes (meaning the income of the business is reported on your personal tax return), you will want to take advantage of new qualified business income deductions. These deductions are available for sole proprietorships, partnerships, and S corporations, as well as LLCs that are taxed as partnerships or S corporations.
The Tax Cuts and Jobs Act (TCJA) that went into effect this year gives owners of pass-through businesses a 20 percent deduction of “qualified business income.” QBI includes business income other than income from investments. Specifically excluded are capital gains, foreign currency gains, wages and dividends, commodities gains, and investment interest income.
There are some limitations on which taxpayers can take advantage of the deductions, so you should speak with your tax or financial planner now, before year’s end, to maximize your ability to claim this new deduction.
The end of 2018 is fast approaching! If you would like to discuss moves you can make before year’s end to lower your taxes, we invite you to contact our law office.
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