Dear Clients & Friends:
While last year at this time we were meshed in uncertainty relating to the new tax law, this year we find ourselves in relatively stable territory. From a tax perspective, most of the major events of 2018 revolved around guidance published by the Treasury Department lending clarity to numerous provisions of the Tax Cuts and Jobs Act of 2017 (TCJA). Because of the new law, we are faced with a whole new landscape this year for tax planning in general and for specific year-end moves. Please note our new business name above.
Year-end planning for individuals
- Determine your marginal tax bracket – In order to evaluate the effects of year-end maneuvers, there is no single piece of information more important than one’s marginal tax bracket. The regular 2018 federal tax rates can be found at http://taxfoundation.org/article/2018-tax-brackets. Throw in the 3.8% tax on net investment income (NIIT) if applicable, and the top Oregon marginal rate of 9.9% and it’s conceivable to have a marginal tax rate of over 50%. Expenditures resulting in a tax deduction should be evaluated at the net cost, i.e. cost of the expenditure less taxes saved. If one is subject to the alternative minimum tax (AMT) the marginal rate may be 26% or 28%. However, very few individuals will be subject to AMT in 2018 due to changes made by the TCJA. The Tax Policy Center estimates that only about 200,000 tax filers are expected to pay AMT in 2018, compared to about 5.25 million who would have paid under previous law.
- Contribute to an IRA by April 15th of 2019. Note that the deduction phases out as income increases if one or both spouses (if married) are covered by an employer plan. That aside, the maximum contribution for 2018 is $5,500 ($6,000 for 2019) plus another $1,000 catch-up contribution for those who are age 50 or older as of 12/31/18. You or your spouse must have earned income to contribute. Also note that if you are subject to the 3.8% net investment income tax which is driven by adjusted gross income (see example below), a deductible contribution will reduce that tax as well.
- Contribute to a Roth IRA – If you are willing to forego a current tax deduction, consider a Roth IRA instead. Although you won’t save any taxes today, the earnings in the account are never taxed, even upon withdraw, if you follow the rules. The maximum contribution is the same dollar amount as for a traditional IRA but subject to phase out beginning at modified adjusted gross income of $189,000 for taxpayers filing jointly and $120,000 for single and head of household taxpayers. Taxpayers with income in excess of the phase out level might want to consider contributing to a traditional non-deductible IRA and then rolling the amount to a Roth. Caveat – there will be tax consequences to the rollover if the taxpayer has an already existing traditional IRA.
- Don’t forget to take the Required Minimum Distribution (RMD) from your retirement plan – Taxpayers who are at least 70½ must take their RMD no later than 12/31/18. If however, you reach age 70½ in 2018, your first RMD can be delayed until April 1, 2019. Also, see the fourth bullet point under “multiple strategies for charitable gifting” below.
- Be wary of the net investment income tax (NIIT) which applies to taxpayers with modified adjusted gross income in excess of $250,000 for married taxpayers filing jointly, $125,000 for married taxpayers filing separately, and $200,000 for all other taxpayers. The tax is assessed on the lesser of one’s net investment income or modified adjusted gross income in excess of the threshold. If the latter, a drop in adjusted gross income results in a NIIT reduction. Example – Olive (a single taxpayer) has modified AGI of $240,000, which includes net investment income of $50,000. Olive’s NIIT is assessed on $40,000. If Olive contributes $6,500 to a traditional IRA, her modified AGI drops to $233,500 and her NIIT is assessed on $33,500. Therefore, Olive not only saved income taxes at her marginal tax rate from making the contribution but also saved another 3.8% NIIT.
- Consider bunching your itemized deductions in one year instead of spreading them over two years. This is especially true with the increase in the standard deduction for 2018 to $24,000 for taxpayers who file jointly, $18,000 for head of household, and $12,000 for single and married taxpayers who file separately. Additional amounts are added for taxpayers who are blind and/or over 65 years old. If you don’t expect to itemize in 2018 forward, consider bunching deductions for medical and charitable contributions for example so that you might benefit from itemizing every other year. Note – Most states, including Oregon, have a much smaller standard deduction. Thus, you should continue to track your itemized deductions to derive a state tax benefit. Point – you’ll only derive a federal benefit from itemized deductions in excess of the standard deduction. Example – you work very hard to drive itemized deductions up to $25,000 on a married filing joint return. Had you not exceeded the standard deduction amount, you would have still been able to deduct $24,000 so you’ve only benefited from $1,000 of the deductions on your federal return.
- Consider multiple strategies for charitable gifting:
- Make charitable donations of appreciated stock held for longer than one year. This avoids taxation of the gain and yields a full fair market value deduction.
- If you want to make large gifts in 2018, consider a “donor advised fund” which allows you to take a deduction for property transferred this year while having the fund dole out the funds to qualified charities at a later date. Consider the Oregon Community Foundation if you’re interested.
- Consider setting up one of a variety of charitable trusts thereby enabling you to gift property this year and take a charitable deduction for the value of the property less the remainder interest. Some charities have “pooled income funds” which are similar but take the paperwork burden off the donor.
- Consider ability to transfer up to $100,000 tax-free from a traditional IRA to charity for owners who have reached age 70 ½. This tax-free transfer can even satisfy an owner’s required minimum distribution for the year.
- Consider donating to the Oregon Cultural Trust (OCT) – If you donate up to $500 on a single return or $1,000 on a married filing joint return to qualifying cultural organizations, you can donate a like amount to the OCT and receive a 100% Oregon tax credit. More info is available at www.culturaltrust.org. Point – Unfortunately, the IRS issued guidance this year which denies a federal tax deduction for contributions to the OCT and other charities which promise a state level tax credit in return unless the contribution was made prior to August 28th, 2018. (See our email blast from August of this year.) Making a donation to the OCT after that date achieves no federal tax savings but does allow one the discretion of allocating their dollars to the Oregon Cultural Trust rather than the state’s general fund.
- Consider selling loss stocks before year end if you expect net capital gains for the year.
- Recognize long term gains if in a low tax bracket – Net long-term capital gains and qualified dividends are subject to a favorable federal tax rate. The maximum federal rate is 20% (plus the 3.8% NIIT if applicable) but drops to 15% to the extent taxable income is less than $479,000 for taxpayers filing jointly, $452,400 for head of households, $425,800 for single individuals, and $239,500 for married individuals filing separately. And, it drops to 0% to the extent taxable income is less than $77,200 for taxpayers filing jointly, $51,700 for head of households, and $38,600 for single individuals and married individuals filing separately. Therefore, if your taxable income is reasonably low, you might be able to recognize long term capital gain or qualified dividend income at no federal tax cost. State taxes will of course apply.
- Remember the new cap on deductible state and local taxes on Schedule A – Because the TCJA capped itemized deductions for taxes at $10,000, there can be no federal benefit for paying state income or property taxes in excess of that amount. The state of Oregon connects to federal law for this purpose, limiting the deduction for taxes to $10,000. Because Oregon state income taxes are not deductible for Oregon purposes, you will only benefit from paying property taxes by year end. Example – Leo has state withholding of $20,000 for the year and owes $12,000 of property taxes. For federal tax purposes, payment of the property taxes will provide no tax benefit because he’s already over the $10,000 cap. For Oregon purposes, he’ll benefit from the first $10,000 of property taxes paid in 2018.
- Contribute to an FSA – If your employer offers a flexible spending account, sign up!
- Consider an installment sale of property vs an outright sale for cash in order to spread revenue over multiple years. This might result in more capital gains in the lower tax brackets and might lower or eliminate the 3.8% net investment income tax on the gain.
- Consider disposing of passive activities with suspended losses to unrelated parties prior to year end. This causes the suspended losses to be immediately deductible without regard to passive loss limitations.
- Consider the status of business activities as passive or non-passive – The effects of classification are many, including deductibility of passive losses, income subject to the 3.8% NIIT, and application of Oregon’s special reduced pass thru entity rate. Note – Effective this year, Oregon expanded application of the special reduced rate to sole proprietorships. The special rate continues to apply to non-passive income from businesses with at least one non-owner Oregon employee who worked at least 1,200 hours during the year.
- Special note regarding revised “kiddie tax” under the TCJA – Prior to 2018, most of a child’s income was subject to tax at the greater of his/her tax rate or that of his/her parents. The TCJA changed the rules in a big way. This year, individuals subject to the “kiddie tax” (generally, those who are under 18 at year end or full-time students under the age of 24 at year end) are taxed using the rates for estates and trusts. Referring to the 2018 tax rate schedules under “determine your marginal tax bracket” above, you can see how egregious those rates are. It’s possible if not probable that your child will be in a higher tax bracket than you under this new regime. Thus, you should consider reducing the child’s taxable income by for example, investing in municipals or growth stocks.
- Make expenditures that qualify for the residential energy efficient property credit – The TCJA preserved the credits for solar, wind, geothermal, and fuel cell property in full through 2019. In 2020 and 2021, the credits are reduced from 30% to 26% and 22% respectively. The credit is set to expire after 2021.
- Consider investing in a “qualified opportunity fund” – see our recent email newsletter on this topic.
- Consider contributing to a 529 plan – While contributions to a 529 plan provide no federal tax deduction, the earnings are tax-free if used to pay qualified higher education expenses. Oregon allows a tax deduction up to $2,375 ($4,750 if filing jointly) in 2018 for contributions to the Oregon College Savings Plan. Excess amounts can be carried forward four years. The TCJA expanded the list of qualifying higher education expenses to include tuition for elementary or secondary public, private, or religious schools, subject to a $10,000 limit per beneficiary. For more information on 529 plans, see https://www.irs.gov/newsroom/529-plans-questions-and-answers.
Year-end planning for businesses
- Set up and contribute to any one of a number of business retirement plans such as a 401(k), SIMPLE, SEP, or profit-sharing plan. All but the SEP must be set up prior to year end (generally by October 1), but all can be funded by the extended due date of the taxpayer’s return.
- Purchase fixed assets before year end to take advantage of the section 179 deduction or 100% bonus depreciation – For many businesses, the difference between the two is inconsequential – both usually result in a 100% deduction for equipment and other tangible personal property. However, the TCJA amended the definition of section 179 property to include selected improvements to nonresidential real property such as roofs and HVAC property. These can be written off under section 179 but not as bonus depreciation. Under section 179, businesses can expense up to $1,000,000 of qualifying fixed assets for years beginning in 2018. The dollar limitation phases out dollar for dollar as total qualifying purchases exceed $2,500,000. Note – Due to a glitch in the TCJA, “qualified improvement property” (QIP) no longer qualifies for bonus depreciation. QIP includes generally, any improvement to an interior portion of a building which is nonresidential real property. Although the committee reports indicate that Congress intended to give QIP a 15-year life, thereby making it eligible property, the drafters of the law failed to get this change incorporated. Therefore, at present, QIP is depreciated over a 39-year life with no bonus.
- Determine whether your business qualifies for the Work Opportunity Tax Credit – This credit applies to employers who hire individuals in groups whose members historically have low employment such as veterans, ex-felons, food stamp recipients, and many more.
- Consider adopting (or retaining) a qualifying family and medical leave plan for employees – The TCJA installed a new tax credit for employers who have a qualifying plan in place which provides at least two weeks of paid family and medical leave to full-time employees (and a prorated amount for part-time employees) which provide pay of at least 50% of an employee’s normal wages while on leave.
- Create basis to absorb owner losses – Make sure the owner(s) of an S corporation or partnership have ample basis to deduct losses prior to year end.
- Consider whether your business activities in another state create “nexus” requiring the filing of a state tax return and payment of the taxes that go along with it. It is sometimes possible to manage activities so that nexus is not created; each state’s rules are different. It is worth noting that states have increasingly abandoned the physical presence nexus standard in favor of an economic presence nexus standard.
- Does your business qualify for research and development credits? The R&D credit is now a permanent tax credit. If your business engages in activities which are intended to develop or improve a product or process, is technological in nature, and which uses a process of experimentation to resolve technical uncertainty, you might qualify. Activities related to software qualify under certain circumstances.
- Planning related to the TCJA’s new 199A pass-through deduction – For a broad discussion of this new law, see our email newsletter from September of this year. If your business qualifies for the deduction but will be limited based on the wage or asset limitation, consider steps such as paying wages to increase the potential deduction, minimizing “guaranteed payments” paid by a partnership in favor of profit allocations, and causing two or more businesses to qualify for aggregation.
Estate & gift environment
The United States has a unified transfer tax system which limits the amount one can transfer to others during their lifetime and at death combined without paying transfer taxes. For 2019, the estate and gift tax exemption is a whopping $11,400,000 and the top federal estate and gift tax rate is 40%. The top Oregon estate tax rate is 16%. Note that Oregon has no gift tax! During 2018 and 2019, an individual can make gifts of $15,000 per donee without using any of the exemption amount. If your net worth is over the estate exemption, it makes sense to consider making annual gifts to whittle some of the excess away. If your net worth is less than the federal exemption amount, consider larger gifts to save Oregon estate tax.
In early 2013, Congress made the estate tax portability rules permanent. This means that if one spouse dies without using up all of the exemption amount, the unused amount can, if an election is made, be used by the surviving spouse upon his or her death. The election must be made on a timely filed federal estate tax return for the first deceased spouse.
Other notable information
- Required filing for foreign bank accounts (FBAR) – Significant penalties are imposed for failing to file the required report if you have an interest or signature authority over a foreign bank account at any time during the year. The report is required if the balance in the account reaches $10,000 at any time during the year.
- W-2 and 1099 filing requirements – Penalties for failing to file a required form can reach as high as $540 per occurrence. In general, your business is required to file a 1099 if you make payments for services, rents, interest, etc., of $600 or more during the year. Forms are required to be provided to the payee and filed with the IRS no later than 1/31/2019.
We hope the year has been happy and prosperous for your family and loved ones. We are grateful for our client and business relationships and hope we can meet your expectations and give you the service and attention you deserve. Please let us know if you have any questions about this newsletter or your tax situation.
Zirkle, Long, & Associates