2019 year-end letter
Dear Clients & Friends:
This year has been a quiet one on the tax legislation front because Washington is so dysfunctional that few bills can make it through the system. We had hoped for a technical corrections bill which would alleviate some of the problems created by the tax law passed late in 2017 but alas we got nothing. There is still a chance we’ll get a bill before year-end as there seems to be some bipartisan agreement on selected provisions, but we’re not holding our breath. If such a bill were to come up for a vote, it might include an expansion of tax breaks for renewable energy, an enhanced earned income credit for single filers without children, a charitable deduction for those who don’t itemize deductions, and one or more of the many needed technical corrections related to the 2017 tax act, such as making qualified improvement property eligible for bonus depreciation.
There is one bill that came very close to being enacted into law, and in fact, still may, with tweaks. The SECURE Act of 2019 as written would raise the age for taking required minimum distributions from retirement accounts from 70 ½ to 72; allow those who have reached age 70 ½ to contribute to an IRA; and make other changes to retirement savings laws. On an unpopular note, it would also kill the “stretch IRA” provision by requiring non-spouse beneficiaries to fully withdraw the balance in an inherited IRA within 10 years. This has caused great consternation among those who have centered their wealth transfer planning around the stretch IRA provision, and who might be relieved to hear that a compromise deal has been reached, although the details of that compromise are unknown.
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 2019 federal tax rates can be found at http://taxfoundation.org/article/2019-tax-brackets. Throw in the 3.8% tax on net investment income (NIIT) if applicable, the 15.3% self-employment tax if applicable (plus another .9% on earned income in some cases), and the top Oregon marginal rate of 9.9% and it’s conceivable to have a marginal tax rate of well over 50%. Expenditures resulting in a tax deduction should be evaluated at the net cost, i.e. cost of the expenditure less taxes saved.
While the alternative minimum tax used to play a big role in tax planning and determining one’s marginal tax planning, that is no longer the case absent unusual circumstances.
- Contribute to an IRA by April 15th of 2020. 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 2019 is $6,000 plus another $1,000 catch-up contribution for those who are age 50 or older as of 12/31/19. 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 $193,000 for taxpayers filing jointly and $122,000 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 12/31/19. If, however, you reach age 70½ in 2019, your first RMD can be delayed until April 1, 2020. 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 $6,000 to a traditional IRA, her modified AGI drops to $234,000 and her NIIT is assessed on $34,000. 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. The standard deduction for 2019 is $24,400 for taxpayers filing jointly, $12,200 for single filers, and $18,350 for heads of household. Additional amounts are added for taxpayers who are blind and/or over 65 years old. If you don’t expect to itemize under normal circumstances, 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.
- 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. However, contributions of long-term capital gain property are limited to 30% of adjusted gross income vs 60% for cash donations. If your non-cash donation is large compared to your adjusted gross income, donating appreciated property could be less favorable.
- If you want to make large gifts in 2019, 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 a qualified conservation easement to a land trust or other qualified organization. The result is preservation of the property in its (mostly) natural state, retention of the land for personal enjoyment, and considerable tax savings.
- 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. While the donation achieves no federal tax savings, it but does allow one the discretion of allocating their dollars to the Oregon Cultural Trust rather than the state’s general fund.
Example – Laurie and Dave have already given in excess of $1,000 to cultural organizations during the year. Specifically, they gave $500 to KLCC and another $500 to the Oregon Country Fair. If they donate $1,000 to the Oregon Cultural Trust by year end, they will receive a $1,000 Oregon tax credit and a $1,000 Oregon tax deduction saving as much as 9.9%. Total tax savings is $1,099 for $1,000 out of pocket.
- 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 $488,851 for taxpayers filing jointly, $461,700 for head of households, $434,550 for single individuals, and $244,425 for married individuals filing separately. And, it drops to 0% to the extent taxable income is less than $78,750 for taxpayers filing jointly, $52,750 for head of households, and $39,375 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 2017 tax bill 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.
- Contribute to an FSA – If your employer offers a flexible spending account, sign up!
- Consider adopting an HSA – Health Savings Accounts have grown in popularity with the rising cost of health insurance premiums. You can make a tax-deductible contribution to an HSA in conjunction with the purchase of qualifying high-deductible health insurance. See our article on HSAs on our website.
- 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. Effective in 2018, 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.
- Avoid the “Kiddie tax” – After the 2017 tax law, 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 2019 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 rate applicable to solar, wind, geothermal, and fuel cell property is 30% through the end of this year. In 2020 and 2021, the credits are reduced to 26% and 22% respectively. The credit is set to expire after 2021.
- Buy an electronic vehicle – Tax credits are available for purchase of most plug-in electric vehicles as well as hybrid plug-ins. Because the credit phases out when manufacturer sales exceed 200,000 qualifying cars, you should check on the rate for the car you’re interested in. Oregon offers rebates as well. As an example, the purchase of a Toyota Prius Prime qualifies the purchaser for a $4,502 federal tax credit and $1,500 Oregon rebate, depending on the purchaser’s personal tax liability.
- Consider investing in a Qualified Opportunity Fund – See our 2018 newsletter on this topic on our website at www.zirklelong.com.
- 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 $2,435 ($4,865 if filing jointly) in 2019 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. Incredibly, Oregon is disconnected from this change, meaning that amounts withdrawn for other than higher education expenses results in an addition to Oregon income. For more information on 529 plans, see https://www.irs.gov/newsroom/529-plans-questions-and-answers.
New for next year – The deduction for contributions to Oregon’s College Savings Plan is replaced with a refundable tax credit. Contributions in excess of the limit in 2019 are still available for the current 4-year carryforward. In 2020, the maximum Oregon credit is $300 for joint filers and $150 for others. See information here https://www.oregoncollegesavings.com/faqs/category/Taxes on the credit allowable for various levels of adjusted gross income. If it’s important to you, consider contributing enough this year to max out the 4-year carryforward and contribute in future years to get the Oregon credit.
Year-end planning for businesses
- 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 definition of section 179 property includes 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 2019. The dollar limitation phases out dollar for dollar as total qualifying purchases exceed $2,500,000. Bonus depreciation remains at its current rate of 100% through 2023.
- 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.
- 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. Under the economic presence test, a business will generally have a filing requirement if sales destined for the state are over a dollar threshold, despite having no other activity in the state. As an example, the state of Washington requires businesses to file and pay the B&O tax for 2019 if gross receipts sourced or attributed to Washington are more than either (1) $285,000 or (2) 25% or more or the business’ gross receipts for the year.
- 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.
- Plan to maximize the 199A pass-through deduction – For a broad discussion of this new law, see our newsletter from September of 2018 on our website. 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.
- Consider investing in or organizing your business as a small business corporation – Section 1202 of the Internal Revenue Code provides a 100% exclusion from income for capital gains on the sale of qualifying stock held for at least five years. See our website for the archived newsletter in January 2017 on the topic.
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 2020, the estate and gift tax exemption is $11,580,000 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 2019 and 2020, 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.
Earlier this year, the Treasury Department issued regulations explaining what happens if the current generous estate and tax exemption sunsets (as it is scheduled to do for deaths in 2026 and thereafter) and one has already gifted amounts up to or exceeding the higher pre-sunset amount. The favorable answer is that one will not be penalized for making gifts that are covered by the exemption in effect at the date of the gift.
Example – Jennifer makes a gift of $9 million in 2019 when the federal exemption amount is $11,400,000. Jennifer dies in 2026 at which time the exemption has reverted to $5 million. Under the regulation, her estate is entitled to an exemption of $9 million. In other words, her estate will not be penalized for gifts made when they were sheltered from gift tax due to a higher exemption at the time the gifts were made.
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 1/31/2020.
- Oregon announced the 2nd highest kicker rebate in history – The kicker is claimed on 2019 tax returns and is equal to 17.71% of one’s 2018 tax liability before all credits other than the credit for taxes paid to other states. See the newsletter on our website for more information.
- New Oregon Corporate Activity Tax is effective as of 1/1/20 – Note that this tax is applicable not just to corporations, but to all businesses including those operating as a sole proprietorship. Refer to our newsletter earlier this year posted on our website. The Oregon Department of Revenue has announced that it will issue rules for implementation in 3 parts beginning next month. We’ll keep you updated as the rules are issued. In the meantime, be aware that businesses which are subject to the tax are expected to register for the CAT in 2020 and pay a 1st quarter estimate by April 30th of 2020, if they expect to owe the tax.
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