With the new year just around the corner, it’s time to start thinking about what you can do now to manage your tax bill for 2019. These five topics will help you start a discussion with your tax advisor that can give you the freedom to enjoy your holidays without any last-minute scrambling for tax deductions.
Capital gain opportunities
Year-end is always a good time to evaluate your investment portfolio and determine what assets should be bought, sold, or held. This year’s review takes on a little extra urgency, as a significant opportunity to defer and even reduce taxes on capital gains will decrease in value after December 31. The Opportunity Zone Program enacted with the Tax Cuts and Jobs Act (TCJA) allows investors to defer taxes on capital gains until as late as 2026 by reinvesting those gains into a qualified fund and holding them there.
If you don’t make your opportunity zone investment before Dec. 31, 2019, it’ll be impossible to hold for seven years and qualify for the additional 5% step-up.
The program has additional incentives for individuals who invest early and hold for the duration. If a qualified investment is held for five years, the law rewards the taxpayer with a 10% increase or “step-up” in tax basis. At seven years, the taxpayer gets an additional 5% basis step-up, for a total of 15%. Those step-ups eliminate the corresponding percentages of deferred capital gains. The catch is that the program as enacted will expire as of Dec. 31, 2026. So, if you don’t invest before Dec. 31, 2019, it’ll be impossible to hold for seven years and qualify for the additional 5% step-up.
Capital loss opportunities
Even if an opportunity zone investment doesn’t fit with your plans, your investments should still be reviewed. Recent market volatility may have created loss positions in some of your investment holdings. If you decide it’s time to sell some of these investments at a loss, you can use the losses to offset other capital gain items recognized during the year. You can even reinvest in the same holding so long as you don’t do it within thirty days of the loss transaction since the “wash-sale” rules may prevent you from taking a current deduction for your loss.
Make your K-1 a number-one priority
If you own a partnership interest or stock in an S corporation, you may be familiar with the Schedule K-1 form used by the business to report your share of relevant income and deductions. It’s always been a key part of the information necessary to prepare your tax return, but the qualified business income deduction (QBID) enacted as part of the TCJA added new layers of complexity and confusion to the process.
While the QBID is often referred to as a 20% deduction for income from pass-through businesses, that percentage can be limited based on various factors. In 2018, many businesses struggled to communicate critical and relevant information to partners and shareholders via the K-1. Tax preparers frequently needed to follow up with the issuers of K-1s to clarify information on the forms or request additional facts necessary to report the results properly on the taxpayer’s Form 1040.
In previous years, taxpayers have typically waited to collect all of their relevant tax documents (W-2s, 1099s, K-1s, etc.) and handed them over to their tax preparers all at once in the proverbial “shoebox.” For 2019, forward K-1s to your preparer as soon as possible in case additional information is needed from the issuer. If the partnership or S corporation in which you own an interest is going to extend its return, obtain as detailed an estimate of your pass-through income or loss and related K-1 disclosure items as possible to support your own tax projections and estimated tax payments.
Forward K-1s to your preparer as soon as possible in case the preparer needs additional information from the issuer.
To the extent you can get projections from the partnership or S corporation throughout the year, that information can also be extremely helpful for year-end planning. If any single business, or a combination of businesses, looks like it could generate significant losses in the current year, early warnings could help you to manage other investments in order to protect against excess business loss limitation rules. In other cases, limitations on business interest expense deductions may increase the taxable income that will be allocated to you.
The TCJA made some major changes for taxpayers who previously itemized deductions. Some itemized deductions were eliminated and others subject to new limitations, like the $10,000 cap on the state and local tax deduction. But, the new law doubled the standard deduction, a move that made it more advantageous for many to take the lump-sum standard deduction provided under the law instead of documenting and calculating a variety of itemized deductions. In order to accumulate deductions in a year that exceed the standard amount ($24,400 for joint filers and $12,200 for singles in 2019), you might need to plan with intent.
One idea is to create a multiyear strategy for bunching deductible payments over which you can control the timing. The goal would be to exceed the standard deduction in year 2 by deferring some year 1 items where possible and accelerating year 3 items when the time comes. The easiest example is mortgage payments. Make your January year 2 payment in January, but make your January year 3 payment before December 31 of year 2 to get 13 months of interest into the year. That technique may be extended to other deductions as well.
Another opportunity is to bunch your charitable contributions similar to the mortgage example above or you could make a large lump-sum charitable donation to a donor-advised fund. Many local community foundations and large investment fund providers offer these types of vehicles. The full amount of the contribution to the donor-advised fund qualifies for a charitable deduction in the current year, but you can direct donations out of the fund to multiple charities in future years. This strategy can be helpful when there is a large bonus or some other event that spikes your income and you want to find some offsetting deductions in the current year.
While we’re on the topic of charitable giving, keep in mind that donating something other than cash that you have on hand could deliver the same benefit to the charity but a better tax result for you. Gifts of appreciated property to public charities like stocks or artwork can result in more favorable tax treatment than you would get if you sold your stocks or paintings and donated cash. Taxpayers over 70½ can also benefit from directing the payment of required IRA distributions directly to a charity.
Give while you’re alive
To optimize the value of your estate plan, you may want to integrate it with an overall wealth transfer plan that includes lifetime gifts. The TCJA doubled the lifetime gift exclusion to an amount in excess of $11 million, but the provision will expire after 2025 at which time, the exclusion will revert to $5 million. (The IRS has issued guidance that lifetime transfers utilizing the TCJA exclusion limit won’t be subject to recapture or “claw-back” when the limit reverts to the lower pre-TCJA amount.)
If you’ve got the wealth but you’re not sure that you want to hand it off to your heirs just yet, you have some options. There are strategies available to create trusts that meet all the preconditions for the gift but still permit you to pull back on the plan if you decide you don’t want to hand over the money at the current time. The key thing is to lay the groundwork early so that you can flip the switch one way or the other when the time comes, rather than scrambling to set up a gift in the waning days of 2025.
While this article has covered some of the broader topics that everyone should be considering this year, it’s no substitute for a discussion with a professional about the specific facts and circumstances of your tax profile. To learn more about steps you can take in the fourth quarter of 2019 to manage your federal tax obligations this year and beyond, please contact a Plante Moran advisor.