Year-End Tax Planning: The Things You Need to Know
Major Tax Changes in 2018
There are some major changes for year-end tax planning for 2018. This has been a tumultuous year for taxes. Tax reform takes affect this year, 2018, and it has significant changes for both individuals and businesses. This is the first major tax reform legislation in more than 30 years. To implement it, the IRS has to create or revise approximately 450 forms, publications and instructions. Also, the IRS has to modify around 140 information technology systems to make sure it can accommodate the new tax forms. This will include writing tax regulations for all of these changes – a daunting task for sure. The following are issues that could affect your or you personally. So you may need to plan for these tax changes.
Refund or Tax Due?
Most taxpayers equate the recent tax reform to a larger refund for their 2018 tax return. However, that may not be the case. Why, you wonder? It is because your tax refund is the difference between what you prepaid through payroll withholding and estimated tax payments and what you owe. Even if your tax bill is lower, if your prepayments were also lower, your refund may not be what you expect.
Underpayment of Taxes
The passage of tax reform came on December 20, 2017. It came just days before employers needed Form W-4 – the Employee’s Withholding Allowance Certificate – for 2018 withholding information from their employees. The passage did not give the IRS time to adjust the form and withholding tables for the new law. It was not until late February that the IRS published revised withholding tables and an updated Form W-4. Even then, there was concern that some employers might be using the old W-4 with the new tables. On top of that, many taxpayers and tax professionals were finding that the revised W-4 and withholding tables did not produce an accurate result. There is a real concern that many taxpayers are in for an unpleasant surprise at tax time. The IRS has been issuing almost daily notices warning taxpayers that they may be under-withheld. This is a real concern for 2018 returns, and you may wish to fine-tune your withholding before year’s end.
Tax Underpayment Penalties
You may be subject to underpayment penalties, should your liability be greater than your prepayments by $1,000 or more. This could simply be the result of several things. First, there could be under-withholding on your wages. Second, you may be underpaying estimated tax if you are self-employed. A third reason my be out-of-the-ordinary income. This includes stock gains, sale of a business or rental or even winning big from the lottery. There are safe harbor prepayments to avoid a penalty; but again, this requires prepaying:
90% of the current year’s tax liability,
100% of the prior year’s tax liability, or
110% of the prior year’s tax liability, if the prior year’s AGI was over $150,000.
If you are underpaid, there is still time to make adjustments and avoid or mitigate the penalty. Adjusting your payroll withholding is the best option. This is because withholding is treated as being paid ratably throughout the year. Also, the computation of the penalty is on a quarterly basis due to the prepayments through that quarter. However, as the end of the year gets closer, there is little time for the change in withholding to kick in. So don’t delay in notifying your employer if you need to increase your withholding.
Alternative Minimum Tax (AMT)
Although Congress had promised to repeal both individual and corporate AMT, they only repealed the corporate AMT. However, even though they didn’t repeal it for individuals, the tax reform act did increase the exemption amounts and phase-out thresholds. And, it eliminated certain deductions that triggered the AMT. This means the AMT will impact fewer taxpayers, giving rise to these possible strategies:
Exercise Incentive Stock Options
These changes to the AMT may allow larger blocks of incentive stock options to be exercised, and the stock that’s issued can be held long-term. Therefore you can enjoy the lower capital gains tax rates without triggering the AMT. This may require long-term tax planning, which may be a multi-year endeavor.
The higher exemptions and phase-outs provide a greater opportunity for taxpayers with AMT tax credit carryover to recapture AMT paid in prior years. If the current year’s regular tax exceeds the AMT, a taxpayer can claim the AMT credit carryover for the difference.
Minimum Required Distributions
Avoid the Minimum Required Distribution Penalties. Once taxpayers reach the age of 70.5, they are required to take what is known as a “required minimum distribution” from their qualified retirement plan or IRA every year. Is this the first year that this rule applies to you? If so, and you haven’t taken your money out yet, there’s no need to panic. You don’t have to do so until some time during the first quarter of next year. Of course, if you wait until 2019 to take your 2018 distribution, you’re going to end up having to take two distributions. One distribution one year: one for 2018 and one for 2019. For those who fell into this category before 2018, you only have until December 31st to withdraw your 2018 distribution to avoid penalties.
Convert into a Roth IRA
Do you have a traditional IRA and your income for 2018 has been very low? Consider converting your traditional IRA into a Roth IRA. This move takes advantage of the tax-free distribution benefits of a Roth IRA in the future. This is especially if you can do so with little or no tax on the conversions. This will probably require a tax projection to determine an amount to convert and the tax cost, if any, of the conversion. However, the tax reform made conversions permanent, and once made, the conversion cannot be undone.
Review Portfolio for Losses
The conventional strategy is to offset as much of your gains as possible with losses. These losses are from selling other assets in your portfolio. Do you have an overall loss? The loss that can be used to offset income is limited to $3,000 ($1,500 for married taxpayers filing separately). The exception here is capital gains. Also, any excess loss carries over to the next year. Keep in mind that losses from the sale of business assets are generally separately allowed in full in the year of sale. And, they are not mixed with the losses from the sale of capital assets.
Assets that are sold and not held long-term (short-term capital gains), don’t receive the benefit of the special rates afforded to long-term capital gains. Taxpayers achieve a better overall tax benefit if they can arrange their transactions to offset short-term capital gains with long-term capital losses.
Make the Most of Higher Education Tax Credits
Both the Lifetime Learning education credit and the American Opportunity Credit allow qualified taxpayers who prepaid tuition bills in 2018 for an academic period that begins by the end of March 2019 to use the prepayments when claiming the 2018 credit. That means that if you are eligible to take the credit and you have not yet reached the 2018 maximum credit for qualified tuition and related expenses paid, you can bump up your credits by paying early for 2019 now. This may not apply to you if you’ve been paying tuition expenses for the entire 2018 tax year, but it will probably provide you with some additional help if your student just started college this fall.
Optimize Health Savings Account Contributions
Here is another valuable year-end tax planning strategy. Did you become eligible to make contributions to a Health Savings Account this year? If so, then you can make deductible contributions into that account up to its maximum amount, no matter when you became eligible. For 2018, the maximum deduction for self-only coverage is $3,450; for family coverage, it is $6,900.
Empty Flexible Spending Accounts
If you have a flexible spending account, double-check to see if there is an account balance. If so, you can use it for medical expenses, including eyeglasses and/or other health care items covered by the FSA. Remember, you will forfeit the funds remaining in the account if you don’t use them by the deadline.
Bunch Charitable Deductions
Many people who itemize take advantage of the ability to take a deduction for their donation to their favorite charity or house of worship. Did you know that you can choose to pay all or part of your 2019 planned giving in 2018 to increase the amount you deduct in 2018? Though this may not be appealing to those who itemize every year. You may find this to be an effective strategy if you only marginally itemize every year. Implementing this strategy means you will alternate between taking the standard deduction one year and itemizing the next. This will give you a big boost in deductions on the year when you itemize.
Minimum IRA Distributions
Additionally, those who are required to take a required minimum distribution from their IRA because they are 70.5 or older can have their RMD paid directly to a qualified charity, and instead of getting a charitable deduction, the distribution is tax-free, which in turn might reduce the amount of your taxable Social Security income. If this strategy appeals to you, don’t wait until the last minute to implement it, as your IRA trustee or custodian will need time to process the paperwork and make the distribution to the charity or charities you designate.
Every Taxpayer’s Situation is Unique
We will continue this discussion in our next blog. Remember, that not all of these scenarios will apply to you. By no means does the list include all the changes brought about by tax reform. However, they cover many of the major issues for taxpayers and small businesses. Do you have any major business, income, or family changes? Do any of the issues in this article affect you? A year-end tax planning appointment may be appropriate. The best way to ensure that you are putting yourself into the best tax-advantage position is to consider all of your tax options. Please call with questions or to make an appointment. We have 3 convenient locations in Norwell, Weymouth and Dedham.
Alex Franch, BS EA
Alex is a Tax Specialist and Partner at Joseph Cahill & Associates / WorthTax. He has a diverse background including a Bachelor of Science from Boston College in Mathematics and extensive military service. Alex is an Enrolled Agent and has a decade of tax preparation experience. He is passionate about serving businesses with tax and financial planning strategies.
Mr. Franch is licensed by the Financial Industry Regulatory Authority (FINRA). He holds a Series 6, 63, 65, and 7, and by the Commonwealth of Massachusetts Division of Insurance.
Alex Franch is a registered representative of, and offers securities and investment advisory services through, Commonwealth Financial Network. He is a registered broker-dealer, Member FINRA/SIPC.
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