It’s the most wonderful time of year, time to help save you money for the 2019 tax season. Year-end planning can seem like a daunting task and should not be taken lightly. Coming off the biggest tax legislation change since 1986, we want to ensure you are taking the necessary actions to make the new tax law work in your favor. In our year-end planning article, we discuss several strategies that should be addressed before 2020.
If you own taxable investment accounts, tax-loss harvesting is a planning strategy that should be considered. The principal benefit is to offset any large capital gains realized in 2019. This strategy will reduce income taxes, allowing your investments to grow at a faster rate without having to withdraw earnings to pay those income taxes.
While it may seem that losses have no inherent benefit, they can prevent you from paying taxes on capital gains. Tax-loss harvesting can involve both short-term (held one year or less) and long-term (held longer than one year) investments. The importance of your broker and CPA working together to implement this strategy is paramount.
Looking ahead, no matter your political affiliation, the potential changing of the guard could result in increased taxes to higher net worth individuals. Harvesting losses could save you a marginal amount in taxes now but could potentially yield much larger savings in years to come.
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Itemized Deductions – Bunching Contributions and Property Taxes
For many taxpayers, the new standard deduction amount of $24,400 has made it more difficult to take advantage of charitable deductions and property taxes. If you are on the border of being able to itemize or take the standard deduction, we recommend bunching these contributions and taxes to a single year.
Using a tool such as a donor advised fund can address this issue for contributions and allow you to continue giving on an annual basis while taking advantage of available tax benefits. You can make a deduction in full to the donor advised fund in the year you need the tax deduction, whether you know the specific organization that you would like to contribute to at the time or not. The money will stay in the fund and grow tax free until you decide the appropriate organization that you would like to grant the gift. This gift can be distributed as a lump sum to the organization or over the same amount of time you would have originally contributed.
It’s important to remind taxpayers that the most tax beneficial form of contributions are long-term appreciated stocks. There are several benefits to donating appreciated stock rather than just writing a check. If held for over a year, appreciated stocks can be donated to a qualified charity at fair market value. On the other hand, if the stocks are sold and the cash is subsequently contributed, taxpayers are hit with paying taxes on that long-term gain.
A similar strategy can be implemented with property taxes. However, since the deductible amount of taxes is now capped at $10,000 a year, grouping property taxes may not be for everyone. Consult your tax advisor as to whether this strategy would be applicable to your tax situation.
Converting Traditional IRAs into Roth Accounts
While we are experiencing some of the lowest federal tax rates in history, it might be time to consider taking advantage of a ROTH conversion strategy. Converting your Traditional IRA into a ROTH IRA is a simple, tax-efficient strategy that can reduce your tax burden upon retirement. The idea is to pay taxes on your contributions now, while in a lower tax-bracket, to avoid a higher tax burden later. ROTH IRAs are ideal for taxpayers who believe they will pay higher tax rates during retirement. The current tax hit from a conversion done this year may turn out to be a relatively small price to pay for avoiding potentially higher future tax rates on the account’s earnings.
Unlike Traditional IRAs, ROTH IRAs include two tax advantages:
- Qualified ROTH IRA withdrawals are federal income tax-free, and
- Required Minimum Distributions (RMDs) are not required after reaching age 70 ½.
Several years ago, the ROTH conversion privilege was only available to those with a modified AGI of $100,000 or less. Now, that restriction is gone, and anyone is eligible to convert from Traditional to a ROTH.
Remember to consult your tax advisor when converting to avoid common pitfalls such as paying early withdrawal penalties, paying unnecessary taxes on your social security benefits, or moving to a higher tax bracket.
Required Minimum Distributions – Qualified Charitable Distributions
Let’s consider taxpayers who have not made the conversion to a Roth IRA. Once you reach 70 ½ or older, you are required to begin taking distributions from your Traditional IRA. These distributions are considered ordinary income and are taxed at your applicable federal income tax rate. There is an alternative to including these distributions as ordinary income. You can make a direct donation from your IRA to a charitable organization up to $100,000 per tax year. The donation must be made to a charitable organization other than a private foundation or donor advised fund, and the charitable organization must provide an acknowledgement letter stating the value received and that no goods or services were provided in return. One of the benefits of the direct charitable donation from your IRA is that the distribution counts towards your Required Minimum Distribution. In addition, the direct charitable donation is excluded from income, lowering your AGI.
Health Savings Accounts
If you have a Health Savings Account (HSA), be sure to maximize your contributions for the year. Contribution limits for 2019 are $3,500 for an individual, $7,000 for a family, and an additional $1,000 for those 55 or older. You must have a high deductible health plan to contribute to an HSA. Contributing to your HSA is a way for you to be able to get an “above the line deduction” for your health care costs without having to incur medical expenses in excess of the AGI threshold. Any contributions you make to the HSA will remain in your account, and any unused funds roll over to the following year.
Considered one of the best tax vehicles available to taxpayers, the HSA is advantageous for more than just the deduction for your contributions. Many HSA accounts offer the flexibility to invest the funds in your account while they are not being used. As you invest these funds, the account will grow tax free. When the time comes to use your HSA for medical bills, the contributions and earnings are not considered taxable.
Gift Tax Exclusion
For 2019, the lifetime exclusion was raised to $11.4 million per person. The 2019 annual exclusion allows you to give up to $15,000 to an unlimited number of recipients counting against your lifetime exclusion. An important point to remember is that federal gift tax applies only to the gift givers, not the gift recipients.
Investing in Mutual Funds
If you are planning to invest in or recently invested in a mutual fund, knowing when your fund’s year-end distribution is could save you from an unexpected tax bill. Research the amount and timing of your mutual fund’s annual capital-gains distributions. This information can be found on most large mutual fund’s websites. When investing, it’s wise to make tax-efficient investment decisions to maximize your returns. Consider waiting to invest in the fund until after the distribution date.
As an alternative to mutual funds, Exchange-Traded Funds (ETFs) can be a more tax efficient option. Similar to mutual funds, ETFs are subject to capital gains and taxation on dividend income. However, these funds are structured to minimize the tax being pushed out to investors. Mutual funds ordinarily distribute capital gains annually, but it is rare for an index-based ETF to pay out capital gains. Mutual fund managers consistently re-balance the fund to accommodate shareholder redemptions or to re-allocate assets. The sale of securities within the mutual fund triggers capital gains for the shareholders. Taxpayers should consider meeting with their investment advisors to see if ETFs would align with their portfolio and tax strategy.
The Kiddie Tax
Congress created the “kiddie tax” rules to prevent families from shifting the tax bill on investment income from the parents’ higher tax bracket to the child’s lower bracket. For 2019, the kiddie tax taxes a child’s investment income above $2,200 at the same rates as trusts and estates, which are typically higher than rates for individuals. If the child is a full-time student who provides less than half of his or her support, the tax usually applies until the year the child turns age 24.
So be careful if you plan to give a child stock to sell to pay college expenses. If the gain is too large and the child’s unearned income exceeds $2,200, he or she could end up paying taxes at the same rates as trusts and estates.
Utilizing a 529 Plan for Estate Planning
Customarily, 529 plans have been popular savings vehicles for post-secondary education. One of the many benefits of 529 plans is that contributions qualify tax-free under the 2019 annual gift tax exclusion of $15,000. As a result, these plans are often used as estate planning tools – allowing parents and grandparents to shelter assets from estate taxes – in addition to college-savings vehicles. However, it’s important to note that funds from a 529 plan may be used exclusively on educational expenses.
Similar to HSA plans, the funds in a 529 plan can be invested and will grow tax free. Taking advantage of this tax tip in addition to the 5-year election, a 529 plan can be super funded up to $75,000 into one year.
Changes Important to Year-End Planning
It is imperative to notify your tax advisor if any life changing events have occurred in 2019 that may impact your taxes. Below are just a few examples:
- Change in filing status: marriage, divorce death or head of household status
- Birth of a child
- Known large capital gains
- Changes in medical expenses
- Employment changes
- Large inheritance
- Large income events in 2019 or upcoming
As opportunities are still available with the TCJA, now is the time to capitalize. Careful planning with your tax advisors at LBMC can help you make the most of the 2019 tax year and beyond.
The LBMC Wealth Advisors Team wishes you and your family a very Merry Christmas and a prosperous New Year!
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LBMC tax tips are provided as an informational and educational service for clients and friends of the firm. The communication is high-level and should not be considered as legal or tax advice to take any specific action. Individuals should consult with their personal tax or legal advisors before making any tax or legal-related decisions. In addition, the information and data presented are based on sources believed to be reliable, but we do not guarantee their accuracy or completeness. The information is current as of the date indicated and is subject to change without notice.