Dear Clients and Friends,
Last December, Congress passed the Tax Cuts and Jobs Act which will greatly impact taxes for 2018. While the law was signed nearly a year ago, the Internal Revenue Service continues to issue regulations in response to tax professional questions in interpreting these new laws. Among the major changes:
- Lower individual income tax rates and wider brackets
- Increase in the standard deduction, so more taxpayers will not itemize
- Eliminates personal exemptions but creates personal tax credits
- Limits the deduction for personal taxes to $10,000 for: state/local sales taxes, income taxes and property taxes (business and rental real estate taxes are not limited)
- Corporate tax rate is a flat 21%
- The alternative minimum tax for corporations was repealed
- Liberalizes depreciation expense for purchases made after 9/27/2017
- New 199A deduction for up to 20% of qualified business income, subject to certain limitations
- Doubles the Federal estate/gift exclusion amount to $11,180,000 per person
Whether your individual situation has been simple or complex, these changes will almost certainly impact you. The purpose of this letter is to offer new and familiar planning opportunities before the end of 2018. We are committed to monitoring new tax developments and can assist you in evaluating the impact of these changes to your situation.
Tax Strategies for Individuals – Timing of Income
To the extent that you can smooth income and not creep into the next higher bracket, you will save taxes. Under the new tax rates and brackets, individuals will be in the 37% tax bracket when their income reaches $500,000 (single)/$600,000 (joint). The 2018 tax tables have been appended. 2018 Tax Rates and Facts
There is an advantage to timing your income if you are:
- In a different tax bracket in 2018 than in 2019
- Subject to the Alternative Minimum Tax (AMT) in 2018, but not in 2019
- Subject to the 3.8% Net Investment Income tax in 2018, but not in 2019
- Subject to the 0.9% Medicare Tax on earned income in 2018, but not in 2019
- An individual that is at least 70½ years old and you want to make a qualified charitable donation from their IRA. Up to $100,000 of their required minimum distribution can be directed to the charity of their choice by instructing their IRA trustee to send money directly to this charity. This is a great planning opportunity if you are also claiming the standard deduction.
- Beneficiaries of trusts should talk to their trustees to see if distributions could be made to minimize overall taxes. Trust rates are normally higher than individual rates.
When to Claim Your Deductions
Prepaying certain expenses might not lower your overall tax due to AMT. Under the new law, since personal taxes are capped at $10,000, the risk of paying more in AMT has been significantly reduced. Prepaying charitable contributions or medical expenses in the current year may save taxes if you itemize your deductions. The following expenses are commonly prepaid as part of year-end tax planning:
- Charitable contributions – Cash contributions to qualified charities can be deducted up to 60% of your adjusted gross income (AGI). When non cash gifts are also made, then the limit is based on 50% of your AGI. Gifts of appreciated property held over one year can be deducted up to 30% of your AGI (20% for gifts to private operating foundations). Avoid paying capital gains tax by gifting the securities, rather than gifting the sales proceeds.
- State and local income taxes – State sales tax deductions are limited to the overall $10,000 limit (including property taxes) under the new law. You can either claim actual taxes paid or use the IRS sales tax table, which computes a sales tax based on your adjusted gross income (plus tax free income). You can also combine the sales tax amount from the table with actual taxes for large purchases: home improvements, vehicles, boats, planes and motor homes.
- Mortgage interest – Your ability to deduct prepaid interest is limited and the IRS is matching the information on the bank’s Form 1098-INT. Home loan interest is allowed for loans up to $1 million for pre-December 15, 2017 loans and after that date for loans up to $750,000.
- Margin interest – If you bought securities on margin, any interest accrued will be deductible if you pay the interest by December 31, 2018 (subject to the investment interest limitation rules).
- Medical expenses – Qualified unreimbursed medical expenses must exceed 7.5% of your AGI to be deductible.
Timing Your Capital Gain Recognition
Short-term capital gain is taxed at your ordinary income tax rate. If you hold a capital asset for more than one year, your capital gain is long-term. Depending on your tax bracket, long-term capital gain is taxed at 0%, 15% or 20%:
|Capital Gains Rate||Single||Joint||Head of Household|
|0%||$0 – 38,600||$0 – 77,200||$0 – $51,700|
Remember: capital gains might also be subject to an additional 3.8% net investment income tax if AGI is over $200,000 (single)/$250,000 (joint).
Capital losses, including worthless securities, will offset capital gains. If there is a net overall capital loss, only $3,000 loss can be claimed per year ($1,500 if married filing separately) and the excess losses carry forward into the future. Be careful not to violate the “wash sale” rule by buying an asset nearly identical to the one you sold at a loss within 31 days before or after the sale. Otherwise, the wash sale rule will prevent you from claiming the loss immediately.
If you sell your principal residence before year end, up to $250,000 of your gain is exempt from tax under current law ($500,000 for joint filers). The IRS requires you to have used the property as your main home for at least two of the last five years to qualify for this treatment.
Contribute to a Retirement Plan to Save Taxes
You or your spouse must have earned income to contribute to a retirement plan. Generally, taxpayers with modified AGI below certain thresholds are permitted to contribute up to $5,500 to a Roth IRA for 2018. (Taxpayers aged 50 or older are allowed an additional $1,000 contribution.) These amounts, however, begin to be reduced for single filers and married couples filing jointly who reach modified AGI of $120,000 and $189,000, respectively.
Planning Point: If you would like to contribute to a Roth IRA, but your income exceeds the threshold, consider contributing to a traditional IRA for 2018 and then converting the IRA to a Roth IRA in 2019. Be aware, however, that the new law prevents the taxpayer from “unwinding” this Roth conversion.
Self-employed individuals can have a Simplified Employee Pension (SEP) plan, contributing up to 25% of their net earnings from self-employment. The maximum contribution limit is $55,000. The self-employed may set up a SEP plan as late as the due date, including extensions. A 401(k) plan is another option for the self-employed. For 2018, a self-employed individual, as an employee, may defer up to $18,500 ($24,500 for age 50 or older) of annual compensation. Acting as the employer, the individual may contribute 25% of net profits, excluding the deferred $18,500, up to a maximum contribution of $55,000.
You may make only one IRA rollover by beneficiary per year. This does not limit direct IRA rollovers from trustee to trustee, but only those distributions to the IRA beneficiary who within 60 days deposits it into an IRA account. Nor does this rule apply to conversions from traditional to Roth IRAs.
The first IRA distribution and rollover will be tax free, but any subsequent rollovers will be subject to regular tax. If the deposit exceeds the IRA contribution limits it will be subject to a 6% annual excise tax until corrected.
Revisit Your Estate and Gift Planning Strategies
Taxpayers are permitted to make annual tax-free gifts of up to $15,000 per recipient ($30,000, if married) without filing a gift tax return ($15,000 a year for 2019). By making these gifts annually, taxpayers can transfer significant wealth out of their estate without using any of their lifetime exclusions.
Gifts can be made for more than $15,000. A gift tax return must be filed to track the amount of estate/gift lifetime exclusion used, which is currently $11.18 million per person ($22.36 million for married couples) for 2018.
If a deceased spouse’s net assets are less than the unused lifetime exemption, the unused portion can be transferred to the surviving spouse by making a portability election on the Federal Estate tax return (note: Washington State does not have a portability election and the 2018 exemption is only $2,193,000). Since the Federal Estate rules have changed, and because Washington State has its own set of estate rules, we strongly recommend that you have your current estate documents reviewed.
Review Your Withholding/Estimated Tax Payments
Review your Federal income tax withholding between now and the end of the year to avoid the penalty for underpaying your 2018 taxes. Underpayment penalties can be avoided by individuals if they timely pay the lesser of 90% of their current tax or 110% of their prior year tax liability. For example, if your AGI exceeded $150,000 in 2017, then the safe harbor for 2018 tax payments is 110% of your total 2017 tax assuming your 2018 income is more than 2017.
Increasing your final estimated tax deposit due Jan. 15, 2019, may reduce some of the penalty but is unlikely to eliminate it entirely. However, withholding payments, even if they are made on the last pay day of the tax year, are deemed as withheld ratably throughout the tax year.
Tax Strategies for Business Owners
Special 100 Percent Bonus Depreciation – Under the new law, businesses are now able to deduct 100% of the cost of new OR used business assets purchased and placed in service beginning on Sep. 27, 2017 if they have a useful life of 20 years or less. The 100% deduction is only available through 2022 and is phased down to 80% in 2023, 60% in 2024, 40% in 2025, and 20% in 2026.
Section 179 Deduction – Section 179 allows businesses to expense the full cost of new or used equipment. The 2018 limit is $1,000,000 for qualifying property. Section 179 expensing is subject to phase outs if a business added more than $2,500,000 of assets; the deduction is reduced dollar for dollar.
Section 1202 Qualified Small Business Stock – Taxpayers may exclude 100% of gain on the sale or exchange of Qualified Small Business Stock held over 5 years. Certain restrictions apply in determining eligibility of the stock, and the exclusion from gross income is limited to the greater of $10 million or ten times the taxpayer’s stock basis.
Section 199A Qualified Business Income Deduction – The current tax reform also ushered in a new deduction for taxpayers who have “qualified business income” (QBI) related to their pass-through activities or solely owned businesses. While subject to several limitations and exceptions, many taxpayers will be able to deduct up to 20% of their QBI.
Repair Regulations – Under the De Minimis Safe Harbor rules, taxpayers may deduct up to $2,500 per invoice for items related to repairs or improvements of property. Due to the complexity of these rules, you should discuss any plans you may have with us.
Hot Button Issues
- In June 2018, the Supreme Court issued an opinion on state taxes in South Dakota v. Wayfair. This case involved the assessment of sales taxes on out-of-state businesses. The Court ruled that South Dakota does not violate interstate commerce laws by taxing remote internet sales by businesses with no presence in their state. This decision is particularly important since electronic commerce has boomed. Clients with sales in multiple states should remain aware of the rules and economic nexus thresholds for each state. For example, Washington state has declared that remote sellers with $10,000 or more in retail sales to Washington purchasers must collect and remit sales tax.
- The IRS remains vigilant in addressing the issue of what constitutes an independent contractor (as opposed to an employee). The definition the IRS continues to apply is much broader than established by prior law. Our business clients could be negatively impacted in payroll taxes, retirement plans, insurance and medical benefits if independent contractors are reclassified to employees.
Affordable Care Act
US residents must prove they have medical coverage for 2018 or pay a penalty of $695 per adult and $347.50 per child ($2,085 maximum) or 2.5% of family income, whichever is greater. (Limited exceptions apply for medical coverage.) The healthcare coverage mandate was repealed but does not take effect until 2019.
Employers with 50 or more full-time equivalent employees (“large employers”) are required to offer an affordable health care plan to employees working in the US. For 2018, if the employer does not offer this medical coverage, they are charged $2,320 per employee (excluding the first 30 employees) to cover their “shared responsibility” payment. These large employers must also file information returns with the IRS to report coverage offered to full-time employees and dependent children. Form 1094-C and Form 1095-C must be filed by February 28, 2019 or April 1, 2019, if filed electronically.
Although the tax reform legislation was passed last year, there always remains the potential for additional changes. Feel free to give us a call with any questions you have. Remember, the IRS issued a Taxpayer Bill of Rights to help you better understand your rights in dealing with the U.S. tax system. However, if you receive any IRS correspondence, do not ignore this notice. You should contact your tax professional to appropriately respond to this notice to avoid or reduce potential charges. We would be happy to set up a meeting or assist you in any additional ways that we can.