This blog was prepared with the assistance of Peter Weitsen, CPA, partner at WithumSmith+Brown, PC.
Nearly two years after the 2017 Tax Cuts and Jobs Act was signed into law, taxpayers are still getting used to the effects it has had on tax rules, tax breaks and tax planning—including deductions and investments.
Here are some ways to plan and manage your taxes to minimize your tax bill under the law. Keep in mind that the law is set to expire on December 31, 2025, so some—but not all—of the tax-planning and management advice will change if the rules are not extended.
Charitable contributions are no longer deductible for taxpayers who use the standard deduction. That is not to say that you should stop donating to charities—it’s still an honorable thing to do. And if you give enough, it may still make sense to itemize and take a deduction. In fact, under the new law you can deduct charitable cash contributions up to 60% of your adjusted gross income, compared with 50% before (and up to 30% on gifts of stock or other appreciated assets). You might want to bunch the contributions together every other year and itemize in those years while taking the standard deduction in the years in between—or you can contribute to a so-called donor advised fund, which allows a donor to bunch smaller gifts into a much larger amount.
An alternative would be for employers to offer employees an informal salary-reduction plan similar to the flexible health-care funding plan. The employer would reduce the employee’s salary by an amount designated by the employee and would make charitable contributions up to that amount as directed by the employee. This way the employee would get a tax break via a reduced salary and the employer would still have the same cost. Both would save on payroll taxes.
Keep in mind that to the extent gross salary is reduced, it could affect how much in 401(k) contributions is allowed and how much in matching contributions is available. It could also affect unemployment compensation…disability benefits…and/or possibly eventual Social Security benefits.
Unreimbursed miscellaneous employee expenses are also no longer deductible except for a few exceptions, such as taxpayers who are Armed Forces reservists or qualified performing artists. Employers can offer employees a similar salary reduction plan as suggested for charitable contributions above as long as the expenses are fully documented.
Standard deduction. The standard deduction nearly doubled in 2018…and for 2019, it is $12,200 for singles and $24,400 for joint filers. For 2020, it goes up to $12,400 for single filers and $24,800 for joint filers. If you itemize, mortgage interest is still deductible (with new limits) as well as up to $10,000 of state and local taxes. Also included are medical costs in excess of 10% of adjusted gross income. However, it might make sense to pay down the mortgage and bring the total itemized deduction below the standard deduction amount while reducing your interest charges long-term.
Interest and dividend income. How you invest is also a tax concern. Interest is taxed at a greater rate than “qualified” dividends and long-term capital gains—both of which have a zero bracket for taxable income of joint filers up to $78,750 in 2019 and $80,000 in 2020.
If you are in a high tax bracket and have corporate bonds or bank certificates of deposit (CDs), consider investing in tax-exempt bonds. The bond yield might be lower than the corporate bonds but could be greater after considering the tax savings.
The following advice was useful before the law took effect and continues to be helpful…
Capital gains. Harvest losses where possible. This means you sell an investment at a loss and use the loss to offset taxes gains. Also, immediately buy similar shares to maintain your stock market risk profile. You must be careful not to engage in a wash sale, which disallows losses if the same or substantially the same securities are purchased within 30 days prior to or after the sale. For example, selling pharmaceutical stocks and purchasing an exchange traded fund for that sector is not the same. Neither is selling various stocks and purchasing stocks in other companies in the same industry. Capital losses can be offset against capital gains and the unused portion can be carried forward indefinitely and to the extent they do not offset current year gains, $3,000 can be deducted annually against other income.
In any years that you realized short-term gains and have stocks with long-term losses in your portfolio, consider realizing those losses to offset the short-term gains.
If you have a low-income year and your capital gains would not be taxed, you should consider selling enough shares to realize a tax-free gain and immediately repurchase those same shares and establish a higher tax basis. Wash sale rules only apply to losses, not gains.
Take advantage of tax benefits such as sheltering capital gains with Qualified Opportunity Zone benefits, providing either a deferral of the gain or making the gain completely tax free. To qualify, the gain must be reinvested within 180 days and the tax law requirements must be fully complied with.
Withholding and estimated tax payments. If you receive income, such as salary, subject to withholding, try to adjust your W-4 exemption statement to have the least amount required to be withheld. Overpaying will not get you any medals and will give the government interest-free funds for a period up to 15 months. Do the same with estimated tax payments. Of course, don’t reduce the amounts so much that you end up facing a big tax bill plus interest and penalties after you file your tax return.
If you are receiving retirement account distributions, you might have a choice in some instances to have withholding or not. Consider taking the full distributions during the year and have the withholding applied to the last distributions of the year. This will delay the tax payments as long as possible. Withholding is always considered to have occurred ratably during the year, so there will be no underestimated tax penalty due to the bunching of the payments toward year end.
Retirement accounts. Tax-deferred IRA accounts and tax-free Roth IRA accounts should be maximized as part of an overall financial plan. Depending on your age, it might be more appropriate to invest in Roth accounts, which are funded with after-tax contributions and then are not taxed any further, rather than traditional IRAs or 401(k) accounts, which face taxes on earnings when they are withdrawn.
Contributions to the retirement accounts from existing savings should be made as early in the year as possible to start the tax-deferred or tax-free accumulation. If made from current earnings, they would need to be made as the funds became available.
If you are receiving required minimum distributions (RMDs) and will be contributing to plans that you are still eligible to maintain, such as a solo 401(k) plan for self-employed individuals, consider delaying the current year’s contributions to the beginning of the following year. Otherwise it will be part of the prior year’s December 31 balance, thereby increasing the following year’s RMD, which will be taxed.
If your contributions are made with payroll deductions, this cannot be done. If you are employed and over age 70½ and are a less-than-5% owner, you do not have to start RMDs from your employer’s 401(k).
If you had a low-income year or a large business loss, consider taking a distribution from your traditional IRA and rolling over the funds into a Roth IRA. Do this to the extent you can to avoid being taxed at higher rates than the minimum brackets.
Employer tax-favored plans. To the extent possible, maximize as much of these benefits as you can. These include flexible spending health-care plans, health savings accounts, 401k plans especially with employer matching contributions, commuting reimbursement payments, and informal matching charitable contribution or expense reimbursement plans (described above).
Estate and gift taxes. Estate taxes have virtually been eliminated for most single people that will leave a 2019 estate under $11.4 million and married couples under $22.8 million. Therefore, planning to reduce those taxes has been drastically reduced. However, making gifts can still be a good strategy for family wealth planning and as a method to transfer wealth early on so that the younger family members would get the benefits of the cash flow and future capital appreciation. There is still a $15,000 annual gift tax exclusion for gifts to each person you want to make gifts to (and double that if there is a consenting spouse).
Further, for those with family businesses where there are some children that work in the business and some that don’t, gifting can be a method to facilitate transfers and eliminate some of the cumbersome gyrations that occur during probate when arrangements have not been made. This could eliminate the need for valuations…negotiations by children among themselves on the value and payment terms…or even having the wrong siblings remaining as co-owners and perhaps thorns in the side of the siblings that operate the business on a daily basis.
Life insurance. The use of a trust has been recommended as a possible estate-tax reduction maneuver. However, if there is substantial coverage, using the trust could still be a mechanism to assure that the funds will remain in the blood line while providing the surviving spouse or guardians with adequate cash flow.
State and local taxes. This article primarily applies to federal taxes, but the same processes apply to state and local taxes. If the state follows the federal rules, not much planning is necessary, but for states that do not, you should plan as much as possible.
Moving to a low-tax state can also reduce overall taxes. Of course, unless you are rich enough, the tax savings usually would not be worth the change in location and lifestyle.
The key is to use as many resources as you can and apply as much as you can to your situation. In many cases it requires mixing and matching and combining tax benefits to maximize your tax position.
Tax planning and management are not an “April 15” event. They require continuous year-round attention. Do so and you will keep your taxes to the lowest legal amount.