This Issues and Insights discusses year-end tax planning strategies. 

  • It’s important to explore your year-end planning opportunities in light of the sweeping changes made to virtually all areas of federal tax law that went into effect this year.
  • Areas such as income and deduction timing, charitable giving, annual exclusion gifts, and others are discussed.
  • While tax planning is always top of mind, the end of the year is also a good time to look at your estate planning documents, your financial assets, and other important considerations.

As the end of the year grows near, it is time to finalize planning for taxes and the steps you need to take to help minimize them. With the passage of the 2017 Tax Cuts and Jobs Act (the Act), it’s important to explore your year-end planning opportunities in light of the sweeping changes made to virtually all areas of federal tax law.

Significant Provisions of the Act

Most of the provisions of the Act are effective for tax years beginning after 2017. Many of the individual income and estate tax provisions that came into effect this year will expire after 2025. For a summary of the new tax law and round-up of important highlights, please read our Issues and Insights, Tax Reform Made Simple?

YEAR-END PLANNING CONSIDERATIONS

The end of the year can be a very busy time, but you should take the time now to optimize your taxes for this year and the next. While tax planning is always top of mind, the end of the year is also a good time to look at your other planning documents, your financial assets, and your long-term plan. The following provides some tips on potential income tax savings strategies, as well as estate planning and other items that are important to consider.

Utilize income and deduction timing strategies

One planning strategy that applies every year is to examine whether it makes sense to defer income to the subsequent year. For individuals, income is taxable when it is received and expenses are deductible in the year that they are paid. It may be beneficial to accelerate or postpone income from year to year so that the income is taxed in a lower income tax bracket in a given year. If tax rates are expected to be lower in 2019 due to an expected drop in income, it is generally beneficial to defer income.

A common approach to income timing involves the sale of publicly traded securities. While the purchase or sale of a security should primarily be based on whether the timing is right for sale from an investment perspective, the timing of the sale also will have a tax impact. In years in which you have recognized capital losses, it can be advantageous to harvest capital gains to offset losses. If it is advisable to sell a security because of market conditions, it might be possible to delay the sale until right after the start of the New Year instead of the end of the current year to defer the tax payable until the following year. Of course, timing the sale of a security for tax purposes should never outweigh protecting the value of the security from downturns in the market. As detailed below, the timing of the sale of a security also can affect the Medicare surtax on net investment income. (Note that the Act did not change the capital gains rates or the 3.8% Medicare surtax.) If you sell stock or securities at a loss and wish to reacquire the same stock, you can do so if you wait for 30 days after the sale to repurchase the stock.

Another way to defer income includes waiting until after the end of the year to take discretionary distributions from Individual Retirement Accounts (IRAs). Generally, taxpayers over age 59½ may take discretionary distributions without penalty. Of course, if you are 70½ or older, you still must meet the required minimum distribution requirements for 2018.

Deduction timing is also an important part of year-end planning. In high income tax rate years, it may be advantageous to pay deductible expenses before the end of the year. If 2018 is a lower income tax rate year either because of lower income or reduced tax rates, it might be better to defer payment of those expenses until they are due in 2019. Conversely, if 2018 is a high income tax rate year, it might be advisable to pay expenses by December 31, even if the bill is not due until January. An example of this type of expense is the 2018 fourth quarter estimated state income taxes generally due on January 15, 2019. They could be paid on December 31 to obtain the deduction in 2018. However, careful consideration should be given to whether the payment of state income taxes will cause the alternative minimum tax (AMT) to be imposed. While AMT should always be considered, it may be less of an issue now because the deduction for state and local taxes is capped at $10,000 per year.

Plan for the Medicare surtax on net investment income

Every year we advise clients to review their portfolios to determine if losses should be harvested to offset capital gains. That review is even more important when the 3.8% Medicare surtax on net investment income applies. The tax is on the lesser of net investment income or the amount by which modified AGI exceeds $200,000 (single) and $250,000 (married). This is a much lower threshold than the taxable income threshold for the highest capital gains and dividend rates.

The Medicare surtax, when added to the applicable capital gains tax rate of 15% or 20%, can result in a capital gains tax of 18.8% to 23.8%. Don’t forget that capital gains also may be taxed at the state level. There are a few ways to reduce the Medicare surtax. One approach that may be appropriate if you have significant capital gains is to harvest capital losses before the end of the year, as referenced earlier. This will reduce the amount of your net investment income subject to the 3.8% surtax.  Another method is to reduce your taxable investment income. Because municipal bond interest income is exempt from federal taxes, it is not included in the calculation of investment income. In planning for future investments, it may be appropriate to have some of your fixed income investments in municipal bonds.

Time your charitable contributions

While year end is a common time for charitable giving, it is important to consider how much of your contribution will be deductible, as the amount of the federal income tax deduction is limited to a percentage of AGI, ranging from 20% to 60%, depending on the kind of assets donated and whether the recipient is a public charity or a private foundation. Thus, charitable contributions can be timed to correspond with the level of income in any given year. The actual deduction for the contribution is subject to myriad complex rules. 

However, the Act eliminated the phase-out of itemized deduction limitations which used to limit the deductibility of charitable contributions. The Act also provides a higher AGI limit for cash gifts to public charities, limiting deductions for such gifts to 60% of AGI, rather than the prior law’s limit of 50% of AGI. Thus, donors making large gifts in 2018 could receive substantial tax benefits from giving. Since the standard deduction has nearly doubled under the new Act, and so many other deductions are eliminated, many donors may no longer be in a position to itemize, eliminating any tax savings from donations. Under the Act, an individual would need total itemized deductions to exceed $12,000, the Act’s new standard deduction for individual taxpayers, up from $6,350 in 2017. Married couples would need deductions exceeding $24,000, up from $12,700 in 2017.

If you would fall into the standard deduction as a result of tax reform, losing the ability to itemize deductions, you may wish to consider making charitable gifts in a single year equivalent to what you would typically give over two to three years, and then not giving directly to charity for the next few years.  As a result, the charitable gift should be large enough to itemize the deduction. However, making large gifts in some years while skipping giving in other years could have an adverse effect on the charities relying on gifts. In that case, it may be helpful to have a discussion with the charity, particularly if it is a small charity, to make clear that it should not rely on a similar sized gift every year, and that the next gift will not be made for several years. For more detailed information on the impact of tax reform on charitable giving, please read A donor’s guide to the new law authored by my colleague, Carol  Kroch, national director of philanthropic planning.

Generally, contributions can range from outright gifts of cash to transfers of stock and property directly to charity. Gifts of appreciated, publicly traded securities held for more than one year can be especially beneficial, as the deduction is based on the fair market value of the gift. Further, transfer of appreciated securities avoids the recognition of any capital gains that would have been recognized if the stock had been sold and the proceeds given to charity. More complex gifts can be structured through entities such as private foundations, donor advised funds, and split interest trusts, such as charitable remainder and lead trusts. Note that the asset donated can change the tax result. For example, the deduction for a gift of closely held stock to a private foundation is limited to basis, usually the initial purchase price. And a gift of property subject to debt, often the case with real estate, can turn the donation into a bargain sale with income tax consequences to the donor.

A gift to charity made by check need only be mailed by year end or charged to your credit card by December 31. But if you are making a gift of anything other than by check or credit card, be sure to allow enough time for completing the gift by year end. Remember to keep the required acknowledgement from the charity for gifts of $250 or more or your deduction can be disallowed. Non-cash gifts, other than publicly traded securities, may also subject to detailed appraisal rules, in order to obtain the deduction.

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This article is for informational purposes only and is not intended as an offer or solicitation for the sale of any financial product or service. It is not designed or intended to provide financial, tax, legal, investment, accounting, or other professional advice since such advice always requires consideration of individual circumstances. If professional advice is needed, the services of a professional advisor should be sought.

IRS Circular 230 disclosure: To ensure compliance with requirements imposed by the IRS, we inform you that, while this publication is not intended to provide tax advice, in the event that any information contained in this publication is construed to be tax advice, the information was not intended or written to be used, and cannot be used, for the purpose of (i) avoiding tax relate penalties under the Internal Revenue Code or (ii) promoting, marketing, or recommending to another party any matters addressed herein.

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