With the changes in our tax code effective this year, many of the old strategies for year-end tax planning have changed. However, there are still numerous steps to take in late 2019 and early 2020 to reduce taxes for returns filed in 2020. Many of the classic deferral and acceleration tactics can still produce results, but in new and different ways.
The key to any year-end planning strategy is to minimize taxes. This is done by either reducing the amount of income received or increasing the amount of deductions, which is all easier said than done. However, there are a few simple things that can be done in the closing weeks of 2019 to accomplish this.
Ordinary income is taxed at seven rates, depending upon the amount of income. Taxes on capital gains also apply at different rates depending upon the amount of taxable income. For 2019, the long-term capital gains rates are as follows:
2019 Capital Gain Rates 0% 15% 20%
Married Filing Jointly $0 to $78,750 $78,751 to $488,850 Over $488,850
Single Filer $0 to $39,375 $39,376 to $434,550 Over $434,550
There is little chance of legislation during 2020, so tax rates are not likely to increase in 2020. There may be little advantage in postponing ordinary income other than cash flow needs as the rates are unlikely to change. Consideration should be given to accurate or delay income to best use the lower tax brackets for 2019 and 2020.
Timing consideration is not limited to capital gain taxes, but also applies to the net investment income (NII) tax. The 3.8% NII tax applies at $200,000 of modified adjusted gross income for single and head-of-household filers, $250,000 for joint filers, and $125,000 for married taxpayers filing separately.
The Tax Cuts and Jobs Act significantly increased the standard deduction. In 2019, the inflation adjusted amounts are $24,400 for joint filers, $18,350 for heads of households, and $12,200 for all other filers. Further, the amount of state and local taxes that can be claimed as an itemized deduction is capped at $10,000. For individuals with limited itemized deductions, one of the best ways to maximize the amount of deductions is to develop a bunching strategy. This involves accumulating charitable contributions, or even medical expenses, from two or more years into one year.
QUALIFIED BUSINESS INCOME DEDUCTION
One of the biggest changes from the Tax Cuts and Jobs Act was the allowance of a 20-percent deduction of qualified business income for owners of sole proprietorships and pass-through entities. This is the qualified business income deduction, and it can apply very generally to most types of businesses, but there are some restrictions. One of the most significant restrictions limits the amount of the deduction for businesses in certain specified areas. Where the business involves the performance of services in health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, investing and investment management, trading, dealing in certain assets or any trade or business where the principal asset is the reputation or skill of one or more of its employees or owners, the amount of the deduction is phased out where the taxpayer’s taxable income exceeds certain thresholds. For 2019, those thresholds begin at $312,400 for joint filers, $160,725 for married taxpayers filing separately, and $160,700 for all others. Taxpayers in one of these specified areas may want to explore ways to defer income to 2020 if they are near the phase-out threshold.
BUSINESS DEPRECIATION AND EXPENSING
The Tax Cuts and Jobs Act granted significant depreciation and expensing increases. Businesses may want to take advantage of 100-percent first-year depreciation on machinery and equipment purchased during the year. Additionally, Code Sec. 179 expensing has an investment limitation of $2,550,000 for 2019, with a dollar limitation of $1,020,000.
REVIEW ESTIMATED TAXES
Due to the changes under the Tax Cuts and Jobs Act, many individuals were shocked to find their withholding and estimated taxes were not adequate under the Act for returns filed for the year 2018. IRS announced that it would only impose a penalty on individuals for underpayment of estimated tax if less than 80 percent of taxes were withheld or paid as estimated taxes during 2018. The standard penalty applies if less than 90 percent of taxes are withheld or paid as estimated taxes and it is anticipated this standard will apply for 2019. Taxpayers still have time before the end of the year to adjust their withholding if they discover that they are still under withholding.