Since passage of the Tax Cuts and Jobs Act, taxpayers and preparers have been adjusting strategy to optimize the significant changes of 2018. With one TCJA filing season down, I’ve taken stock of some of the not-so-common tax situations encountered and the strategies developed to work around them this year. While not all-encompassing, this list highlights strategies many taxpayers can explore.
1. Maximizing The Qualified Business Income Deduction
QBI is a key component of the TCJA, and strategies still exist to maximize this opportunity, such as increasing owner wages. For example, a closely held business was making more money last year and paying owners reasonable salaries (above the Social Security tax wage base) from their S-corporation. However, considering profitability and the 20% QBI deduction, there weren’t enough wages for the full deduction. Increasing W-2 wages allowed for the full 20% deduction, which far outweighed the additional employment tax obligations. Planning and ensuring sufficient wages have been paid before year end is key.
Additionally, properly logging rental property activity for classification as a trade or business purpose can impact QBI. IRS Notice 2019-07 indicates the number of hours of activity performed within a rental activity may determine whether it qualifies as a trade or business. For example, taxpayers making several improvements or managing significant tenant turnover may rise to the level of a trade eligible for the QBI deduction. But, if the activity is producing a tax loss, QBI may not be desirable. Flip-flopping (between trade or business and investment income) isn’t ideal, but the facts and circumstances surrounding the activity may change from year to year, making a significant difference.
2. Rethinking Charitable Donations
The TCJA changed the perspective on charitable giving, and for donors routinely gifting a few thousand dollars annually, grouping several years of donations can optimize the federal tax benefit. If able, make three years of donations in one year to get above the itemized deductions mark for 2019. Likewise, for itemizing taxpayers near the $24,000 married filing jointly standard deduction, making three years’ worth of donations this year allows for a larger deduction and allows for the increased standard deduction the other two years. For seniors, making donations from an individual retirement account to satisfy required minimum distributions can help avoid increasing adjusted gross income, which can affect Medicare premiums, taxability of Social Security and many states’ taxable income.
3. Accounting For State Tax Credit Changes And Federal Deductions For Charitable Giving
The TCJA and recent guidance have created an unexpected challenge: The federal itemized deductions for charitable contributions resulting in a state credit are reduced by the amount of state tax credit received (regardless of if/when it is used) significantly reducing the tax breaks for these donations. Similarly, be wary of workarounds whereby states have attempted to form charitable organizations specifically to combat the new $10,000 state and local tax deduction limit. Some legitimate state initiatives exist to work around the new limitations, but they are beyond this article’s scope. Consult your advisor, and account for these adjustments when projecting federal tax liability.
4. Paying Children For Mutual Payoff
With a $12,000 standard deduction, which applies regardless of whether a taxpayer is dependent, significant opportunity exists for small-business owners to optimize deductions. Partners and sole proprietors can compensate children $12,000 tax-free for federal purposes to the child and still receive a deductible expense for the parent. Go a step further by contributing a portion of those wages to a Roth IRA for college or a first home.
5. Snagging Little Deductions
Take advantage of the state deduction for use of 529 plan funds to pay for private school tuition where available and applicable to the taxpayer’s situation. Each state is unique.
6. Benefitting Employees And Organizations For Mutual Gain
Unreimbursed employee expenses are no longer deductible for employees, but a way exists to counter this and benefit the organization and its employees. By reformulating accountable reimbursement plans, employers provide employees a tax-free benefit while preserving the tax deduction of the expenditure. With education and communication, an expanded reimbursement program might adequately replace some amount of wage. This strategy may be especially advantageous for travel-heavy industries.
7. Avoiding Surprises With Healthcare Costs
Some self-employed individuals and early retirees using the health insurance marketplace were caught off guard this year because while the marketplace simplifies getting insurance, it comes with significantly high premiums offset by advance premium tax credits. This tax credit is often vital for affording health coverage, but keeping track of income throughout the year is critical to ensuring no pay-back of any credit received. Increased income from retirement distributions or reduced depreciation and interest expense within a business can cause such surprises.
8. Utilizing Gains And Losses
Strategizing carefully around capital gains and losses is still essential. Keeping an eye on big gains coming through and offsetting with a loss is key. While tax alone should not determine whether to sell an investment, be aware of where you stand, especially if holding investments with large losses that may not be used for a long time.
Corrections, clarifications and other guidance are still coming through, so stay up to date on state conformance with federal laws. Most states are not consistent with federal laws, especially when it comes to the big numbers in QBI and bonus depreciation, and strategies should account for this.
Are you questioning whether these situations apply to you? Reviewing your tax situation should be your first priority this quarter. Tax plans are as unique as fingerprints: No two individuals’ or businesses’ are alike. Thorough research, honest and comprehensive conversation between taxpayer and preparer, and a proactive plan are essential to making tax time as pain-free as possible.
The information provided here is not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation.