I'm including this article from our newsletter because it's related to the topic I'll be speaking on Saturday November 14.
I'm planning on covering a few of the items in our talk, but will not have time to cover everything, so this is available for your review. You can also subscribe to our free newsletter at mccartneycpa.com for similar monthly updates.
This version has been shortened a bit to focus on items most likely to be of interest to members of the club. So here goes:
What is Tax Preparation?
Tax preparation is the process of preparing and filing a tax return. Generally, it is a one-time event that culminates in signing your return and finding out whether you owe the IRS money or will be receiving a refund.
For most people, tax preparation involves one or two trips to an accountant (CPA), generally around tax time (i.e., between January and April), to hand over your financial documents so that he or she can prepare and file your tax return. They focus on making sure any tax reporting on your return complies with federal and state tax law.
Alternately, Individual taxpayers might use an enrolled agent, attorney, or a tax preparer who doesn't necessarily have a professional credential. No matter who you use, you expect them to be trustworthy (you will be entrusting them with your personal financial details), skilled in tax preparation, and to accurately file your income tax return in a timely manner.
What is Tax Planning?
Tax planning is a year- round process with meetings often occuring shortly before year-end (as opposed to a seasonal event after the year is over) and is a separate service from tax preparation. Both individuals and business owners can take advantage of tax planning services, which are typically performed by a CPA or an Enrolled Agent (EA) with in-depth experience and knowledge of tax law, rather than a tax preparer.
Examples of tax planning include the following: Bunching expenses (e.g., medical) to maximize deductions, tax-loss harvesting to offset investment gains, increasing retirement plan contributions to defer income, and determining the best timing for capital expenditures or capital gains to reap the tax benefits. If you have a business it may involve restructuring your business entity or making tax elections to minimize tax.
Good recordkeeping is also an important part of this process. Having up to date interim records helps in making efficient year-end projections, as well as helping at tax filing time.
Another important benefit of tax planning projections is to help determine whether you have paid in enough withholding tax during the year to avoid penalties for underpayment of estimated tax. You may still have an opportunity to increase your withholding or pay in estimated tax deposits to the IRS before year end to help avoid this problem. In many cases, the IRS will charge a penalty if you wait until April or later to pay in your tax due.
When you're ready to learn more about what strategies you can use to reduce your tax bill next year, please call our office at 817-563-7717. We offer no obligation fee estimates. We can do a brief introductory review of your situation to discover your potential for savings, and if the savings potential turns out to be minimal, then there's no need to spend a lot more time and money. Our goal is to always do what's right for our clients.
Individual Taxpayers: Year-End Tax Planning Strategies
With the end of the year fast approaching, now is the time to take a closer look at tax planning strategies you can use to minimize your tax burden for 2020.
General Tax Planning Strategies
General tax planning strategies for individuals include accelerating or deferring income and deductions, as well as careful consideration of timing-related tax planning strategies concerning investments, charitable gifts, and retirement planning. For example, taxpayers might consider using one or more of the following strategies:
Investments. Selling any investments on which you have a gain (or loss) this year. For more on this, see Investment Gains and Losses, below.
Charitable deductions. Bunching charitable deductions (scroll down to read more about charitable deductions) every other year is also a good strategy if it enables the taxpayer to get over the higher standard deduction threshold under the Tax Cuts and Jobs Act of 2017 (TCJA). Another option is to put money into a donor-advised fund that enables donors to make a charitable contribution and receive an immediate tax deduction. The fund is managed by a public charity on behalf of the donor, who then recommends how the money is distributed over time. Please call if you would like more information about donor-advised funds.
Under the CARES Act of 2020, this year (2020) eligible individuals may take an above-the-line deduction of up to $300 in cash for charitable contributions made to qualified charitable organizations. Cash contributions are those that are paid with cash, check, electronic fund transfer, or payroll deduction. Taxpayers can claim the deduction even if they do not itemize on their 2020 taxes.
Medical expenses. Medical expenses are deductible only to the extent they exceed a certain percentage of adjusted gross income (AGI), therefore, you might pay medical bills in whichever year they would do you the most tax good. To deduct medical and dental expenses in 2020, these amounts must exceed 7.5 percent of AGI. By bunching medical expenses into one year, rather than spreading them out over two years, you have a better chance of exceeding the thresholds, thereby maximizing the deduction.
Deductible expenses such as medical expenses and charitable contributions can be prepaid this year using a credit card. This strategy works because deductions may be taken based on when the expense was charged on the credit card, not when the bill was paid. Likewise, with checks. For example, if you charge a medical expense in December but pay the bill in January, assuming it's an eligible medical expense, it can be taken as a deduction on your 2020 tax return. Invoices or oices or bills to clients or customers this year to be paid in full by the end of December; however, make sure you keep an eye on estimated tax requirements. Conversely, if you anticipate a lower income next year, consider deferring sending invoices to next year.
Withholding. If you know you have a set amount of income coming in this year that is not covered by withholding taxes, there is still time to increase your withholding before year-end and avoid or reduce any estimated tax penalty that might otherwise be due.
Avoid the penalty by covering the extra tax in your final estimated tax payment and computing the penalty using the annualized income method.
Accelerating or Deferring Income and Deductions
Strategies that are commonly used to help taxpayers minimize their tax liability include accelerating or deferring income and deductions. Which strategy you use depends on your current tax situation.
Most taxpayers anticipate increased earnings from year to year, whether it's from a job or investments, so this strategy works well. On the flip side, however, if you anticipate a lower income next year or know you will have significant medical bills, you might want to consider deferring income and expenses to the following year.
In cases where tax benefits are phased out over a certain adjusted gross income (AGI) amount, a strategy of accelerating income and deductions might allow you to claim larger deductions, credits, and other tax breaks for 2020, depending on your situation. Roth IRA contributions, child tax credits, higher education tax credits, and deductions for student loan interest are examples of these types of tax benefits.
Accelerating income into 2020 is also a good idea if you anticipate being in a higher tax bracket next year. This is especially true for taxpayers whose earnings are close to threshold amounts that make them liable for the Additional Medicare Tax or Net Investment Income Tax ($200,000 for single filers and $250,000 for married filing jointly). See more about these two topics, below.
Taxpayers close to threshold amounts for the Net Investment Income Tax (3.8 percent of net investment income) should pay close attention to "one-time" income spikes such as those associated with Roth conversions, sale of a home or any other large asset that may be subject to tax.
Examples of accelerating income include
Paying your entire property tax bill, including installments due in 2021, by year-end. If you have taxes escrowed with your mortgage company, make sure they pay it out of escrow before year end. Your tax deposits into escrow do not count as actual taxes paid. ;
Under TCJA, the deduction for state and local taxes (SALT) was capped at $10,000. Once a taxpayer reaches this limit the two strategies above are not effective for federal returns.
Paying 2021 tuition in 2020 to take full advantage of the American Opportunity Tax Credit, an above-the-line tax credit worth up to $2,500 per student that helps cover the cost of tuition, fees, and course materials paid during the taxable year. Forty percent of the credit (up to $1,000) is refundable, which means you can get it even if you owe no tax.
Additional Medicare Tax
Taxpayers whose income exceeds certain threshold amounts ($200,000 single filers and $250,000 married filing jointly) are liable for an additional Medicare tax of 0.9 percent on their tax returns (or as much as 3.8% including investment income, see below) but may request that their employers withhold additional income tax from their pay to be applied against their tax liability when filing their 2020 tax return next April.
As such, higher income taxpayers should consider doing what they can to reduce adjusted gross income below those threshholds. Contributing to Roth IRAs and tax deferred plans like a 401(k) help later because distributions are not subject to the Medicare Tax.
Charitable Contributions
Property, as well as money, can be donated to a charity. You can generally take a deduction for the fair market value of the property; however, for certain property, the deduction is limited to your cost basis. While you can also donate your services to charity, you may not deduct the value of these services. You may also be able to deduct charity-related travel expenses and some out-of-pocket expenses, however.
Keep in mind that a written record of your charitable contributions - including travel expenses such as mileage - is required to qualify for a deduction. A donor may not claim a deduction for any contribution of cash, a check, or other monetary gift unless the donor maintains a record of the contribution in the form of either a bank record (such as a canceled check) or written communication from the charity (such as a receipt or a letter) showing the name of the charity, the date of the contribution, and the amount of the contribution.
Contributions of appreciated property (i.e. stock) provide an additional benefit because you avoid paying capital gains on any profit.
In addition to the $300 above the line deduction for taxpayers that don't itemize (see above), taxpayers who do itemize deductions can take advantage of another provision in the CARES Act that allows them to deduct cash donations to public charities in amounts of up to 100 percent of adjusted gross income (AGI) - but only for tax year 2020. In 2019, the limit for the deduction for cash contributions was 60% of AGI.
Qualified charitable distributions (QCDs). Taxpayers who are age 70 1/2 and older can reduce income tax owed on required minimum distributions (RMDs) - a maximum of $100,000 or $200,000 for married couples - from IRA accounts by donating them to a charitable organization(s) instead. Eligible taxpayers can take advantage of QCDs even though the CARES Act eliminated the requirement for required minimum distributions for 2020.
Starting in 2020, the age at which taxpayers are required to take minimum distributions from IRAs, SIMPLE IRAs, SEP IRAs, or other retirement plan accounts was raised to age 72. In prior years, the age was 70 1/2.
Investment Gains and Losses
Investment decisions are often more about managing capital gains than about minimizing taxes. For example, taxpayers below threshold amounts in 2020 might want to take gains; whereas taxpayers above threshold amounts might want to take losses.
Fluctuations in the stock market are commonplace; don't assume that a down market means investment losses as your cost basis may be low if you've held the stock for a long time.
Minimize taxes on investments by judicious matching of gains and losses. Where appropriate, try to avoid short-term capital gains, which are taxed as ordinary income (i.e., the rate is the same as your tax bracket).
In 2020 tax rates on capital gains and dividends remain the same as 2019 rates (0%, 15%, and a top rate of 20%); however, threshold amounts have been adjusted for inflation as follows:
- 0% - Maximum capital gains tax rate for taxpayers with income up to $40,000 for single filers, $80,000 for married filing jointly.
- 15% - Capital gains tax rate for taxpayers with income above $40,000 for single filers, $80,000 for married filing jointly.
- 20% - Capital gains tax rate for taxpayers with income above $441,450 for single filers, $496,600 for married filing jointly.
Where feasible, reduce all capital gains and generate short-term capital losses up to $3,000. As a general rule, if you have a large capital gain this year, consider selling an investment on which you have an accumulated loss. Capital losses up to the amount of your capital gains plus $3,000 per year ($1,500 if married filing separately) can be claimed as a deduction against income.
Wash Sale Rule. After selling a securities investment to generate a capital loss, you can repurchase it after 30 days. This is known as the "Wash Rule Sale." If you buy it back within 30 days, the loss will be disallowed. Or you can immediately repurchase a similar (but not the same) investment, e.g., and ETF or another mutual fund with the same objectives as the one you sold.
If you have losses, you might consider selling securities at a gain and then immediately repurchasing them, since the 30-day rule does not apply to gains. That way, your gain will be tax-free; your original investment is restored, and you have a higher cost basis for your new investment (i.e., any future gain will be lower).
Net Investment Income Tax (NIIT)
The Net Investment Income Tax, which went into effect in 2013, is a 3.8 percent tax that is applied to investment income such as long-term capital gains for earners above a certain threshold amount ($200,000 for single filers and $250,000 for married taxpayers filing jointly). Short-term capital gains are subject to ordinary income tax rates as well as the 3.8 percent NIIT. This information is something to think about as you plan your long-term investments. Business income is not considered subject to the NIIT provided the individual business owner materially participates in the business.
Transferring Income to other Family Members
Several popular strategies involve shifting income to other family members who may be taxed at lower tax brackets.
If you have a business you may consider hiring children or other lower income people, which lowers your income but gets picked up by them at lower tax brackets.
Another possibility is giving shares of a pass through company you own, such as a partnership or S-Corporation, so that a pro-rata share of the income gets taxed at the other family member's rate.
You may also consider putting investment assets into your child's name, but be careful of the so called "Kiddie Tax" discussed below.
Tax Rate Structure for the Kiddie Tax
The kiddie tax rules changed under the TCJA. For tax years 2018 through 2025, unearned income exceeding $2,200 is taxed at the rates paid by trusts and estates instead of the parent’s tax rate. For ordinary income (amounts over $12,950), the maximum rate is 37 percent. For long-term capital gains and qualified dividends, the maximum rate is 20 percent.
Exception. If the child is under age 19 or under age 24 and a full-time student and both the parent and child meet certain qualifications, then the parent can include the child's income on the parent's tax return.
Other Year-End Moves
Roth Conversions. Converting to a Roth IRA from a traditional IRA would make sense if you've experienced a loss of income (lowering your tax bracket) or your retirement accounts have decreased in value. Please call if you would like more information about Roth conversions.
Maximize Retirement Plan Contributions. If you own an incorporated or unincorporated business, consider setting up a retirement plan if you don't already have one. It doesn't need to be funded until you pay your taxes, but allowable contributions will be deductible on this year's return.
If you are an employee and your employer has a 401(k), contribute the maximum amount ($19,500 for 2020), plus an additional catch-up contribution of $6,500 if age 50 or over, assuming the plan allows this, and income restrictions don't apply.
If you are employed or self-employed with no retirement plan, you can make a deductible contribution of up to $6,000 a year to a traditional IRA (deduction is sometimes allowed even if you have a plan). Further, there is also an additional catch-up contribution of $1,000 if age 50 or over.
Health Savings Accounts. Consider setting up a health savings account (HSA). You can deduct contributions to the account, investment earnings are tax-deferred until withdrawn, and any amounts you withdraw are tax-free when used to pay medical bills.
In effect, medical expenses paid from the account are deductible from the first dollar (unlike the usual rule limiting such deductions to the amount of excess over 10 percent of AGI). For amounts withdrawn at age 65 or later not used for medical bills, the HSA functions much like an IRA.
To be eligible, you must have a high-deductible health plan (HDHP), and only such insurance, subject to numerous exceptions, and you must not be enrolled in Medicare. For 2020, to qualify for the HSA, your minimum deductible in your HDHP must be at least $1,400 for self-only coverage or $2,800 for family coverage.
529 Education Plans. Maximize contributions to 529 plans, which can now be used for elementary and secondary school tuition as well as college or vocational school.
Don't Miss Out.
Implementing these strategies before the end of the year could save you money. If you are ready to save money on your tax bill, please contact the office today.
Year-End Tax Planning Strategies for Business Owners
Several end-of-year tax planning strategies are available to business owners that can be used to reduce their tax liability. Let's take a look:
Deferring Income
Businesses using the cash method of accounting can defer income into 2021 by delaying end-of-year invoices so that payment is not received until 2021. Businesses using the accrual method can defer income by postponing the delivery of goods or services until January 2021.
Purchase New Business Equipment
Bonus Depreciation. Businesses are allowed to immediately deduct 100% of the cost of eligible property placed in service after September 27, 2017, and before January 1, 2023, after which it will be phased downward over a four-year period: 80% in 2023, 60% in 2024, 40% in 2025, and 20% in 2026.
Section 179 Expensing. Businesses should take advantage of Section 179 expensing this year whenever possible. In 2020, businesses can elect to expense (deduct immediately) the entire cost of most new equipment up to a maximum of $1.04 million of the first $2.59 million of property placed in service by December 31, 2020. Keep in mind that the Section 179 deduction cannot exceed net taxable business income. The deduction is phased out dollar for dollar on amounts exceeding the $2.59 million threshold and eliminated above amounts exceeding $3.63 million.
Computer or peripheral equipment placed in service after December 31, 2017, are not included in listed property.
For property placed in service in taxable years beginning after December 31, 2017, taxpayers can elect to include certain improvements made to nonresidential real property after the date when the property was first placed in service.
1. Qualified improvement property, which means any improvement to a building's interior. However, improvements do not qualify if they are attributable to:
- the enlargement of the building,
- any elevator or escalator or
- the internal structural framework of the building.
2. Roofs, HVAC, fire protection systems, alarm systems, and security systems.
Qualified Property. Qualified property is defined as property that you placed in service during the tax year and used predominantly (more than 50 percent) in your trade or business. Property that is placed in service and then disposed of in that same tax year does not qualify, nor does property converted to personal use in the same tax year it is acquired.
Real estate qualified improvement property is eligible for immediate expensing, thanks to the CARES Act, which corrected an error in the Tax Cuts and Jobs Act. Taxpayers are also able to amend 2018 tax returns, if necessary.
Please contact the office if you have any questions regarding qualified property.
Timing for purchase of business equipment. You might be able to increase your tax benefit if you buy equipment at the right time. Here's a simplified explanation:
Conventions. The tax rules for depreciation include "conventions" or rules for figuring out how many months of depreciation you can claim. There are three types of conventions. To select the correct convention, you must know the type of property and when you placed the property in service.
The half-year convention: This convention applies to all property except residential rental property, nonresidential real property, and railroad gradings and tunnel bores (see mid-month convention below) unless the mid-quarter convention applies. All property that you begin using during the year is treated as "placed in service" (or "disposed of") at the midpoint of the year. This means that no matter when you begin using (or dispose of) the property, you treat it as if you began using it in the middle of the year.
You buy a $70,000 piece of machinery on December 15. If the half-year convention applies, you get one-half year of depreciation on that machine.
The mid-quarter convention: Use the mid-quarter convention if the cost of equipment placed in service during the last three months of the tax year is more than 40 percent of the total cost of all property placed in service for the entire year. If the mid-quarter convention applies, the half-year rule does not apply, and you treat all equipment placed in service during the year as if it were placed in service at the midpoint of the quarter in which you began using it.
The mid-month convention: This convention applies only to residential rental property, nonresidential real property, and railroad gradings and tunnel bores. It treats all property placed in service (or disposed of) during any month as placed in service (or disposed of) on the midpoint of that month.
If you're planning on buying equipment for your business, please call and speak with a tax professional who can help you figure out the best time to buy that equipment and take full advantage of these tax rules.
Other Year-End Moves to Take Advantage Of
Qualified Business Income Deduction. Many business taxpayers - including owners of businesses operated through sole proprietorships, partnerships, and S corporations, as well as trusts and estates, may be eligible for the qualified business income. This deduction is worth up to 20 percent of qualified business income (QBI) from a qualified trade or business for tax years 2018 through 2025. Your taxable income must be under $163,300 ($326,600 for joint returns)in 2020 to take advantage of the deduction.
The QBI is complex, and tax planning strategies can directly affect the amount of deduction, i.e., increase or reduce the dollar amount. As such, it is especially important to speak with a tax professional before year's end to determine the best way to maximize the deduction.
Small Business Health Care Tax Credit. Small business employers with 25 or fewer full-time-equivalent employees with average annual wages of $50,000 indexed for inflation (e.g., $55,000 in 2019) may qualify for a tax credit to help pay for employees' health insurance. The credit is 50 percent (35 percent for non-profits).
Business Energy Investment Tax Credits. Business energy investment tax credits are still available for eligible systems placed in service on or before December 31, 2022, and businesses that want to take advantage of these tax credits can still do so.
Business energy credits include geothermal electric, large wind (expires at the end of 2020), and solar energy systems used to generate electricity, to heat, cool, or to provide hot water for use in a structure, or to provide solar process heat.
Hybrid solar lighting systems, which use solar energy to illuminate the inside of a structure using fiber-optic distributed sunlight, are eligible; excluded, however, are passive solar and solar pool heating systems. Utilities are allowed to use the credits as well.
Repair Regulations. Where possible, end of year repairs and expenses should be deducted immediately, rather than capitalized and depreciated. Small businesses lacking applicable financial statements (AFS) can take advantage of de minimis safe harbor by electing to deduct smaller purchases ($2,500 or less per purchase or invoice). Businesses with applicable financial statements can deduct $5,000. Small businesses with gross receipts of $10 million or less can also take advantage of safe harbor for repairs, maintenance, and improvements to eligible buildings. Please call if you would like more information on this topic.
Depreciation Limitations on Luxury, Passenger Automobiles, and Heavy Vehicles. As a reminder, tax reform changed depreciation limits for luxury passenger vehicles placed in service after December 31, 2017. If the taxpayer doesn't claim bonus depreciation, the maximum allowable depreciation deduction for 2020 is $10,100 for the first year.
Deductions are based on a percentage of business use. A business owner whose business use of the vehicle is 100 percent can take a larger deduction than one whose business use of a car is only 50 percent.
For passenger autos eligible for the additional bonus first-year depreciation, the maximum first-year depreciation allowance remains at $8,000. It applies to new and used ("new to you") vehicles acquired and placed in service after September 27, 2017, and remains in effect for tax years through December 31, 2022. When combined with the increased depreciation allowance above, the deduction amounts to as much as $18,100 in 2020.
Heavy vehicles including pickup trucks, vans, and SUVs whose gross vehicle weight rating (GVWR) is more than 6,000 pounds are treated as transportation equipment instead of passenger vehicles. As such, heavy vehicles (new or used) placed into service after September 27, 2017, and before January 1, 2023, qualify for a 100 percent first-year bonus depreciation deduction as well.
Retirement Plans. Self-employed individuals who have not yet done so should set up self-employed retirement plans before the end of 2020. Call today if you need help setting up a retirement plan.
Dividend Planning. Reduce accumulated corporate profits and earnings by issuing corporate dividends to shareholders.
Paid Family and Medical Leave Credit. Last chance to take advantage of the employer credit for paid family and medical leave, which expires at the end of 2020.
Year-end Tax Planning Could Make a Difference in Your Tax Bill
If you'd like more information, please call 817-563-7717 to schedule a consultation to discuss your specific tax and financial needs and develop a plan that works for your business.
