2018 Year-end Tax Planning for Individuals and Businesses
Year-end planning for 2018 takes place against the backdrop of a new tax law, the Tax Cuts and Jobs Act (TCJA or the Act). Signed into law on December 22, 2017, the Act is the most significant tax overhaul in thirty years and contains numerous provisions that affect individuals and businesses generally beginning with the 2018 year. Many of these provisions will expire on January 1, 2026, whereby tax law then will revert to pre-2018 law. California has not yet conformed to any of the Act’s provisions resulting in even more federal to California tax differences. As the end of the year approaches, we want to point out some of the Act’s noteworthy changes that you should take into consideration for your year-end tax and wealth preservation planning.
A number of tax planning strategies should be considered with your year-end analysis. Strategies involving the acceleration of expenses and/or the deferral of income can often provide an immediate cash tax benefit. Capital gains planning (including capital loss harvesting) and contributions to tax-deferred accounts, such as retirement savings and flexible spending accounts play a role in a successful year-end tax strategy. You can find a list of tax planning suggestions located on our website. As explained below, the Act contains several taxpayer-friendly provisions which may play a role in tax planning such as the Qualified Business Income (“QBI”) deduction for certain pass-thru entities and sole proprietorships, more accelerated depreciation provisions, and capital gain deferral/exclusion for investment in Qualified Opportunity Zones.
Updates and Planning You Should Know About
Lower individual income tax rates – Top income tax rate was reduced from 39.6% to 37% and the taxable income threshold for the highest rate increased from $470,700 to $600,000 (Married Filing Joint); and from $418,400 to $500,000 (Single).
State and Local Tax Deduction and Real Estate Tax Deduction –Tax years 2018 through 2025: No more than $10,000 may be deducted for a combination of state and local income taxes and real estate taxes on investment or personal property.
Standard Deduction – Many taxpayers who itemized deductions year over year will no longer be able to do so due to the capped deduction for state and local income taxes and real estate taxes. The Act provides some relief with an increased standard deduction from $12,700 to $24,000 (Married Filing Joint), and from $6,350 to $12,000 (Single).
Charitable Contribution percentage – Increased Adjusted Gross Income (“AGI”) limitation from 50% to 60% for donations of cash to public charities.
Mortgage Interest Deduction - Tax years 2018 through 2025: Interest deduction allowed on qualified acquisition indebtedness (first and second homes) incurred before December 15, 2017 up to $1,000,000 (Married Filing Joint); Interest deduction allowed on qualified acquisition indebtedness incurred after December 14, 2017, up to $750,000; Interest deduction on home equity indebtedness suspended until 2026.
Pease Limitation – No further limitation on itemized deductions for high income earners (limitation permanently repealed). Thus, a large charitable contribution made by a high income earner will not be eroded provided the contribution is within the applicable statutory AGI limitations.
Miscellaneous Itemized Deductions – All miscellaneous itemized deductions subject to the 2% AGI floor are suspended through 2025.
Alternative Minimum Tax – Tax years 2018 through 2025: Increased exemption of $109,400 for Married Filing Joint; Phase-out of exemption increased to $1 million. Due to the capped deduction for state and local income taxes and real estate taxes and the elimination of miscellaneous itemized deductions, taxpayers may be able to exercise Incentive Stock Options “tax-free” as the spread between their regular tax over Tentative Minimum Tax may be greater under the Act than under old law. Individual planning strategies:
- Evaluate applying a “bunching strategy” to pull or push discretionary medical expenses and charitable contributions into the year where they will provide the most benefit.
- Postpone income until 2019 and accelerate deductions into 2018 if doing so may enable you to claim larger deductions, credits, and other tax breaks for 2018 that are phased out over varying levels of adjusted gross income (AGI). These include deductible IRA contributions, child tax credits, and higher education tax credits. Postponing income could be advantageous for those taxpayers who anticipate being in a lower tax bracket next year due to changed financial circumstances.
- Disposing devalued assets before year-end, but be mindful of the wash sale rule which precludes loss recognition when substantially similar stock or securities are purchased within 30 days before or after the sale;
- Analyze passive activities to determine if “active” status can be achieved, and evaluate elections to “group” certain activities for purposes of determining net gains and losses from active and passive activities;
- Time charitable contributions, including donations of appreciated securities held for more than one year; and
- Fund a Health Savings Account if you meet the eligibility requirements.
- Since California has not conformed to any provisions in the Act, property taxes on investment property are still deductible for California purposes. Consider pre-payment of property taxes, particularly if income is expected to increase in 2019.
Qualified Business Income Deduction (“QBI”) – Tax Years 2018 through 2025:
Individuals, trusts, and estates may qualify for a deduction equal to 20% of their qualified business income from pass-thru entities or sole proprietorships, subject to certain limitations. For Married Filing Joint taxpayers with taxable income between $315,000 and $415,000 (half of that for all other taxpayers), the deduction begins to be subject to W-2 wages and unadjusted property basis limitations. Above the phase-out range, Specified Service Trade or Businesses no longer qualify for the deduction; all other businesses are subject to the full wage and basis limitations. Please refer to the HCVT Tax Alert on QBI for further information about the deduction.
Bonus depreciation – 100% bonus depreciation provision allows taxpayers to accelerate depreciation expense on new or used qualified property placed in service during the year. The deduction is not subject to any phase-outs and is only applicable for federal purposes.
Section 179 depreciation – The business expensing limit increased to $1 million per year, and the phase-out amount of qualified property acquisitions increased to $2.5 million. Eligible property has been expanded to include certain personal property used in connection with furnishing lodging and certain nonresidential real property improvements.
Qualified Opportunity Zones (“QOZ”) – Gain deferral and partial gain exclusion on capital gain invested in a QOZ. Individuals, trusts, C and S Corporations, REIT’s and partnerships can sell their appreciated capital assets and elect to reinvest the resulting capital gain income into a Qualified Opportunity Fund (QOF) within 180 days of the sale of the capital asset from which the gains were generated. Gains from calendar year pass-through entities will be recognized at calendar year-end unless the pass-through entity elects not to reinvest in a QOF and the individual investors opt to recognize the gain on the actual disposition date. There is a 10% step-up in basis provided the QOF is held for more than five years. If the QOF is held for at least seven years (in total), an additional 5% will be added to basis bringing the total step-up to 15% in year seven. 85% of the deferred gain is fully recognized by year 2026. After ten years, the investment is adjusted to fair market value and will continue to fluctuate over time as the value changes resulting in no further federal gain or loss upon an ultimate sale of the QOF.
Each state governor was empowered to designate specific economically challenged census tracts that met statutory guidelines. Currently, there are over 8,700 census tracts (approximately 10% are in CA) throughout the U.S., plus all Territories of the U.S., which qualify for QOZ investment. For a more detailed overview and additional information, please see our Tax Alerts.
Domestic Production Activities Deduction – repealed after 2017.
Entertainment expenses – Disallowed deductions for entertainment, amusement, or recreation activities under all circumstances.
Business Interest Expense – For taxpayers with average annual gross receipts in excess of $25 million, the deduction for business-related interest expense is generally limited to 30% of taxable income; carryover provisions apply. Real estate businesses that use the Alternative Depreciation System (ADS) may elect not to be subject to the limitation.
Corporate tax rate – permanently lowered from the top rate of 35% to flat rate of 21%. Applies to personal service corporations as well. Double taxation still looms but is now lower.
Carried Interest – After 2017, gain from partnership profits interests, granted or held in connection with the performance of investment services, will be treated as short-term capital gain if the partnership interest has not been held for more than three years.
- Review inventory to identify subnormal goods that may be offered for sale below carrying cost. Even if not sold by year-end, the difference between the reduced sales price and the carrying cost may be written-off for income tax purposes;
- Cash basis taxpayers can accelerate payment of employee bonuses by year-end to reduce their taxable income (this may also help with maximizing the qualified business income deduction). Accrual basis taxpayers can generally defer the payment of non-owner employee bonuses until the fifteenth day of the third month following the taxable year of the accrual;
- Evaluate optimal qualified plan structure and funding;
- Analyze at-risk and general tax basis to ensure the proper tax impact from pass-thru income, losses, credits, and distributions;
- Evaluate the long-term cost-benefit of C-Corp vs. S-Corp vs. LLC structure in light of corporate and individual income tax rates;
- Pay expenses by credit card to claim deductions without using immediate cash (and earn reward points);
- Establishment of an IC-DISC to reduce the tax on export income.
Estate and Gift Tax Planning
With no current threat to the use of discounts for lack of control and marketability when valuing transfers of ownership interests in family-owned businesses, estate and gift planning remains a useful tool to maximize estate tax savings on the transfer of assets. The increase in the estate and gift lifetime exemption implemented by the Act makes it even more attractive to consider wealth transfer planning.
- If you have been putting off estate planning, or need to review your existing plan, please contact us to discuss how you can make transfers in the most tax-efficient manner.
- Consider making gifts to take advantage of the current annual gift exclusion of $15,000 per person.
- Transfers made on behalf of another directly to:
- Educational institutions for tuition, and
- Medical facilities
are not reportable gifts and thus do not impact the annual gift exclusion or the transferor’s lifetime exemption.
- In addition to the annual gift exclusion, the per person lifetime exemption increased to $11,180,000 in 2018 and $11,400,000 in 2019.
We hope this information is helpful and if you have any questions, contact your HCVT tax advisor directly.