planning 2018-2019 tax - fitaxguy.com · fund admiral shares) have u.s. federal government bills,...

2018-2019 Tax Planning

ChooseFI San DiegoOctober 13, 2018Presented by Sean Mullaney@SeanMoneyandTax

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Presenter: Sean Mullaney. This work is licensed under a Creative Commons Attribution 4.0 International License.

The information presented in this slide deck is for general information purposes only. It does not constitute legal, tax, accounting, or financial advice to any person or entity.

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Tax Reform

Changes to Individual Deductions

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New Standard Deduction

Filing Status 2017 2018

Single $6,350 $12,000

Married Filing Joint $12,700 $24,000

Married Filing Separate $6,350 $12,000

Head of Household $9,350 $18,000

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Significant Reduction of State and Local Tax Deduction

In 2017, taxpayers itemizing deductions could deduct state and local income taxes and personal property taxes without limit.

Starting in 2018, the state and local tax deduction will be limited to a total combined amount of $10,000 including both income taxes and personal property taxes. For taxpayers using the married filing separate status the limit is $5,000.

Note that this cap applies to only those taxes deductible as itemized deductions. It should not apply to taxes paid with respect to rental real estate. See https://www.forbes.com/sites/kellyphillipserb/2018/01/12/ask-the-taxgirl-the-10000-salt-cap-rental-real-estate/#2eaff2ca3b3a

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Elimination of Personal Exemptions

In 2017, the personal exemption per taxpayer and eligible dependent was $4,050. For the 2018 through 2025 tax years, there is no personal exemption.

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Elimination of Miscellaneous Expenses

In 2017, miscellaneous expenses could be taken as an itemized deduction (usually subject to a 2% of AGI floor). Tax reform has eliminated the deduction. Important eliminated deductions include:

● Job related tuition● Unreimbursed employee expenses (the largest ones were often unreimbursed travel

expenses)

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Itemized Deductions: Bunching Deductions

For the charitably inclined, consideration should be given to “bunching” deductions in one particular tax year, so as to claim large itemized deductions in some years and the standard deduction in some years.

For example, Joe and Megan, a married couple, either rent or own their house outright. They intend to give $10,000 annually to their favorite charity for the next five years. They could, instead, give $50,000 to the charity in 2018, elect to itemize their deductions in 2018, and then claim the standard deduction in the 2019 through 2022 taxable years.

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Itemized Deductions: Donor Advised Funds

For the charitably inclined, consideration should be given to donating to a donor advised fund. These funds allow for a bunching of deductions. The donor donates to the fund in one year, and then directs the fund to make disbursements to charities in the future. The advantages are an upfront tax deduction while the donor’s preferred charities receive funds under the time schedule controlled by the donor.

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Charitable Contributions for Those 70 ½ and Older

For those who have attained the age of 70 ½ and have traditional IRAs or other tax deferred retirement vehicles, strong consideration should be given to “qualified charitable distributions” (“QCDs”).

Such taxpayers can contribute up to $100,000 to charity directly from their traditional IRA without the amounts contributed being included in taxable income. The main advantage of this strategy is that the taxpayer’s “required minimum distribution” (“RMD”) can be satisfied without a taxable income inclusion (assuming transaction is executed properly).

See IRS Publication 590-B. Often it is advisable to work with a tax professional on this strategy.

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https://www.irs.gov/forms-pubs/about-publication-590-b


Charitable Contributions: Appreciated StockIn today’s environment (Fall 2018) there are many appreciated stock positions in individual American portfolios. For the charitably inclined, consideration should be given to donating appreciated stock. If you have held it for more than one year, you can deduct the entire fair market value (“FMV”) of the stock, up to 30% of your adjusted gross income (“AGI”), or you can elect to deduct the basis of the stock, up to 60% of AGI.

The donor avoids recognizing the built in gain on the donated stock.

Stock held for one year or less allows the donor to deduct the lesser of the basis or FMV.

Stock with a built in loss should generally not be donated to charity. Rather, it should be sold first and then the proceeds should be donated to the charity.

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2018 & 2019 Planning Ideas

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2018 & 2019 Roth ConversionsTax Reform lowered the federal tax brackets. Further, there is no guarantee that unlimited Roth Conversions will continue to be the law. Consideration should be given to converting amounts in traditional IRAs to Roth IRAs. This very much depends on a taxpayer’s individual circumstances.

- Is the current taxable year and/or next taxable year a particularly high or low income year for the taxpayer?

- Consider the “tax insurance” benefits of Roth Conversions (lock in low rates; lower investment income that is taxed by paying taxes). However, see GoCurryCracker analysis.

- Action Item: Remember, to qualify as a 2018 (as opposed to a 2019) Roth Conversion, the conversion must be complete by December 31, 2018 - do not delay if you want to pursue this strategy.

- There is no longer an ability to unwind a Roth Conversion (Tax Reform repealed unwinds, known as “recharacterizations”).

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https://www.gocurrycracker.com/roth-sucks/


Tax Gain Harvesting

Tax Gain Harvesting - Single filers with a taxable income (including gains on sale of assets) of up to $38,600 and married filing joint filers with a taxable income of up to $77,200 pay a zero percent long term capital gains rate in 2018.

Such taxpayers may want to consider selling appreciated financial assets at a gain to increase tax basis and/or rebalance at a zero percent federal rate.

But consider state income tax effect (California, for example, taxes the first dollar of taxable income and does not have a preferential rate for long-term capital gains).

Tax gain harvesting can also apply when a taxpayer has a large capital loss in the current year or a large capital loss carryforward.

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Tax Loss Harvesting

Tax Loss Harvesting - Capital losses can offset capital gains. Further, up to $3,000 of capital losses can offset ordinary income during the taxable year. Thus, taxpayers should review their portfolios in the fourth quarter to see if there are tax loss harvesting opportunities and whether such planning might make sense.

Anyone considering this planning must navigate the wash sale rules which deny the loss if the taxpayer buys the same security or a similar security within 30 days (backward and forward) of the sale for which the loss is expected to be claimed.

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Adjusting Withholding

Always get a huge tax refund? Did you pay an underpayment penalty to the IRS last year? It’s never a bad idea to review your tax withholding, and Tax Reform makes it even more advantageous to do so.

Consider reviewing your withholding with a tax professional or using the IRS Withholding Calculator (https://apps.irs.gov/app/withholdingcalculator/) to do so. If necessary, file a revised Form W-4 with your employer.

Also, consideration should be given to quarterly estimated tax payments for the self-employed, those with side hustles, and/ those with real estate and/or investment income.

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https://apps.irs.gov/app/withholdingcalculator/


Federal Interest is State Tax Free

Many bond mutual funds and ETFs (for example, VBTLX - Vanguard Total Bond Market Index Fund Admiral Shares) have U.S. federal government bills, notes, and bonds in their portfolios. Interest attributable to obligations of the federal government is not subject to state income tax.

If you are subject to state income tax and own such a mutual fund or ETF (or directly hold federal government obligations), ensure that you subtract out the interest attributable to federal government obligations from your state taxable income.

Action Item: Your broker should send you a statement with a ratio to inform you how much of your Form 1099 dividend from the mutual fund is attributable to federal government obligations and is thus to be subtracted from your state taxable income. Be sure to provide this to your tax preparer or have it handy when you prepare your own tax return.

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Tax Basketing of InvestmentsInvestors should consider the various tax baskets in which they can hold investments (i.e., taxable accounts, traditional IRAs/401(k)s/etc., Roth IRAs/401(k)s/etc., and HSAs). Depending on the tax attributes of the income, it may make sense to place one investment in a particular tax basket.

Example: Dave is 40 years old and pursuing financial independence. He owns $150K worth of VTSAX in a Roth IRA and holds $350K in cash in a taxable account. Dave has decided that his portfolio should consist of 70% VTSAX (assume it pays a 3% dividend qualifying for the 15% qualified dividend income (“QDI”) rate) and 30% VTIAX (assume it pays a 3.5% dividend qualifying for the 15% QDI rate and 1% annually is withheld for foreign income taxes). Dave would be well advised to purchase the required $150K of VTIAX in his taxable account in order to preserve the ability to claim a foreign tax credit with respect to dividends received from his VTIAX holding. If the VTIAX is held in the Roth IRA (or any other tax advantaged account), Dave will not be able to claim the foreign tax credits generated by the VTIAX dividends.

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Net Unrealized Appreciation (“NUA”)

If you leave employment and you have employer stock in your 401(k) plan, you should consider NUA.

401(k)s are great, but assets in them do not qualify for preferential long-term capital gains treatment. NUA is an exception. It requires current recognition of ordinary income to the extent of the historic amounts contributed to purchase the employer stock and a 10% penalty on such amounts, but it allows for the gain to qualify for deferred long-term capital gains treatment.

Example: Jennifer leaves her job at Kramerica Industries in 2018. Jennifer previously purchased $100,000 worth of Kramerica stock in her 401(k). Due to Kramerica’s incredible run up in the stock market, Jennifer’s stock is now worth $1,000,000. If she elects NUA treatment, she would (a) roll over her Kramerica stock to a taxable account; (b) recognize $100,000 of ordinary income on her 2018 tax return, (c) owe a $10,000 penalty with her 2018 tax return and (d) have NUA in the Kramerica stock of $900,000. At anytime Jennifer can sell the Kramerica stock (if/when she chooses to). Doing so triggers the $900,000 NUA, creating a long-term capital gain.

NUA has complexities - taxpayers should strongly consider consulting with a tax professional.

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HSA Receipts

Taxpayers with health savings accounts (“HSAs”) should save all medical receipts. Taxpayers can reimburse themselves tax free (for federal tax purposes) from an HSA for previously incurred medical expenses. There is no time limit for making such a reimbursement.

Action Item: Consider scanning medical receipts and saving digital copies of the receipts.

Often it is advantageous to pay for medical expenses out of taxable accounts instead of with HSA money, because keeping the money in the HSA allows it to grow and compound tax free (for federal tax purposes).

California, Alabama, and New Jersey do not recognize HSAs and treat them as taxable accounts.

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Tax Reform

Section 199A Qualified Business Income Deduction

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Section 199A Basics

Section 199A, enacted as part of Tax Reform, provides a 20 percent deduction for certain income. Generally, two types of income qualify:

1) “Qualified Business Income” or “QBI” from a domestic business operated as a “flow-through” (i.e., sole proprietorship, partnership, S corporation, trust, or estate) -- subject to taxable income limits and possibly other limits; and,

2) Qualified REIT dividends and qualified publicly traded partnership (“PTP”)income.

See the Preamble to the Section 199A Proposed Regulations

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https://www.irs.gov/pub/irs-drop/reg-107892-18.pdf


Section 199A Basics

The Section 199A deduction “is the lesser of (1) the sum of the combined amountsdescribed in the prior [slide] or (2) an amount equal to 20 percent of theexcess (if any) of taxable income of the taxpayer for the taxable year over the netcapital gain of the taxpayer for the taxable year.” -- Preamble to the Section 199A Proposed Regulations

Note that “net capital gain” includes qualified dividend income (“QDI”).

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Section 199A Basics

Section 199A looks at the world and see three types of income:

1) QBI (which does not include wage income)2) Qualified REIT dividends and qualified PTP income3) All other income.

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Section 199A QBI

Generally, QBI is income from a trade or business (as defined under normal U.S. tax principles).

It is important to maintain documentation supporting that the activity is a trade or business. Important that the activity not be considered a hobby.

QBI does not include wage income. It also does not include certain portfolio income unless that income is attributable to a trade or business.

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Section 199A Two Types of QBI

There are two types of QBI:

1) Specified service trade or business (“SSTB”) income

2) All other QBI

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Section 199A SSTB Income

The Preamble to the Proposed Regulations defines SSTB as follows:

[T]he definition of an SSTB for purposes of section 199A is (1) any trade or businessinvolving the performance of services in the fields of health, law, accounting, actuarialscience, performing arts, consulting, athletics, financial services, brokerage services, orany trade or business where the principal asset of such trade or business is thereputation or skill of one or more of its employees or owners, and (2) any trade orbusiness that involves the performance of services that consist of investing andinvestment management, trading, or dealing in securities (as defined in section475(c)(2)), partnership interests, or commodities (as defined in section 475(e)(2)).

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Section 199A First Question

Question 1: What type of income do you have?

1) QBI2) Qualified REIT dividends and qualified PTP income3) All other income.

If QBI, then see slide 29 and the following slides for possible deductibility

If qualified REIT dividends or qualified PTP income, it qualifies for the Section 199A deduction. See slide 34.

If any other type of income, the income does not qualify for the Section 199A deduction.

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Section 199A Second Question

Question 2: Is your taxable income (in 2018) $157,500 or less ($315,000 or less for MFJ filers)?

YES: Your QBI qualifies for the full Section 199A deduction, subject only to the limitation of 20% of taxable income less net capital gain.

NO: Your Section 199A deduction for QBI is subject to 1 or 2 limitations. See next slide (#30).

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Section 199A Second Question (Cont.)Question 2: Is your taxable income (in 2018) $157,500 or less ($315,000 or less for MFJ filers)?

NO: Your Section 199A deduction for QBI is subject to one limitation and possibly a second limitation.

1) Over the taxable income thresholds, all QBI is subject to a limitation on the Section 199A deduction based on W-2 wages paid by the business and the unadjusted asset basis in the business. The more of these attributes, the greater the Section 199A deduction.

2) SSTB income suffers an additional limitation. The Section 199A deduction for such income is phased out for taxable incomes between $157,500 and $207,500 ($315,000 and $415,000 for MFJ filers).

Note that unadjusted asset basis is generally the acquisition cost of property. It includes tangible property (including buildings) but does not include land.

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Section 199A and FI

Section 199A is a significant benefit for those pursuing financial independence, side hustles, and the like. If taxable income is low enough, self-employment income from a trade or business qualifies without much further complexity.

Further, regardless of whether you take the standard deduction or claim itemized deductions you are entitled to the Section 199A deduction.

Further note that once the previously mentioned taxable income thresholds are exceeded, Section 199A becomes tremendously complex. Consulting with a tax professional is strongly recommended.

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Section 199A and FI Examples

Example 1: Tom has $100,000 of W-2 wage income, $1,000 of QDI, makes $10,000 from a trade or business side hustle reported on Schedule C, and claims the standard deduction on his tax return. Tom’s Section 199A deduction is the lesser of 20% of his taxable income less net capital gain ($100,000 plus $10,000 less $12,000) ($98,000 X 20% = $19,600) or 20% of his QBI ($10,000 X 20% = $2,000). Thus, Tom’s Section 199A deduction is $2,000.

Example 2: Martha owns a sole proprietorship engaged in a trade or business which earned $100,000 this year. Martha also earned $1,000 of QDI and claims the standard deduction on her tax return. Martha’s Section 199A deduction is the lesser of 20% of her taxable income less net capital gain ($100,000 less $12,000) ($88,000 X 20% = $17,600) or 20% of her QBI ($100,000 X 20% = $20,000). Thus, Martha’s Section 199A deduction is $17,600.

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Section 199A and Real Estate Investing

Based on the proposed regulations, it does not appear that passive real estate rentals qualify for the Section 199A deduction. However, real estate investing that rises to the level of a trade or business should qualify.

Generally speaking, investing in real estate as a professional engaged in an active trade or business is better than holding it as a passive investor (from an income tax perspective) because 1) its avoids the application of the passive activity loss rules; 2) it avoids the Net Investment Income 3.8% surtax; and now 3) it qualifies the activity to the Section 199A deduction (subject to the limitations once taxable income exceeds $157,500 in 2018 ($315,000 for MFJ filers)).

Consideration should also be given to owning REIT stock outright, whereby the investor can qualify dividends for the Section 199A deduction without the taxable income limitations. For more, please see Jeffrey Levine’s post here: https://www.kitces.com/blog/reit-real-estate-investments-section-199a-qbi-deduction/

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Section 199A Qualified REIT Dividends

Qualified REIT dividends qualify for the Section 199A deduction. No need for the taxpayer to be in a trade or business and there are no limitations based on taxable income.

Considerations:

1) The income from the REIT must be ordinary dividend income. REITs sometimes pass out other types of income (such as unrecaptured Section 1250 income or capital gain dividends). These types of other income do not qualify for the Section 199A deduction. Check your Form 1099 to verify that the income qualifies as an ordinary dividend.

2) It is not clear that dividends from REIT mutual funds and ETFs will qualify for the Section 199A deduction. They do not under the proposed regulations. NAREIT wrote a comment letter encouraging the IRS and Treasury to allow dividends from mutual funds and ETFs to qualify.

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https://www.reit.com/sites/default/files/Nareit-Comments-Proposed-Section-199A-Regulations.pdf


Section 199A QBI Losses

If, instead of qualified business income, a taxpayer has a qualified business loss (a “QBI loss”) during the taxable year, the loss carries forward to offset QBI in the succeeding year.

Importantly, the loss does not offset REIT dividends and PTP income for purposes of the Section 199A deduction, so a taxpayer with a current year QBI loss and current year REIT dividends (and/or PTP income) can still claim a Section 199A deduction with respect to the REIT dividends (and/or PTP income).

Please see the previously referenced Jeffrey Levine post on this topic.

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https://www.kitces.com/blog/reit-real-estate-investments-section-199a-qbi-deduction/


Section 199A Planning● Structuring -- the income of sole proprietorships and single member LLCs qualifies for

the Section 199A deduction, while salaries paid to owners by S corporations and guaranteed payments paid to partners by partnerships do not qualify for the Section 199A deduction.

● Lowering taxable income to fall below the limitation thresholds (for example, increase deductible retirement plan contributions).

● Turning non-QBI into QBI through segmenting one existing business into multiple businesses which must compensate each other for services rendered/property used.

● Consider electing out of Section 179 expensing and bonus depreciation to increase QBI.

● Reduce leverage on trade or business rental real estate. ● Resources:

○ https://www.kitces.com/blog/small-business-owner-section-199a-qualified-business-income-qbi-deduction-strategies/

○ https://www.madfientist.com/section-199a/

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https://www.kitces.com/blog/small-business-owner-section-199a-qualified-business-income-qbi-deduction-strategies/

https://www.kitces.com/blog/small-business-owner-section-199a-qualified-business-income-qbi-deduction-strategies/

https://www.madfientist.com/section-199a/


Section 179 Small Business Expensing

For property placed in service after December 31, 2017:

Tax Reform increased the Section 179 small business expensing (as opposed to depreciation over time) annual limit to $1M (from $510K).

Tax Reform added to the list of assets within nonresidential real estate that can qualify for Section 179 (the real estate itself does not qualify).

Eligible Section 179 property now includes property used to furnish lodging (furniture, appliances, etc. - the real estate itself does not qualify).

Section 179 is complex and has some complex interplay with the Section 199A deduction. Taxpayers should consult with their tax advisor on these issues.

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Inherited IRAs, 401(k)s, and Other Qualified Plans

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Inherited IRAs, 401(k)s, and Qualified PlansBeneficiary designation forms control who inherits IRAs, 401(k)s, and other qualified plans. If they are not completed, the assets could (a) pass to a person or persons the original owner did not intend for them to pass to and (b) could create a big tax headache for the beneficiaries.

If the owner designates individuals as beneficiaries, they can generally elect to spread out the annual required minimum distributions (“RMDs”) from the account over the longer of their remaining expected lifetime or the owner’s expected lifetime (spouses benefit from more generous rules). This spreading out mimizies the tax hit related to the account and greatly increases the after-tax value of the account for the beneficiary.

If there isn’t a filed beneficiary designation form passing the account to an individual(s), there is a risk the account will pass to the owner’s estate, which is not a qualified beneficiary. In that case the entire account must be distributed to the beneficiaries within the 5 years following the year of death, which almost certainly will be an awful tax result for the beneficiaries.

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Inherited IRAs, 401(k)s, and Qualified Plans

Action Item: Review and update beneficiary designation forms on all IRAs, 401(k)s, and qualified plans. Ensure proper beneficiary designation forms are on file with the plan administrator.

Doing so ensures the assets are inherited by the right people, and the assets are passed in a tax-efficient manner that does not create a significant tax problem for the beneficiaries.

Generally, ERISA plan assets must be left to a spouse unless a valid spousal waiver is in place. State laws may also apply to i) require a certain amount of assets are left to the spouse and/or ii) deem a portion of an IRA or other account as community property, and thus partially belonging to the spouse.

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Inheriting an IRA, 401(k), or a Qualified Plan

Beneficiaries inheriting IRAs, 401(k)s, and/or qualified plans often should consult a tax professional.

Planning considerations and issues include (but are not limited to):

● If the owner reached age 70 ½ prior to death, he or she was required to take an RMD for the year of death. If they did not do so, the beneficiary must take this RMD by December 31 of the year of the owner’s death.

● For non-spouse beneficiaries (and some spousal beneficiaries), it is important to take the RMD for the first full year after the death of the owner (must be taken by December 31 of the year following the death).

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Inheriting an IRA, 401(k), or a Qualified Plan (Cont.)

Beneficiaries inheriting IRAs, 401(k)s, and/or qualified plans often should consult a tax professional.

Planning considerations and issues include (but are not limited to) (Continued):

● Ensure the account is properly titled. For example, a non-spouse IRA beneficiary should title the account in a manner similar to the following: Emmett “Doc” Brown IRA (Deceased 10/26/1985) F/B/O Martin McFly, Beneficiary

● The 60 day rollover rule does not apply to non-spouse beneficiaries who inherit IRAs - never take a check for an inherited IRA, 401(k), or qualified plan.

● Spouses have the option to treat the account as their own or to be treated as a beneficiary.

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