Year-End Tax Planning

By Christopher R. English, President of Lumen Capital Management, LLC

This may be hard to believe, but 2019 is quickly coming to an end. Although you might be focused on getting through the holidays, you may want to look ahead and start thinking about year-end tax planning. Why? Because the best way to minimize your taxes is to be proactive. If you wait until the last minute, you might miss out on some tax-efficient opportunities. That’s why I’ve teamed up with Indigo Marketing to put together this piece that hopefully shares some general ideas for you to think about as you get your tax situation organized before we ring in 2020. Please understand I am offering up some broad ideas for you to think about as we roll into year end. Anything regarding your specific situation should be discussed with your tax professional.

1. Decide If You Want To Itemize

The new tax law made the standard deduction $12,200 for individuals and $24,400 for married couples filing jointly. The TCJA eliminated many older deductions, including miscellaneous deductions for tax preparation fees, investment expenses, home office expenses (unless you’re self-employed), and unreimbursed employee business expenses. It also capped the deduction for state and local income tax (SALT) at $10,000, and limited the home mortgage interest deduction to acquisition indebtedness up to $750,000 in mortgage loan interest (for new mortgages taken out since 2018; the limit remains $1,000,000 for all existing mortgages). The floor for unreimbursed medical expenses, which was temporarily lowered to 7.5% of adjusted gross income (AGI) for tax years 2017 and 2018 only, reverted to 10% of AGI in 2019. 

These changes resulted in fewer taxpayers being able to itemize on their returns under the new law. However, for many taxpayers, the significant increase in the standard deduction made up for the loss of itemized deductions. However, you still need to tally up your allowable deductions in 2019 to determine if they add up to more than the standard deduction. In that case If you know your deductible expenses will exceed those amounts, then consider itemizing. But if you want to itemize and are coming in under the standard deduction amount, you need to take action soon. You might want to consider “bunching” your deductions.

2. “Bunch” Deductions

December 31st is the deadline for capturing medical expenses or making charitable donations for the 2019 tax year. Some taxpayers may find themselves on the fence when it comes to itemizing due to a significant amount of unreimbursed medical expenses, or a desire to take advantage of the higher floor for charitable deductions, which rose to 60% of AGI under the new law. 

“Bunching” deductions into the current tax year is a strategy you may want to explore to increase your itemized deductions. For example, if you have a significant amount of unreimbursed medical expenses, it may make sense to accelerate elective treatments, procedures, or medical equipment costs into 2019 if your combined deductions will bring you over the standard deduction amount.

If bunching charitable deductions in years where you will be able to itemize makes sense in your situation, you may want to consider a donor-advised fund to achieve that goal. Donor-advised funds are established with public charities. As the donor, you transfer money or appreciated stock and receive a deduction in the year the charitable donation is made. 

Make the most of your generosity when donating to charitable organizations. Contribute appreciated assets such as stocks or shares in mutual funds, provided you have owned the property for more than a year. If so, you can deduct the full value and neither you nor the charity pays tax on the appreciation. 

3. Make Sure You Fund Your Retirement Accounts

Contributing the maximum allowed to tax-deferred retirement accounts, such as 401(k)s or IRAs, is one of the most effective ways to reap the tax benefits and reduce taxable income. In 2019, you can contribute up to $19,000 to a 401(k) or 403(b) in the form of salary deferrals. And if you’re 50 or older in 2019, you can make an additional $6,000 catch-up contribution, for a total maximum contribution of $25,000. In 2020, these limits will increase to $19,500, and $6,500 for catch-up contributions. If you’ll be 50 or older next year, that provides an opportunity to reduce your taxable income by $26,000 in 2020. 

The contribution limits for individual retirement accounts (IRAs) have also increased in 2019, to $6,000 for those under age 50, and an additional $1,000 catch-up contributions for those age 50 or over, for a total annual contribution of $7,000. (IRA limits will remain the same in 2020.) In addition, many employers match some or all of your contributions. 

Even if you can’t save up to the limit, deposit as much as you can before the end of the year and at least enough to receive your full employer match. Free money into a tax-deferred account is a tax-planning dream!

If you participate in an employer-sponsored retirement plan, you may be able to designate some or all of your contributions as Roth contributions. While Roth contributions are made on an after-tax basis and don’t reduce your current MAGI, qualified distributions will be tax-free. Roth contributions may be especially beneficial for higher-income earners who are ineligible to contribute to a Roth IRA.

Keep in mind you only have until December 31st to maximize your 401(k), 403(b) or other employer-sponsored retirement plan contributions for the 2019 tax year. This is unlike individual retirement accounts, or IRAs, where you can make 2019 contributions up until April 15, 2020. 

4. Consider A Roth IRA Conversion

If you have a traditional IRA, consider whether you might benefit from converting some or all of it to a Roth IRA. A conversion can allow you to turn tax-deferred future growth into tax-free growth while providing important estate planning advantages. Unlike traditional IRAs, Roth IRAs are not subject to RMDs so you can let the entire balance grow tax-free over your lifetime for the benefit of your heirs.

Whether a conversion makes sense for you depends on a number of factors, including your age, whether the conversion would push you into a higher income tax bracket, and your current tax bracket now and expected tax bracket in retirement. One very important factor when considering a Roth IRA conversion is whether you can afford to pay the tax on the conversion in the year you are making the switch. All monies converted into a Roth IRA are taxable in the year of conversion. Also, remember that you do not need to convert the entire amount to a Roth at one time. You can transfer the money in stages over time, and space out the taxes owed on the conversion. Keep in mind that under the Tax Cuts & Jobs Act (TCJA) you no longer have the option to undo a Roth IRA conversion by “recharacterizing” the account as a traditional IRA. However, you can still recharacterize new Roth IRA contributions as traditional contributions if you do it by the applicable deadline and meet all other requirements. 

Deciding whether to do a Roth conversion is a discussion I would highly suggest you take up with your tax professional. Don’t do anything without considering the cash flow consequences of that decision.  Finally, keep in mind that the conversion to a Roth means you are relying on the U.S. Government not to change the taxing provisions on Roths in the future. While there does not seem to be any movement to tax Roth IRAs at this time or require an RMD on these accounts, keep in mind that what Congress gives it can also take away.

5. Give, Then Give Some More

You can give up to $15,000 to each individual of your choice in 2019 without paying gift tax or tapping your lifetime estate and gift tax exemption. Your spouse can also give $15,000 to the same person or persons in 2019, for a total of $30,000 tax-free gift. Any unused amount is gone forever. You cannot give extra next year to make up for it. Annual gifts over the exclusion amount will trigger the filing of a gift tax return for the year. But no gift tax will be due unless your total lifetime gifts exceed $11,400,000.

One way to give is by opening a 529 account for a child or grandchild. While 529 accounts are funded with after-tax money, it could save you on taxes in the future since the money grows tax-free and no taxes are due when you take the money out for qualified expenses. Plus, some states offer a tax deduction or credit for 529 plan contributions. (1)

6. Make A Qualified Charitable Distribution (QCD) 

If you’re over age 70½ and have an individual retirement account (IRA), a qualified charitable distribution (QCD) may be a more beneficial way to satisfy your charitable giving goals, especially if you don’t have enough deductions to itemize. With a QCD, the custodian of your traditional IRA makes distributions directly to a charitable organization on your behalf. The advantage here is that distributions paid directly to a charity are not taxable and will not be added to your adjusted gross income, so it will not trigger a Medicare premium surcharge and will count toward your required minimum distribution (RMD) for the year. You can direct all or a part of the RMD (up to $100,000 per tax year) to a qualified charitable organization and you will only be taxed on any remaining portion of the distribution that you received. You cannot deduct the donation. 

Transfers to a donor-advised fund, charitable gift annuity, charitable remainder trust, or any other life-income or split interest gift arrangement are not treated as a qualified charitable distribution. Make sure you obtain a receipt from the charity to substantiate the donation. 

7. Max Out Your HSA

If you have access to a health savings account (HSA) with your high-deductible health plan, you can enjoy triple-tax savings with no federal income tax, no state or local taxes, and no Federal Insurance Contribution Act (FICA) taxes. Your contributions are tax-deferred and withdrawals are tax-free for medical expenses. 

Since your balances roll over from year to year, you can max out the account without worrying about using it up right away. For 2019, the contribution limit is $3,500 for an individual and $7,000 for a family, with a $1,000 catch-up bonus for those over age 55. 

Why Pay More In Taxes Than You Need To? 

Tax planning can be a smart way to not only move closer to realizing your goals, but in identifying gaps in your overall financial plan. Engaging in tax planning throughout the year can help lessen or shift your tax burden, free up more money to save or spend, and help you avoid mistakes that can result in penalties or paying more than your fair share. 

However, you never want to make decisions based solely on the tax consequences. Tax planning is part of a comprehensive approach to planning driven by your financial and lifestyle goals. Before putting any of these strategies in place, be sure to meet with your tax professional as well as your financial advisor to coordinate and implement the strategies that are right for you.

We Can Help

Tax planning is one of the most critical aspects of your financial plan because you can save significant amounts of money by implementing strategies and working the tax law to your advantage. Because it’s so important, you should turn to a knowledgeable professional to help you make the right tax decisions and set up your tax plan for success, year after year. If you’d like to learn more about how Lumen Capital Management can help you meet your financial and tax planning needs, reach out to my office at 312.953.8825 or lumencapital@hotmail.com.

About Chris

Christopher R. English is the President and founder of Lumen Capital Management, LLC-a Registered Investment Advisor regulated by the State of Illinois. A copy of our ADV Part II is available upon request. We manage portfolios for investors, developing customized portfolios that reflect a client’s unique risk/reward parameters. We also manage a private partnership currently closed to outside investors. Mr. English has over three decades of experience working with individuals, families, businesses, and foundations. Based in the greater Chicago area, he serves clients throughout Illinois, as well as Florida, Massachusetts, California, Indiana, and other states. To schedule a complimentary portfolio review, contact Chris today by calling 312.953.8825 or emailing him at lumencapital@hotmail.com.

Back Friday.

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(1)  http://www.savingforcollege.com/articles/coming-soon-big-changes-to-529-plans