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Complicating Matters

By Kristina Drzal Houghton, CPA, MST

Year-end tax planning in 2019 remains as complicated as ever. Notably, we are still coping with the massive changes included in the biggest tax law in decades — the Tax Cuts and Jobs Act (TCJA) of 2017 — and pinpointing the optimal strategies. This monumental tax legislation includes myriad provisions affecting a wide range of individual and business taxpayers.

Among other key changes for individuals, the TCJA reduced tax rates, suspended personal exemptions, increased the standard deduction, and revamped the rules for itemized deductions. Generally, the provisions affecting individuals went into effect in 2018, but are scheduled to “sunset” after 2025. This provides a limited window of opportunity in some cases.

Kristina Drzal Houghton

The impact on businesses was just as significant. For starters, the TCJA imposed a flat 21% tax rate on corporations, doubled the maximum Section 179 ‘expensing’ allowance, limited business interest deductions, and repealed write-offs for entertainment expenses. Unlike the changes for individuals, most of these provisions are permanent, but could be revised if Congress acts again.

For your convenience, this article is divided into two sections: individual tax planning and business tax planning. Be aware that the concepts discussed in this article are intended to provide only a general overview of year-end tax planning. It is recommended that you review your personal situation with a tax professional.

INDIVIDUAL TAX PLANNING

Age-old Planning

Postpone income until 2020 and accelerate deductions into 2019 if doing so will enable you to claim larger deductions, credits, and other tax breaks for 2019 that are phased out over varying levels of adjusted gross income (AGI). These include deductible IRA contributions, child tax credits, higher-education tax credits, and deductions for student-loan interest. Postponing income also is desirable for those taxpayers who anticipate being in a lower tax bracket next year due to changed financial circumstances. In some cases, however, it may pay to actually accelerate income into 2019. For example, that may be the case where a person will have a more favorable filing status this year than next (e.g., head of household versus individual filing status), or expects to be in a higher tax bracket next year.

“Generally, the provisions affecting individuals went into effect in 2018, but are scheduled to ‘sunset’ after 2025. This provides a limited window of opportunity in some cases.”

If you believe a Roth IRA is better than a traditional IRA, consider converting traditional-IRA money invested in beaten-down stocks (or mutual funds) into a Roth IRA in 2019 if eligible to do so. Keep in mind, however, that such a conversion will increase your AGI for 2019, and possibly reduce tax breaks geared to AGI (or modified AGI).

It may be advantageous to try to arrange with your employer to defer, until early 2020, a bonus that may be coming your way. This could cut as well as defer your tax.

Capital-gain Planning

Long-term capital gain from sales of assets held for more than one year is taxed at 0%, 15%, or 20%, depending on the taxpayer’s taxable income. The 0% rate generally applies to the excess of long-term capital gain over any short-term capital loss to the extent that it, when added to regular taxable income, is not more than the maximum zero-rate amount (e.g., $78,750 for a married couple).

YEAR-END ACTION: If the 0% rate applies to long-term capital gains you took earlier this year. For example, if you are a joint filer who made a profit of $5,000 on the sale of stock bought in 2009, and other taxable income for 2019 is $70,000, then before year-end, try not to sell assets yielding a capital loss because the first $5,000 of such losses won’t yield a benefit this year. And if you hold long-term appreciated-in-value assets, consider selling enough of them to generate long-term capital gains sheltered by the 0% rate.

Itemized Deductions

Among the most prominent tax changes for individuals, the TCJA essentially doubled the standard deduction while modifying the itemized-deduction rules for 2018 through 2025. For 2019, the inflation-indexed standard deduction is $12,200 for single filers and $24,400 for joint filers.

SEE: List of Accounting Firms

YEAR-END ACTION: With the assistance of your professional tax advisor, figure out if you will be claiming the standard deduction or itemizing deductions in 2019. The results of this analysis will likely dictate your tax planning approach at the end of the year.

Some or all of these TCJA provisions on itemized deductions may affect the outcome:

• The deduction for state and local taxes (SALT) is limited to $10,000 annually. This includes any combination of SALT payments for (1) property taxes and (2) income or sales taxes.

• The deduction for mortgage interest expenses is modified, but you can still write off interest on ‘acquisition debt’ within generous limits.

• The deduction for casualty and theft losses is eliminated (except for disaster-area losses).

• The deduction for miscellaneous expenses is eliminated, but certain reimbursements made by employers may be tax-free to employees.

• The threshold for deducting medical and dental expenses, which was temporarily lowered to 7.5% of adjusted gross income (AGI), reverts to 10% of AGI, beginning in 2019.

TIP: Depending on your situation, you may want to accelerate deductible expenses into the current year to offset your 2019 tax liability. However, if you do not expect to itemize deductions in 2019, you might as well postpone these expenses to 2020 or beyond.

Charitable Donations

Generally, itemizers can deduct amounts donated to qualified charitable organizations, as long as substantiation requirements are met. The TCJA increased the annual deduction limit for monetary contributions from 50% of AGI to 60% for 2018 through 2025. Any excess is carried over for up to five years.

If you are age 70½ or older by the end of 2019, have traditional IRAs, and particularly if you can’t itemize your deductions, consider making 2019 charitable donations via qualified charitable distributions from your IRAs. Such distributions are made directly to charities from your IRAs, and the amount of the contribution is neither included in your gross income nor deductible on Schedule A, Form 1040. But the amount of the qualified charitable distribution reduces the amount of your required minimum distribution, which can result in tax savings.

YEAR-END ACTION: Absent extenuating circumstances, try to ‘bunch’ charitable donations in the year they will do you the most tax good. For instance, if you will be itemizing in 2019, boost your gift giving at the end of the year. Conversely, if you are claiming the standard deduction this year, you may decide to postpone contributions to 2020.

For donations of appreciated capital-gain property that you have owned longer than one year, such as stock, you can generally deduct an amount equal to the property’s fair market value (FMV). Otherwise, the deduction is typically limited to your initial cost. Also, other special rules may apply to gifts of property. Notably, the annual deduction for property donations generally cannot exceed 30% of AGI.

If you intend to donate securities to a charity, you might choose securities you have held longer than one year that have appreciated substantially in value. Conversely, it usually is preferable to keep securities you have owned less than a year.

TIP: If you donate to a charity by credit card late in the year — for example, if you are making an online contribution — you can write off the donation on your 2019 return, even if you do not actually pay the credit-card charge until 2020.

Alternative Minimum Tax

Briefly stated, the alternative minimum tax (AMT) is a complex calculation made parallel to your regular tax calculation. It features several technical adjustments, inclusion of ‘tax preference items,’ and subtraction of an exemption amount (subject to a phase-out based on your income). After comparing AMT liability to regular tax liability, you effectively pay the higher of the two.

YEAR-END ACTION: Have your AMT status assessed. Depending on the results, you may then shift certain income items to 2020 to reduce AMT liability for 2019. For instance, you might postpone the exercise of incentive stock options (ISOs) that count as tax preference items.

Thanks to the TCJA, the AMT is now affecting fewer taxpayers. Notably, the TCJA substantially increased the AMT exemption amounts (and the thresholds for the phase-out), unlike the minor annual ‘patches’ authorized by Congress in the recent past.

TIP: The two AMT rates for single and joint filers for 2019 are 26% on AMT income up to $194,800 ($97,400 if married and filing separately) and 28% on AMT income above this threshold. Note that the top AMT rate is still lower than the top ordinary income-tax rate of 37%.

Education Tax Breaks

The tax law provides tax benefits to parents of children in college, within certain limits. These tax breaks, including a choice involving two higher-education credits, have been preserved by the TCJA.

YEAR-END ACTION: If you pay qualified expenses for next semester by the end of the year, the costs will be eligible for a credit in 2019, even though the semester does not begin until 2020.

Typically, you must choose between the American Opportunity Tax Credit (AOTC) and the Lifetime Learning Credit (LLC). The maximum AOTC of $2,500 is available for qualified expenses of each student, while the maximum $2,000 LLC is claimed on a per-family basis. Thus, the AOTC is usually preferable. Both credits are phased out based on modified adjusted gross income.

The TCJA also allows you to use Section 529 plan funds to pay for up to $10,000 of K-12 tuition expenses tax-free. Previously, qualified expenses only covered post-secondary schools.

TIP: If your student may be graduating in 2020, you may want to hold off and pay the spring 2020 tuition in early January 2020. The student can usually use this credit to offset their own 2020 tax liability even if the parent’s income exceeds the thresholds.

Estimated Tax Payments

The IRS requires you to pay federal income tax through any combination of quarterly installments and tax withholding. Otherwise, it may impose an ‘estimated tax’ penalty.

YEAR-END ACTION: No estimated tax penalty is assessed if you meet one of these three ‘safe-harbor’ exceptions under the tax law. These exceptions consider the timing of quarterly estimates as well as your withholdings. You should review your payments with a tax professional prior to year-end.

BUSINESS TAX PLANNING

Depreciation-related Deductions

Under the TCJA, a business may benefit from a combination of three depreciation-based tax breaks: (1) the Section 179 deduction, (2) ‘bonus’ depreciation, and (3) regular depreciation.

YEAR-END ACTION: Acquire property and make sure it is placed in service before the end of the year. Typically, a small business can then write off most, if not all, of the cost in 2019.

1. Section 179 deductions: This tax-code section allows you to ‘expense’ (i.e., currently deduct) the cost of qualified property placed in service during the year. The maximum annual deduction is phased out on a dollar-for-dollar basis above a specified threshold.

The maximum Section 179 allowance has been raised gradually over the last decade, but the TCJA gave it a massive boost. In 2017, the deduction limit was $510,000, and the phase-out threshold was $2.03 million. Those figures rose to $1 million and $2.5 million in 2018, and $1.02 million and $2.55 million in 2019.

However, note that the Section 179 deduction cannot exceed the taxable income from all your business activities this year. This could limit your deduction for 2019.

2. Bonus depreciation: The TCJA doubled the previous 50% first-year bonus depreciation deduction to 100% for property placed in service after Sept. 27, 2017. It also expanded the definition of qualified property to include used, not just new, property.

Note that the TCJA gradually phases out bonus depreciation after 2022. This tax break is scheduled to disappear completely after 2026.

3. Regular depreciation: Finally, if there is any remaining acquisition cost, the balance may be deducted over time under the Modified Accelerated Cost Recovery System (MACRS).

TIP: A MACRS depreciation deduction may be reduced if the cost of business assets placed in service during the last quarter of 2019 (Oct. 1 through Dec. 31) exceeds 40% of the cost of all assets placed in service during the year (not counting real estate). Additionally, many states, including Massachusetts and Connecticut, do not recognize bonus depreciation. This should be included in your planning considerations.

Travel Expenses

Although the TCJA repealed the deduction for entertainment expenses beginning in 2018, you can still deduct expenses for travel and meal expenses while you are away from home on business and in other limited situations. The primary purpose of the expense must meet strict business-related rules.

If you travel by car, you may be able to deduct your actual expenses, including a depreciation allowance, or opt for the standard mileage deduction. The standard mileage rate for 2019 is 58 cents per business mile (plus tolls and parking fees). Annual depreciation deductions for ‘luxury cars’ are limited, but the TCJA generally enhanced those deductions for vehicles placed in service in 2018 and thereafter.

TIP: The IRS recently issued a ruling that explains when food and beverage costs are deductible when those costs are stated separately from entertainment on invoices or receipts.

QBI Deductions

The TCJA authorized a deduction of up to 20% of the ‘qualified business income’ (QBI) earned by a qualified taxpayer. This deduction may be claimed by owners of pass-through entities — partnerships, S corporations, and limited liability companies (LLCs) — as well as sole proprietors.

YEAR-END ACTION: The QBI deduction is reduced for some taxpayers based on the amount of their income. Depending on your situation, you may accelerate or defer income at the end of the year, according to the figures.

First, however, it must be determined if you are in a ‘specified service trade or business’ (SSTB). This includes most personal-service providers. Then three key rules apply:

1. If you are a single filer with income in 2019 below $160,725 or a joint filer below $321,400, you are entitled to the full 20% deduction.

2. If you are a single filer with income in 2019 above $210,700 or a joint filer above $421,400, your deduction is completely eliminated if you are in an SSTB. For non-SSTB taxpayers, the deduction is reduced, possibly down to zero.

3. If your income falls between the thresholds stated above, your QBI deduction is reduced, regardless of whether you are in an SSTB or not.

TIP: Other rules and limits may apply, including new guidelines for real-estate activities. Consult with your tax advisor for more details about your situation.

Business Repairs

While expenses for business repairs are currently deductible, the cost of improvements to business property must be written off over time. The IRS recently issued regulations that clarify the distinctions between repairs and improvements.

YEAR-END ACTION: When appropriate, complete minor repairs before the end of the year. The deductions can offset taxable business income in 2019.

Estimated Tax Payments

A corporation (other than a large corporation) that anticipates a small net operating loss for 2019 (and substantial net income in 2020) may find it worthwhile to accelerate just enough of its 2020 income (or to defer just enough of its 2019 deductions) to create a small amount of net income for 2019.

YEAR-END ACTION: This will permit the corporation to base its 2020 estimated tax installments on the relatively small amount of income shown on its 2019 return, rather than having to pay estimated taxes based on 100% of its much larger 2020 taxable income.

Bottom Line

These are just some of the year-end steps that can be taken to save taxes. As previously mentioned, be aware that the concepts discussed in this article are intended to provide only a general overview of year-end tax planning. It is recommended that you review your personal situation with a tax professional.

Kristina Drzal-Houghton, CPA, MST is the partner in charge of Taxation at Holyoke-based Meyers Brothers Kalicka, P.C.; (413) 536-8510.

Section 199A

Section 199A of the Tax Cuts and Jobs Act was created to level the playing field when it comes to lowering the corporate tax rate for those businesses not acting as C corporations. For most profit-seeking ventures, qualifying for the deduction is not difficult, but for rental real estate, it becomes more difficult.

By Lisa White, CPA

On Dec. 22, 2017, the Tax Cuts and Jobs Act (TCJA) was signed into law, bringing with it a plethora of changes, affecting, albeit in varying degrees, every taxable and non-taxable entity and individual.

One of the primary focuses of the act was to lower the corporate tax rate to a flat rate of 21%. In order to keep the taxable-entity landscape equitable, however, a provision was necessary for those businesses not operating as C corporations.

Thus, Section 199A was created, providing for a deduction of up to 20% of qualified business income from a domestic business operating as a sole proprietorship, partnership, S corporation, trust, or estate.

The first step in assessing the benefit of the Section 199A deduction is to determine if there is a qualified activity. The statute uses Section 162 of the Internal Revenue Code to designate qualification — which is difficult since Section 162 does not actually provide a clear definition of what constitutes a trade or business.

“What might be the easiest way to approach making the determination is the ‘walks like a duck, quacks like a duck’ scenario. If the activity is a profit-seeking venture that requires regular and continuous involvement, there should not be an issue with rising to the level of a qualified trade or business under Section 162 — and thus being eligible for the Section 199A deduction.”

Instead, case law must be used to support the position taken. What might be the easiest way to approach making the determination is the ‘walks like a duck, quacks like a duck’ scenario. If the activity is a profit-seeking venture that requires regular and continuous involvement, there should not be an issue with rising to the level of a qualified trade or business under Section 162 — and thus being eligible for the Section 199A deduction.

For rental real estate, the determination becomes a bit more complicated. If the rental activity consists of property being rented to or among a group of commonly controlled businesses, where the same owner — or group of owners — owns directly or indirectly at least 50% of both the rental property and the operating business, and the operating business is not a C corporation, then the qualifying designation is automatic. Otherwise, to make the determination, we must once again turn to case law.

Here, this becomes problematic, as there is limited history supporting the position that rental activities rise to the level of a Section 162 trade or business, as the designation heretofore was unnecessary.

In response to concerns about the lack of guidance, the Internal Revenue Service issued Revenue Procedure 2019-7, which provides for a safe harbor under which a rental-real-estate activity will be treated as qualifying for the Section 199A deduction. In addition to holding the rental property either directly or through a disregarded entity, other qualifying factors include the following:

• Separate books and records are maintained for each rental activity (or rental activity group);

• At least 250 hours of rental services are performed each year on each rental activity; and

• For tax years ending after 2018, contemporaneous records are maintained detailing hours of services performed, description of services performed, dates on which services were performed, and, who performed the services.

When making the determination of whether an activity rises to the level of a trade or business under the general rules, each activity must be assessed separately, and no grouping is permitted.

Alternatively, the safe-harbor provision provides an opportunity to elect to group rental activities together in order to meet the other qualifications. The caveat here is that commercial properties must be grouped only with other commercial properties, and likewise for residential properties. Once made, the grouping election can be changed only if there is a significant change in the facts and circumstances. The rental services performed that qualify for the 250-hour requirement include tasks such as advertising, negotiating leases, collecting rent, and managing the property, among others. Financial-management activities, such as arranging financing or reviewing financial statements, do not qualify as ‘rental services,’ nor does the time spent traveling to and from the property. The rental services can be performed by the owners of the property or by others, such as a property-management company.

The safe-harbor election is available to both individuals and pass-through entities and is made by attaching a signed affidavit to the filed return stating that the requirements under the safe-harbor provision have been met.

It’s important to note here that, although meeting the safe-harbor requirements will qualify the activity for Section 199A, it does not provide automatic qualification under Section 162. Similarly, failure to satisfy the safe-harbor requirements does not mean the activity automatically does not qualify for the deduction. Instead, support for the position will just need to be derived from considering other relevant factors and/or case law that can be used as precedent.

Additionally, the safe-harbor election cannot be made for residences used personally for more than 14 days during the year, nor for properties rented on a triple-net-lease basis, a scenario where the tenant is responsible for the taxes, insurance, and general maintenance related to a rental property.

If pursuing the Section 199A deduction for rental property without using the safe-harbor provision, some factors to consider documenting would be the type of property rented, the day-to-day involvement of the owner (or the owner’s agent), and the types and significance of any ancillary services provided.

It seems the courts have applied a relatively low threshold in finding rental activities to rise to the level of a Section 162 trade or business, but it’s also important to note that implications of that designation have changed significantly. One thing is for certain: if the position is taken that the rental activity is a trade or business for the Section 199A deduction, then it needs to be treated as a trade or business in all other aspects, as well, which could mean additional filings (i.e. Forms 1099) and becoming subject to different tax regulations (i.e. interest-limitation rules).

Ultimately, although the Section 199A deduction was implemented as a means of leveling the playing field for the tax impact of entity choice and could potentially offer significant tax savings, in order to take advantage of the deduction, the related activity must first qualify for the deduction.

Reaching this designation is relatively easy for most business operations, but might require more analysis when considering rental activities. There are some options available, such as the safe-harbor and grouping elections, but the related tax impact should be carefully considered prior to making any election.

Be sure to consult with your tax advisor if you have any questions.

Lisa White, CPA is a tax manager with the Holyoke-based public accounting firm Meyers Brothers Kalicka, P.C.; (413) 322-3542; [email protected]

The Tax Cuts and Jobs Act Still Reverberates in Year-end Tax Planning