I am reading about the impact of Covid-19 as I push to
get all client tax returns completed and filed by the deadline, which may or
may not be extended.
Everyone is concerned and I wanted to respond.
These are scary times, both
for personal health for you and your family and for your finances. We worry about who will get sick, possibly
die, and who will be out of work and have major life changes.
Much of the ultimate outcome depends
on how quickly governments respond – “stop everything immediately” contains the
infections and thus allows the economy to bounce back sooner, while delayed
responses mean many more infections and deaths, with a prolonged, deeper hit to
On investing, to those who ask,
“should I cash out,” my answer is, “it’s already too late, the markets have
already gone down far, and even if you had sold a month ago, knowing when to
buy back in is so tricky that you would probably be worse off.” The truth is, when so many individual investors
ask if it is time to sell, that is often a signal to buy.
Here is an excerpt from a Merrill Lynch research post (credited to Jared Woodard, Derek Harris, Chris Flanagan, Justin Devery and Jordan Young) that I received last week, which crystalizes my experience from the downturns I lived through as well as the downturns I have studied:
Why stay invested?
Not staying invested means missing most of the long-term market upside…it’s simply too difficult to time the market. A strong impulse to hide out in cash is often a sign that a buying moment is near:
• We know that the best days often follow the worst and this has been the sharpest drop into a bear market in history (Chart 3);
• Since 1929, in the 24 months following a bear market, S&P 500 total returns have averaged 20%. Excluding the Great Depression, the average gain was 27% (Chart 4);
• Since 1931, an investor who missed the 10 best days of each decade made 91% in equities. Staying invested meant earning 14,962%;
• In the 2010s, missing the 10 best days meant gaining only 95% instead of 190%;
• Over any 10-year period, the odds of ending with equity losses are just 4%;
Let me know if this helps. And let me know if you want to talk.
Last year, we provided a three-part series explaining the impact of the new tax law. In our first part, we discussed the impact of the new law on personal taxes and in our second part, we discussed planning for small businesses. In this part, we update the third part posted last year, which is our guide for year-end moves to reduce total taxes between 2019 and 2020.
Can you act at
Each year we advise that you be practical, focusing on where
you can actually take action.
For many, the new $24,000 standard deduction for married
couples, $12,000 for single taxpayers, means you will not itemize (i.e., your
total for itemized deductions is less than the standard amount so you take the
higher, standard deduction). The
standard deduction goes up when you reach 65.
If you are not itemizing, you have fewer ways in which to
affect change in the taxes due in either year (but you can also stop collecting
receipts for those deductions!).
One technique for getting around the limit is to bunch
deductions from two or more years into one year. The one deduction that you can easily move is
for charitable donations. Your state,
local and real estate taxes are limited to a $10,000 maximum and you cannot
accelerate, or delay, significant amounts of mortgage interest.
If you do not want any one charity to receive the full
amount in a single year, you can still use this bunching strategy. Donate to a donor advised fund, from which
you may be able to designate donations to particular charities in future years.
IRA donations: If you are 70½ or older, you have the option of distributing up to $100,000 from your IRA or other qualified plan to an IRS-approved charity and having none of the distribution taxed.
Capital Gains: Review your portfolio. You may be able to “harvest losses” to offset capital gains realized on stock sales or mutual fund capital gains distributions. If you have substantial unrealized gains, consider donating to a charity. See below.
The tax planning
If you are able to itemize, determine what income and deductions you can move from 2019 to 2020 or vice versa. You want to minimize total taxes for both years. Make sure your planning includes the 3.8% Medicare tax on high income and review Roth conversions (Roth distributions are not taxed, so converting a traditional or roll-over IRA to a Roth could be beneficial, as long as the tax cost now is not too great). And business owners will want to review our post on planning under 199A for QBID.
Next, review the impact of moving income and expense to see what happens if you shift any of these amounts from one year to the other year.
But, watch for the Alternative Minimum Tax (“AMT”):
The exemption for the AMT and the threshold
above which that exemption gets phased out are now higher than before 2018, so fewer
taxpayers will owe the AMT.
Finally, if you have not maxed-out your 401(k) plan, IRA, Health Savings Account or flex plan account, consider doing so before the end of the year.
Your mutual funds may have large capital gains distributions. Christine Benz says, “Brace yourself: 2019 is apt to be another not-so-happy capital gains distribution season, with many growth-oriented mutual funds dishing out sizable payouts.”
your unrealized losses to see if you can “harvest” those losses to offset or “shelter”
realized gains, reducing your total taxable income. If you have more losses than gains, you can
take up to $3,000 of capital losses against other income.
you sell an asset that you would prefer to retain, in order to realize gains in
2019, make sure you do not run afoul of the wash-sale rule (any loss on an
asset that you repurchase in 30 days will be disallowed, so you have to either
wait 30 days or purchase a similar asset that fits your asset allocation while
not counting against the wash sale rule).
If you have significant unrealized gains, consider using
appreciated stock for charitable donations – that way you avoid the tax on the
gain while still getting the full fair market value for your charitable
Some reminders on itemized
As you may recall, mortgage interest on new home purchases is deductible only for loans of up to $750,000 used to purchase or improve your primary or secondary residence. Interest on home equity loans will not be deductible, except when the home equity indebtedness is used to purchase or improve the residence.
Also, all miscellaneous deductions were eliminated. This includes investment and tax preparation
fees, safe deposit box charges and unreimbursed employee business expenses. And moving expenses are no longer allowed
(except for military personnel in certain cases).
Check taxes paid
Make sure your total paid in withholdings and estimates
meets the safe harbor rules. If not, you
could owe interest for under-withholding.
Estate plan review
While you review your taxes, consider reviewing your estate plan and beneficiary designations. The federal exemption is just over $11 million in 2019, so fewer people will owe any federal estate tax. However, many states still impose estate taxes on smaller estates. If you have “excess wealth” and want to reduce your taxable estate by gifting assets to children or others, you can give $15,000 per person, per year. If your spouse joins you, that is $30,000 per person. This includes funding a 529 plan for education costs – expanded to provide for more than just college.
Note, however, that holding appreciated assets for the step up in basis at death may be better for your heirs than gifting.
Check on 2018
Check to see if you over-paid a penalty for
under-withholding. If you filed early,
the penalty calculation may have over-stated the total you owe, so you will
want to review your 2018 filing.
Carefully review any income and deductions that you can
still shift to see if moving will lessen the total taxes you pay for 2019 and 2020.
This tax update may give you reasons to amend your tax returns regarding the tax extenders, SALT workarounds, domicile audits and empowerment zones. Let me know if you need help.
Many tax returns were prepared assuming that Congress would pass a law for the “tax extenders” as it has in past years. However, the bill extending deductions and credits for 2018 and 2019 has not passed. Other matters have the attention of Congress.
The tax extenders include 26 tax breaks that expired at the end of 2017 and 2018. Some are for businesses, such as motor speedway depreciation, biodiesel credits, and disaster relief. Others are for individuals, such as retaining the 7.5% threshold instead of 10% for medical expenses, the private mortgage insurance (PMI) deduction, exclusion of up to $2 million from income from mortgage debt forgiveness on your home, and an above-the-line deduction college tuition and qualified expenses.
If you filed your 2018 returns relying on passage, and the extender bill does not pass, you could face an inquiry form the IRS. If you filed without relying on the extenders, and the bill does pass, you may be able to amend your 2018 filing to obtain a refund.
SALT and work around attempts by states
As you know from the first post in our series on the Tax Cut and Job Act (“TCJA”), the new tax law places a $10,000 cap on state and local taxes, or “SALT.” This includes state and city income taxes, property taxes, sales taxes and excise taxes.
Some states, including New York and New Jersey, felt that TCJA targeted them and responded with workarounds. One such measure provides that certain payments of state income taxes would be treated as charitable contributions, so that the full amount would be allowed as part of your Schedule A deductions.
The IRS reacted by indicating that only the IRS determines what are allowable Schedule A deductions and this workaround was not one of them. As Christy Rakoczy Bieber wrote recently on creditkarma.com:
If you’re counting on a SALT cap workaround from your state to keep your federal taxes low, you may face an unpleasant surprise at tax time since the IRS has made clear it won’t allow you to take deductions for charitable donations if you received tax credits.
Trying to avoid the state taxes
Some people with homes in more than one state have taken another approach to SALT limits by claiming to be residents of the state imposing less income taxes. For example, if you have homes in Massachusetts and in Florida, you would clearly pick Florida because there is no state income tax.
If you do pick a no or low-income tax state, be careful. The state that is missing out on tax revenue may conduct a domicile audit. Having the documentation to prove your residency is key. While residency is based on your “state of mind,” an audit would focus on a list of facts, including where you spend more time, the state in which you have a driver’s license and vote, where you receive your mail, and where you worship. Be sure to take the necessary steps and retain proof.
Empowerment Zone rollovers and Qualified Small Business Stock Sales (QSBS)
There are provisions for favorable treatment of certain capital gains transactions. Here are two:
If you purchased stock in a qualified small business, you may be able to exclude gain on the sale. The exclusion is even higher for certain empowerment zones, and;
You can roll over gain from certain sales into investments in an empowerment zone, delaying or even reducing the tax on the gain. There are opportunity funds into which you can invest for this deferral. If you think you need to amend, or if you have any questions on this post or any other matter, let me know. I am here to help.
If you think you need to amend, or if you have any questions on this post or any other matter, let me know. I am here to help.
The Tax Cut and Jobs Act brought the most significant changes to our income taxes in the last thirty years. We continue to assess its impact in this post, which provides updates and some strategies for items discussed at the end of 2018 in these three posts:
As a quick summary of the posts, in the first post, we discussed the impact of the new law on personal taxes; in the second post, we discussed planning for small businesses; and in our third post, we provided a practical guide for year-end action.
Itemized deduction strategies
As we noted in these tax planning posts, far fewer US Taxpayers will itemize because of the increased $24,000 standard deduction for married couples ($12,000 for individuals). One estimate is that the number will be about 6% of all taxpayers for 2018, down from over 30% in prior years.
Bunching your itemized deductions
into a single year is one way to push your total above the standard deduction amount,
and thus restore the tax deduction benefit for such items as charitable
donations. We discussed bunching and
giving to donor advised funds in our third
post. As we noted then,
charitable donations are the easiest Schedule A items to which to apply
Miscellaneous deductions are gone; Or are they?
Now that the miscellaneous
itemized deductions are gone, can you do anything with tax prep and investment
Take tax prep fees on other schedules
For the tax preparation fees, you can deduct those amounts on Schedule C, Schedule E (page 1), or Schedule F. And, if you have K-1s, input the fees as unreimbursed expenses so that the fees flow to Schedule E (page 2).
Capitalize investment fees
As for investment fees, there is support for capitalizing these costs, but the support is not dispositive. This interpretation of the Treasury regulations is that you can capitalize the cost of evaluating the value of stocks purchased and sold. You would need to elect to capitalize the related fee for each transaction, so this could be a great deal of work, depending on the amount of fees and number of stocks purchased or sold in a given year. Taking this approach seems fair, as the treatment parallels treatment of fees in mutual fund, where the advisory fees are netted out before capital gain and dividend distributions to shareholders.
Notes: First, that there is a Treasury memorandum that says you cannot add carrying costs to basis. Second, even if you could, capitalizing takes a great deal of work so it may not be worth the effort.
The first $1,050 of unearned income for children who are dependents is not taxed in 2018. Amounts above that level are taxed at the same rate as trusts and estates. Those brackets are quite compressed compared to individual brackets. Nonetheless, a child of a parent in the 37% tax bracket can still have $12,500 of income taxed at a lower rate. That could save taxes on college funds (but compare to sheltering in a 529 plan).
Child tax credit
The $2,000 child credit phases out at much higher adjusted income levels for 2018: over $400,000 for married couples, $200,000 for single taxpayers. If your child is age 17 or over, you lose the $2,000 credit, but you may qualify for the $500 dependent credit. This credit could not only applies to college students, it covers disabled children, elderly parents and other family that are your dependents.
QBID for rental real estate
The IRS regulations provide a
safe harbor for people who spend 250 or more hours a year on activities related
to their rental properties. You will
need to keep records of your time and maintain separate bank accounts for the
Enterprise Zone rollovers
You can roll over gain from stock or other capital assets to investments in an enterprise zone, delaying tax on the gain, and even eliminating tax on a portion. We will post more on this at a future date.
With the doubling of the federal gift and estate tax credit, few estates will be subject to federal estate tax. This means that gifting is not nearly as important as retaining low basis assets for the step at death. By this we mean that keeping assets in your name results in those assets are treated as having basis equal to the fair market value at death, so your heirs only pay tax on any gain that occurs after your death.
There have been many changes to our tax law, so if you are not sure how you are affected, contact me for some planning. Maybe we can help you save on taxes!