A Focus on How Sweeping Changes are Affecting Planning

Now is the time to make sure you are taking full advantage of the extensive changes that will affect this year's tax returns.

This article includes items for you to consider with your tax, legal, and accounting advisors. PNC does not provide legal, tax, or accounting advice unless, with respect to tax advice, PNC Bank has entered into a written tax services agreement.

This year the wealth planning landscape has been affected not only by significant tax reform, but by the return of market volatility.

We believe it is wise to review plans before year end to explore tactics that may reduce this year’s taxes and enhance your wealth plans overall.

Below we focus on strategies most affected by the events of this year and actions that would need to be taken by year end.

Idea 1: Explore Tax-Loss Harvesting

Market volatility has returned with a vengeance this year.[1] This sharp rise in volatility may mean you have incurred losses. You may be able to use them to decrease your 2018 tax bill through tax-loss harvesting.

Tax-loss harvesting generates capital losses by selling assets that are currently worth less than what you paid for them. These losses are then used to offset capital gains recognized during the year. At some point in the future, the plan may be to repurchase the asset. If you recognize a loss, you must wait at least 31 days to repurchase the same asset or the tax loss will be disallowed.[2]

Planning Point: If your capital losses exceed your capital gains, you can use up to $3,000 of the excess loss to offset other income. Any remaining capital losses can be carried forward to future years.[3] For example, if you sell an asset and recognize a $15,000 capital loss and have $10,000 of capital gains, you can then claim zero gains for the year. Additionally, you can use $3,000 of your remaining $5,000 in capital losses to offset other income in 2018. The remaining $2,000 may be used to reduce taxable income in 2019.

Idea 2: Revisit Deferred Compensation Arrangements

Before making 2019 elections to nonqualified deferred compensation arrangements, we believe it is important to have an analysis run to determine the attractiveness of deferring income and if so, the deferral timing.

Deferred compensation plans allow highly compensated employees to postpone receiving a portion of their income to a future year. The idea is to lower income levels during high-earning years. The income is then paid out at a future date chosen by the employee, typically at a time when overall income, and its corresponding tax bracket, is lower. Additionally, during the deferral period the income may be invested in a selection of investments set by the plan provider and grow on a tax-deferred basis. If an employee leaves employment, the plan typically returns the participant’s vested balance at that time.[4]

Under The Tax Cuts and Jobs Act (TCJA) most taxpayers are now in lower tax brackets, but the lower tax rates are scheduled to expire at the end of 2025. This means that income deferred to 2026 and beyond may be subject to higher tax rates than would now apply.

The decision as to whether to defer income, the timing of deferred compensation distributions, and changing existing election dates, if possible, is complex.

It is impossible to know what future tax rates may be, though it is possible to project what income may be at the time the compensation is taken and how deferred compensation fits in with other available planning strategies.

The Internal Revenue Service (IRS) requires deferred compensation elections to be completed prior to December 31, 2018.[5] Many employers require elections to be finalized earlier.

Idea 3: Double-Check Withholding Payments

The IRS significantly reduced the withholding tables after the TCJA became law. As a result, the amount of federal tax withheld from your salary may be significantly less than in previous years. This lower withholding may not be enough to satisfy your federal tax liability.

This means you may owe taxes, and you may also be subject to interest and penalties. The IRS has published a simplified withholding calculator that can provide a rough estimate of overall withholding and income taxes for 2018.[6]

Planning Point: By updating/changing your W-4, your employer can adjust the amount withheld from your salary to cover any shortfall, negating potential interest and penalties. If you simply cut a check and pay the IRS, you may still be open to interest charges.

Planning Point: If you are subject to taking required minimum distributions (RMDs) from a defined contribution plan, such as a 401(k) or IRA, it may make sense to increase the amount of tax withheld from the RMD to cover any tax payment shortfall. Just as with salary withholding, taxes withheld from RMDs can reduce or negate interest and penalty fees.

Year-End Planning Checklist

Each year we believe it is important to review the following list of planning to-dos and strategies.

  • Take RMDs: Remember to take RMDs from traditional IRAs, 401(k)s, and 403(b)s.[7] Failure to do so may result in a hefty 50% federal tax penalty on any portion of the RMD not taken. Retirees generally are required to begin taking RMDs by April 1 of the year after they attain age 70-1/2.[8] Thereafter, RMDs must be taken every year by December 31.
  • Make sure you have charitable receipts: To claim an income tax deduction for a donation over $250, you must obtain a written acknowledgement of your donation from the charity. Donors need to maintain a copy of the transaction for donations less than $250.
  • Evaluate annual exclusion gifts: If you wish to transfer assets, consider doing so before year end. Every individual can make annual exclusion gifts of up to $15,000 per person to anyone without it counting against the lifetime gift exemption of $11.18 million. Married couples who elect to split gifts can gift up to $30,000 per donee.[9] The annual exclusion expires on December 31 and cannot be carried over into 2019.
  • Consider discretionary trust distributions: Trustees might want to consider, when permissible, distributing some trust income to beneficiaries if they are in a lower income tax bracket than the trust. For example, a trust reaches the 37% tax rate with taxable income of $12,500 while individuals reach this rate at taxable income of $500,000, or $600,000 for married filing jointly.
  • Weigh deferring income: Consider postponing the recognition of income until 2019 if it makes sense. For example, selling an asset in January wil push the income, and the capital gain tax, into 2019.
  • Minimize exposure to net investment income tax (NIIT) and Medicare surtax: Some taxpayers may be subject to an additional 3.8% NIIT and a 0.9% Medicare surtax if their adjusted gross income (AGI) is greater than $200,000 or $250,000 if married filing jointly.[10] Review strategies to lower AGI, such as delaying recognition of income and maximizing contributions to tax-deferred accounts, including 401(k), simplified employee pensions and health savings accounts.

 

Idea 4: Maximize the Benefit of Charitable Contributions

Tax reform greatly increased the standard deduction and suspended or limited several itemized deductions beginning this year. This means that fewer people will benefit from itemizing. People with itemized deductions greater than or close to the standard deduction may want to consider maximizing the benefit of their charitable contributions in 2018. Below are some strategies that may help you accomplish this.

Consider cash - Cash contributions to public charities, such as churches, hospitals, and schools, are deductible up to 60% of AGI while most contributions of appreciated securities are limited to 30% of AGI.[11] It may be more beneficial to gift cash. Factors such as your AGI, the amount you wish to contribute, and investment portfolio considerations need to be weighed.

Bunching contributions - This entails making larger contributions less often so you can accumulate deductions and itemize. For example, if a married couple (filing jointly) contributes $15,000 per year to charity, assuming no other itemized deductions, they will not exceed the $24,000 standard deduction and will not receive a tax benefit for their contributions. However, if they contribute $30,000 every other year, they should be able to itemize in the year they make the charitable contribution and benefit from an additional $6,000 deduction that year.

Planning Point: A donor-advised fund (DAF) can be an effective vehicle when bunching charitable contributions. This is because you are eligible to take an income tax deduction in the year the contribution is made to the DAF, but there is no RMD that needs to be made in any given year.[12] The cost of a DAF should be factored into the decision if this is an option for you.

Qualified Charitable Distributions (QCDs): Individuals aged 70-½ and older may make qualified distributions from their IRAs directly to qualified charities up to $100,000 annually.These distributions are not taxable federal income for the donor and count toward the IRA’s RMD.[13] Particularly, for those who are no longer itemizing, a QCD is an attractive option to satisfy charitable goals tax efficiently.

Idea 5: Look at Contributions to 529 Plans

529 plans can be an excellent way to save for educational expenses. The recent tax legislation has expanded their use to include distributions of up to $10,000 per year for elementary and secondary school tuition, transforming them from a college savings account to a lifelong educational savings vehicle. A unique feature of 529 plans is they allow donors to front-load accounts with up to five years of annual exclusion gifts. This means that in 2018 you can contribute up to $75,000 ($150,000 for a married couple) to a 529 plan and still qualify for annual exclusion gift treatment.[14] 529 plans grow tax free and distributions for qualified educational expenses are also tax free. Most states offer a state tax deduction for 529 contributions.

Note: Most states follow federal tax rules for 529 distributions, but not all. Confer with a tax advisor who understands the laws of your state to determine how these rules will affect you.

Idea 6: Consider Accelerating Medical and Dental Expenses

This year medical and dental expenses are deductible to the extent they exceed 7.5% of AGI. Beginning in 2019, these expenses must exceed 10% of AGI to be deductible. If you itemize and have large medical or dental expenses, consider paying these expenses in 2018 to the extent it makes sense. Medical and dental expenses include payments for medical or dental care for you, your spouse, or your dependents. Qualified expenses include payments for doctors or dentists, prescription drugs, health insurance premiums, certain long- term care premiums,[15] and other costs including health-related lodging and mileage.

This year has been marked by significant change on all fronts. As year-end approaches, it is a good time to review wealth plans so they address and take advantage of the new tax environment. It is equally important to reflect on what is truly most important to you so that your plans can help achieve those goals.