As the year draws to a close, we have pulled together a number of tax tips that may be beneficial, some of which need to be acted before the end the of the year to be useful for 2019.
Education Credit – Since the American Opportunity credit for higher education expenses is only allowed in the first four calendar years for each eligible student, taxpayers may benefit from prepaying the education expenses for an academic period beginning in the first three months of the next year. This is especially important when you consider that most students enter college in the last half of the first eligible tax (calendar) year and qualify for the credit with only half a year’s expenses during the first year. Working out a payment plan where the tuition is prepaid under the three-month rule in each of the eligible years would more evenly spread the tuition over the four years.
Avoiding Underpayment Penalties Strategy – Most high-income taxpayers and those who might end up with higher-than-normal income because they are likely to receive extraordinary taxable income should consider paying 110% of their prior year’s tax to meet the safe harbor for avoiding an underpayment penalty. And then, no matter how much they end up owing for the year, they will not need to pay up until the April due date. However, this exception requires the prepayments to be made evenly and to be paid in a timely manner by quarter; underpayments generally can’t be made up later and still qualify for the safe harbor. But, since withholding is treated as being paid evenly throughout the year (unless the taxpayer elects actual withholding amounts), the estimated tax shortfall of the even-payments-by-quarter requirement can be made up by having extra withholding at the end of the year.
Spousal IRA Strategy –If one spouse works and the other does not, tax law allows the non-working spouse to base his or her contribution to an IRA on the working spouse’s income. This tax benefit is frequently overlooked when spouses have been working and basing their individual contributions on their own income for years and then one of the spouses retires. Even if the working spouse has a pension plan at work and his or her income precludes making an IRA contribution, the non-working retired spouse can still make a contribution based on the working spouse’s income. However, be careful since traditional IRA contributions, both deductible and non-deductible, are not allowed in the year when an individual turns 70½ or any subsequent years. This restriction does not apply to Roth IRA contributions.
Qualified Charitable Distributions – With the tax reform’s substantial increase in the standard deduction, many taxpayers no longer itemize their deductions and thus get no tax benefit from making charitable contributions. However, individuals age 70½ or older—who must withdraw annual required minimum distributions (RMDs) from their IRAs—can annually transfer up to $100,000 from their IRAs to qualified charities. Here is how this provision, if utilized, works:
(1) The IRA distribution is excluded from income;
(2) The distribution counts toward the taxpayer’s RMD for the year; and
(3) The distribution does NOT count as a charitable contribution deduction.
At first glance, this may not appear to provide a tax benefit. However, by excluding the distribution, a taxpayer lowers his or her adjusted gross income (AGI), which helps for other tax breaks (or punishments) that are pegged at AGI levels, such as medical expenses when itemizing deductions, passive losses, and taxable Social Security income. In addition, non-itemizers essentially receive the benefit of a charitable contribution to offset the IRA distribution.
Medical Expenses – Self-employed taxpayers can deduct health insurance premiums they pay for themselves and their dependents above the line, which is helpful when taking the standard deduction or when the medical expenses do not exceed the 10% of AGI threshold for itemized deductions. Also, don’t overlook including long-term care and Medicare B and D premiums.
Election to Deduct Start-Up Costs – Many taxpayers overlook that they can elect to deduct up to $5,000 of start-up and $5,000 of organizational expenses in the first year of a business. Each of these $5,000 amounts is reduced by the amount by which the total start-up expense or organizational expense exceeds $50,000. Expenses not deductible in the first year of the business must be amortized over 15 years.
State and Local Tax (SALT) Deductions – The IRS has released final regulations related to the state and local taxes (SALT) deduction limitation imposed by the 2017 tax reform legislation and the attempts by various states, most notably NY, NJ, and CT, to skirt the $10,000 ($5,000 MFS) limitation. These attempts to bypass the limitation offered the states’ residents the ability to make a charitable contribution in return for a credit against their state or local taxes, thus converting a limited tax deduction into a fully deductible charitable contribution. The final regulations only allow a charitable deduction for the difference between the contribution amount and the tax credit provided by the state.
The proposed regulations also include an exception for if the tax credit does not exceed 15% of the taxpayer's payment or 15% of the fair market value of the property transferred by the taxpayer.
Electric Car Credit – There is a non-refundable tax credit for as much $7,500 when purchasing a plug-in electric motor vehicle. However, that credit begins to phase out once each manufacturer’s sales reach 200,000 vehicles. Three of the more popular plug-in electric vehicles have reached the phaseout, and Tesla vehicles purchased in the last quarter of 2019 still qualify for a $1,875 credit but purchases after 2019 will no longer qualify for the credit in 2020. In addition, the credit for Chevrolet and Cadillac vehicles is being phased out, and only $1,875 of credit will be allowed for purchases in the last quarter of 2019 and the first quarter of 2020, after which the credit will no longer apply. The credit amount is based on the year that you place the vehicle in service (i.e., begin driving the vehicle) even if you bought the vehicle in an earlier year.
Alimony – As a reminder, for divorce decrees finalized after 2018, alimony is no longer deductible by the payer or taxable to the recipient. This change has no effect on divorce decrees entered into before 2019 that are unmodified, for which alimony continues to be deductible by the payer and taxable to the recipient.
Heath Insurance Penalty – The ACA penalty for not being insured no longer applies at the federal level. But some states, including California, have instituted a penalty, and residents of states that have a penalty should be sure to get their 2020 coverage in place by the end of 2019 to avoid a penalty for 2020.
Cryptocurrency Transactions – Beware! The IRS has cryptocurrency on its radar and is ramping up enforcement programs. Cryptocurrency (virtual currency) is treated as property, and every time it is sold or used, the gain or loss from the transaction must be computed and reported in the same manner as a stock transaction.
Qualified Opportunity Funds (QOFs) – Taxpayers can defer capital gains into QOFs, with tax on the gain deferred until 12/31/26 or when the QOF is sold, whichever is earlier.
Solar Credit – A federal credit for the purchase and installation costs of a residential solar system is fading away. After being 30% of the cost for several years through 2019, the credit amount will drop to 26% in 2020 and then 22% in 2021, the final year of the credit.
If you have questions related to these or other tax issues, please give TaxUSign a call at 253.234.7180.