As the end of the year is fast approaching, we should consider any last-minute strategies that might help reduce your 2019 tax bill. Last year was the first year to be impacted by the Tax Cuts and Jobs Act of 2017 (TCJA). While there was no significant new legislation in 2019 affecting individual taxes, situations do change from year to year, thus requiring a fresh look at how to approach year-end tax planning. The following are strategies that may benefit you and that we should discuss before December 31.
Section 179 Expensing and Bonus Depreciation
Two of the biggest tax incentives available to any business are the Section 179 expense deduction and the bonus depreciation deduction. And it’s not an either/or proposition. You may be eligible for both, depending on the amount of your business’s taxable income. These deductions can significantly lower your taxable income, thus saving a bundle on federal and state income taxes. Whether any last-minute purchases before the end of the year are advisable will depend not only on your business needs but whether the extra deductions available can be utilized in 2019.
Under the Section 179 expensing option, you can immediately expense the cost of up to $1,020,000 of “Section 179” property placed in service in 2019. This amount is reduced dollar for dollar (but not below zero) by the amount by which the cost of the Section 179 property placed in service during the year exceeds $2,550,000. The Section 179 deduction is also limited to your aggregate taxable income for the year derived from the active conduct of a trade or business. Thus, unlike depreciation, the Section 179 expense cannot be used to reduce income below zero. This expensing option is available to individuals, S corporations, C corporations, and partnerships. It’s important to note that, to be considered Section 179 property, the property must meet certain eligibility requirements, be acquired for business use, and be acquired by purchase. In addition, certain limitations apply to the expensing of passenger automobiles and sport utility vehicles.
In addition to the Section 179 expense option, an additional first-year depreciation allowance, known as bonus depreciation, is available for qualifying property placed in service in 2019. Generally, unless you elect out of the bonus depreciation deduction, 100 percent of the cost of qualifying property, which is not expensed under Section 179, must be deducted. This applies to new or used trade or business property. The property must meet an “original use” or “used acquisition” requirement. A deduction is still available even if you use the property for personal purposes, as long as your business use is more than 50 percent. However, if your business use of the property falls to 50 percent or less, you may have to recapture your earlier deductions as income. Unlike with the Section 179 deduction, there is no taxable income limitation on a deduction for bonus depreciation.
As you can see, the purchase of a vehicle for your business could result in a substantial tax write-off. And if your business needs a large passenger vehicle, consideration should be given to purchasing a sport utility vehicle weighing more than 6,000 pounds. Vehicles under that weight limit are considered listed property and deductions are limited to $18,100 for cars, trucks and vans acquired and placed in service in 2019. However, if the vehicle is more than 6,000 pounds, up to $25,500 of the cost of the vehicle can be immediately expensed.
S Corporation Shareholder Salaries
For any business operating as an S corporation, it’s important to ensure that shareholders involved in running the business are paid an amount that is commensurate with their workload. The IRS scrutinizes S corporations which distribute profits instead of paying compensation subject to employment taxes. Failing to pay arm’s length salaries can lead not only to tax deficiencies, but penalties and interest on those deficiencies as well. The key to establishing reasonable compensation is being able to show that the compensation paid for the type of work an owner-employee does for the S corporation is similar to what other corporations would pay for similar work. If you are in this situation, we need to document the factors that support the salary you are being paid.
Bunching Deductions into 2019
As you may know, TCJA significantly increased the standard deduction for all taxpayers. This means that many individuals who previously received a tax benefit by itemizing deductions no longer do, because taking the standard deduction is more advantageous. For 2019, the standard deduction is $12,200 for single taxpayers, $24,400 for married taxpayers filing a joint return,
In addition, there is a $10,000 limitation ($5,000 in the case of married taxpayers filing separately) on the combined amount of state income taxes and property taxes that may be deducted when itemizing. Unfortunately, this $10,000 limitation applies to single as well as married taxpayers and is not indexed for inflation.
If the total of your itemized deductions in 2019 will be close to your standard deduction amount, alternating between bunching itemized deductions into 2019 and taking the standard deduction in 2020 (or vice versa) could provide a net-tax benefit over the two-year period. For example, if you give a certain amount to charities each year, and if it’s financially feasible, you might consider doubling up this year on your contributions rather than spreading the contributions over a two-year period. You also might consider setting up a Donor Advised Fund that allows you to take a charitable contribution in the year of the contribution to the fund and making donations at a later date. If these amounts, along with your mortgage interest and medical expenses exceed your standard deduction, then you should double up on the expenses this year and take the standard deduction next year.
Charitable Contribution Deductions
As a result of the increase in the standard deduction, some taxpayers are no longer getting a benefit from itemizing their deductions, such as charitable contributions, as they once were. However, as noted above, you can still help charities and get a tax benefit if you contribute enough to get over the standard deduction amount or bunch itemized deductions that would otherwise be spread over multiple years into one year.
Additionally, you can reap a larger tax benefit by donating appreciated assets, such as stock, to a charity. Generally, the higher the appreciated value of an asset, the bigger the potential value of the tax benefit. Donating appreciated assets not only entitles you to a charitable contribution deduction but you also avoid the capital gains tax that would otherwise be due if you sold the stock. For example, if you own stock with a fair market value of $1,000 that was purchased for $250 and your capital gains tax rate is 15 percent, the capital gains tax would be $113 ($750 gain x 15%). If you donate that stock instead of selling it, and are in the 24 percent tax bracket, you get an ordinary income deduction worth $240 ($1,000 FMV x 24%). You also save $150 in capital gains tax that you would otherwise pay if you sold the stock. Thus, the after-tax cost of the gift of appreciated stock is $647 ($1,000 – $240 – $113) compared to the after tax cost of a donation of $1,000 cash which would be $760 ($1,000 – $240). However, it’s important to also keep in mind that tax deductions for appreciated property are limited to 50 percent of your adjusted gross income.
Finally, taxpayers 70 1/2 years old and older who own an individual retirement account (IRA) are required to take minimum distributions from that account each year and include those amounts in taxable income. If you are in this category, a special rule allows you to make a charitable contribution directly from your IRA to a charity. This has several benefits. First, since charitable contributions deductions are usually only available to individuals who itemize, individuals who take the standard deduction instead can benefit from this rule. Second, making the contribution directly to a charity counts towards your required minimum distribution but that amount is not included in income and thus reduces your taxable income and adjusted gross income (AGI). A lower AGI is advantageous because it increases your ability to take medical expense deductions that you might not otherwise be able to take. For example, medical expenses are only deductible to the extent those expenses exceed 10 percent of your AGI and a lower AGI means you can deduct more medical expenses. In addition, as AGI increases, more of your social security income is subject to tax. Finally, the 3.8 percent net investment income tax applies to the extent your AGI exceeds a certain level.
By investing in a qualified retirement plan you’ll not only receive a current tax deduction, thereby reducing current year income tax, but you can sock away money for your retirement years. If your employer has a 401(k) plan and you are under age 50, you can defer up to $19,000 of income into that plan. Catch-up contributions of $6,000 are allowed if you are 50 or over.
If you have a SIMPLE 401(k), the maximum pre-tax contribution for 2019 is $13,000. That amount increases to $16,000 if you are 50 or older.
If certain requirements are met, contributions to an individual retirement account (IRA) may be deductible. If you are under 50, the maximum contribution amount for 2019 is $6,000. If you are 50 or older but less than 70 1/2, the maximum contribution amount is $7,000.
Reevaluating Your Stock Portfolio
Year end is a good time to review your stock portfolio to see if you might want to divest yourself of stocks that have lost value since you originally bought them. We should evaluate whether you might benefit from selling off appreciated stocks, particularly those that would generate a short-term capital gain, and using the resulting gain to limit your exposure to a long-term capital loss on stocks you may want to dump, since the deduction of long-term capital gains is limited. And any net capital gain you may reap will be taxed at the substantially reduced capital gain tax rate.
The tax rate for net capital gain is generally no higher than 15 percent for most taxpayers. Some or all of your net capital gain may be taxed at 0 percent if your income is not above $39,375 (single), $78,750 (joint), or $52,750 (head of household). However, a 20 percent tax rate on net capital gain does apply to the extent that your ordinary taxable income is over $434,550 (single), $488,850 (joint), $244,425 (married filing separately), or $461,700 (head of household).
Oklahoma Pass-Through Entity Election
Remember that we made an election this summer for many of you whereby pass-through entities can choose to be taxed at the entity level.
For 2019, an electing entity calculates the tax on each member’s distributive share of the entity’s income. The entity’s distributive share of federal taxable income for each member must first be adjusted to arrive at each member’s respective share of Oklahoma taxable income for corporations or adjusted gross income for individuals. Tax is applied at the highest marginal tax rate applicable to that member. The total of the tax amounts calculated at the member level is then aggregated and reported as the entity level pass-through entity tax. Losses are calculated at the entity level and may be carried back and carried forward by the electing entity.
The due date for the pass-through entity tax is the same as the electing entity’s standard income tax return due date, with estimate payments required for tax years beginning on or after January 1, 2020.
Please contact us at your convenience so we can set up an appointment and to estimate your tax liability for the year and determine whether any estimated tax payments may be due before year end.