Tax Reform and Year-End Considerations: What You Need to Know

The Tax Cuts and Jobs Act (TCJA) was the most sweeping overhaul of the U.S. tax code in more than three decades, and its changes will impact nearly every 2018 federal income tax return. As the year draws to a close, now is the time to consider year-end tax planning strategies to help you maximize deductions and minimize your tax bill – for this year and the year ahead.

Individuals

• Standard and Itemized Deductions: Beginning with the 2018 tax year, the standard deduction has increased to $12,000 for single filers and to $24,000 for those who are married filing jointly. Since the TCJA eliminates or reduces many deductions previously taken, taxpayers who have historically itemized their deductions may find it advantageous to take the standard deduction going forward. Two notable changes are the elimination of miscellaneous itemized deductions and the reduction of the state and local tax deduction to $10,000, which means it will no longer be beneficial for some taxpayers to prepay state tax.
• Charitable Contributions:  Due to the increased standard deduction, fewer taxpayers will itemize their tax deductions. As a result, many taxpayers will not realize a tax benefit for charitable contributions. Instead of making smaller annual gifts, taxpayers may consider front-loading several annual gifts into a donor advised fund. This could have the effect of “pushing” a taxpayer over the standard deduction amount in a given year, thus enabling them to itemize their deductions for that year.

If a taxpayer is subject to required minimum distributions (RMDs) from an individual retirement account (IRA), consideration may be given to making a qualifying charitable distribution (QCD). A QCD allows up to $100,000 per year to be transferred directly from an IRA to a qualified charity. Any QCD counts toward the RMD but also reduces the taxable amount of an IRA distribution.

• Gifting and Estate Tax: The TCJA increased the estate tax exemption to $11.18 million for 2018, up from $5.49 million (per individual) in 2017. Taxpayers projected to exceed the exemption may mitigate the expected tax by gifting assets now to limit their future estate tax. The annual gift tax exclusion increased for 2018 from $14,000 to $15,000, which is the amount individuals can give tax-free to any person annually without the use of exemption.
• Qualified Opportunity Zones: The TCJA established the Qualified Opportunity Zone (QOZ) program to provide a tax incentive for private, long-term investment in economically distressed areas. Taxpayers can utilize this new initiative to defer tax on capital gain (and other tax advantages) from the sale of property, stocks, or businesses by investing capital gain directly in a Qualified Opportunity Fund (QOF). There are complex rules to navigate, but taxpayers who have or will have capital gain in 2018 should talk to their tax professional about how they can defer tax by investing in a QOF.
• Capital Gain: Capital gain treatment has remained similar to prior years, maintaining preferential rates and limiting capital loss carryover deductions to $3,000 per year. If investors have capital gain this year, they should coordinate with their tax and financial advisor to determine whether any losses are available to harvest before year-end.

• Retirement Plans and Tax Deferred Accounts: Taxpayers should consider making the maximum contribution allowed to retirement plans and tax deferred accounts. In 2018, the annual contribution limit to a 401(k) increased to $18,500 ($24,500 if over age 50). The IRA contribution limit will remain at $5,500 for 2018, and the catch-up contribution for people 50 and older will remain at $1,000. The 2018 maximum health savings account (HSA) contribution increased to $6,900 for family and $3,450 for self-only. Taxpayers can make 2018 contributions through April 15, 2019.
• 529 Plans: Designed to encourage saving for future education costs, 529 plans allow taxpayers to take tax-free distributions from the plan and use them for qualified education expenses. Previously limited to post-secondary education, these qualified expenses were expanded by the TCJA to include tuition at any elementary or secondary (K-12) school whether it is public, private, or religious. This allows taxpayers to take tax-free distributions sooner than anticipated while still taking full advantage of the tax incentives offered at the state level.

Businesses

• C Corporation Tax Rate: The TCJA changed corporate income tax rates from a graduated system with a top rate of 35 percent to a flat 21 percent rate. This change may lead business owners to consider converting entities to the corporate form; however, C corporations are subject to double taxation – once at the corporate level and then again at the individual level. Business owners should consider this before a change is made and should discuss their business goals with their tax advisor to determine which entity structure is most advantageous.

• Depreciation: Under the TCJA, the Section 179 deduction was increased from $500,000 to $1 million. Additionally, qualified asset purchases made after September 27, 2017 may now qualify for 100 percent bonus depreciation, meaning that both new and used assets (with a recovery period of 20 years or less) can qualify for bonus depreciation. Taxpayers considering asset acquisitions should make them prior to year-end in order to secure a 2018 income tax deduction.

• Pass-through Deduction: One of the most significant changes under TCJA was the newly enacted Section 199A, otherwise known as the pass-through deduction. This new provision allows owners of pass-through entities to deduct up to 20 percent of qualified business income (subject to potential W-2 and qualifying property limitations). However, not all businesses qualify for this new deduction. Businesses involving the performance of services in the fields of health, law, accounting, actuarial sciences, performing arts, consulting, athletics, or financial or brokerage services do not qualify for this deduction. Whether businesses qualify for this deduction or not, organizations should understand how this change will impact their tax bill.

• Net Operating Losses (NOLs): Under prior law, NOLs could be carried back two years and carried forward for 20 years. NOLs could also be used to offset 100 percent of a taxpayer’s taxable income in a single year (subject to AMT considerations). Beginning with the 2018 tax year, NOLs can only be carried forward – not back – and can only offset 80 percent of a taxpayer’s taxable income. Businesses should evaluate their tax strategy with their advisor in light of this change.

For questions on how these year-end tax considerations apply to you, please contact your KSM advisor.