Six Tips for Reducing Your 2019 Income Tax Liabilities
Certainly the ramifications of the 2017 Tax Cuts and Jobs Act (“TCJA”) will be with us for a long while. But now that your 2018 income tax returns are filed, let’s focus on six 2019 planning strategies you can implement today to help increase your income tax savings this year and reduce April 2020 tax due.
1. Review 2019 Form W-2 federal tax withholdings and increase the amount of tax withheld.
Many individuals were under-withheld in 2018 due to the changes in the W-4 tax withholding tables under the TCJA. As a result, many taxpayers had federal tax due to the IRS when they filed in April 2019 because they did not increase their 2018 tax withholding rates to conform to the new 2018 tax rates. The updated withholding tax tables were in effect for about nine months in 2018. In 2019, with the new rates having been in effect for 12 months, under-withholding of federal income tax will be worsened, and significant federal income tax will be due in April 2020 if taxpayers do not increase the amount of 2019 tax withheld. Further, keep in mind there is now a backup withholding rate of 24%; in this instance, for example where you receive a bonus in 2019, you should make sure the proper amount of tax was paid (the backup withholding rate was 25% in the 2019 first quarter).
2. Take advantage of the 20% deduction for 2019 qualified business income (“QBI”) from pass-through entities.
This is another significant component in the TCJA that allows a tax deduction, but many taxpayers and advisors found it challenging to take advantage of in 2018. This 20% deduction applies to business entities that are not subject to corporate income tax (e.g., sole proprietorships, partnerships, S corporations, LLCs and other pass-through entities), and for these entities the income tax liability is paid by the owners (typically individuals) of these businesses. As such, the QBI provisions apply to the majority of businesses in the U.S, because pass-through entities are among the most common business structures.
Business owners operating a specified service trade or business (SSTB) can only claim a QBI deduction where the taxpayer’s (individual’s) taxable income is within certain ranges. The calculation of a taxpayer's QBI deduction depends on whether the taxpayer's taxable income is (1) below a lower taxable income threshold ($157,500, or $315,000 if filing a joint return), (2) above a higher taxable income threshold ($207,500, or $415,000 if filing a joint return), or (3) between the lower and higher taxable income thresholds. Further, the QBI deduction is limited to the greatest of 50% of the W-2 wages of the trade or business or the sum of 25% of the W-2 wages of the trade or business plus 2.5% of the unadjusted basis of qualified depreciable business property.
Finally, the business owner should be aware of the definition of an SSTB, which is any trade or business involving the performance of services in the fields of (i) health; (ii) law and accounting; (iii) actuarial science; (iv) performing arts; (v) consulting; (vi) athletics; (vii) financial services [including investing and investment management, trading, dealing in securities, partnership interests or commodities, and brokerage services]; and (viii) any trade or business where the principal asset is “the reputation or skill of one or more of its employees.”
3. Analyze a C corporation structure as a business entity alternative in 2019, compared to a pass-through entity where the taxpayer (owner) is an individual.
The TCJA reduced the C corporation tax rate effective in 2018 from a top rate of 35% in 2017 to a flat rate of 21%. By comparison, the top federal individual tax rate is now 37% on taxable income greater than $510,300. Therefore, an individual as a business owner—where business income is passed through to the individual, see 2. above—could be subject to a 37% tax rate. By comparison, with a top tax rate of 21%, a C corporation could also benefit from additional tax deductions that may not be available to an individual owner of a business due to limitations on individual tax deductions imposed by the TCJA. Thus, a business owner should perform an analysis in 2019 of the benefits and consequences of operating as a C corporation compared to a pass-through entity.
4. Maximize your 2019 contributions to IRAs, 401(k) plans and health flexible spending arrangements (“HFSAs”).
The IRS increased the annual contribution limits for 401(k) and similar work retirement plans, as well as IRAs, by $500 each. You can now add up to $19,000 into a 401(k) and $6,000 to IRAs. While these $500 contribution increases appear modest, it’s always wise to utilize tax-advantaged IRA and 401(k) plan contributions to maximize your savings, obtain tax deductions (subject to limitations), and benefit from tax-deferred investment returns. There are also catch-up contribution allowances for those age 50 and older who can make additional contributions beyond the annual limits.
HFSAs also provide a benefit utilizing tax-free dollars to pay medical expenses not covered by health plans. Eligible employees can elect how much to contribute to an HFSA through payroll deductions, and current enrollees can contribute up to $2,700 during the 2019 plan year. Amounts contributed are not subject to federal income tax, Social Security tax or Medicare tax. If the plan allows, the employer may also contribute to an employee’s separate flexible spending account.
5. Take advantage of expanded opportunities for federal estate and gift tax planning.
Prior to the TCJA, the federal estate and tax exemption was $5.49 million for individuals and $11.2 million for married couples. In 2019, it’s $11.4 million per person and $22.8 million for married couples. According to the U.S. Treasury, there were 1,890 estates subject to the tax in 2018, compared to 6,460 before the exemption was increased under the TCJA.
Also, consider the annual federal gift tax exclusion, which is $15,000 in 2019 for gifts by an individual to another person and $30,000 by an individual to a married couple. These amounts can be gifted to an individual—or trusts containing certain provisions—without incurring a gift tax. Amounts paid for an individual’s tuition, medical expenses paid for another person, or gifts to your spouse are not subject to any gift tax.
Finally, review your will and ensure proper language is cited that will facilitate utilization of the new estate tax exemptions. Consider testamentary transfers to trusts to establish asset funding for spouses, partners, children and grandchildren, and utilize the unlimited marital deduction. For current planning purposes, consider 2019 gifts to trusts for beneficiaries and the transfer of life insurance to trusts to exclude proceeds from potential estate tax. Draft advance health care directives and document custodians for minor children in the event of a premature passing. Ensure your overall estate plan also conforms to the estate or inheritance tax rules in your state of residence, and be mindful of similar provisions in the state of residency of intended beneficiaries.
6. Utilize IRC Section 529 savings accounts.
Tax advantaged education benefits include student loan interest deductions, tax-free direct tuition payments, and tax-free tuition waivers. While all the preceding benefits existed before the TCJA, don’t forget to leverage these tax benefits. First, utilize IRC Sec. 529 plans to fund education expenses, which includes expenses for private K-12 education. Earnings on contributions to IRC Sec. 529 savings accounts are not subject to federal tax, and they are generally not subject to state tax when used for the qualified education expenses of the designated beneficiary (e.g., tuition, fees, books, room and board) at an eligible education institution as well as tuition at elementary or secondary schools. Contributions to a 529 plan are not tax deductible; however, student loan interest is deductible up to $2,500 for interest paid on student loans. And when you pay tuition directly to an academic institution for the benefit of a family member, no gift tax applies. Tuition waivers for graduate students (including those who teach or do research in exchange for tuition) remain tax-free.
The TCJA offers tremendous proactive planning opportunities. To take full advantage of these, as well as fully mitigate risk, we recommend you work closely with your tax and business advisor.