Archive for November 2018

Does prepaying property taxes make sense anymore?

Prepaying property taxes related to the current year but due the following year has long been one of the most popular and effective year-end tax-planning strategies. But does it still make sense in 2018?

The answer, for some people, is yes — accelerating this expense will increase their itemized deductions, reducing their tax bills. But for many, particularly those in high-tax states, changes made by the Tax Cuts and Jobs Act (TCJA) eliminate the benefits.

What’s changed?

The TCJA made two changes that affect the viability of this strategy. First, it nearly doubled the standard deduction to $24,000 for married couples filing jointly, $18,000 for heads of household, and $12,000 for singles and married couples filing separately, so fewer taxpayers will itemize. Second, it placed a $10,000 cap on state and local tax (SALT) deductions, including property taxes plus income or sales taxes.

For property tax prepayment to make sense, two things must happen:

  1. You must itemize (that is, your itemized deductions must exceed the standard deduction), and
  2. Your other SALT expenses for the year must be less than $10,000.

If you don’t itemize, or you’ve already used up your $10,000 limit (on income or sales taxes or on previous property tax installments), accelerating your next property tax installment will provide no benefit.

Example

Joe and Mary, a married couple filing jointly, have incurred $5,000 in state income taxes, $5,000 in property taxes, $18,000 in qualified mortgage interest, and $4,000 in charitable donations, for itemized deductions totaling $32,000. Their next installment of 2018 property taxes, $5,000, is due in the spring of 2019. They’ve already reached the $10,000 SALT limit, so prepaying property taxes won’t reduce their tax bill.

Now suppose they live in a state with no income tax. In that case, prepayment would potentially make sense because it would be within the SALT limit and would increase their 2018 itemized deductions.

Look before you leap

Before you prepay property taxes, review your situation carefully to be sure it will provide a tax benefit. And keep in mind that, just because prepayment will increase your 2018 itemized deductions, it doesn’t necessarily mean that’s the best strategy. For example, if you expect to be in a higher tax bracket in 2019, paying property taxes when due will likely produce a greater benefit over the two-year period.

For help determining whether prepaying property taxes makes sense for you this year, contact us. We can also suggest other year-end tips for reducing your taxes.

Would a Roth 401(k) plan suit your employees?

Roth 401(k) accounts have been around for quite a while. But many employers still don’t offer them and many employees still don’t understand them. As the name implies, these plans are a hybrid — taking some characteristics from Roth IRAs and some from traditional employer-sponsored 401(k)s. When considering (or reconsidering) your retirement plan options, look into whether a Roth 401(k) would suit your employees.

Contribution limits

An employer with a traditional 401(k), 403(b) or governmental 457(b) plan can offer designated Roth 401(k) accounts. As with traditional 401(k) accounts, eligible employees can elect to defer part of their salaries to Roth 401(k) accounts, subject to annual limits. The employer may choose to provide matching contributions, but matching can go into only traditional accounts.

For 2019, a participating employee can contribute up to $19,000 ($25,000 if he or she is age 50 or older) on a combined basis to a Roth 401(k) and/or a traditional 401(k). The most someone can contribute to a Roth IRA for 2019 is $6,000 ($7,000 for those age 50 or older).

The ability to contribute to a Roth IRA is phased out for higher-income taxpayers, but there’s no such restriction for a Roth 401(k). This can make Roth 401(k)s particularly attractive to employees with higher incomes who’d like to take advantage of Roth benefits.

Pluses and minuses

Employee contributions to Roth 401(k) accounts are made with after-tax dollars, instead of pretax dollars. Therefore, employees forfeit a key traditional 401(k) tax benefit.

On the plus side, after an initial period of five years, “qualified distributions” from a Roth 401(k) are 100% exempt from federal income tax, just like qualified distributions from a Roth IRA. In contrast, traditional 401(k) distributions are taxed at ordinary-income rates, currently as high as 37%.

In general, qualified distributions are those made after a participant reaches age 59-1/2, or made because of death or disability. Therefore, employees can take qualified Roth 401(k) distributions after age 59-1/2 and pay no tax, as opposed to the hefty tax bill that may be due from traditional 401(k) payouts.

And unlike traditional 401(k)s, which generally mandate required minimum distributions (RMDs) after age 70-1/2, Roth 401(k)s have no RMDs (except for beneficiaries who inherit them).

Popularity increasing

Data indicates that the popularity of Roth 401(k)s is increasing. For example, survey results released by global consultancy Willis Towers Watson earlier this year revealed that 70% of responding employers now offer Roth features within their 401(k) plans. That’s a notable rise from results of the firm’s earlier surveys — namely, 46% in 2012 and 54% in 2014. We can help you further explore the benefits, risks and overall feasibility of adding a Roth 401(k) to your benefits lineup.

Will you be age 50 or older on December 31? Are you still working? Are you already contributing to your 401(k) plan or Savings Incentive Match Plan for Employees (SIMPLE) up to the regular annual limit? Then you may want to make “catch-up” contributions by the end of the year. Increasing your retirement plan contributions can be particularly advantageous if your itemized deductions for 2018 will be smaller than in the past because of changes under the Tax Cuts and Jobs Act (TCJA).

Catching up

Catch-up contributions are additional contributions beyond the regular annual limits that can be made to certain retirement accounts. They were designed to help taxpayers who didn’t save much for retirement earlier in their careers to “catch up.” But there’s no rule that limits catch-up contributions to such taxpayers.

So catch-up contributions can be a great option for anyone who is old enough to be eligible, has been maxing out their regular contribution limit and has sufficient earned income to contribute more. The contributions are generally pretax (except in the case of Roth accounts), so they can reduce your taxable income for the year.

More benefits now?

This additional reduction to taxable income might be especially beneficial in 2018 if in the past you had significant itemized deductions that now will be reduced or eliminated by the TCJA. For example, the TCJA eliminates miscellaneous itemized deductions subject to the 2% of adjusted gross income floor — such as unreimbursed employee expenses (including home-off expenses) and certain professional and investment fees.

If, say, in 2018 you have $5,000 of expenses that in the past would have qualified as miscellaneous itemized deductions, an additional $5,000 catch-up contribution can make up for the loss of those deductions. Plus, you benefit from adding to your retirement nest egg and potential tax-deferred growth.

Other deductions that are reduced or eliminated include state and local taxes, mortgage and home equity interest expenses, casualty and theft losses, and moving expenses. If these changes affect you, catch-up contributions can help make up for your reduced deductions.

2018 contribution limits

Under 2018 401(k) limits, if you’re age 50 or older and you have reached the $18,500 maximum limit for all employees, you can contribute an extra $6,000, for a total of $24,500. If your employer offers a SIMPLE instead, your regular contribution maxes out at $12,500 in 2018. If you’re 50 or older, you’re allowed to contribute an additional $3,000 — or $15,500 in total for the year.

But, check with your employer because, while most 401(k) plans and SIMPLEs offer catch-up contributions, not all do. Also keep in mind that additional rules and limits apply.

Additional options

Catch-up contributions are also available for IRAs, but the deadline for 2018 contributions is later: April 15, 2019. And whether your traditional IRA contributions will be deductible depends on your income and whether you or your spouse participates in an employer-sponsored retirement plan. Please contact us for more information about catch-up contributions and other year-end tax planning strategies.

Tax reform expands availability of cash accounting

Under the Tax Cuts and Jobs Act (TCJA), many more businesses are now eligible to use the cash method of accounting for federal tax purposes. The cash method offers greater tax-planning flexibility, allowing some businesses to defer taxable income. Newly eligible businesses should determine whether the cash method would be advantageous and, if so, consider switching methods.

What’s changed?

Previously, the cash method was unavailable to certain businesses, including:

  • C corporations — as well as partnerships (or limited liability companies taxed as partnerships) with C corporation partners — whose average annual gross receipts for the previous three tax years exceeded $5 million, and
  • Businesses required to account for inventories, whose average annual gross receipts for the previous three tax years exceeded $1 million ($10 million for certain industries).

In addition, construction companies whose average annual gross receipts for the previous three tax years exceeded $10 million were required to use the percentage-of-completion method (PCM) to account for taxable income from long-term contracts (except for certain home construction contracts). Generally, the PCM method is less favorable, from a tax perspective, than the completed-contract method.

The TCJA raised all of these thresholds to $25 million, beginning with the 2018 tax year. In other words, if your business’s average gross receipts for the previous three tax years is $25 million or less, you generally now will be eligible for the cash method, regardless of how your business is structured, your industry or whether you have inventories. And construction firms under the threshold need not use PCM for jobs expected to be completed within two years.

You’re also eligible for streamlined inventory accounting rules. And you’re exempt from the complex uniform capitalization rules, which require certain expenses to be capitalized as inventory costs.

Should you switch?

If you’re eligible to switch to the cash method, you need to determine whether it’s the right method for you. Usually, if a business’s receivables exceed its payables, the cash method will allow more income to be deferred than will the accrual method. (Note, however, that the TCJA has a provision that limits the cash method’s advantages for businesses that prepare audited financial statements or file their financial statements with certain government entities.) It’s also important to consider the costs of switching, which may include maintaining two sets of books.

The IRS has established procedures for obtaining automatic consent to such a change, beginning with the 2018 tax year, by filing Form 3115 with your tax return. Contact us to learn more.

Mutual funds: Handle with care at year end

As we approach the end of 2018, it’s a good idea to review the mutual fund holdings in your taxable accounts and take steps to avoid potential tax traps. Here are some tips.

Avoid surprise capital gains

Unlike with stocks, you can’t avoid capital gains on mutual funds simply by holding on to the shares. Near the end of the year, funds typically distribute all or most of their net realized capital gains to investors. If you hold mutual funds in taxable accounts, these gains will be taxable to you regardless of whether you receive them in cash or reinvest them in the fund.

For each fund, find out how large these distributions will be and get a breakdown of long-term vs. short-term gains. If the tax impact will be significant, consider strategies to offset the gain. For example, you could sell other investments at a loss.

Buyer beware

Avoid buying into a mutual fund shortly before it distributes capital gains and dividends for the year. There’s a common misconception that investing in a mutual fund just before the ex-dividend date (the date by which you must own shares to qualify for a distribution) is like getting free money.

In reality, the value of your shares is immediately reduced by the amount of the distribution. So you’ll owe taxes on the gain without actually making a profit.

Seller beware

If you plan to sell mutual fund shares that have appreciated in value, consider waiting until just after year end so you can defer the gain until 2019 — unless you expect to be subject to a higher rate next year. In that scenario, you’d likely be better off recognizing the gain and paying the tax this year.

When you do sell shares, keep in mind that, if you bought them over time, each block will have a different holding period and cost basis. To reduce your tax liability, it’s possible to select shares for sale that have higher cost bases and longer holding periods, thereby minimizing your gain (or maximizing your loss) and avoiding higher-taxed short-term gains.

Think beyond just taxes

Investment decisions shouldn’t be driven by tax considerations alone. For example, you need to keep in mind your overall financial goals and your risk tolerance.

But taxes are still an important factor to consider. Contact us to discuss these and other year-end strategies for minimizing the tax impact of your mutual fund holdings.

If most of your money is tied up in your business, retirement can be a challenge. So if you haven’t already set up a tax-advantaged retirement plan, consider doing so this year. There’s still time to set one up and make contributions that will be deductible on your 2018 tax return!

More benefits

Not only are contributions tax deductible, but retirement plan funds can grow tax-deferred. If you might be subject to the 3.8% net investment income tax (NIIT), setting up and contributing to a retirement plan may be particularly beneficial because retirement plan contributions can reduce your modified adjusted gross income and thus help you reduce or avoid the NIIT.

If you have employees, they generally must be allowed to participate in the plan, provided they meet the qualification requirements. But this can help you attract and retain good employees.

And if you have 100 or fewer employees, you may be eligible for a credit for setting up a plan. The credit is for 50% of start-up costs, up to $500. Remember, credits reduce your tax liability dollar-for-dollar, unlike deductions, which only reduce the amount of income subject to tax.

3 options to consider

Many types of retirement plans are available, but here are three of the most attractive to business owners trying to build up their own retirement savings:

  1. Profit-sharing plan. This is a defined contribution plan that allows discretionary employer contributions and flexibility in plan design. You can make deductible 2018 contributions as late as the due date of your 2018 tax return, including extensions — provided your plan exists on Dec. 31, 2018. For 2018, the maximum contribution is $55,000, or $61,000 if you are age 50 or older and your plan includes a 401(k) arrangement.
  2. Simplified Employee Pension (SEP). This is also a defined contribution plan, and it provides benefits similar to those of a profit-sharing plan. But you can establish a SEP in 2019 and still make deductible 2018 contributions as late as the due date of your 2018 income tax return, including extensions. In addition, a SEP is easy to administer. For 2018, the maximum SEP contribution is $55,000.
  3. Defined benefit plan. This plan sets a future pension benefit and then actuarially calculates the contributions needed to attain that benefit. The maximum annual benefit for 2018 is generally $220,000 or 100% of average earned income for the highest three consecutive years, if less. Because it’s actuarially driven, the contribution needed to attain the projected future annual benefit may exceed the maximum contributions allowed by other plans, depending on your age and the desired benefit.

You can make deductible 2018 defined benefit plan contributions until your tax return due date, including extensions, provided your plan exists on Dec. 31, 2018. Be aware that employer contributions generally are required.

Sound good?

If the benefits of setting up a retirement plan sound good, contact us. We can provide more information and help you choose the best retirement plan for your particular situation.