With year-end rapidly approaching, now is the time to take steps to cut your 2019 tax bill, before it’s too late. This is Part 1 of my short list of foolproof year-end strategies for individual taxpayers to consider. Here goes.
Game your generous standard deduction allowance
Tax law changes
The Tax Cuts and Jobs Act (TCJA) almost doubled the standard deduction amounts. For 2019, the standard deduction allowances are:
- $12,200 if you are single or use married filing separate status.
- $24,400 if you and your spouse file jointly.
- $18,350 if you are a head of household.
If your total itemizable deductions for 2019 will be close to your standard deduction amount, consider making enough additional expenditures for itemized deduction items before year-end to exceed the standard deduction. Those prepayments will lower this year’s tax bill. Next year, your standard deduction will be a bit bigger thanks to an inflation adjustment, and you can claim it then.
- The easiest deductible expense to prepay is included in the house payment due on January 1. Accelerating that payment into this year will give you 13 months’ worth of itemized home mortgage interest deductions in 2019. Although the TCJA put new limits on these deductions, you are probably unaffected.
- Next up on the prepayment menu are state and local income and property taxes that are due early next year. Prepaying those bills before year-end can decrease your 2019 federal income tax bill, because your itemized deductions total will be that much higher. However, the TCJA decreased the maximum amount you can deduct for state and local taxes to $10,000 or $5,000 if you use married filing separate status. So, beware of that limitation.
Warning: The state and local tax prepayment drill can also be a bad idea if you will owe the dreaded alternative minimum tax (AMT) this year. That’s because write-offs for state and local income and property taxes are completely disallowed under the AMT rules. Therefore, prepaying those expenses may do little or no tax-saving good if you will be in the AMT. Thankfully, changes included in the TCJA took millions of taxpayers out of the AMT zone, but not everybody. Ask your tax adviser if you are in the clear for this year or not.
- Consider making bigger charitable donations this year and smaller donations next year to compensate (more about charitable donations later). That could cause your itemized deductions to exceed your standard deduction this year. Next year, you can claim the standard deduction.
- Finally, consider accelerating elective medical procedures, dental work, and expenditures for vision care. For 2019, you can deduct medical expenses to the extent they exceed 10% of your adjusted gross income (AGI), assuming you itemize.
Carefully manage gains and losses in your taxable investment accounts
If you hold investments in taxable brokerage firm accounts, consider the tax advantage of selling appreciated securities that have been held for over 12 months. The federal income tax rate on long-term capital gains recognized in 2019 is only 15% for most folks, although it can reach the maximum 20% rate at higher income levels. See below for those rates. The 3.8% net investment income tax (NIIT) can also apply at higher income levels.
To the extent you have capital losses from earlier this year or capital loss carryovers from pre-2019 years, selling winners this year will not result in any tax hit. In particular, sheltering net short-term capital gains with capital losses is a tax-smart move because net short-terms gains would otherwise be taxed at your higher ordinary income rate of up to 37%.
What if you have some loser investments that you would like to unload? Biting the bullet and taking the resulting capital losses this year would shelter capital gains, including high-taxed short-term gains, from other sales this year.
If selling some losers would cause your capital losses to exceed your capital gains, the result would be a net capital loss for the year. No problem. That net capital loss can be used to shelter up to $3,000 of 2019 income from salaries, bonuses, self-employment income, interest income, royalties, and whatever else ($1,500 if you use married filing separate status). Any excess net capital loss from this year is carried forward to next year and beyond.
In fact, having a capital loss carryover could turn out to be a pretty good deal. The carryover can be used to shelter both short-term gains and long-term gains recognized next year and beyond. This can give you extra investing flexibility in those years, because you won’t have to hold appreciated securities for over a year to get a preferential tax rate. You’ll pay 0% to the extent you can shelter gains with your loss carryover. And because the top two federal rates on net short-term capital gains recognized in 2020 will be 35% and 37% (plus the 3.8% NIIT if applicable), having a capital loss carryover to shelter high-taxed short-term gains recognized next year could be a very good thing.
Depending on political developments and future tax rate changes, capital loss carryovers into 2021 and beyond could turn out to be really valuable.
If you are charitably inclined: sell loser shares and give away resulting cash; give away winner shares
If you want to make gifts to some favorite relatives and/or charities, they can be made in conjunction with an overall revamping of your taxable account stock and equity mutual fund portfolios. Make gifts according to the following tax-smart principles.
Gifts to relatives
Don’t give away loser shares (currently worth less than what you paid for them). Instead, sell the shares and book the resulting tax-saving capital loss. Then you can give the cash sales proceeds to your relative.
On the other hand, you should give away winner shares to relatives. Most likely, they will pay a lower tax rate than you would pay if you sold the same shares.
For purposes of meeting the more-than-one-year rule for gifted shares, you can count your ownership period plus the gift recipient’s ownership period. Even if the winner shares have been held for a year or less before being sold, your relative will probably pay a much lower tax rate on the resulting short-term capital gain than you would.
Gifts to charities
The principles for tax-smart gifts to relatives also apply to donations to IRS-approved charities.
Sell loser shares and collect the resulting tax-saving capital losses. Then give the cash sales proceeds to favored charities and claim the resulting tax-saving charitable write-offs (assuming you itemize deductions). Following this strategy delivers a double tax benefit: tax-saving capital losses plus tax-saving charitable deductions.
On the other hand, you should donate winner shares instead of giving away cash. Why? Because donations of publicly traded shares that you have owned for over a year result in charitable deductions equal to the full current market value of the shares at the time of the gift (assuming you itemize). Plus, when you donate winner shares, you escape any capital gains taxes on those shares. So, this idea is double tax-saver: you avoid capital gains taxes, and you get a tax-saving charitable deduction (assuming you itemize). Meanwhile, the tax-exempt charitable organization can sell the donated shares without owing anything to the IRS.
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