The passing of the Tax Cuts and Jobs Act of 2017 (TCJA) resulted in many changes in the tax code affecting individual taxpayers. The new tax rules have changed the planning process in order to minimize 2018 federal income tax liability. In particular, several itemized deductions are either eliminated are limited, and the standard deduction has nearly doubled in amount for all tax filing categories.
The following are five key strategies for saving on taxes as the year 2018 winds down.
1. “Bunching” itemized deductions
TCJA increased the standard deduction and eliminated or limited several itemized deductions. Individuals with total itemized deductions of $12,000 or less, or married couples filing married filing jointly and with $24,000 or less in itemized deductions will most likely use the standard deduction when they file their 2018 federal income tax returns. What this means is a simpler tax filing. Individuals taking the standard deduction will not be able to itemize deductions for items such as charitable contributions, home mortgage interest, state and local taxes, and certain other deductions. Several itemized deductions were eliminated including tax preparation fees, employee business expenses, and investment fees.
If an individual is on the cusp of itemizing rather than taking the standard deductions, it may make sense to “bunch” in one year potential itemized deductions rather than spreading the deduction over several years. An example is charitable contributions. An individual may want to give two, three or even five years’ worth of charitable donations in a single year, and then take a few years off from charitable giving and take the standard deduction. Focusing all donations in a single year can increase the value of deductions beyond the itemized deduction versus standard deduction threshold for a single year. The individual will then take the standard deduction in the “skip” years.
For 2018, individuals have until Dec. 31, 2018 to make their charitable contributions (cash, check or goods) to their favorite charities. The charitable limit is 60 percent of one’s adjusted gross income (AGI) for the year. This is an increase under TCJA from 50 percent of one’s AGI in prior years. If an individual uses a credit card to make a charitable contribution between now and Jan. 1, 2019, then the contribution will count for 2018, even if the credit card bill is paid in 2019.
2. Use capital losses and gains as a means of tax-loss “harvesting”
TCJA did not change the rules for tax loss “harvesting”. Those individuals owning capital assets (stocks, bonds, mutual funds, ETF’s, closed end funds, etc.) held in non-retirement brokerage accounts may want to take advantage of the recent drop in value of any of these capital assets. So far this month, the stock market has had a rough December with a decline for the month in several stock indices of about 6 to 7 percent. A loss on the sale of a capital asset can be used to offset realized capital gains, and then any excess capital losses may be used up to offset $3,000 of other income (salary, dividend, interest, and/or rental income). An investor may sell at a loss to offset capital gains and other income, and then reinvest the proceeds in the same capital assets to maintain one’s investment strategy. But the investor needs to make sure that he or she complies with the IRS “wash sale” rules. Tax loss “harvesting” needs to be completed by Dec. 31, 2018.
3. Consider a Roth IRA conversion
TCJA lowered income tax rates and changed the income thresholds for different individual tax brackets. These changes are set to expire in 2025 at which time tax rates will revert to what they were in 2017 (pre-TCJA) and adjusted for inflation. Those individuals who own traditional IRAs may be able to effectively lock in today’s lower tax rates by converting now their traditional IRAs to Roth IRAs. Since the traditional IRA owner pays taxes on the conversion amount up front, rather than when the IRA owner withdraws the funds, the IRA owner will owe no taxes on future earnings provided the Roth IRA withdrawals are qualified. If income tax rates go up, as they are expected to do after 2025, or if the IRA owner’s income increases in the future, a Roth IRA conversion could save the IRA owner taxes.
Another potential advantage for Roth IRAs is that Roth IRAs are not subject to required minimum distributions (RMDs), like traditional IRAs are. This is another reason to convert traditional IRAs invested in equities (stocks) before year-end. Many stocks and stock mutual funds have decreased in value during December as the stock market has declined. Converting traditional IRAs that have decreased in value will result in less tax liability as a result of conversion to a Roth IRA.
4. Contribute to a 529 college savings account
For parents and grandparents worried about how to pay for their children’s and grandchildren’s future college education, 529 accounts are a tax-advantaged way to help pay future college expenses. The accounts allow savings to grow at least tax-deferred, and avoid taxes altogether on investment gains if used to pay tuition, room and board, and other qualified expenses. TCJA allows up to $10,000 of 529 accounts to be used for primary and secondary school tuition expenses each year.
5. Maximize contributions to retirement and health savings accounts
For most federal employees, it is too late to contribute to the Thrift Savings Plan (TSP) for 2018. But the TSP contribution limit for regular contributions for calendar year 2019 has increased from $18,500 to $19,000. Employees are highly encouraged to make the election to increase their TSP contributions for 2019 as soon as possible so that their new contribution election amount becomes effective on the first pay date in Jan. 2019. Employees are also eligible to contribute to some type of IRA for 2018, traditional or Roth. While the deadline for making a 2018 IRA contribution is April 16, 2019 (the 2018 federal income tax filing deadline), employees are nevertheless encouraged to make their 2018 IRA contributions. The sooner an employee contributes to the IRA, the sooner it will grow, tax-deferred (traditional IRA) or tax-free (Roth IRA).
Another option for reducing taxable income for 2018 is contributing to a Health Savings Account, assuming one has established an HSA for 2018 and is enrolled in a high deductible health plan (HDHP). HSA contributions are made with before-taxed dollars and therefore reduce federal taxable income. HSA earnings are federal and potentially state income tax-free, as are withdrawals used to pay HSA-qualified medical expense. Federal employees enrolled for 2018 in an HDHP offered through the Federal Employees Health Benefits (FEHB) program can contribute up to $3,450 for a self only plan, and up to $6,900 for a family plan, plus an extra $1,000 if the HSA owner is age 55 or older as of Dec. 31, 2018. Note that for FEHB plans that have HDHPs and HSAs, part of the employee’s and agency’s FEHB premiums are directly contributed to the HSA each pay date. This is called the “premium pass through”. Employees are encouraged to calculate the amount of the premiums in their HDHP are contributed to their HSA and determine how much of their money they can contribute to the HSA in order to receive tax-related savings from their contributions. Employees have until April 16, 2019 (tax-filing deadline) to make their 2018 HSA contributions.