As we approach year-end we urge you to be proactive with tax planning as the tax reduction ideas below need to be implemented prior to December 31, 2018.
Here are five ideas that may help reduce your taxes.
“Bunch” Charitable Contributions to Reduce Taxes
To reduce the amount of taxes you pay, you want to subtract as many deductions as possible from your income to make your taxable income as small as possible. Almost everyone is familiar with this idea of claiming “tax deductions.”
Tax rules include a built-in amount of deduction called the “standard deduction,” which automatically reduces taxable income by a set amount. For 2018 that “automatic” deduction is $24,000 for married filing jointly households. ($12,000 for single)
So unless the sum of the 3 main items you can deduct - mortgage interest, state and local taxes including property taxes ($10,000 maximum), and charitable contributions - is greater than $24,000 those 3 items provide no tax benefit to you. You might as well just take the $24,000 automatic deduction.
But what if there was a way to deduct more than the $24,000, thereby reduce your taxes more, without having a negative effect on your situation?
Referring to the 3 main items you can deduct, charitable contributions offer the most flexibility in the amount and timing of the deduction. This is where the idea of bunching comes in.
Thanks to our friends at Fidelity Investments, here is a 2 ½ minute video that does a great job of explaining bunching. In the video they discuss using a donor advised fund to implement the bunching which is great, but you can give the funds directly to a charity or charities if that works better for you.
Offset High-Income Years
Comparing your 2018 income with what you think it may be in 2019, will it be higher next year? Lower? Or about the same? Regardless if it is higher or lower there may be tax reduction opportunities. The opportunities are around charitable giving. Here’s the formula:
Income lower in 2019 - larger charitable contributions in 2018
Income higher in 2019 - larger charitable contributions in 2019
The idea is to increase charitable contributions in higher income years when your tax bracket may be higher which results in a larger tax benefit. The opposite is true in lower income years.
A year-over-year tax analysis may be helpful to quantify the benefit of different point in time contributions. Your accountant is best suited to do this but we would be glad to help also.
Take Advantage of the Annual Gift Tax Exclusion
If you would like to support family members or loved ones, annual gifting is a good strategy. This may shift the income generated from the asset from your high tax bracket to the recipient’s lower tax bracket thereby saving money on taxes. For 2018, the federal gift tax rules let you give up to $15,000 to as many people as you would like free of gift tax. This number is $30,000 for a married couple. The $15,000 / $30,000 exclusion does not roll over from year to year, so it pays to make gifts annually.
Donate Your IRA Required Minimum Distribution to Charity
As a retirees over age 70 ½ you can give up to $100,000 to charity tax-free from an IRA and have it count as your required minimum distribution (RMD) for the year. Making the tax-free transfer keeps the money out of your adjusted gross income which is beneficial and it also may make less of your Social Security benefits taxable.
If you have already taken your RMD for 2018, you could still make the transfer up to the $100,000 limit. Also, given the tax benefits of this strategy, we want to consider this idea in 2019 and beyond.
Keep in mind that you need to transfer the money directly from the IRA to the charity for it to count as the tax-free transfer.
Reexamine Choice of Business Entity
The tax overhaul created a new income tax deduction if you own a non-corporate business. The deduction equals 20% of "qualified business income" and is taken against the business owner’s taxable income. For example, if your business is structured as an S-Corporation and as the owner your taxable income is $100,000, your deduction could be as high as $20,000. That’s quite a tax savings.
The 20% business income deduction, however, is not automatic. There are six limitations on a taxpayer’s ability to take the deduction and the details are too complex to get into here. If you haven’t had a conversation about this opportunity with your account I encourage you to do so soon.