2019-2020 TAX PLANNING GUIDE - Lutz, Selig ...
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2019-2020 TAX
PLANNING
GUIDE
Year-round strategies to make the tax laws work for you
33 Century Hill Drive | Latham, NY 12110 | (518) 783-7200
3748 State Hwy 30 | Amsterdam, NY 12010 | (518) 773-2267
420 Lexington Avenue, Suite 300 | New York, NY 10170 | (212) 297-6204
www.lutzseligzeronda.com
Tax planning is as
essential as ever
ast year, most of the provisions of the massive Tax Cuts and Jobs Act (TCJA) went into
L effect. They included small income tax rate reductions for most individual tax brackets and
a substantial reduction for corporations. The TCJA also provided a large tax deduction for
owners of pass-through entities, expanded the availability of child credits to more higher-income
taxpayers, and significantly increased exemptions for the individual alternative minimum tax (AMT)
and the estate tax.
But it wasn’t all good news for taxpayers. The TCJA also eliminated or limited many tax breaks, and
much of the tax relief provided is only temporary (unless Congress acts to make it permanent).
What does this all mean? Tax planning is as essential as ever.
This guide provides an overview of the most consequential changes under the TCJA and other key
tax provisions you need to be aware of. It offers a variety of strategies for minimizing your taxes in the
current tax environment. Use it to work closely with your tax advisor to identify the best strategies for
your particular situation. He or she also can keep you apprised of any new tax law developments that
occur this year that might affect you.
Contents
Year-To-Date Review.................................................2 Click here
Executive Compensation...........................................6 Click here
Investing....................................................................8 Click here
Real Estate...............................................................12 Click here
Business Ownership.................................................14 Click here
Charitable Giving....................................................16 Click here
Family & Education.................................................18 Click here
Retirement...............................................................20 Click here
Estate Planning........................................................22 Click here
Tax Rates..................................................................24 Click here
2 Year-To-Date Review
Planning for income and deductions
can be a challenge post-TCJA
ven though tax rates on
E “ordinary income” gen-
erally went down under
CHART 1 2019 standard deduction
the Tax Cuts and Jobs Act (TCJA),
Filing status Standard deduction1
these rates are still higher than
those that apply to much of your Singles and separate filers $12,200
investment income. So careful tax Heads of households $18,350
planning remains critical. Ordinary
Joint filers $24,400
income generally includes salary,
income from self-employment or 1
Taxpayers age 65 or older or blind can claim an additional standard deduction: $1,300 if married,
$1,650 if unmarried.
business activities, interest, and
distributions from tax-deferred Whatever the reason behind your Through 2025, your entire itemized
retirement accounts. Some of it desire to time income and expenses, deduction for state and local taxes —
may also be subject to employment you may be able to control the timing including property tax and either
tax, or you may have to pay the of these income items: income or sales tax — is limited to
alternative minimum tax (AMT), $10,000 ($5,000 if you’re married
under which different tax rates y Bonuses, filing separately). (Deducting sales
apply. If possible, try to control tax instead of income tax may be
to your tax advantage the timing y Consulting or other self-employment
beneficial if you reside in a state
of your ordinary income as well as income,
with no, or low, income tax or you
your deductible expenses (which y U.S. Treasury bill income, and purchased a major item, such as a
might be significantly reduced under car or boat.)
the TCJA). y Retirement plan distributions, to
the extent they won’t be subject
The limit on the state and local
Timing income and expenses to early-withdrawal penalties and
tax deduction significantly impacts
aren’t required. (See page 20.)
Smart timing of income and expenses higher-income taxpayers with large
can reduce your tax liability, and poor state and local income tax and/or
timing can unnecessarily increase Some expenses with potentially property tax bills. Not only is it
it. When you don’t expect to be controllable timing are mortgage affecting their timing strategies, but
subject to the AMT (see page 3) interest, investment interest expense in many cases they’re experiencing
in the current year or the next year, and charitable contributions. a large drop in their total itemized
deferring income to the next year deductions. (Homeowners should also
and accelerating deductible expenses Impact of the TCJA consider the TCJA changes to the
into the current year may be a good on timing strategies mortgage interest and home equity
idea. Why? Because it will defer tax, The TCJA makes timing income and debt interest deductions. See page 12.)
which usually is beneficial. deductions more challenging because
some strategies that taxpayers have Suspension of miscellaneous itemized
But when you expect to be in a implemented in the past may no longer deductions subject to the 2% floor.
higher tax bracket next year — or make sense. Here’s a look and some This deduction for expenses such as
you expect tax rates to rise — the significant changes affecting deductions: certain professional fees, investment
opposite approach may be beneficial: expenses and unreimbursed employee
Accelerating income will allow more Reduced deduction for state and business expenses is suspended through
income to be taxed at your current local tax. Property tax used to be a 2025. While this eliminates the home
year’s lower rate. And deferring popular expense to time. But with the office deduction for employees who
expenses will make the deductions TCJA’s limit on the state and local tax work from home, if you’re self-employed,
more valuable, because deductions deduction, property tax timing will you may still be able to deduct home
save more tax when you’re subject to likely provide little, if any, benefit for office expenses. (See Case Study 5 on
a higher tax rate. higher-income taxpayers. page 12.)
Year-To-Date Review 3
More-restricted personal casualty and Suspension of the itemized deduction Account — or make deductible
theft loss deduction. Through 2025, this reduction. It’s not all bad news for contributions to an HSA you set
itemized deduction is suspended except itemized deductions. Under pre-TCJA up yourself — up to $3,500 for
if the loss was due to an event officially law, if your adjusted gross income self-only coverage and $7,000 for
declared a disaster by the President. (AGI) exceeded the applicable thresh- family coverage for 2019 (plus $1,000
old, certain itemized deductions were if you’re age 55 or older). HSAs can
Increased standard deduction. When reduced by 3% of the AGI amount bear interest or be invested, growing
we’re talking about timing deductions, over the threshold (not to exceed 80% tax-deferred similar to an IRA.
we generally mean itemized deductions. of otherwise allowable deductions). Withdrawals for qualified medical
Taxpayers can choose to either itemize Through 2025, the TCJA suspends expenses are tax-free, and you can
certain deductions or take the standard this reduction. carry over a balance from year
deduction based on their filing status. to year.
Itemizing deductions when the total Tax-advantaged
will be larger than the standard deduc- saving for health care FSA. You can redirect pretax
tion saves tax. You may be able to save taxes without income to an employer-sponsored
having to worry about the medical Flexible Spending Account up to an
The TCJA nearly doubled the standard expense deduction floor (see “What’s employer-determined limit — not
deduction. While many higher-income new!” below) by contributing to one to exceed $2,700 in 2019. The plan
taxpayers will still benefit from itemiz- of these accounts: pays or reimburses you for qualified
ing, some — such as those in low-tax medical expenses. What you don’t
states, who don’t have mortgages or HSA. If you’re covered by a qualified use by the plan year’s end, you gener-
who aren’t charitably inclined — may high deductible health plan, you ally lose — though your plan might
now save more tax by claiming the can contribute pretax income to an allow you to roll over up to $500 to
standard deduction. See Chart 1 for employer-sponsored Health Savings the next year. Or it might give you
the 2019 standard deduction amounts. a 2½-month grace period to incur
expenses to use up the previous year’s
contribution. If you have an HSA,
WHAT’S It may be harder to deduct your FSA is limited to funding certain
NEW! medical expenses this year permitted expenses.
If medical expenses not paid via
Smaller AMT threat
tax-advantaged accounts or reim-
bursable by insurance exceed a The top AMT rate is 28%, compared
certain percentage of your adjusted to the top regular ordinary-income
gross income (AGI), you can claim tax rate of 37%. But the AMT rate
an itemized deduction for the typically applies to a higher taxable
amount exceeding that “floor.” This income base. You must pay the AMT
floor has always been difficult for if your AMT liability exceeds your
higher-income taxpayers to exceed, regular tax liability.
and it may be even harder this year.
The TCJA substantially increases
The TCJA had reduced the floor from 10% to 7.5% for 2017 and 2018, but it the AMT exemptions through 2025.
will be 10% when you file your 2019 tax return unless Congress extends the (See Chart 8 on page 24.) This means
7.5% floor. (Check with your tax advisor for the latest information.) fewer taxpayers will have to pay the
AMT. In addition, there aren’t as
Eligible expenses may include health insurance premiums, long-term-care many differences between what’s
insurance premiums (limits apply), medical and dental services, and prescription deductible for AMT purposes and
drugs. Mileage driven for health care purposes also can be deducted — at 20 regular tax purposes (see Chart 2
cents per mile for 2019. on page 4), which also will reduce
AMT risk. However, AMT will
Consider bunching elective medical procedures (and any other services and
remain a threat for some higher-
purchases whose timing you can control without negatively affecting your or your
income taxpayers.
family’s health) into alternating years if it would help you exceed the applicable
floor and you’d have enough total itemized deductions to benefit from itemizing.
So before timing your income and
If one spouse has high medical expenses and a relatively lower AGI, filing sepa- expenses, determine whether you’re
rately may allow that spouse to exceed the AGI floor and deduct some medical already likely to be subject to the
expenses that wouldn’t be deductible if the couple filed jointly. Warning: Because AMT — or whether the actions
the alternative minimum tax (AMT) exemption for separate returns is considerably you’re considering might trigger it.
lower than the exemption for joint returns, filing separately to exceed the floor Deductions used to calculate regular
could trigger the AMT. tax that aren’t allowed under the
AMT can trigger AMT liability.
4 Year-To-Date Review
Some income items also might
trigger or increase AMT liability: What itemized deductions are
CHART 2
also deductible for AMT purposes?
y Long-term capital gains and quali-
fied dividend income, even though Expense Regular tax AMT For more information
they’re taxed at the same rate for See “Impact of the TCJA on
State and local income tax n
both regular tax and AMT purposes, timing strategies” on page 2.
y Accelerated depreciation adjust- See “Home-related
Property tax n deductions” on page 12.
ments and related gain or loss
differences when assets are sold, and Mortgage interest
See “Home-related
n n deductions” on page 12.
y Tax-exempt interest on certain
Interest on home equity debt
private-activity municipal See “Home-related
used to improve your principal n n
bonds. (For an exception, see residence or second residence
deductions” on page 12.
the warning on page 11.)
See Case Study 4 on
Investment interest n n page 11.
Finally, in certain situations exercising
incentive stock options (ISOs) can See “What’s new!” on
Medical expenses n n page 3.
trigger significant AMT liability. (See
the warning at the top of page 7.) Charitable contributions n n See page 16.
Avoiding or reducing AMT
preference on ISO exercises, you may office expenses. (See Case Study 5 on
With proper planning, you may be be entitled to a credit in a subsequent page 12.) Above-the-line deductions
able to avoid the AMT, reduce its year. In effect, this factors in timing are particularly valuable because they
impact or even take advantage of its differences that reverse in later years. reduce your AGI and, depending on
lower maximum rate. To determine the specific deduction, your modified
the right timing strategies for your AGI (MAGI), which are the triggers
Employment taxes
situation, work with your tax advisor for certain additional taxes and the
to assess whether: In addition to income tax, you must
pay Social Security and Medicare phaseouts of many tax breaks.
You could be subject to the AMT this taxes on earned income, such as
salary and bonuses. The 12.4% Social Additional 0.9% Medicare tax
year. Consider accelerating income
into this year, which may allow you Security tax applies only up to the Another employment tax that higher-
to benefit from the lower maximum Social Security wage base of $132,900 income taxpayers must be aware of
AMT rate. And deferring expenses you for 2019. All earned income is subject is the additional 0.9% Medicare tax.
can’t deduct for AMT purposes may to the 2.9% Medicare tax. Both It applies to FICA wages and net
allow you to preserve those deductions taxes are split equally between the self-employment income exceeding
(but watch out for the annual limit on employee and the employer. $200,000 per year ($250,000 if
the state and local tax deduction). If married filing jointly and $125,000
you also defer expenses you can deduct Self-employment taxes if married filing separately).
for AMT purposes, the deductions If you’re self-employed, you pay
may become more valuable because both the employee and employer If your wages or self-employment
of the higher maximum regular tax portions of employment taxes on income varies significantly from year
rate. Finally, carefully consider the your self-employment income. The to year or you’re nearing the threshold
tax consequences of exercising ISOs. employer portion (6.2% for Social for triggering the additional Medicare
Security tax and 1.45% for Medicare tax, income timing strategies may
You could be subject to the AMT tax) is deductible above the line. help you avoid or minimize it. For
next year. Consider taking the opposite example, if you’re an employee,
approach. For instance, defer income As a self-employed taxpayer, you may perhaps you can time when you
to next year, because you’ll likely pay benefit from other above-the-line receive a bonus or exercise stock
a relatively lower AMT rate. Also, deductions as well. You can deduct options. If you’re self-employed, you
before year end consider selling any 100% of health insurance costs for may have flexibility on when you
private-activity municipal bonds whose yourself, your spouse and your depen- purchase new equipment or invoice
interest could be subject to the AMT. dents, up to your net self-employment customers. If you’re an S corporation
income. You also can deduct contri- shareholder-employee, you might
If you pay AMT in one year on deferral butions to a retirement plan and, if save tax by adjusting how much you
items, such as depreciation adjustments, you’re eligible, an HSA for yourself. receive as salary vs. distributions.
passive activity adjustments or the tax And you might be able to deduct home (See “Owner-employees” at right.)
Year-To-Date Review 5
Also consider the withholding rules. to self-employment taxes — even if level) as opposed to dividends (which
Employers must withhold the addi- the income isn’t distributed to you. aren’t deductible at the corporate level
tional tax beginning in the pay period But such income may not be subject to yet are still taxed at the shareholder
when wages exceed $200,000 for the self-employment taxes if you’re a limited level and could be subject to the 3.8%
calendar year — without regard to partner or the LLC member equivalent. NIIT) if the overall tax paid by both
an employee’s filing status or income Check with your tax advisor on whether the corporation and you would be less.
from other sources. So your employer the additional 0.9% Medicare tax on
might withhold the tax even if you earned income or the 3.8% NIIT (see Warning: The IRS scrutinizes corporate
aren’t liable for it — or it might not page 10) will apply. payments to shareholder-employees
withhold the tax even though you are for possible misclassification, so tread
liable for it. S corporations. Only income you carefully.
receive as salary is subject to employ-
If you don’t owe the tax but your ment taxes and, if applicable, the 0.9% Estimated payments
employer is withholding it, you can Medicare tax. To reduce these taxes, and withholding
claim a credit on your 2019 income you may want to keep your salary You can be subject to penalties if
tax return. If you do owe the tax but relatively — but not unreasonably — you don’t pay enough tax during the
your employer isn’t withholding it, low and increase the income that is year through estimated tax payments
consider filing a W-4 form to request taxed to you through your Schedule and withholding. Here are some
additional income tax withholding, K-1 by virtue of your share of the strategies to help avoid underpayment
which can be used to cover the shortfall earnings from the business. That penalties:
and avoid interest and penalties. Or income isn’t subject to the corporate
you can make estimated tax payments. level tax or the 0.9% Medicare tax
Know the minimum payment rules.
and, typically, is not subject to the
For you to avoid penalties, your
Owner-employees 3.8% NIIT. Plus, you may be able to
estimated payments and withholding
There are special considerations if benefit from the Section 199A deduc-
must equal at least 90% of your tax
you’re a business owner who also tion (see page 14) on the K-1 earnings.
liability for 2019 or 110% of your
works in the business, depending on 2018 tax (100% if your 2018 AGI
its structure: C corporations. Only income you was $150,000 or less or, if married
receive as salary is subject to employ- filing separately, $75,000 or less).
Partnerships and limited liability ment taxes and, if applicable, the 0.9% Warning: You may be at a greater risk
companies. Generally, all trade or Medicare tax. Nonetheless, you may for underwithholding due to TCJA
business income that flows through to prefer to take more income as salary changes. See “What’s new!” below.
you for income tax purposes is subject (which is deductible at the corporate
Use the annualized income
installment method. This method
WHAT’S often benefits taxpayers who have
NEW!
Underwithholding may still be a risk
large variability in income from
month to month due to bonuses,
To reflect changes under the TCJA — such as the
investment gains and losses, or
increase in the standard deduction, suspension
seasonal income (at least if it’s
of personal exemptions and changes in tax rates
skewed toward the end of the year).
and brackets — for 2018 the IRS updated the
Annualizing computes the tax due
tables that indicate how much employers should
based on income, gains, losses and
withhold from their employees’ paychecks for
deductions through each estimated
federal income taxes. Generally the amount
tax period.
withheld was reduced.
As a result, some taxpayers didn’t have enough withheld to pay their ultimate tax Estimate your tax liability and increase
liabilities under the TCJA. They found themselves with an unexpected tax bill when withholding. If you determine you’ve
they filed their 2018 tax returns. In some cases, taxpayers even owed interest and underpaid, consider having the tax
penalties, though the IRS has provided some relief in certain circumstances. shortfall withheld from your salary or
year end bonus by Dec. 31. Because
The withholding tables for 2019 are very similar to those for 2018, so you withholding is considered to have been
may still be at risk for underwithholding. An IRS calculator can help you more paid ratably throughout the year, this
accurately estimate how much should be withheld. (Go to IRS.gov and search is often a better strategy than making
“withholding.”) You may find that you need to increase your withholding by filling up the difference with an increased
out a new Form W-4 and submitting it to your employer. You can modify your quarterly tax payment, which may
withholding at any time during the year, or even multiple times within a year. still leave you exposed to penalties for
earlier quarters.
6 Executive Compensation
What’s the tax impact of
your executive compensation?
f you’re an executive or other There are some potential disad- Such a delay will defer income tax
I key employee, you might
receive stock-based compensa-
vantages of a Sec. 83(b) election,
however. First, prepaying tax in the
and may allow you to reduce or avoid
exposure to the additional 0.9%
tion, such as restricted stock, restricted current year could push you into a Medicare tax (because the RSUs are
stock units (RSUs) or stock options higher income tax bracket and trigger treated as FICA income). However,
(either incentive or nonqualified), or or increase your exposure to the addi- any income deferral must satisfy
nonqualified deferred compensation tional 0.9% Medicare tax. But if your the strict requirements of Internal
(NQDC). The tax consequences of company is in the earlier stages of Revenue Code Section 409A. Also
these types of compensation can be development, the income recognized keep in mind that it might be better
complex — subject to ordinary income, may be relatively small. to recognize income now because of
capital gains, employment and other the currently low tax rates.
taxes. So smart tax planning is crucial. Second, any taxes you pay because of
the election can’t be refunded if you Incentive stock options
Restricted stock eventually forfeit the stock or sell it ISOs allow you to buy company
Restricted stock is stock your at a decreased value. However, you’d stock in the future (but before a set
employer grants to you subject to a have a capital loss in those situations. expiration date) at a fixed price equal
substantial risk of forfeiture. Income to or greater than the stock’s FMV
recognition is normally deferred until Third, when you sell the shares, any at the date of the grant. Thus, ISOs
the stock is no longer subject to that gain will be included in net investment don’t provide a benefit until the stock
risk (that is, it’s vested) or you sell it. income and could trigger or increase appreciates in value. If it does, you
When the restriction lapses, you pay your liability for the 3.8% NIIT. (See can buy shares at a price below what
taxes on the stock’s fair market value page 10.) they’re then trading for, provided
(FMV) at your ordinary-income rate. you’re eligible to exercise the options.
(The FMV will be considered FICA See Case Study 1 for additional
income, so it could trigger or increase information, and work with your ISOs receive tax-favored treatment
your exposure to the additional 0.9% tax advisor to map out whether the but must comply with many rules.
Medicare tax. See page 4.) Sec. 83(b) election is appropriate Here are the key tax consequences:
for your situation.
But you can instead make a y You owe no tax when ISOs are
Section 83(b) election to recognize RSUs granted.
ordinary income when you receive RSUs are contractual rights to receive
y You owe no regular income tax
the stock. This election, which you stock, or its cash value, after the award
when you exercise the ISOs.
must make within 30 days after has vested. Unlike restricted stock,
receiving the stock, allows you to RSUs aren’t eligible for the Sec. 83(b) y If you sell the stock after holding
convert potential future appreciation election. So there’s no opportunity the shares at least one year from the
from ordinary income to long-term to convert ordinary income into exercise date and two years from
capital gains income and defer it capital gains. the grant date, you pay tax on the
until the stock is sold. sale at your long-term capital gains
But they do offer a limited ability to rate. You also may owe the NIIT.
The election can be beneficial if the defer income taxes: Unlike restricted
y If you sell the stock before long-term
income at the grant date is negligible stock, which becomes taxable imme-
capital gains treatment applies, a
or the stock is likely to appreciate diately upon vesting, RSUs aren’t
“disqualifying disposition” occurs and
significantly before income would taxable until the employee actually
any gain is taxed as compensation at
otherwise be recognized. And with receives the stock. So rather than
ordinary-income rates. (Disqualified
ordinary-income rates now especially having the stock delivered immedi-
dispositions aren’t, however, subject
low under the Tax Cuts and Jobs Act ately upon vesting, you may be able
to FICA and Medicare tax, including
(TCJA), it might be a good time to to arrange with your employer to
the additional 0.9% Medicare tax.)
recognize income. delay delivery.
Executive Compensation 7
Warning: If you don’t sell the stock in
the year of exercise, a tax “preference” CASE The TCJA provides tax deferral
item is created for the difference
STUDY 1 opportunity in certain circumstances
between the stock’s FMV and the
Jason was about to receive some
exercise price (the “bargain element”)
stock-based compensation from
that can trigger the AMT. A future
his employer, so he contacted his
AMT credit, however, should mitigate tax advisor to find out what the
this AMT hit. Plus, you may now tax consequences would be. His
be at lower AMT risk because of advisor explained that the tax treat-
the higher AMT exemption and ment would depend on the type of
exemption phaseout range under the stock-based compensation. For
TCJA. (See Chart 8 on page 24.) example, Jason might be able to
Consult your tax advisor because the take advantage of the Section 83(b)
rules are complex. election. (See “Restricted stock” at
left.) Or he might be eligible for a
If you’ve received ISOs, plan carefully tax break under the TCJA.
when to exercise them and whether to
immediately sell shares received from The TCJA break allows for the deferral of tax on stock-based compensation in
an exercise or hold them. Waiting certain circumstances. Generally, it gives taxpayers the opportunity to match the
taxation of restricted stock and stock options with the timing of the sale of the
to exercise ISOs until just before the
stock. It’s intended for situations in which there is no ready market for the sale
expiration date (when the stock value
of the stock.
may be the highest, assuming the
stock is appreciating) and holding on The availability of the deferral opportunity is limited, however. It generally will
to the stock long enough to garner apply only if at least 80% of full-time employees are covered by the stock-based
long-term capital gains treatment compensation plan.
often is beneficial. But there’s also
market risk to consider. Plus, acting
earlier can be advantageous in several The timing of ISO exercises also could 401(k)s, in several ways. For example,
situations: positively or negatively affect your unlike 401(k) plans, NQDC plans can
liability for the higher ordinary-income favor highly compensated employees,
y Exercise early to start the holding tax rates, the 20% long-term capital but plan funding isn’t protected from
period so you can sell and receive gains rate and the NIIT. See Case the employer’s creditors. (For more on
long-term capital gains treatment Study 1 for additional information 401(k)s, see page 20.)
sooner. and, with your tax advisor, evaluate
the risks and crunch the numbers to One important NQDC tax issue is
y Exercise when the bargain element determine the best strategy for you. that employment taxes (see page 4)
is small or when the market price are generally due once services have
is close to bottoming out to reduce Nonqualified stock options been performed and there’s no longer
or eliminate AMT liability. a substantial risk of forfeiture — even
The tax treatment of NQSOs is dif-
y Exercise annually so you can buy ferent from the tax treatment of ISOs: though compensation may not be paid
only the number of shares that NQSOs create compensation income or recognized for income tax purposes
will achieve a breakeven point (taxed at ordinary-income rates) on until much later. So your employer
between the AMT and regular the bargain element when exercised may withhold your portion of the
tax and thereby incur no addi- (regardless of whether the stock is employment taxes from your salary
tional tax. held or sold immediately), but they or ask you to write a check for the
don’t create an AMT preference item. liability. Or it may pay your portion, in
y Sell in a disqualifying disposition which case you’ll have additional tax-
and pay the higher ordinary- able income. Warning: The additional
income rate to avoid the AMT You may need to make estimated tax
payments or increase withholding to 0.9% Medicare tax could also apply.
on potentially disappearing
appreciation. fully cover the tax on the exercise.
Keep in mind that an exercise could Keep in mind that the rules for NQDC
trigger or increase exposure to top tax plans are tighter than they once were,
On the negative side, exercising and the penalties for noncompliance
early accelerates the need for funds rates, the additional 0.9% Medicare
tax and the NIIT. can be severe: You could be taxed on
to buy the stock, exposes you to a plan benefits at the time of vesting,
loss if the shares’ value drops below and a 20% penalty and potential
your exercise cost, and may create NQDC plans
interest charges also could apply. So
a tax cost if the preference item These plans pay executives in the future check with your employer to make sure
from the exercise generates an for services to be currently performed. it’s addressing any compliance issues.
AMT liability. They differ from qualified plans, such as
8 Investing
The ins and outs of
taxes on investments
ax treatment of investments Remember: Appreciation on invest- Wash sale rule
T varies dramatically based
on factors such as type of
ments isn’t taxed until the investments
are sold, deferring tax and perhaps
If you want to achieve a tax loss
with minimal change in your
investment, type of income it pro- allowing you to time the sale to your portfolio’s asset allocation, consider
duces, how long you’ve held it and tax advantage — such as in a year the wash sale rule. It prevents you
whether any special limitations or when you have capital losses to absorb from taking a loss on a security if
breaks apply. And while the Tax the capital gain. (See Case Study 2.) you buy a substantially identical
Cuts and Jobs Act (TCJA) didn’t Or, if you’ve cashed in some big gains security (or an option to buy such
change the long-term capital gains during the year and want to reduce your a security) within 30 days before
rates, its changes to ordinary-income 2019 tax liability, look for unrealized or after you sell the security that
tax rates and tax brackets do have an losses in your portfolio and consider created the loss. You can recognize
impact. Here’s a look at some of the selling them before year end to offset the loss only when you sell the
ins and outs of taxes on investments. your gains. Both long- and short-term replacement security.
But remember that taxes should gains and losses can offset one another.
never be the primary driver of your
investment decisions.
CHART 3 What’s the maximum 2019 capital gains tax rate?
Capital gains tax and timing
Although time, not timing, is gener- Type of gain Rate1
ally the key to long-term investment
Taxpayer’s ordinary-
success, timing can have a dramatic Short-term (assets held 12 months or less)
income tax rate
impact on the tax consequences of
investment activities. Your long-term Long-term (assets held more than 12 months) 15%
capital gains rate can be as much Some key exceptions
as 20 percentage points lower than
Long-term gain of certain higher-income taxpayers 20%2
your ordinary-income tax rate. The
long-term capital gains rate applies Most long-term gain that would be taxed at 10% or
0%
to investments held for more than 12% based on the taxpayer’s ordinary-income rate
12 months. The applicable rate Long-term gain on collectibles, such as artwork
28%
depends on your income level and and antiques
the type of asset you’ve sold. (See Long-term gain attributable to certain recapture of
Chart 3.) 25%
prior depreciation on real property
Gain on qualified small business (QSB) stock held
Because of TCJA-related changes to more than 5 years
the brackets, through 2025 the top
n Acquired on or before Feb. 17, 2009 14%3
long-term gains rate of 20% kicks
in before the top ordinary-income n Acquired after Feb. 17, 2009, and before
7%4
rate does. (See Chart 8 on page 24.) Sept. 28, 2010
Higher rates still apply to certain n Acquired on or after Sept. 28, 2010 0%
types of assets. (See Chart 3.) In addition, the 3.8% NIIT applies to net investment income to the extent that modified adjusted
1
gross income (MAGI) exceeds $200,000 (singles and heads of households), $250,000 (married
Holding on to an investment until filing jointly) or $125,000 (married filing separately).
you’ve owned it more than one year The 20% rate applies to taxpayers with taxable income exceeding $434,550 (singles), $461,700
2
(heads of households), $488,850 (joint filers) or $244,425 (separate filers).
may help substantially cut tax on any
Effective rate based on a 50% exclusion from a 28% rate.
3
gain. Keeping it even longer can also
Effective rate based on a 75% exclusion from a 28% rate.
4
make tax sense.
Investing 9
Fortunately, there are ways to avoid
CASE
triggering the wash sale rule and
STUDY 2
Use capital losses to absorb unrecognized gains
still achieve your goals. For example,
you can:
Cynthia’s year-to-date net realized
losses are $53,000. Her portfolio
y Sell the security and immediately includes $100,000 of stock that
buy securities of a different she paid only $50,000 for. Cynthia
company in the same industry has been thinking about selling it
or shares in a mutual fund that to diversify her portfolio, but she’s
holds securities much like the been concerned about the capital
ones you sold, gains tax.
y Sell the security and wait 31 days Her tax advisor suggests that now
to repurchase the same security, or might be a good time to sell the
y Before selling the security, purchase stock because her $50,000 gain
additional shares of that security would essentially be tax-free: The gain would absorb $50,000 of losses, leaving
equal to the number you want to Cynthia with a $3,000 net loss that she could use to offset ordinary income.
sell at a loss, and then wait 31 days
to sell the original portion.
0% rate And if you bought the same security
Alternatively, you can do a bond swap, The 0% rate generally applies to at different times and prices and want
where you sell a bond, take a loss and long-term gain that would be taxed at to sell high-tax-basis shares to reduce
then immediately buy another bond 10% or 12%, based on the taxpayer’s gain or increase a loss to offset other
of similar quality and duration from a ordinary-income rate. However, a very gains, be sure to specifically identify
different issuer. Generally, the wash small portion of income in the top of which block of shares is being sold.
sale rule doesn’t apply because the the 12% brackets won’t be eligible for
bonds aren’t considered substantially the 0% rate. Mutual funds
identical. Thus, you can achieve a Investing in mutual funds is an easy
tax loss with virtually no change in If you have adult children in the way to diversify your portfolio. But
economic position. 10% or 12% tax bracket, consider beware of the tax pitfalls. First,
transferring appreciated assets to mutual funds with high turnover
Warning: You can’t avoid the wash them so they can sell the assets and rates can create income that’s taxed
sale rule by selling stock at a loss in enjoy the 0% rate. But keep in mind at ordinary-income rates. Choosing
a taxable account and purchasing that the 0% rate applies only to the funds that provide primarily long-term
the same stock within 30 days in a extent that capital gains “fill up” gains can save you more tax dollars
tax-advantaged retirement account. the gap between your child’s taxable because of the lower long-term rates.
income and the top end of the 0%
Loss carryovers bracket. For 2019, the 0% bracket Second, earnings on mutual funds are
for singles tops out at $39,375 (just typically reinvested, and unless you or
If net losses exceed net gains, you can
$100 less than the top of the 12% your investment advisor increases your
deduct only $3,000 ($1,500 for married
ordinary-income bracket). basis accordingly, you may report more
taxpayers filing separately) of the net
losses per year against other income gain than required when you sell the
(such as wages, self-employment Warning: If the child will be under fund. Brokerage firms are required to track
and business income, dividends and age 24 on Dec. 31, first make sure he (and report to the IRS) your cost basis in
interest). or she won’t be subject to the “kiddie mutual funds acquired during the tax year.
tax.” (See page 18.) Also consider any
gift tax consequences. (See page 22.) Third, buying equity mutual fund shares
You can carry forward excess losses
until death. Loss carryovers can be a late in the year can be costly taxwise.
powerful tax-saving tool in future years Paying attention to details Such funds often declare a large capital
if you have a large investment portfolio, If you don’t pay attention to the gains distribution at year end, which is
real estate holdings or a closely held details, the tax consequences of a a taxable event. If you own the shares
business that might generate substantial sale may be different from what on the distribution’s record date, you’ll
future capital gains. you expect. For example, the trade be taxed on the full distribution amount
date, not the settlement date, of even if it includes significant gains
publicly traded securities determines realized by the fund before you owned
Finally, remember that capital gains
the year in which you recognize the the shares. And you’ll pay tax on those
distributions from mutual funds can
gain or loss. gains in the current year — even if you
also absorb capital losses.
reinvest the distribution.10 Investing
Small business stock Passive activities and document your time. Contempo-
By purchasing stock in certain If you’ve invested in a trade or business raneous recordkeeping is better than
small businesses, you can diversify in which you don’t materially partic- records that are created after the fact.
your portfolio. You also may enjoy ipate and where income or loss flows
preferential tax treatment: through to your tax return, remember If you don’t pass the material partici-
the passive activity rules. Why? Passive pation test, consider:
Conversion of capital loss to ordinary activity income may be subject to the
loss. If you sell qualifying Section 1244 3.8% NIIT (See Case Study 3), and Increasing your involvement. If you can
small business stock at a loss, you can passive activity losses generally are exceed 500 hours, the activity no longer
treat up to $50,000 ($100,000, if married deductible only against income from will be subject to passive activity rules.
filing jointly) as an ordinary, rather than other passive activities. You can carry
a capital, loss — regardless of your hold- forward disallowed losses to the follow- Grouping activities. You may be able to
ing period. This means you can use it to ing year, subject to the same limits. group certain activities together to be
offset ordinary income, reducing your tax treated as one activity for tax purposes
by as much as 37% of this portion of the To avoid passive activity treatment, and exceed the 500-hour threshold.
loss. Sec. 1244 applies only if total capital you must “materially participate” in But the rules are complex, and there
invested isn’t more than $1 million. the activity, which typically means are potential downsides to consider.
you must participate in the trade or
Tax-free gain rollovers. If within 60 business more than 500 hours during Looking at other activities. If you have
days of selling qualified small business the year or demonstrate that your passive losses, one option is to limit
(QSB) stock you buy other QSB stock involvement constitutes substantially your participation in another activity
with the proceeds, you can defer the tax all of the participation in the activity. that’s generating income, so that you
on your gain until you dispose of the new But there are other ways to meet don’t meet the 500-hour test. Another
stock. The rolled-over gain reduces your the material participation test. Plus, is to invest in an additional income-
basis in the new stock. For determining there are special rules that apply to producing trade or business that will be
long-term capital gains treatment, the real estate. (See page 13.) To help passive to you. Under both strategies,
new stock’s holding period includes the ensure your hours claim will be able to you’ll have passive income that can
holding period of the stock you sold. To withstand IRS scrutiny, carefully track absorb some or all of your passive losses.
be a QSB, a business must be engaged
in an active trade or business and must CASE
not have assets that exceed $50 million, Watch out for the NIIT
STUDY 3
among other requirements.
Earlier this year, Dev accepted
Exclusion of gain. Generally, tax- a new job with a large salary
payers selling QSB stock are allowed increase. His investment portfolio
to exclude up to 50% of their gain if also was doing well, so he was
concerned that he could become
they’ve held the stock for more than
subject to the 3.8% net investment
five years. But, depending on the
income tax (NIIT). He contacted
acquisition date, the exclusion may be
his tax advisor to learn more.
greater: The exclusion is 75% for stock
acquired after Feb. 17, 2009, and before She explained that taxpayers with
Sept. 28, 2010, and 100% for stock modified adjusted gross income
acquired on or after Sept. 28, 2010. (MAGI) over $200,000 per year
($250,000 if married filing jointly
The taxable portion of any QSB gain and $125,000 if married filing
will be subject to the lesser of your separately) may owe the NIIT on
ordinary-income rate or 28%, rather top of whatever other tax they owe
than the normal long-term gains rate. on their investment income. The
(See Chart 3 on page 8.) Thus, if NIIT equals 3.8% of the lesser of
the 28% rate and the 50% exclusion net investment income or the amount by which MAGI exceeds the applicable
apply, the effective rate on the QSB threshold. Net investment income can include capital gains, dividends, interest,
gain will be 14% (28% × 50%). rental income and other investment-related income (but not business income or
self-rental income from an active trade or business).
Keep in mind that all three of these Dev’s advisor explained that many of the strategies that can help him save or defer
tax benefits are subject to additional income tax on his investments can also help him avoid or defer NIIT liability. And
requirements and limits. Consult your because the threshold for the NIIT is based on MAGI, strategies that reduce his
tax and financial advisors to be sure MAGI — such as making retirement plan contributions (see page 20) — could
an investment in small business stock also help him avoid or reduce NIIT liability.
is right for you.Investing 11
Disposing of the activity. This
generally allows you to deduct all CASE
STUDY 4 Can you deduct investment interest expense?
passive losses — including any loss
on disposition (subject to basis and
Frida borrowed to make some
capital loss limitations). But, again,
investments this year, and she was
the rules are complex.
wondering if the interest would be
deductible. So she consulted her
Even if you do pass the material tax advisor.
participation test, be aware that
your loss deduction might still be He told her that investment
limited under the TCJA’s rules interest expense — interest on
for deducting business losses. See debt used to buy assets held for
Case Study 6 on page 14. investment, such as margin debt
used to buy securities — generally
Income investments is deductible for both regular tax
and alternative minimum tax (AMT)
Qualified dividends are taxed at the purposes. But special rules apply.
favorable long-term capital gains
tax rate rather than at your higher First, Frida’s investment interest
ordinary-income tax rate. expense deduction would be
limited to her net investment income, which, for the purposes of this deduction,
Interest income, however, generally generally includes taxable interest, nonqualified dividends and net short-term
is taxed at ordinary-income rates. So capital gains (but not long-term capital gains), reduced by other investment
stocks that pay qualified dividends expenses. Any disallowed interest expense is carried forward, and Frida can
may be more attractive taxwise than deduct it in a later year against net investment income.
other income investments, such as
If her interest expense exceeds her net investment income, Frida may elect to
CDs and taxable bonds. But there
treat all or a portion of her net long-term capital gains or qualified dividends as
are exceptions.
investment income in order to deduct more of her investment interest expense.
But if she does, that portion of the long-term capital gain or dividend will be
Some dividends, for example, are taxed at ordinary-income rates.
subject to ordinary-income rates.
These include certain dividends from: Frida’s advisor also explained that payments a short seller makes to the stock
lender in lieu of dividends may be deductible as investment interest expense.
y Real estate investment trusts (REITs), But interest on debt used to buy securities that pay tax-exempt income, such
as municipal bonds, isn’t deductible. Finally, he told Frida to keep in mind
y Regulated investment companies that passive interest expense — interest on debt incurred to fund a passive
(RICs), activity — becomes part of her overall passive activity income or loss, subject
y Money market mutual funds, and to limitations.
y Certain foreign investments.
y Interest on state and local govern- But you also need to consider
The tax treatment of bond income ment bonds is excludable on federal factors such as risk and how well
varies. For example: returns. If the bonds were issued in each bond will help achieve your
your home state, interest also may overall investment goals.
y Corporate bond interest is fully tax- be excludable on your state return,
able for federal and state purposes. depending on the state. Warning: Tax-exempt interest
from private-activity municipal
y Bonds (except U.S. savings bonds)
The fact that a bond is exempt from bonds can trigger or increase AMT
with original issue discount (OID)
federal tax doesn’t necessarily make it a liability. However, any income
build up “interest” as they rise
better choice than a comparable taxable from tax-exempt bonds issued in
toward maturity. You’re generally
bond. Municipal bonds, for example, 2009 and 2010 (along with 2009
considered to earn a portion of
typically offer lower yields than compa- and 2010 re-fundings of bonds
that interest annually — even
rable corporate bonds. To make a fair issued after Dec. 31, 2003, and
though the bonds don’t pay this
comparison, you need to calculate the before Jan. 1, 2009) is excluded
interest annually — and you must
tax-equivalent yield — which incor- from the AMT. And AMT is less
pay tax on it.
porates tax savings into the municipal of a risk for most taxpayers now.
y Interest on U.S. government bonds bond’s yield — using this formula: (See page 3.)
is taxable on federal returns but
exempt by federal law on state and Tax-equivalent yield = actual yield /
local returns. (1 – your marginal tax rate).12 Real Estate
Saving taxes on your
home and other real estate
here are many ways you can Higher-income taxpayers owning on up to $100,000 of home equity debt
T maximize the tax benefits
associated with owning a
valuable homes in high-property-tax
locations have seen a huge drop in the
used for any purpose, such as to pay off
credit card debt or to buy a car.)
principal residence, vacation home or federal tax benefit they receive from
rental property. Tax planning is also their property tax payments. Home rental rules
important if you’d like to sell your If you rent out all or a portion of your
home or other real estate this year. Mortgage interest deduction. You principal residence or second home
But don’t forget about the Tax Cuts generally can deduct interest on mort- for less than 15 days, you don’t have to
and Jobs Act (TCJA). It impacts some gage debt incurred to purchase, build report the income. But expenses directly
home-related deductions and some or improve your principal residence associated with the rental, such as adver-
tax breaks for real estate investors and and a second residence. Points paid tising and cleaning, won’t be deductible.
other real property businesses. related to your principal residence also
may be deductible. Through 2025, the If you rent out your principal residence
Home-related deductions TCJA reduces the mortgage debt limit or second home for 15 days or more,
The TCJA included many changes from $1 million to $750,000 for debt you’ll have to report the income. But you
affecting tax breaks for home ownership. incurred after Dec. 15, 2017, with may be entitled to deduct some or all of
Consider these itemized deductions in some limited exceptions. your rental expenses — such as utilities,
your tax planning: repairs, insurance and depreciation.
Home equity debt interest deduction. Exactly what you can deduct depends on
Property tax deduction. Through Through 2025, the TCJA effectively whether the home is classified as a rental
2025, the property tax deduction is limits the home equity interest deduction property for tax purposes (based on the
subject to a $10,000 limit on com- to debt that would qualify for the home amount of personal vs. rental use):
bined deductions for state and local mortgage interest deduction. (Under
taxes. (See page 2 for more details.) pre-TCJA law, interest was deductible Rental property. You can deduct rental
expenses, including losses, subject to
CASE The self-employed can still the real estate activity rules discussed
STUDY 5 claim the home office deduction at right. Property tax attributable to
the rental use of the home isn’t subject
Taylor had heard that the TCJA had eliminated the home office deduction. When to the $10,000 limit on the state and
she met with her tax advisor, however, she was relieved to learn that she was still local tax deduction. You can’t deduct
eligible. Why? any interest that’s attributable to your
personal use of the home. However,
Her advisor explained that, under the TCJA, employees can no longer deduct you can take the personal portion of
home office expenses, because of the suspension of miscellaneous deductions
property tax as an itemized deduction
subject to the 2% of adjusted gross income (AGI) floor. (See page 2.)
(subject to the $10,000 limit).
However, Taylor is self-employed. As long as her home office is her principal
place of business (or used substantially and regularly to conduct business) and Nonrental property. You can deduct
that’s the only use of the space, she likely can deduct from her self-employment rental expenses only to the extent of
income a portion of her mortgage interest, property taxes, insurance, utilities and your rental or other passive income.
certain other expenses, and the depreciation allocable to the space. Or she may Any excess can be carried forward to
be able to use the simplified method for calculating the deduction. offset rental income in future years. You
also can take an itemized deduction for
Using the simplified option, Taylor can deduct $5 per square foot for up to 300 square the personal portion of both mortgage
feet (maximum of $1,500 per year). Although she won’t be able to depreciate the por- interest and property taxes, subject to
tion of her home that’s used as an office — as she could filing Form 8829 — she can the applicable limits. In some instances,
claim mortgage interest, property taxes and casualty losses as itemized deductions to it may be beneficial to reduce personal
the extent otherwise allowable, without needing to apportion them between personal
use of a residence so it will be classified
and business use of her home.
as a rental property.Real Estate 13
Home sales stuck with passive losses, consider 3. Accelerated depreciation. This
When you sell your principal residence, increasing your hours so you’ll meet break allows a shortened recovery
you can exclude up to $250,000 of gain the test. Keep in mind that special period of 15 years — rather than 39
($500,000 for married couples filing rules for spouses may help you meet years — for “qualified improvement
jointly) if you meet certain tests. Gain the material participation test. property.” This is a much broader
that qualifies for exclusion will also be Warning: To help withstand IRS property category than the one the
excluded from the 3.8% NIIT. (See scrutiny, be sure to keep adequate break applied to before the TCJA.
page 10.) To support an accurate tax records of time spent. However, due to a drafting error in
basis, maintain thorough records, the TCJA, 15-year depreciation
including information on your original Depreciation-related breaks won’t be available unless a technical
cost and subsequent improvements, Three valuable depreciation-related correction is issued. (Check with your
reduced by any casualty losses and breaks may be available to real estate tax advisor for the latest information.)
depreciation claimed based on business investors:
use. Warning: Gain that’s allocable to Business interest
a period of “nonqualified” use generally 1. Bonus depreciation. This addi- expense deduction
isn’t excludable. tional first-year depreciation is Under the TCJA, interest paid or
available for qualified assets, which accrued by a business is deductible
Losses on the sale of any personal before the TCJA included qualified up to 30% of “adjusted taxable
residence aren’t deductible. But if part improvement property. But due to a income.” Taxpayers (other than
of your home is rented out or used drafting error in the TCJA, qualified tax shelters) with average annual
exclusively for your business, the loss improvement property will be eligible gross receipts of $25 million or less
attributable to that portion may be for bonus depreciation only if a for the three previous tax years are
deductible. technical correction is issued. (Check exempt from the interest expense
with your tax advisor for the latest deduction limitation.
Because a second home is ineligible information.)
for the gain exclusion, consider con- Some other taxpayers are also exempt,
verting it to rental use before selling. When available, bonus depreciation including real property businesses —
It can be considered a business asset, is increased to 100% (up from 50%) but only if they elect to continue to
and you may be able to defer tax on for qualified property placed in service fully deduct their interest. And if they
any gains through an installment sale through Dec. 31, 2022. For 2023 make the election, they’re required to
or a Section 1031 exchange. Or you through 2026, bonus depreciation is use the alternative depreciation system
may be able to deduct a loss, but only scheduled to be gradually reduced. for real property used in the business.
to the extent attributable to a decline Warning: Under the TCJA, real
in value after the conversion. estate businesses that elect to deduct Tax-deferral strategies
100% of their business interest are It’s possible to divest yourself of appre-
Real estate activity rules ineligible for bonus depreciation. ciated investment real estate but defer
Income and losses from investment the tax liability. Such strategies may
real estate or rental property are 2. Section 179 expensing election. even help you keep your income low
passive by definition — unless you’re This allows you to deduct (rather than enough to avoid triggering the 3.8%
a real estate professional. Why is this depreciate over a number of years) NIIT and the 20% long-term capital
important? Passive activity income qualified improvement property — a gains rate. Consider these deferral
and losses have some negative tax definition expanded by the TCJA from strategies:
consequences. (See “Passive activi- leasehold-improvement, restaurant
ties” on page 10.) and retail-improvement property. Installment sale. An installment sale
The TCJA also allows Sec. 179 allows you to defer gains by spreading
To qualify as a real estate professional, expensing for certain depreciable them over several years as you receive
you must annually perform: tangible personal property used the proceeds. Warning: Ordinary gain
predominantly to furnish lodging and from certain depreciation recapture is
y More than 50% of your personal for the following improvements to recognized in the year of sale, even if
services in real property trades or nonresidential real property: roofs, no cash is received.
businesses in which you materially HVAC equipment, fire protection and
participate, and alarm systems, and security systems. Sec. 1031 exchange. Also known as a
“like-kind” exchange, this technique
y More than 750 hours of service in For qualifying property placed in allows you to exchange one real estate
these businesses during the year. service in 2019, the expensing limit investment property for another and
is $1.02 million. The break begins defer paying tax on any gain until
Each year stands on its own, and there to phase out dollar-for-dollar when you sell the replacement property.
are other nuances to be aware of. If asset acquisitions for the year exceed Discuss the limits and risks with your
you’re concerned you’ll fail either $2.55 million. (These amounts are tax advisor.
test and be subject to the NIIT or adjusted annually for inflation.)You can also read
