While most provisions of the Tax Cuts and Jobs Act (TCJA) have gone into effect last year and either apply through 2025 or are permanent, there are two significant tax changes under the act for 2019. Here’s a quick overview.
1. Deductions on medical expenses
It is no secret that health care costs increase every year, therefore, claiming any tax breaks related to health care is essential. However, there are requirements on how one can claim medical expenses that were already difficult for many taxpayers to meet, and it may be even harder to achieve this year.
For investors, fall is an excellent time to review year-to-date gains and losses. Not only can it help you assess your financial health, but it also can help you determine whether to buy or sell investments before year-end to save taxes. This year, you also need to keep in mind the impact of the Tax Cuts and Jobs Act (TCJA). While the TCJA didn’t change long-term capital gains rates, it did change the tax brackets for long-term capital gains and qualified dividends.
For 2018 through 2025, these brackets are no longer linked to the ordinary-income tax brackets for individuals. So, for example, you could be subject to the high long-term capital gains rate even if you aren’t subject to the top ordinary income tax rate.
Pre- TCJA regulations
For the last several years, individual taxpayers faced three federal income tax rates on long-term capital gains and qualified dividends: 0%, 15%, and 20%. The rate brackets were tied to the ordinary-income rate brackets.
Specifically, if the long-term capital gains and/or dividends fell within the 10% or 15% ordinary-income brackets, no federal income tax was owed. If they fell within the 25%, 28%, 33% or 35% ordinary-income brackets, they were taxed at 15%. And, if they fell within the maximum 39.6% ordinary-income bracket, they were taxed at the maximum 20% rate.
In addition, higher-income individuals with long-term capital gains and dividends were also hit with the 3.8% net investment income tax (NIIT). It kicked in when modified adjusted gross income exceeded $200,000 for singles and heads of households and $250,000 for married couples filing jointly. So, many people actually paid 18.8% (15% + 3.8%) or 23.8% (20% + 3.8%) on their long-term capital gains and qualified dividends.
The TCJA retains the 0%, 15% and 20% rates on long-term capital gains and qualified dividends for individual taxpayers. However, from 2018 through 2025, these rates have their own brackets. Here are the 2018 brackets:
- 0%: $0 – $38,600
- 15%: $38,601 – $425,800
- 20%: $425,801 and up
- Heads of households:
- 0%: $0 – $51,700
- 15%: $51,701 – $452,400
- 20%: $452,401 and up
- Married couples filing jointly:
- 0%: $0 – $77,200
- 15%: $77,201 – $479,000
- 20%: $479,001 and up
For 2018, the top ordinary income rate of 37%, which also applies to short-term capital gains and non-qualified dividends, doesn’t go into effect until income exceeds $500,000 for singles and heads of households or $600,000 for joint filers. (Both the long-term capital gains brackets and the ordinary-income brackets will be indexed for inflation for 2019 through 2025.) The new tax law also retains the 3.8% NIIT and its $200,000 and $250,000 thresholds.
2018 year-end planning
With new tax rate thresholds to understand, year-end tax planning for investments is especially complicated in 2018. If you have questions, please contact us.
The Tax Cuts and Jobs Act (TCJA) loosened the restrictions on the eligibility rules for using the cash method of accounting. This made this method — which is simpler than the accrual method — available to more businesses. Now the IRS has provided procedures a small business taxpayer can use to obtain automatic consent to change its method of accounting under the TCJA. If you have the option to use either accounting method, it pays to consider whether switching methods would be beneficial.
Cash vs. accrual
Generally, cash-basis businesses recognize income when it’s received and deduct expenses when they’re paid. Accrual-basis businesses, on the other hand, recognize income when it’s earned and deduct expenses when they’re incurred, without regard to the timing of cash receipts or payments.
In most cases, a business is permitted to use the cash method of accounting for tax purposes unless it’s:
- Expressly prohibited from using the cash method, or
- Expressly required to use the accrual method.
Cash method advantages
The cash method offers several advantages, including:
Simplicity. It’s easier and cheaper to implement and maintain.
Tax-planning flexibility. It offers greater flexibility to control the timing of income and deductible expenses. For example, it allows you to defer income to next year by delaying invoices or to shift deductions into this year by accelerating the payment of expenses.
An accrual-basis business doesn’t enjoy this flexibility. For example, to defer income, delaying invoices wouldn’t be enough; the business would have to put off shipping products or performing services.
Cash flow benefits. Because income is taxed in the year it’s received, the cash method does a better job of ensuring that a business has the funds it needs to pay its tax bill.
Accrual method advantages
In some cases, the accrual method may offer tax advantages. For example, accrual-basis businesses may be able to use certain tax-planning strategies that aren’t available to cash-basis businesses, such as deducting year-end bonuses that are paid within the first 2½ months of the following year and deferring income on certain advance payments.
The accrual method also does a better job of matching income and expenses, so it provides a more accurate picture of a business’s financial performance. That’s why it’s required under Generally Accepted Accounting Principles (GAAP).
If your business prepares GAAP-compliant financial statements, you can still use the cash method for tax purposes. But weigh the cost of maintaining two sets of books against the potential tax benefits.
Making a change
Keep in mind that cash and accrual are the two primary tax accounting methods, but they’re not the only ones. Some businesses may qualify for a different method, such as a hybrid of the cash and accrual methods.
If your business is eligible for more than one method, we can help you determine whether switching methods would make sense and can execute the change for you if appropriate.
The massive changes the Tax Cuts and Jobs Act (TCJA) made to income taxes have garnered the most attention. However, the new law also made major changes to gift and estate taxes. While the TCJA didn’t repeal these taxes, it did significantly reduce the number of taxpayers who’ll be subject to them, at least for the next several years. Nevertheless, factoring taxes into your estate planning is still important.
The TCJA more than doubles the combined gift and estate tax exemption and the generation-skipping transfer (GST) tax exemption, from $5.49 million for 2017 to $11.18 million for 2018.
This amount will continue to be annually adjusted for inflation through 2025. Absent further congressional action, however, the exemptions will revert to their 2017 levels (adjusted for inflation) for 2026 and beyond.
The rate for all three taxes remains at 40% — only three percentage points higher than the top income tax rate.
Even before the TCJA, the vast majority of taxpayers didn’t have to worry about federal gift and estate taxes. While the TCJA protects even more taxpayers from these taxes, those with estates in the roughly $6 million to $11 million range (twice that for married couples) still need to keep potential post-2025 estate tax liability in mind in their estate planning. Although their estates would escape estate taxes if they were to die while the doubled exemption is in effect, they could face such taxes if they live beyond 2025.
Any taxpayer who could be subject to gift and estate taxes after 2025 may want to consider making gifts now to take advantage of the higher exemptions while they’re available.
Factoring taxes into your estate planning is also still important if you live in a state with an estate tax. Even before the TCJA, many states imposed estate tax at a lower threshold than the federal government did. Now the differences in some states will be even greater.
Finally, income tax planning, which became more important in estate planning back when exemptions rose to $5 million more than 15 years ago, is now an even more important part of estate planning.
For example, holding assets until death may be advantageous if estate taxes aren’t a concern. When you give away an appreciated asset, the recipient takes over your tax basis in the asset, triggering capital gains tax should he or she turn around and sell it. When an appreciated asset is inherited, on the other hand, the recipient’s basis is “stepped up” to the asset’s fair market value on the date of death, erasing the built-in capital gain. So retaining appreciating assets until death can save significant income tax.
Review your estate plan
Whether or not you need to be concerned about federal gift and estate taxes, having an estate plan in place and reviewing it regularly is important. Contact us to discuss the potential tax impact of the TCJA on your estate plan.