2019 Tax Planning: A Comprehensive Approach
• Volatility in the market leads to tax-loss harvesting opportunities.
• Qualified opportunity zone investments could defer capital gains tax.
• Maximize the tax-efficiency of charitable gifts.
Now is a good time to consider a comprehensive tax planning strategy that goes beyond income. Starting well in advance of year-end provides the time required to optimize tax-saving opportunities encompassing income, charitable gifts, trusts and estates. Your Glenmede Relationship Manager can assist with evaluating and implementing a holistic approach that may provide significant tax benefits.
Income Tax Opportunities
Volatility and Tax-loss Harvesting
Year-end volatility and resulting paper losses can be helpful in lessening the tax burden of gains taken earlier in the year or paid out by mutual funds. You may opt to sell some loss positions to minimize your tax bill. To keep your portfolio properly balanced, your advisor can discuss the option to purchase a similar security or exchange-traded fund (ETF) to replace the sold security or, alternatively, wait more than 30 days to re-purchase the identical security. These measures are necessary to avoid “wash sale” treatment, a tax rule disallowing a capital loss if you purchase the same or “substantially identical” security within 30 days before or after the sale. Care is warranted. Wash sales can occur not only in a single investment account, but across multiple accounts having the same ownership, even if those accounts are with multiple managers or are separate IRA accounts
Qualified Opportunity Zone Funds (QOF)
These funds invest in low-income communities identified as “opportunity zones.” An investor may defer taxation of a capital gain if the gain proceeds are reinvested in a QOF. Tax on the gain is deferred until 2026 or the year in which the investor’s position in the QOF is sold, if sooner. Ten percent of the gain may be excluded (via step-up in tax basis) if you hold the QOF for at least five years, and an additional five percent step-up in tax basis is available after seven years. Post-acquisition capital gain on the sale of your position in a QOF in is not taxable if you hold the QOF for at least 10 years. Currently, there are few publicly available QOF investment opportunities and those that exist have very short performance track records. Still, they may deserve further evaluation in the right circumstances.
Annual Exclusion Gifts
Every taxpayer may give up to $15,000 per year to an unlimited number of individuals free of gift tax, a provision that will not change in 2020. Giving property to heirs in a lower income tax bracket during the donor’s lifetime is one way to realize income tax savings. To maximize value received by your heirs, give cash or high-basis assets, so the recipient is not burdened with income tax consequences. Low-basis, highly-appreciated assets are used more tax-efficiently for charitable gifts. Of note, a gift of a check to an individual is considered completed only when the check is deposited. If your child or grandchild does not deposit a $15,000 holiday check until January 2, the gift will be attributed to 2020, not 2019.
Consider Trust Distributions
Some irrevocable family trusts give the trustees unfettered discretion to pay income to beneficiaries each year, or to accumulate the income instead. Consider whether (a) it makes sense within the context of the family to make distributions to certain beneficiaries and, if it does, (b) whether the distributions can be made tax-efficiently. Tax efficiency arises if the beneficiaries’ marginal tax rates are lower than the trust’s, or the distribution will avoid imposition of the 3.8 percent Net Investment Income Tax (NIIT). Trusts pay the highest marginal income tax rate (37 percent) and NIIT on retained income in excess of $12,750.
Beware of the “Kiddie Tax”
This still exists, although the forms and filings are not as burdensome as in past years. It taxes a child’s unearned income (investment income and capital gains) at trust and estate rates. The kiddie tax applies to all children under age 18 and most between the ages of 18 and 23 who are full-time students.
Optimize Break Points in Long-term Capital Gain
There are a few transitions in our lives when we may take advantage of the 0 percent capital gains rate if income is below a certain level. You will pay a 0 percent capital gains rate if your aggregate income (including the capital gains) is less than $39,375, or $78,750 if married filing jointly. Income is more likely to meet the threshold when a young person enters the work force or an older person is retiring. Taxable retirement account and trust distributions are part of the income calculation, but careful planning can lead to excellent results.
Example: A young person entering the work force, who is the beneficiary of a minor’s trust or Uniform Transfers to Minors Act (UTMA) account, might take a complete distribution from the trust, sell the highly appreciated securities and pay no capital gains tax—provided total income is less than $39,375. Similarly, a retiring person age 70 or younger, who owns highly appreciated securities, might plan his retirement date to avoid income in the following year and defer Social Security and taxable distributions from retirement accounts until a later year. He may be able to sell his highly appreciated securities and avoid some capital gains tax. If he has no other taxable income and is married, he will pay 0 percent on the first $78,750 of capital gain and 15 percent on the next $410,100. This technique requires careful planning with your accountant and a full understanding of your income sources.
Beware: The IRS Hunt for Crypto-currency and Foreign Income
The IRS sent notices to some crypto-currency investors this summer warning them to report and pay tax on their crypto-currency transactions. For years these transactions occurred under a cloak of non-disclosure, but the IRS now has access to many transaction records, making it easier to identify owners. Remember: Using crypto-currency to pay for something is a sale of that currency that may trigger a capital gain. Similarly, the IRS is ferreting out undisclosed foreign assets and income, and applying severe penalties to individual owners who have not disclosed it.
Tax-efficient Charitable Gifts
Make a Charitable Gift from an IRA After
reaching age 70½, you may make a Qualified Charitable Distribution (QCD) of up to $100,000 per year from your IRA to a public charity. The amount of the QCD is excluded from your taxable income and is not deductible. The gift is most tax-effective when the charitable gift is part of your Required Minimum Distribution (RMD). If you have already satisfied the RMD and want to make additional gifts, discuss with your accountant whether it is tax-effective to use your IRA. Make a note for next year to link your RMD to any anticipated future charitable gifts.
Bunching Charitable Gifts
The new, higher standard deductions ($12,200 for single filers, $24,400 for married couples) significantly benefit many taxpayers. On the flip side, the higher standard deductions also mean a taxpayer will not itemize if total itemized deductions are less than the standard deduction. For example, a married couple with a $10,000 state tax deduction and $14,000 of charitable contributions will choose the greater $24,400 standard deduction in 2019, rather than itemizing. They will get no separate tax benefit from charitable contributions. If this pattern persists year after year, the taxpayers will not realize any tax benefit for charitable contributions.
However, if charitable gifts are combined over two- or three-year periods, a portion will become tax efficient. If the same couple makes all of their anticipated 2019 and 2020 gifts outright to their charities or to a Donor-Advised Fund in 2019, their aggregate 2019 deductions will equal $38,000 (2019 real estate taxes plus $28,000 in charitable gifts), making $13,600 of the charitable deductions tax efficient. By using a Donor-Advised Fund, the couple may identify specific charitable beneficiaries in 2019 and 2020, even though they will revert to using the $24,400 standard deduction in 2020. For more on this topic, see Bunching Charitable Gifts and information about Glenmede’s Donor-Advised Fund.
Defer Capital Gains Tax with a Charitable Remainder Trust
Investors who are charitably inclined can defer capital gains by creating a Charitable Remainder Trust(CRT). By contributing the gain property to the CRT before it is sold, the investor will be taxed with the realized capital gain only as it is paid out to her over time. The actuarial interest payable to the charity at the termination of the trust must be equal to at least 10 percent of the value of the trust at inception. A charitable deduction for that 10 percent may be available to the settlor in the year the trust is created. A 65-year-old investor can expect a 19 percent distribution from the trust based on the value of the trust at the beginning of each new year, paid to her for the remainder of her life or until the trust is earlier exhausted. There are many variations of this trust that can be implemented to meet a variety of goals and payouts.
Estate and Tax Gift Opportunities
Annual Exclusion Gifts
In addition to providing income tax advantages, annual exclusion gifts accumulate over time to reduce a taxable estate. The individual estate and gift tax exemption is $11.4 million this year and $11.58 million in 2020, but under current law will revert to $5 million (adjusted for inflation) in 2026. Any assets removed from your estate through non-taxable gifts avoid the potential 40 percent tax at your death.
Complete Large Gifts
Until recently, there has been uncertainty about what will happen when the estate tax exemption reverts to $5 million in 2026. Would current gifts made in excess of the $5 million be clawed back and taxed in estates after 2025? In late 2018, the IRS published guidance providing reassurance this will not be the case. For example, if an $11 million gift trust were created today and the grantor died in 2026, we now have confidence the $6 million difference would not be subject to estate tax even if the estate tax exemption at the time of death were less than $11 million.
While we have summarized useful strategies, tax planning should not occur in isolation. Your Relationship Manager can help you consider taxes in the context of your overall portfolio—and goals for charitable contributions and estate planning.
This article is intended to be an unconstrained review of matters of possible interest to The Glenmede Trust Company’s clients and friends and is not intended as personalized investment advice. Advice is provided in light of a client’s applicable circumstances and may differ substantially from this presentation. Opinions or projections herein are based on information available at the time of publication and may change thereafter. Information gathered from other sources is assumed to be reliable, but accuracy is not guaranteed. Outcomes (including performance) may differ materially from expectations herein due to various risks and uncertainties. Any reference to risk management or risk control does not imply that risk can be eliminated. All investments have risk. Clients are encouraged to discuss the applicability of any matter discussed herein with their tax advisor and Glenmede representative. Nothing herein is intended as legal advice or tax advice, and any references to taxes which may be contained in this communication are not intended to and cannot be used for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promotion, marketing or recommending to another party any transaction or matter addressed herein. You should consult your attorney regarding legal matters, as the law varies depending on facts and circumstances.