Good News, Bad News? Planning Now for 2019 Taxes

February 28, 2019

Amidst completing their 2018 income tax returns, people in high-tax states like New York, New Jersey and California are likely adjusting to the reality of no longer being able to take deductions exceeding $10,000 for state and local taxes. For others, the lesson might be that their employer withheld too little based on the new IRS tables, and unexpected taxes are owed. For the majority of Americans, however, the news is good.

Good news for all is that exemptions from gift and estate tax remain generous. As the April 15th filing deadline nears, here are some thoughts about actions you can take now, and the learning that can help minimize your taxes for next year:

1. Review Withholding and Estimated Taxes

Is your employer withholding enough taxes from your paycheck? Recognizing the difficulties of implementing withholdings under the 2017 Tax Act, the IRS will likely forgive the under-withholding for 2018 if you pay at least 85 percent of the 2018 tax liability. If you need to adjust your withholding, complete and submit a new Form W-4 to your employer.

Similarly, individuals with significant investment earnings or non-wage income can review their strategies for paying estimated taxes. Estimated taxes are paid quarterly and based on income for the previous quarter. Taxes withheld from IRAs and other non-wage sources, however, are treated as being withheld ratably over the full year. The implication is that one can wait until the end of the year and pay withholding from an IRA distribution in lieu of paying quarterly estimated taxes without penalty. The withholding amount from the IRA distribution is credited as if you paid in taxes throughout the year. For some, this is an efficient way to delay tax payments and preserve investment assets for growth over the year.

2. Give and Spend Wisely
While state and local tax deductions have been limited to $10,000, other deductions have survived:

  • Medical expenses may be deducted to the extent they exceed 10% of adjusted gross income.
  • Mortgage interest may be deducted, although limits apply
  • Charitable deductions are permitted in an amount not to exceed 60% of adjusted gross income for cash or gifts to public charities. Other limits may apply depending on the type of charity or asset.

The wrinkle in the 2017 Tax Act is that itemized deductions above are only tax efficient to the extent aggregate deductions exceed the taxpayer’s standard deduction.  The standard deduction, at $12,200 per person, is higher than previous years. Therefore, in order for itemized deductions to be tax efficient, the aggregate must be greater than $12,200 (or $24,400 for a married couple). This threshold may not be difficult to meet for a single person in a high-tax state but may pose a problem for married couples. For example, a married couple living in New Jersey, who pays $50,000 per year for state and local real estate taxes, can only itemize $10,000 of those taxes. In order to benefit from itemized deductions, the couple needs more than $14,000 of charitable or medical deductions and/or mortgage interest. If the aggregate itemized deductions are less than $24,400, the couple will use the standard deduction.

One way to make itemized deductions more tax-efficient is to bunch them into alternate years. This is where “give and spend wisely” comes in. If the taxpayer gives $10,000 annually to charity, paying the charitable gifts this year for both 2019 and 2020 will double the itemized deduction available this year. In 2020, the taxpayer will rely on the standard deduction, and perhaps remind the charity that the 2020 gift was made early. Similarly, unreimbursed medical expenses, like elective surgery, might be accelerated or postponed into a year the taxpayer knows there will be sufficient tax-efficient itemized deductions.

Last, taxpayers over the age of 70½ should be making charitable gifts directly from an IRA. The IRS permits direct distributions up to $100,000 to be made to public charities and does not include the distribution in taxable income.

3. The Exemption from Federal Estate and Gift Tax
Americans can now give up to $11,400,000, during life or at death, free of estate or gift tax. The generous exemption means most Americans will not pay this tax and will focus instead on income tax consequences of lifetime and testamentary gifts.

Assets owned by a decedent at death receive a “step-up” in tax cost basis to fair market value. This permanently eliminates any capital gains taxes on the built-in capital gains for those assets. On a parallel track, families often use trusts to pass wealth to younger generations. While assets added to a trust will partially consume the $11,400,000 exemption, the assets do not receive a cost basis step-up when transferred to the trust. Additionally, most trusts, other than spousal trusts, are not included in a decedent’s estate and the assets in the trust never receive a basis step-up.   

Changes in state laws now recognize some circumstances where a trust can be modified to include the assets in the taxable estate of a beneficiary and achieve a step-up. This can be especially useful and tax-efficient when the gross assets of a decedent beneficiary, including the trust assets, are likely to be less than $11,000,000. Without a periodic basis step-up, trusts continuing over many decades will likely amass significant capital gains liability. Families that fit this profile should consult with an experienced attorney to explore whether this technique is applicable to their family’s situation. 

Finally, families should not forget the receipt of a gift is not taxable to the recipient. Any individual may give up to $15,000 per recipient to an unlimited number of individuals without triggering a gift tax filling. Additionally, the direct payment of tuition or medical bills for someone else is not a taxable or reportable gift at all.

This material is intended to be a review of issues or topics of possible interest to Glenmede Trust Company clients and friends and it is not personalized investment, estate planning, tax or legal advice. Advice is provided in light of a client’s applicable circumstances and may differ substantially from this presentation. This material may contain Glenmede’s opinions, which may change without notice after date of publication. Information gathered from third-party sources is assumed reliable but is not guaranteed. This publication may not be used as legal or tax advice.