2019 Individual Year End Tax Planning Options
As the end of the year is fast approaching, we should consider any last-minute strategies that might help reduce your 2019 tax bill. Last year was the first year to be impacted by the Tax Cuts and Jobs Act of 2017 (TCJA). While there was no significant new legislation in 2019 affecting individual taxes, situations do change from year to year, thus requiring a fresh look at how to approach year-end tax planning.
Why plan? Well, it’s the IRS and the state tax authorities again.
· The IRS audits taxpayers in person less but sends out more notices than ever.
· The correspondence audits are more common, and they may be harder to win in the absence of solid documentation
· The interest on underpayments alone, before their penalties, our fees, and anything due to your resident state, is set at 6%.
· The penalties themselves are harder to abate, and repeat underpayments may cost more over time in our fees.
· The California Franchise Tax Board is tougher on penalties every year.
· If you have any major changes impacting your taxes, such as business or real estate dispositions, vesting stock options, we encourage you to see us as soon as possible to assess if we can help avoid tax liability via any and all legally acceptable means currently available to us.
The following are strategies that may benefit you and that we should discuss before December 31.
Rental Real Estate
Rental Real Estate and the QBI Deduction
If a client operates a rental real estate enterprise, whether individually or through a flow-through entity, the QBI deduction may apply to that client if certain criteria are met. For example, the rental activity must qualify as a Code Sec. 162 trade or business. While there are no strict guidelines as to what constitutes such a trade or business, the IRS has issued some safe harbor rules under which a taxpayer's business will qualify for the QBI deduction, assuming the required election is made and other applicable rules are met. For one, a client's rental activity must be considerable, regular, and continuous in scope. In determining whether a rental real estate activity meets this criteria, relevant factors include, but are not limited to, the following:
(1) the type of rented property (commercial real property versus residential property);
(2) the number of properties rented;
(3) the taxpayer's or taxpayer's agent's day-to-day involvement;
(4) the types and significance of any ancillary services provided under the lease; and
(5) the terms of the lease (for example, a net lease versus a traditional lease and a short-term lease versus a long-term lease).
An interest in mixed-use property may be treated as a single rental real estate enterprise or may be bifurcated into separate residential and commercial interests. Mixed-use property is defined as a single building that combines residential and commercial units. An interest in mixed-use property, if treated as a single rental real estate enterprise, may not be treated as part of the same enterprise as other residential, commercial, or mixed-use property.
Under the safe harbor rules, the following conditions must be met for a rental real estate enterprise to qualify for the QBI deduction:
(1) separate books and records are maintained to reflect the income and expenses for each rental real estate enterprise;
(2) for rental real estate enterprises that have been in existence less than four years, 250 or more hours of rental services are performed per year with respect to the rental real estate enterprise (with slightly less stringent requirements for rental real estate enterprises that have been in existence for at least four years);
(3) contemporaneous records have been maintained, including time reports, logs, or similar documents, regarding the following: (i) hours of all services performed; (ii) description of all services performed; (iii) dates on which such services were performed; and (iv) who performed the services; and
(4) certain compliance requirements are met.
Thus, to qualify for this deduction, it's important to determine if the safe harbor conditions are met and, if not, whether such conditions can be met by year end. Alternatively, even if the safe harbor requirements are not met, certain actions may be taken to ensure that a real estate enterprise falls within the "trade or business" guidelines for taking the QBI deduction.
Compliance Tip: At the end of October, the IRS issued Rev. Proc. 2019-38 which summarizes the rules necessary for meeting the rental real estate safe harbor and qualifying for the deduction under Code Sec. 199A. A rental real estate enterprise making the safe harbor election must file an election statement with its return. See ¶330,235.
Finally, whether a rental real estate enterprise is considered a passive activity with respect to a taxpayer is important in determining whether losses from the activity are deductible. Generally, passive activity losses are only deductible against passive activity income. However, a deduction of up to $25,000 ($12,500 if married filing separately) may be allowed against nonpassive income to the extent an individual actively participates in the rental real estate activities. However, the deduction is subject to a phaseout for individuals with modified adjusted gross income above $100,000 (or $50,000 if married filing separate).
Qualified Improvement Property Glitch Remains Unfixed
While practitioners had hoped that Congress would enact technical corrections legislation this year to fix certain glitches in the Tax Cuts and Jobs Act of 2017 (TCJA), that did not happen. Due to a drafting error, the 15-year recovery periods that were available for qualified leasehold improvements, qualified restaurant property, and qualified retail improvement property placed in service before 2018, no longer exist for such property placed in service after 2017. Instead, the depreciation period is 39 years. As a result, until legislation is enacted fixing this mistake, such property does not meet the bonus depreciation criteria specified in Code Sec. 168(k)(2)(A) (i.e., the recovery period is not 20 years or less) and it is thus not eligible for bonus depreciation.
Section 199A Qualified Business Income Deduction
The Code Sec. 199A qualified business income (QBI) deduction is another potentially big deduction for clients with a qualified trade or business. The deduction is available to sole proprietors, partners in a partnership, members of an LLC taxed as a partnership, S corporation shareholders, or trusts and estates. Whether a client is eligible for the deduction depends on whether the client has a qualified trade or business and the client's taxable income.
Qualified trades or businesses include trades or businesses for which the taxpayer is allowed a deduction for ordinary and necessary business expenses under Code Sec. 162. In general, to be engaged in a trade or business under Code Sec. 162, the taxpayer must conduct the activity with continuity and regularity and the primary purpose for engaging in the activity must be for income or profit. If a taxpayer owns an interest in a pass-through entity, the trade or business determination is made at that entity's level. Material participation under Code Sec. 469 isn't required for the QBI deduction. Qualified trades or businesses do not include activities conducted by C corporations and the performance of services as an employee.
Additionally, specified service trades or businesses (SSTB) aren't qualified trades or businesses if the taxpayer has taxable income above a certain threshold (before the QBI deduction). An SSTB is defined as any trade or business involving the performance of services in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, including investing and investment management, trading, or dealing in securities, partnership interests, or commodities, and any trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees. Engineering and architecture services are specifically excluded from the definition of a specified service trade or business. The thresholds above which an SSTB will not fully qualify for the QBI deduction are $160,725 if married filing separately; $321,400 if married filing jointly; $160,700 for all others. Above those thresholds a partial deduction may be available before the deduction is fully phased out.
The first step in determining the QBI deduction is to determine the QBI component, which is generally 20 percent of the taxpayer's QBI from the taxpayer's trades or businesses. Where the taxpayer's taxable income (before the QBI deduction) exceeds the applicable thresholds, a reduction to the QBI deduction is phased in until the deduction is entirely eliminated. In this case, the QBI for each of trade or business may be partially or fully reduced to the greater of 50 percent of W-2 wages paid by the qualified trade or business, or 25 percent of W-2 wages plus 2.5 percent of the unadjusted basis immediately after acquisition (UBIA) of qualified property from the qualified trade or business. The partial or full reduction to QBI is determined by the taxpayer's taxable income. If taxable income (before the QBI deduction) is: (1) at or below the threshold, there is no need to reduce QBI; (2) above the threshold but below the phase-in range (more than $160,725 but below $210,725 if married filing separately; $321,400 and $421,400 if married filing jointly; $160,700 and $210,700 for all others), the reduction is phased in; or (3) above the threshold and phase-in range, the full reduction applies.
If the taxpayer is a patron of an agricultural or horticultural cooperative, the taxpayer must reduce cooperative QBI by the lesser of: 9 percent of the QBI allocable to qualified payments, or 50 percent of W-2 wages from the trade or business allocable to the qualified payments.
If the net amount of QBI from all qualified trades or businesses during the tax year is a loss, it is carried forward as a loss from a qualified trade or business to the next tax year (and reduces the QBI for that year).
Self-employed Retirement Planning
The retirement benefits can be significantly expanded with a SEP IRA, a solo 401(K), or defined benefit plan, if applicable.
Section 179 Expensing and Bonus Depreciation Deductions
Generally, the two biggest deductions that can reduce a client's taxable income are the Code Sec. 179 expense deduction and the 100 percent bonus depreciation deduction. And, as a result of TCJA, bonus depreciation can now be taken on used property as well as new property. It's important to remember that bonus depreciation rules apply unless a taxpayer specifically elects out of those rules. A business may want to elect out of bonus depreciation if the business expects a tax loss for the year and the bonus depreciation would just increase that loss. By not taking bonus depreciation in the current year, a business can defer depreciation deductions into future years where it expects to have taxable income that can be offset by the depreciation deductions. Of course, where the business is operated through a flow-through entity, additional considerations must be given to the tax situation of the owner of the flow-through entity and whether the owner can benefit from the flow-through of the bonus depreciation deductions.
Since the Code Sec. 179 expense deduction can't reduce taxable income, this is a better option for clients with taxable income. This year, the maximum Code Sec. 179 expense deduction is $1,020,000. This amount is reduced dollar for dollar (but not below zero) by the amount by which the cost of the Section 179 property placed in service during the year exceeds $2,550,000.
If a client is looking for business-related property to purchase in order to reap the maximum benefit of the Code Sec. 179 expense deduction and/or the bonus depreciation deduction, a vehicle purchase could result in a substantial tax savings. By purchasing a sport utility vehicle weighing more than 6,000 pounds, a client can obtain a bigger deduction than if a smaller vehicle is purchased. Because vehicles that weigh 6,000 pounds or less are considered listed property, deductions are limited to $18,100 for cars, trucks and vans acquired and placed in service in 2019. However, if the vehicle weighs more than 6,000 pounds, up to $25,500 of the cost of the vehicle can be immediately expensed.
In October, the IRS issued final and proposed bonus depreciation regulations which clarify the implementation of the bonus depreciations rules. Under the proposed regulations, upon which taxpayers may rely immediately, a de minimis rule provides that a taxpayer is not deemed to have had a prior depreciable interest in a property - and thus that property is eligible for bonus depreciation in the taxpayer's hands - if the taxpayer previously disposed of that property within 90 days of the date on which that property was placed in service. In addition, the proposed rules provide for an election that taxpayers may make to treat certain components of self-constructed property as eligible for bonus depreciation.
Vehicle-Related Deductions and Substantiation Requirements
In an audit involving a business, the IRS is quick to focus on vehicle expense deductions and whether such deductions are adequately substantiated. Thus, practitioners should ensure that the following are part of any client's business tax records with respect to each vehicle used in a business:
(1) the amount of each separate expense with respect to the vehicle (e.g., the cost of purchase or lease, the cost of repairs and maintenance, etc.);
(2) the amount of mileage for each business or investment use and the total miles for the tax period;
(3) the date of the expenditure; and
(4) the business purpose for the expenditure.
For purposes of the above, the following are considered adequate for substantiating such expenses:
(1) records such as a notebook, diary, log, statement of expense, or trip sheets; and
(2) documentary evidence such as receipts, canceled checks, bills, or similar evidence.
It's important to impress upon clients that records are only considered adequate to substantiate vehicle expenses if they are prepared contemporaneously at the time the expense is incurred.
Fringe Benefit/Retirement Programs
There are substantial tax and other benefits available to a business that offers fringe benefits and retirement plans to employees. For example, an employer has a better chance of attracting and retaining talented workers by offering such benefits, which in turn reduces the costs of searching for and training new employees. Employers can deduct contributions made on behalf of their employees to qualified retirement plans and, under Code Sec. 45E, a tax credit of up to $500 is available for setting up a qualified plan.
In addition, business owners can take advantage of the retirement plan themselves, as can their spouse. Where a spouse is not currently on the payroll of a business, consideration should be given to adding him or her as an employee and paying a salary up to the maximum amount that can be deferred into a retirement plan. So, for example, if a business owner's spouse is 50 years old or over and receives a salary of $25,000, all of it could go into a 401(k), leaving the spouse with a retirement account but no taxable income.
To help employees with medical expenses, a business may want to consider setting up a high deductible health plan paired with a health savings account (HSA). The benefits to a business include savings on health insurance premiums that would otherwise be paid to traditional health insurance companies and having employee wage contributions to the plan not being counted as wages and thus neither the employer nor the employee is subject to FICA taxes on the payroll contributions. As for employees, they can reap a tax deduction for funds contributed to the HSA, they can invest the funds for future medical costs because there is no use-it-or-lose-it limit like there is for flexible spending accounts and thus the funds can grow tax free and be used in retirement.
A business might also consider establishing a flexible spending arrangement (FSA) which allows employees to be reimbursed for medical expenses and is usually funded through voluntary salary reduction agreements with the employer. The employer has the option of making or not making contributions to the FSA. Some of the benefits of an FSA include the fact that contributions made by the business can be excluded from the employee's gross income, there are no employment or federal income taxes deducted from the contributions, reimbursements to the employee are tax free if used for qualified medical expenses, and an FSA can be used to pay qualified medical expenses even if the employer or employee haven't yet placed the funds in the account.
Home Office Expenses
When the TCJA eliminated the miscellaneous itemized expense deduction, it eliminated the ability of employees to deduct home office expenses. However, taxpayers with their own business can still file a Schedule C and take a home office expense deduction if part of the home is used for that business. State income taxes, property taxes, and home mortgage interest allocable to your business can also be deducted and such deductions are not subject to the limitations that apply to individual taxpayers who do not operate a Schedule C business from their home.
General Tax Planning
By investing in a qualified retirement plan you'll not only receive a current tax deduction, thereby reducing current year income tax, but you can sock away money for your retirement years. If your employer has a 401(k) plan and you are under age 50, you can defer up to $19,000 of income into that plan. Catch-up contributions of $6,000 are allowed if you are 50 or over.
If you have a SIMPLE 401(k), the maximum pre-tax contribution for 2019 is $13,000. That amount increases to $16,000 if you are 50 or older.
If certain requirements are met, contributions to an individual retirement account (IRA) may be deductible. If you are under 50, the maximum contribution amount for 2019 is $6,000. If you are 50 or older but less than 70 1/2, the maximum contribution amount is $7,000. Contributions exceeding the maximum amount are subject to a 6 percent excise tax. Even if you are not eligible to deduct contributions, contributing after-tax money to an IRA may be advantageous because it will allow you to later convert that traditional IRA to a Roth IRA. Qualified withdrawals from a Roth IRA, including earnings, are free of tax, while earnings on a traditional IRA are taxable when withdrawn.
If you already have a traditional IRA, we should evaluate whether it is appropriate to convert it to a Roth IRA this year. You'll have to pay tax on the amount converted as ordinary income, but subsequent earnings will be free of tax and the decrease in tax rates that are effective this year makes such a conversion less costly than it would have been in previous years. Of course, this option only makes sense if the tax rates when the money is withdrawn from the Roth IRA are anticipated to be higher than the tax rates when the traditional IRA is converted. And if you have a traditional 401(k), 403(b), or 457 plan that includes after-tax contributions, you can generally rollover these after-tax amounts to a Roth IRA with no tax consequences. A rollover of a SIMPLE 401(k) into a Roth IRA may also be available. As with all tax rules, there are qualifications that apply to these rollovers that we should discuss before any actions are taken.
Finally, if you make qualified retirement savings contributions during 2019 you can claim a retirement savings credit of up to $1,000 (single or head of household) or $2,000 (joint filers) if your adjusted gross income does not exceed $64,000 (married filing jointly), $48,000 (head of household), or $32,000 (all other taxpayers).
Bunching Deductions into 2019
As you may know, TCJA significantly increased the standard deduction for all taxpayers. This means that many individuals who previously received a tax benefit by itemizing deductions no longer do, because taking the standard deduction is more advantageous. For 2019, the standard deduction is $12,200 for single taxpayers, $24,400 for married taxpayers filing a joint return, $18,350 for taxpayers filing as head of household, and $12,200 for married taxpayers filing separately.
In addition, there is a $10,000 limitation ($5,000 in the case of married taxpayers filing separately) on the combined amount of state income taxes and property taxes that may be deducted when itemizing. Unfortunately, this $10,000 limitation applies to single as well as married taxpayers and is not indexed for inflation.
If the total of your itemized deductions in 2019 will be close to your standard deduction amount, alternating between bunching itemized deductions into 2019 and taking the standard deduction in 2020 (or vice versa) could provide a net-tax benefit over the two-year period. For example, if you give a certain amount to charities each year, and if it's financially feasible, you might consider doubling up this year on your contributions rather than spreading the contributions over a two-year period. If these amounts, along with your mortgage interest and medical expenses exceed your standard deduction, then you should double up on the expenses this year and take the standard deduction next year.
Similar opportunities may be available for bunching property tax payments and state income tax payments, subject to TCJA's $10,000 limitation on deductions for such payments. This strategy can be especially attractive for single taxpayers because the standard deduction is so much lower for single individuals. It's important to remember, however, that the deduction for property taxes applies only to property taxes that have been assessed. Thus, if the assessment for 2019 property taxes occurred in 2018 and the taxes are due in 2019, you can deduct in 2019 the taxes assessed for 2019 that you have paid as well as the property taxes assessed for 2020, assuming you also pay the 2020 taxes in 2019.
Finally, if any of your real estate or income taxes can be allocated to a trade or business, they are not subject to the $10,000 limitation.
Mortgage Interest Deduction
If you sold your principal residence during the year and acquired a new principal residence, the deduction for any interest on your acquisition indebtedness (i.e., mortgage) could be limited. The TCJA limits the interest deduction on mortgages of more than $750,000 obtained after December 14, 2017. The deduction is limited to the portion of the interest allocable to $750,000 ($375,000 in the case of married taxpayers filing separately). For mortgages acquired before December 15, 2017, the limitation is the same as it was under prior law: $1,000,000 ($500,000 in the case of married taxpayers filing separately). However, as discussed below, if you operate a business from your home, an allocable portion of your mortgage interest is not subject to these limitations.
You can potentially deduct interest paid on home equity indebtedness, but only if you used the debt to buy, build, or substantially improve your home. Thus, for example, interest on a home equity loan used to build an addition to your existing home is typically deductible, while interest on the same loan used to pay personal living expenses, such as credit card debts, is not.
Charitable Contribution Deductions
As a result of the increase in the standard deduction, some taxpayers are no longer getting a benefit from itemizing their deductions, such as charitable contributions, as they once were. However, as noted above, you can still help charities and get a tax benefit if you contribute enough to get over the standard deduction amount or bunch itemized deductions that would otherwise be spread over multiple years into one year.
Additionally, you can reap a larger tax benefit by donating appreciated assets, such as stock, to a charity. Generally, the higher the appreciated value of an asset, the bigger the potential value of the tax benefit. Donating appreciated assets not only entitles you to a charitable contribution deduction but you also avoid the capital gains tax that would otherwise be due if you sold the stock. For example, if you own stock with a fair market value of $1,000 that was purchased for $250 and your capital gains tax rate is 15 percent, the capital gains tax would be $113 ($750 gain x 15%). If you donate that stock instead of selling it, and are in the 24 percent tax bracket, you get an ordinary income deduction worth $240 ($1,000 FMV x 24%). You also save $150 in capital gains tax that you would otherwise pay if you sold the stock. Thus, the after-tax cost of the gift of appreciated stock is $647 ($1,000 - $240 - $113) compared to the after tax cost of a donation of $1,000 cash which would be $760 ($1,000 - $240). However, it's important to also keep in mind that tax deductions for appreciated property are limited to 50 percent of your adjusted gross income.
Finally, taxpayers 70 1/2 years old and older who own an individual retirement account (IRA) are required to take minimum distributions from that account each year and include those amounts in taxable income. If you are in this category, a special rule allows you to make a charitable contribution directly from your IRA to a charity. This has several benefits. First, since charitable contributions deductions are usually only available to individuals who itemize, individuals who take the standard deduction instead can benefit from this rule. Second, making the contribution directly to a charity counts towards your required minimum distribution but that amount is not included in income and thus reduces your taxable income and adjusted gross income (AGI). A lower AGI is advantageous because it increases your ability to take medical expense deductions that you might not otherwise be able to take. For example, medical expenses are only deductible to the extent those expenses exceed 10 percent of your AGI and a lower AGI means you can deduct more medical expenses. In addition, as AGI increases, more of your social security income is subject to tax. Finally, the 3.8 percent net investment income tax applies to the extent your AGI exceeds a certain level.
Reevaluating Your Stock Portfolio
Year end is a good time to review your stock portfolio to see if you might want to divest yourself of stocks that have lost value since you originally bought them. We should evaluate whether you might benefit from selling off appreciated stocks, particularly those that would generate a short-term capital gain, and using the resulting gain to limit your exposure to a long-term capital loss on stocks you may want to dump, since the deduction of long-term capital gains is limited. And any net capital gain you may reap will be taxed at the substantially reduced capital gain tax rate.
The tax rate for net capital gain is generally no higher than 15 percent for most taxpayers. Some or all of your net capital gain may be taxed at 0 percent if your income is not above $39,375 (single), $78,750 (joint), or $52,750 (head of household). However, a 20 percent tax rate on net capital gain does apply to the extent that your ordinary taxable income is over $434,550 (single), $488,850 (joint), $244,425 (married filing separately), or $461,700 (head of household). Additionally, the following types of capital gains have different tax rate structures: (1) the taxable part of a gain from selling certain qualified small business stock is taxed at a maximum 28 percent rate; (2) the net capital gain from selling collectibles (such as coins or art) is taxed at a maximum 28 percent rate; and (3) the portion of certain unrecaptured gain from selling real property is taxed at a maximum 25 percent rate. If you have been involved in any such transactions during the year, we should review your options for reducing the tax on those transactions.
Substantial Increases in Deductions or Nontaxable Income Could Result in AMT Exposure
While fewer taxpayers are subject to the alternative minimum tax (AMT) as a result of the TCJA increasing exemption amounts and raising the exemption phaseout levels, the AMT is not completely dead. Certain adjustments to your taxable income, or certain exclusions from gross income, for regular tax purposes are not allowed for AMT purposes and will increase your AMT income (AMTI), thus potentially subjecting you to the AMT. Typical items which may reduce regular income but are not allowed for AMTI purposes include the standard deduction, the state and local income tax deduction, and the deduction for property taxes. In addition, the exercise of incentive stock options can result in AMT income, whereas such income is not recognized for regular tax purposes. Thus, if you have exercised any incentive stock options or have had a substantial increase in certain deductions in 2019, but have not previously been subject to the AMT, there is the possibility that you could be subject to the AMT for 2019.
If you work from home, one strategy for avoiding the AMT is to allocate part of your mortgage interest or property taxes to your Schedule C business. To the extent you can claim items on your Schedule C, they aren't added back in calculating AMTI.
While all taxpayers are eligible for an exemption from the AMT, the amount of the exemption depends on your filing status. For 2019, the exemption amounts for individuals, other than those subject to the kiddie tax, are (1) $111,700 in the case of a joint return or a surviving spouse; (2) $71,700 in the case of an individual who is unmarried and not a surviving spouse; and (3) $55,850 in the case of a married individual filing a separate return. However, these exemptions are phased out by an amount equal to 25 percent of the amount by which your alternative minimum taxable income (AMTI) exceeds: (1) $1,020,600 in the case of married individuals filing a joint return and surviving spouses and (2) $510,300 in the case of all other individuals.
Planning for the 3.8 Percent Net Investment Income Tax
A 3.8 percent tax applies to certain net investment income of individuals with income above a threshold amount. The threshold amounts are $250,000 (married filing jointly and qualifying widow(er) with dependent child), $200,000 (single and head of household), and $125,000 (married filing separately). In general, investment income includes, but is not limited to: interest, dividends, capital gains, rental and royalty income, non-qualified annuities, and income from businesses involved in trading of financial instruments or commodities. Thus, while the top tax rate for qualified dividend income is generally 20 percent, the top rate on such income increases to 23.8 percent for a taxpayer subject to the net investment income tax (NIIT).
If it appears you may be subject to the NIIT, the following actions may help avoid the tax and we should discuss whether any of these options make sense in light of your financial situation.
Donate or gift appreciated property. As discussed above, by donating appreciated property to a charity, you can avoid recognizing the appreciation for income tax purposes and for net investment income tax purposes. Or you may gift the property so that the donee can sell it and report the income. In this case, you'll want to gift the property to individuals that have income below the $200,000 (single) or $250,000 (couples) thresholds.
Replace stocks with state and local bonds. Interest on tax-exempt state and local bonds are exempt from the NIIT. In addition, because such interest income is not included in adjusted gross income, it can help keep you below the threshold for which the NIIT applies.
If you are in the real estate business, we should review the criteria for being classified as a real estate professional in addition to the criteria necessary for meeting the safe harbor requirements mentioned above for obtaining the qualified business income deduction. If you meet the requirements for being a real estate professional, your rental income is considered nonpassive and thus escapes the NIIT.
If you intend to sell any appreciated assets, consider whether the sale can be structured as an installment sale so the gain recognition is spread over several years.
Since capital losses can offset capital gains for NIIT purposes, consider whether it makes sense to sell any losing stocks, but keeping in mind the transaction costs associated with selling stocks.
If you have appreciated real property to dispose of and are not considered a real estate professional, a like-kind exchange may be more advantageous. By deferring the gain recognition, you can avoid recognizing income subject to the NIIT.
Because the NIIT does not apply to a trade or business unless (1) the trade or business is a passive activity with respect to the taxpayer, or (2) the trade or business consists of trading financial instruments or commodities, we may want to look at ways in which a venture you are involved with could qualify as a trade or business. However, such classification could have Form 1099 reporting implications whereas personal payments are not reportable if your activity is not considered a trade or business.
Additional Medicare Tax
An additional Medicare tax of 0.9 percent is imposed on wages, compensation, and self-employment income in excess of a threshold amount. The threshold amounts are $250,000 (joint return or surviving spouse), $125,000 (married individual filing a separate return), and $200,000 (all others). However, the threshold amount is reduced (but not below zero) by the amount of the taxpayer's wages. Thus, a single individual who has $145,000 in self-employment income and $130,000 of wages is subject to the .9 percent additional tax on $75,000 of self-employment income ($145,000 - $70,000 (the $200,000 threshold - $130,000 in wages)). No tax deduction is allowed for the additional Medicare tax.
For married couples, employers do not take a spouse's self-employment income or wages into account when calculating Medicare tax withholding for an employee. If you and your spouse will exceed the $250,000 threshold in 2019 and have not made enough tax payments to cover the additional .9 percent tax, you can file Form W-4 with the IRS before year end to have an additional amount deducted from your paycheck to cover the additional .9 percent tax. Otherwise, underpayment of tax penalties may apply.
Medical Expenses and Health Savings Accounts
For 2019, your medical expenses are only deductible as an itemized deduction to the extent they exceed 10 percent of your adjusted gross income. Depending on what your taxable income is expected to be in 2019 and 2020, and whether itemizing deductions would be advantageous for you in either year, you may want to accelerate any optional medical expenses into 2019 or defer them until 2020. The right approach depends on your income for each year, expected medical expenses, as well as your other itemized deductions.
However, health saving accounts (HSAs) present an attractive alternative. If you are eligible to set up such an account, you can deduct the amount you contribute to the account in computing adjusted gross income. Thus, the contributions are deductible whether you itemize deductions or not. Distributions from an HSA are tax free to the extent they are used to pay for qualified medical expenses (i.e., medical, dental, and vision expenses). For 2019, the annual contribution limits are $3,500 for an individual with self-only coverage and $7,000 for an individual with family coverage.
Revised Kiddie Tax Rules
One of the changes made by TCJA involves what is known as the "kiddie tax." The kiddie tax applies to a child's net unearned income (e.g., dividends, interest, and capital gain distributions) over $2,200. While such income used to be taxed at the parent's marginal income tax rate and took into consideration the unearned income of any siblings, TCJA simplified the calculation so that the child's unearned income is taxed at trust and estate tax rates. Although the trust and estate tax rates are similar to the individual tax rates, the tax brackets are much lower, meaning higher rates of tax apply to lower levels of income.
For 2019, the top marginal tax rate for a couple filing a joint return is 37% for taxable income over $612,350. For income subject to the estate and trust tax rates, the 37% tax rate begins at taxable income over $12,750. There is a way to save some taxes here, however, if your child is under the age of 18 at the end of 2019 and didn't have earned income that was more than half of the child's support, or a full-time student at least age 19 and under age 24 and the end of 2019 and didn't have earned income that was more than half of the child's support. For such children, you can elect to include the child's income on your tax return. However, we would need to evaluate whether adding such income to your tax return would subject you to the net investment income tax of 3.8 percent.
Child-Related Expenses and Credits
While the TCJA eliminated the personal and dependent exemption deductions that applied to tax years before 2018, it increased the child tax credit available for years after 2017 and increased the income level at which taxpayers are eligible for the credit. For 2019, if you file a joint return and your modified adjusted gross income (MAGI) is $400,000 or less, you are eligible for a $2,000 child tax credit for each qualifying child. If you are filing as single, head of household, or married filing separately, the MAGI limitation for claiming a child tax credit is $200,000 or less. For income above those levels, a pro rata credit may be available depending on total MAGI. Taxpayers with income below certain thresholds may be eligible for a refundable child tax credit.
Additionally, if you paid someone to take care of your child or a dependent so you can work or look for work, you may be entitled to a tax credit for up to 35 percent of the expenses paid. The amount of employment-related expenses used to calculate the credit is generally limited to $3,000 for one qualifying individual or $6,000 for two or more qualifying individuals. Various qualifications must be met in order to be eligible for the credit, but if you incurred such expenses, you may qualify. Additionally, if you paid someone to come to your home and care for a child or dependent, you may be a household employer subject to e