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Wealth Planning Insights

2019 Year-End Tax and Wealth Transfer Planning

Employees, retirees and business owners can take steps now to make the most of 2019 tax planning opportunities.

 

As the 2019 calendar year draws to a close, it is time once again to consider what actions to take before year-end to manage taxes and preserve and grow the family balance sheet.

Interest rates are low, tax rates are stable, gift and estate tax exclusion levels are high, and there has been a bit of market volatility this year. Taking these macro-level considerations into account in the context of individual circumstances presents a clear opportunity to plan and to act. We are, however, in a post-2017 Tax Cuts and Jobs Act and pre-2020 election year hiatus, and there is the risk that complacency could set in. That would be unfortunate, as opportunities may be lost. Now is the time to assess alternatives and to choose a course of action. As a reminder, each individual’s tax situation is unique and should be evaluated with the help of trusted legal and tax advisors.

IF YOU ARE IN THE WORKFORCE

While compensation income is taxed at relatively high rates, individuals with earned income have opportunities to save and invest with tax benefits –

  • Make maximum level contributions to qualified retirement accounts.
  • Make make-up contributions to qualified retirement accounts if age 50 or older.
  • Consider converting a traditional IRA to a Roth IRA.
  • Make contributions to health savings accounts.

401(k)s and individual retirement accounts (IRAs) don’t require much of an introduction. But there are important distinctions between 401(k)s and IRAs, such as contribution limitations and deadlines. And there are both traditional and Roth IRAs and 401(k)s. Traditional 401(k) contributions are made pre-tax. For some, traditional IRA contributions are also pre-tax, but high income earners who contribute to retirement plans at work generally cannot deduct traditional IRA contributions.

Roth 401(k) and Roth IRA contributions, on the other hand, are made “after tax.” Both traditional and Roth accounts offer the benefit of no-tax growth in the accounts, but whereas distributions from traditional accounts are taxed as ordinary income, distributions from Roth accounts are tax-free.

Converting a traditional IRA to a Roth IRA may be a strategy to consider, particularly if market values dip a bit. Although a conversion will generate a current tax bill, growth and future distributions will be tax-free. Having tax-free income in retirement may be welcome. And Roth IRA balances remaining at death distributed to beneficiaries will also be tax-free. Modeling outcomes with your advisor is an important first step to making an informed Roth conversion decision.

Unlike 401(k)s and IRAs, health savings accounts (HSAs) tend to get overlooked and are underutilized. An HSA is a tax-advantaged way to save and pay for medical expenses if you have a high-deductible health plan (HDHP). And high deductible doesn’t actually have to be that high – for 2019, the IRS defines a HDHP as any plan with a deductible of at least $1,350 for an individual or $2,700 for a family. The benefits of using an HSA are trifold – contributions are tax deductible, growth in an HSA is not taxed currently, and distributions to pay for qualified medical expenses are tax-free. Like 401(k)s and IRAs, HSAs have contribution limits. If you have self-only health insurance, you can contribute a maximum of $3,500 for the 2019 calendar year. However, if you have family health insurance, you can contribute a maximum of $7,000 for 2019. In addition, if you are 55 years old or older (not 50), these amounts increase by as much as $1,000. But – as soon as you enroll in any part of Medicare you are no longer HSA eligible.

IF YOU ARE A RETIREE

Year-end planning is just as important in retirement as it is prior to retirement. But some of the “to-do” items differ –

  • Confirm that all required minimum distributions have been made from qualified retirement accounts to avoid penalties.
  • Consider whether to make required distributions from a traditional IRA to a qualifying charity.
  • Review tax withholding on traditional retirement account distributions and make desired changes for the new year.
  • Review Medicare and other insurance enrollment and adjust as necessary during the applicable enrollment periods.

The “SECURE Act” for retirement savings has been in the news for much of the year. However, as of the date of this article, it has not been passed by the Senate or signed by the president, and there has been no change in the rules for retirement account contributions, distributions or extended (stretch) payouts for beneficiaries. The upside to this is that there are not new rules or requirements to incorporate into year-end planning for retirement accounts.

For those 70-1/2 and older, checking to see that all required minimum distributions (RMDs) are taken from traditional retirement accounts is a must. Failing to take required distributions may result in a 50% excise tax on the amount not distributed. For those who give to charity, required distributions of up to $100,000 may be made directly from a traditional IRA (but not a 401(k)) to a qualified charity. Donor advised funds and private foundations do not “qualify.” Qualifying charitable distributions (QCDs) are not included in income and are entirely tax-free.

The array of types of retirement accounts with differing tax treatment can result in an unanticipated tax bill at tax time. Now that the year-end is approaching, it may be advantageous to check in with your CPA or trusted advisor to confirm that the withholding amounts on your traditional retirement account distributions are appropriate, particularly if you have just begun taking distributions.

And there is healthcare. Many open enrollment periods for 2020 coverage commence in the fall and continue through early December. For example, Medicare health and drug plans change from year-to-year and certain open enrollment runs from October 15 to December 7. This is a complex area, and understanding your options with regard to the open enrollment periods and associated deadlines will help ensure your healthcare coverage is well accounted for and well maintained as 2019 comes to a close and 2020 begins.

IF YOU ARE A BUSINESS OWNER

Although many thresholds and tax brackets will be adjusted for inflation from 2019 to 2020, tax rates will not change. This matters for all taxpayers, but is of particular significance for those with business income –

  • In a steady tax rate environment, defer business income and accelerate business deductions.
  • Manage taxable income to qualify for the 20% qualified business income deduction – make retirement account, HSA and charitable contributions.

There has been much consternation about the $10,000 cap on state and local tax (SALT) deductions for individual taxpayers. But this deduction applies a bit differently where a taxpayer has business income. For example, a taxpayer with Schedule C (Business), Schedule E (Rental Real Estate, Royalties, etc.) or Schedule F (Farming) income is able to deduct real estate taxes on these schedules (not subject to the SALT limitations on Schedule A). This deduction does not include state income taxes, and with the SALT limits there is seldom reason to pay state income taxes early. Review business income and deductions and manage timing at year-end.

Managing taxable thresholds is instrumental to secure the greatest benefit available from the 20% qualifying business income deduction. The deduction is subject to complete phase-outs for individuals, trusts and estates with service businesses and $210,700 or more of taxable income in 2019. This number is $421,400 for married couples filing a joint return. If your income is close to the $210,700 / $421,400 threshold for 2019 and you have qualified business income, consider if it’s beneficial to make additional contributions to a retirement account, health savings account, charity or donor advised fund as a means to reduce taxable income below the threshold. For instance, if you are single with qualified service business income and your income currently stands at $212,699, a contribution of at least $2,000 to your HSA (assuming you qualify) could be the push you need to get you below the income threshold and therefore qualify for the 199A qualified business income deduction.

IF YOU ARE A PHILANTHROPIST

According to the Giving USA 2019 Annual Report, donations fell last year despite a strong economy, which prompted fundraising experts to predict troubling signs ahead. If history repeats itself, there is a silver lining – the last time Congress enacted a major tax overhaul, in 1986, giving fell the following year but then recovered. Despite decreased giving in 2018, charitable needs remain. To ensure you are part of the “recovery” in 2019, before year-end –

  • Review your year-to-date giving and fill in any gaps in your regular giving.
  • Determine whether to make gifts in cash or with appreciated marketable securities.
  • Determine whether to “bunch” gifts to itemized income tax deductions or to “bunch and smooth” with a donor advised fund.
  • If you are required to take minimum distributions from a traditional IRA, consider the required minimum distribution to a qualified charity alternative.
  • In this season of giving, have a conversation with children and grandchildren about why you give and explore ways they can become involved in giving.

There were no new limits on charitable deductions with the 2017 Tax Cuts and Jobs Act. In fact, the adjusted gross income cap on cash contributions to public charities was increased from 50% to 60%. Cash gifts are easy. But also consider making gifts of appreciated marketable securities held for a year or more (rather than selling and donating the proceeds) to avoid tax on the gain.

The Tax Cuts and Jobs Act did increase the standard deduction, and as a result fewer taxpayers itemize their tax deductions. To obtain the benefit of itemizing, consider “bunching” charitable contributions you would ordinarily make over multiple years in a single year. The bunching strategy provides the benefit of itemizing deductions for the year of the contribution and taking the standard deduction the following year(s) if contributions are reduced by reason of the prior bunching.

If you would like to bunch for tax purposes but prefer that charities receive gifts over multiple years, consider a donor advised fund. The beauty of the donor-advised fund is that the donor receives an income tax deduction for the year of the contribution to the fund and distributions may be made from the fund to charities over multiple years.

Having a discussion with your children and grandchildren about why you give can be as fulfilling as giving itself. Whichever philanthropic strategy you intend on implementing, a conversation centered on giving with the next generation can engage and educate in a way that instills values and adds context. The insight shared in this regard will last well-beyond the planning that comes and goes with each year-end.

IF YOU ARE MAKING WEALTH TRANSFERS

At year-end, review your balance sheet in light of your goals for your lifestyle and consider your wealth transfer alternatives. In the current low interest rate, high gift and estate tax exclusion, and somewhat volatile market environment, as you close out the year –

  • Review your balance sheet and determine what to sell, what to give and what to keep.
  • Use your “use it or lose it” annual gift exclusions.
  • Take advantage of the increase in the lifetime gift exclusion amount.
  • Leverage exclusions using interest rate favored GRATs and similar strategies.

Before year end, review your balance sheet and identify your “tax wise” alternatives. As noted above, charitable gifts of appreciated marketable securities are one alternative. But 2019 was a moderately volatile year, and you may have tax losses to harvest. Work with your advisors to execute tax loss harvesting prior to year-end.

Gift your annual exclusion amount to family – either in cash or in assets. For 2019, you can give up to $15,000 to as many people as you would like without using any of your lifetime gift exclusion. You can give up to $30,000 if you are married and a US person. The $15,000 / $30,000 annual gift exclusion does not carry over from year to year, which makes it a “use it or lose it” strategy.

Also consider use of part or all of the increase in the lifetime gift and estate exclusion amount. Last year, the exclusion was $11.18 million. This year, it’s $11.4 million. If you tapped out your exclusion in 2018, you have an additional $220,000 available for gifting. These amounts are doubled for married couples. Remember, the current increased exclusion amount is scheduled to sunset on December 31, 2025 and revert back to $5 million (adjusted for inflation).

Consider taking advantage of the low interest rate environment by seeking out opportunities for interest rate sensitive planning. One technique that has  a greater advantage in a low interest rate environment is the Grantor Retained Annuity Trust (GRAT). A GRAT offers a valuable opportunity to transfer excess investment return with little to no gift tax. In essence, trust assets in excess of annuity payments to the grantor determined based on the Internal Revenue Code Section 7520 rate (set based on interest rates at the time the trust is established) will pass to your beneficiaries free of estate and gift tax. Another technique that is advantageous in a low interest rate environment involves a sale to an intentionally defective grantor trust (IDGT). The strategy starts with an initial gift to an IDGT followed by a subsequent sale of high growth/ high income property to the trust in exchange for a promissory note with an interest rate that is equal to the applicable federal rate for the term of the note. Similar to the GRAT, the benefit is that the trust assets can grow at a rate exceeding the interest rate of the note, allowing the difference to be eliminated from your estate and ultimately transferred to your chosen beneficiaries’ tax-free.

FINISHING WELL

Mitigating your income tax burden and executing on your wealth transfer tax strategy are considerations that have no “season,” but year-end brings planning into focus. We encourage you to work with your wealth planning and management, legal and tax advisors to create a plan that aligns with your particular circumstances and unique values to help you achieve your goals.


FOR MORE INFORMATION

As a premier financial firm, Northern Trust specializes in Goals Driven Wealth Management backed by innovative technology and a strong fiduciary heritage. Our Wealth Planning Advisory Services team leverages our collective experience to provide financial planning, family education and governance, philanthropic advisory services, business owner services, tax strategy and wealth transfer services to our clients. It is our privilege to put our expertise and resources to work for you.

If you would like to learn more about these and other services offered by Northern Trust, contact a Northern Trust professional at a location near you or visit us at northerntrust.com.

Suzanne L. Shier

Wealth Planning Practice Executive & Chief Tax Strategist/ Tax Counsel
Suzanne L. Shier is the Wealth Planning Practice Executive and Chief Tax Strategist/Tax Counsel for Wealth Management at Northern Trust and serves on the Wealth Management Operating Group.

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