5 Year-End Tax Planning Strategies

November 22, 2019, by Mac Frasier

The end of the year is quickly approaching. As people turn their attention to holiday shopping and celebrations with friends and family, taxes may be the last thing on their minds. However, implementing one or more of these strategies by the end of the year could make a big difference in April.

1. Max out your retirement plan

Review your retirement plans to ensure you have maxed out your contributions for 2019.  For 401(k) and 403(b) plans, the limit is $19,000 plus an additional, allowable ‘catch-up ‘of $6,000 for plan participants aged 50 and over.  This means a person can potentially lower their taxable income by $25,000 while increasing their retirement savings.  Since this strategy was not impacted by the 2017 Tax Cuts and Jobs Act (TCJA), it remains a great tactic for tax payers with a workplace retirement plan.

2. Qualified Charitable Distributions

Once an IRA owner reaches age 70½, they must take a Required Minimum Distributions (RMD) each calendar year, which is a taxable event.  Individuals who aren’t dependent on their RMD to meet their budget needs should consider using a portion or all of their RMD for their charitable giving.  Currently, an eligible tax payer can donate up to $100,000 / year to charity and exclude that amount from their taxable income! Depending on your marginal tax bracket, the savings can be substantial.

3. Gifting highly appreciated stock

Consider making charitable donations using low-cost basis stock instead of cash. The deduction will be limited to 30% of your adjusted growth income, but any excess can generally be carried forward and deducted over as many as five subsequent years. The table below outlines the impact of donating appreciated stock versus giving cash. The tax savings can be significant.

 

Donate appreciated stock

Donate $10,000 cash

Sell stock and donate cash

Charitable Deduction

$10,000

$10,000

$10,000

Ordinary Income Tax savings (Assumes 35% Rate)

$3,500

$3,500

$3,500

Capital gains tax paid (assumes 15% tax rate on $8,000 gain)

$1,200 saved

N/A

$1,200 paid

Net tax savings

$4,700

$3,500

$2,300

4. Tax loss harvesting

If you have realized capital gains throughout the year in your taxable accounts, consider realizing some losses before the end of the year. This is known in the investment industry as ‘Tax Loss Harvesting.’  Long-term losses are first applied against long-term gains, and then against short-term gains. Meanwhile, short-term losses are applied first to short-term gains. This sequence takes place because long-term capital gains are taxed at a lower tax rate than short-term capital gains.

Example:  If you were to sell several stocks with a combined long-term gain of $20,000, the full $20,000 would be subject to 15% or 20% Long Term Capital Gains Tax Rate depending on your income.  However, if you also sold some stocks for a combined long-term capital loss of $13,000 you would be able to reduce your total realized gains to $7,000.    This means your taxable gains for the year would drop from $20,000 to $7,000, which should lead to some good tax savings.

If you choose to implement a tax loss harvesting strategy, you should be aware of the Wash-Sale Rule.  The wash sale rule states that you can’t sell a security for a loss and purchase the same security or “substantially identical” security for a period of 30 days before and after the sale date.  Violation of this rule will result in the taxpayer not being allowed to claim the loss.

5. Bunch Charitable Deductions

One of the more significant changes in the TCJA was to raise the standard deduction amount (2019 – $12,200 for single and $24,400 for married filing jointly). As a result, not as many people itemize their deductions on an annual basis. If you are charitably inclined and want to ensure you can deduct your giving, you may want to consider using a Donor Advised Fund to ‘bunch’ your deductions.  A donor advised fund (DAF) is a charitable investment account that provides simple, flexible, and efficient ways to manage charitable giving. However, the money or assets that go into a donor advised fund becomes an irrevocable transfer to a public charity with the specific intent of funding charitable gifts. The example below illustrates how it works.

Example:  If a married taxpayer makes $15,000 in charitable donations every tax year and has additional itemized deductions of $8,000, they will take that standard deduction of $24,400. However, if they use a Donor Advised Fund and put two years of charitable donations ($30,000) in, they can take an itemized deduction of $38,000 in year one.  For year two they will then take the standard deduction of $24,800 (2020 Standard Deduction for Married Filing Jointly) since they will only $8,000 in itemized deductions.  By bunching the charitable giving into one year you can create $62,800 of total deductions between years one and two versus $49,200 if you only used the standard deduction.  For a tax payer this would increase your total deductions by $13,600 which could lead to significant tax savings.

These 5 strategies are a few of the more common ways people can reduce their tax bill. Although it is necessary for everyone to pay their taxes, there is no reason why you shouldn’t follow the IRS rules in order to minimize them if you can. Please talk to your CPA or other tax advisor to see if they, or any others, will work for you.

Oakworth Capital Bank does not provide tax advice.   All decisions regarding the tax implications of these strategies should be discussed with your tax advisor before being implemented.