The 2018 tax bills are surprising many people, especially retirees. Some paid less than they expected because of the 2017 tax law, but others were disappointed with their savings or paid higher taxes.
Don’t be surprised or disappointed by your 2019 income tax bill. The best way to avoid tax surprises is to begin planning early in the year. Many people wait until the last few months of the year for year-end tax planning. You’ll likely save a bundle by planning for 2019 taxes as soon as your 2018 income tax return is completed. Study that 2018 return and take these steps.
Estimate your 2019 taxes now. Begin with the numbers on the 2018 return and change the items you know will be different. You’ll have a good handle now on how the 2017 tax law affects you. This estimate gives you a benchmark for your planning.
Examine the tax brackets. Study the 2019 tax brackets to see where you fall. If you’re near the breakpoint of a tax bracket, careful planning could save you a substantial amount.
When you’re near the bottom of a tax bracket, a few changes in your income and deductions could drop you into the lower tax bracket, reaping significant savings. When you’re near the top of a tax bracket, however, you need to be careful. A few extra dollars of income or fewer dollars of deductions could push you into the next bracket, substantially increasing the tax rate on that extra income.
You also need to know if you’re near the breakpoints for the Stealth Taxes. Retirees are especially vulnerable to them. Additional income could cause more Social Security benefits to be included in gross income, increase or trigger the Medicare premium surtax, increase the 3.8% tax on net investment income, or cause other hidden tax in-creases. Know where you stand regarding these and other Stealth Taxes.
Plan your income. Some income is out of your control, such as salaries, pensions, Social Security, required minimum distributions (RMDs), and interest and dividends on investments. But you have a say on when other in-come is recognized.
Before selling investments from taxable accounts, see how it will affect your tax bracket. You might benefit from delaying the sale until next year or selling a position in stages over two or more years instead of bunching it in one year. The same goes for distributions from traditional IRAs or 401(k)s that exceed your RMDs. When you need additional cash, is there a source that would be more tax efficient? For example, could you sell an investment that has a loss or modest capital gains?
Make gifts early in the year. We discussed this in the January 2019 issue, but it’s worth the reminder. If you’re going to give investment or income-producing property to family members as part of your estate plan, it’s probably better to give it early in the year. The early gifts remove from your tax return the income the property will generate this year.
Plan charitable contributions. There’s a major change in charitable contribution deductions for many people, especially retirees and near-retirees, under the 2017 tax law. Because the standard deduction was doubled, many taxpayers won’t have total itemized expenses that exceed their standard deductions. They’ll have to take the standard deduction instead of itemizing deductions on Schedule A. The result is they don’t receive any additional tax break for charitable contributions, mortgage interest and other itemized expenses.
One solution is to bunch several years of charitable contributions in one year. You can do this by contributing a lump sum to a donor-advised fund. (See our March 2018 issue for details.) You also can donate appreciated capital gain property from a taxable account instead of cash. You deduct the fair market value of the property and don’t owe taxes on the capital gains that accrued while you owned the property.
Those over age 70½ can make contributions from their traditional IRAs using the qualified charitable distribution (QCD). Details are in our May 2016 issue.
Have assets in the right accounts. When it’s possible, you should own investments that pay ordinary in-come in tax-deferred accounts such as traditional IRAs and 401(k)s. That way the income isn’t included in your gross income until you’re ready to spend it. Appropriate investments include bonds and bond funds, certificates of deposit and real estate investment trusts. Tax-favored investments should be in taxable investment accounts. These include long-term capital gain investments, such as stocks and mutual funds, and stocks that pay qualified dividends.
Don’t change your investment allocation just because of the tax law. If most of your nest egg is in one type of account, you can’t have all the right assets in the right accounts. But when you own these different assets, own as much of them in the right accounts as you can.
Review your mutual funds. Some mutual funds are tax efficient. They consider taxes when managing their portfolios, so they don’t make large taxable distributions to shareholders. But other mutual funds don’t consider taxes and have a history of making large distributions near the end of the year. That’s not a problem when the funds are owned in tax-advantaged accounts, such as IRAs.
But shareholders who own the funds in taxable accounts don’t have much time to plan ways to reduce taxes on the year-end distributions. Taxable distributions reduce the after-tax return on their mutual funds. In your taxable accounts, it’s better to invest in mutual funds that let you control the tax bills. Examine the distribution histories of your funds and any you’re considering for purchasing shares.
Carefully plan major changes. Are you planning to sell your home? If so, how much of the gain will be taxable? Have you carefully calculated your tax basis to minimize the taxable gain? See our January 2019 issue for details. Does it make sense to convert part of a traditional IRA or 401(k) to a Roth ac-count? You should reconsider this each year, because circumstances can change. You also should work with a tax advisor before deciding when to sell or exercise stock options. And consider income taxes for the entire family as part of your estate plan.
Adjust estimated tax payments, withholding. In a recent survey, many retirees said it took them several years to learn to avoid penalties from incorrectly estimated taxes and withholding. When estimated tax payments and withholding aren’t right, retirees pay unnecessary penalties. Plan your estimated taxes and with-holding for 2019 when your 2018 tax return is prepared. See our June 2018 issue for details.