How to Start Your Tax Plan for Next Year

How to Start Your Tax Plan for Next Year

A lot of taxpayers are confused and unsettled due to the uncertainty around whether we are going to have a new tax reform in the U.S. or not. As a result, the majority of individuals and businesses are waiting for the Congress to come up with a decision before they start planning their tax return. However, this can be a big mistake and here is why.

There’s no guarantee that any changes will be introduced, but collating the relevant documents and filing an annual return is quite a lengthy process. It would be much easier and time efficient for you to create your tax-planning strategy now and just make the adjustments later, if any are needed. It isn’t a good idea to wait until you receive your 1099 in order to start getting ready for filing. Also, a top recommendation from all reputable tax advisors and professionals is to file as soon as possible after the end of the tax year. This is to avoid tax-return identity theft, which can potentially put you in big trouble. Ideally, you should have all of your backup data by January so that you won’t waste any time after your 1099 arrives.

Something very useful you could do now is to estimate your current year’s tax liability. You should know that your taxes have to be paid as you earn, whether from self-employment or wages. This is done through withholding or estimated tax payments, which are due on the 15th of April, June, September, and January. It is essential to do this because if you don’t pay enough, you can incur a penalty for underpayment of estimated tax. To prevent such financial loss, you must pay 25% of:

  • 90% of the current year’s tax liability, or
  • 100% of the previous year’s tax liability

If you are married and earn more than $150,000 a year, this becomes 110%. Same applies if you are single and have an annual income higher than $75,000.

This is why early planning is so important. If you believe you may have underpaid your estimated tax in the first two quarters of the year, you can make up for it by increasing the withholdings from your income. Doing so will help you avoid penalties at the end of the tax year.

But that’s not all. Knowing where you are with your taxes has further benefits. For example, you can apply certain strategies to reduce or deter the taxes you would owe by the time you have to file your return.

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Accelerating deductions or postponing income

This strategy is particularly good for individuals and organizations who think that they will move into a lower tax bracket in the new year that they currently are in. How can you apply this strategy:

  • Make your anticipated charitable contributions for next year now
  • Pay your property taxes in advance
  • Prepay your state income taxes

Businesses should:

  • Sell investments that have brought a capital loss.
  • Make large purchases (vehicles, technology, equipment) now that would be needed in the future and use the expenses in the current tax year return.
  • Pay bonuses or extra payments in January, rather than in December.
  • If cash-based put billing customers on hold until January.
  • Maximize the 401(k) contribution plan

When using this strategy you will be able to decrease your taxable income and possibly enter a lower tax bracket. In some cases, you could even fall under certain thresholds and make use of more itemized deductions, some credits and avoid being a subject to the Net investment income tax.

Accelerating income or postponing deductions

Now let’s look at the reverse situation. If you are expecting to make much more in 2018 and jump into a higher tax bracket make note of the following strategies:

  • Aim to take a bonus from your employment before the year ends.
  • Take any planned retirement distributions now. Unfortunately, if you are a subject to the 10% penalty you won’t be able to do that.
  • Sell some investments that have accumulated long-term capital gains and profits.
  • If your state permits, delay your state estimated tax payments until January.
  • Do not make large business purchases, such as equipment and inventory in the current year.

More strategies to consider:

  • If you are above 70 you can make charitable contributions directly to the selected charity from your individual retirement account and ask for an acknowledgment from the charity. This is done to satisfy the minimum required distribution from retirement accounts. The contribution you make will not be included in your income, which potentially can decrease the tax on your Social Security and your payments towards Medicare parts B and D. In some cases you can even save more if your deductions are low enough to not be itemized.
  • Put a certain amount in a donor-advised fund. This will be deducted from your current tax year’s income, but the funds can be distributed in the following years.
  • For parents who pay college fees, there’s another door to get some money back, even if their income is too high to claim education credits. It practically depends on your child getting a good job in the last year of college and being able to provide more than half of their own support in the same year when tuition is paid. They may be eligible for the American Opportunity Tax Credit worth of $2,500, which you can ask to have back. Some colleges expect Spring semester fees to be paid before the end of the calendar year, which is also an opportunity for you to put that as an expense for the current year.
  • Those in a low tax bracket should consider converting a traditional IRA into a Roth IRA. Although you will have to pay the tax on that now, the benefits it brings is that it would grow tax-free in the future, you won’t be taxed on distributions taken in retirement, it can reduce the required minimum distributions and also you can change your mind later and convert back if you wish.
  • If you want to gift money to your child, who is an adult and falling into the 10%-15% bracket, you should gift them appreciated securities. When they decide to sell those, they will have to pay no capital gain tax. The maximum amount you can gift in 2017, that won’t be taxed is $14,000 and if you are married, your spouse can gift the same to that person.
  • Make use of the money you have contributed to a flexible spending account. Otherwise, you might just lose it. Check if your employer offers a grace period for using the money or an option to roll over a certain amount to the next year.
  • If you pay tuition fees or medical costs for another person, transfer the payments directly to the provider. Such payments won’t be counted towards your annual gift-tax exclusion.
  • Probably the most important thing when estimating your income in the current year is to know whether you are a subject to the alternative minimum tax.

The American Institute of CPA’s has both a PFP Executive Committee and a Personal Finance Specialist (PFS) Credential Committee, whose members have shared a generous number of strategies and guidelines to get 2019 off to a great financial start, because the earlier taxpayers give attention to their personal finances, the greater the benefits they will enjoy.

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Crypto-and offshore compliance

For the IRS, cryptocurrency compliance is a priority for 2020. In 2019 the IRS started by mailing letters to taxpayers who might not have reported their virtual currency transactions or did so incorrectly.

The IRS also added a checkbox on Schedule 1 of Form 1040, where they ask taxpayers to confirm any financial interests in virtual currency, a checkbox reminiscent of questions about offshore accounts on Schedule B (which also remains a compliance target for the IRS).

If you neglect to answer these questions or do so incorrectly, you might become liable for severe criminal and civil penalties.

Develop good data security habits

The security of your financial data has to be a priority every day of the year. This is especially critical when you update software and operating systems or change internet providers or purchased a new computer. Tax professionals are required, by law, to create and follow a written information security plan to protect client data. The same goes for taxpayers, who should make it a priority to protect themselves from identity theft and related tax fraud. The creation of strong passwords, avoidance of public wifi connections during the transmission of sensitive financial data, and due care when you discuss financial and tax matters can go a long way towards achieving this goal.

Review estate planning

The trifecta of well-designed estate planning documents, beneficiary designations and other non-probate assets must be reviewed annually irrespective of whether you as a taxpayer have been impacted by increased federal estate tax exemption amounts in terms of the TCJA.

Family and marital trusts might have become redundant, or might now require increased flexibility; Trusts designed to coincide with stretch IRA provisions may need some attention. If you went through any significant life changes, you should confirm that your erstwhile strategies still conform with your overall estate and tax planning goals (e.g., If you converted a second home to a business).

Revisit beneficiary designations

At the beginning of a cycle, for example, when you begin a new career or start with a wealth-creating strategy, you were most likely looking at beneficiary designations for retirement accounts, life insurance, and other non-probate assets. Later on, this changes and we often forget all about them. With recent changes in the law including the SECURE Act under the Further Consolidated Appropriations Act of 2020, you might be impacted in respect of how you and your beneficiaries contribute to and benefit from retirement and other accounts. It makes sense to revisit those beneficiary designations for a change, just to make sure they still hold up.

Withholding check-up

It is always wise to start your thinking about the coming tax year by revisiting your tax withholding. If you were impacted by the TCJA or expect significant life changes (getting married, buying a house), the more so.

An audit of your withholding will help you predetermine that you are not withholding too little or too much in tax. Knowing this from day one, will show you if you have to make changes on the new Form W-4, Employee’s Withholding Certificate. To do your audit – or check up – use the IRS’ Tax Withholding Estimator on the IRS website.

Tax planning and compliance is a marathon and not a race. You have to go at it all year round. If you start early in the year, you will have the heads up on any surprises during the year.

A New Year Means a Fresh Look at Finances

The beginning of a new year presents an opportunity to, “ …begin the year with a fresh plan”, says PFP Executive Committee member Lisa Featherngill, CPA/PFS. This is important because updating your balance sheet creates a clear starting point from which you can then set your financial goals, such as reducing debt, increasing investments, or a similar financial aim, for the year. Lisa goes on to say, “It’s that simple, but you have to know where you are now in order to determine where you want to be.”

Take Stock of Automatic Payment Subscriptions and Renewals

The guidance from another key PFP Executive Committee member, Brooke Salvini, (CPA/PFS), is that automatic payments and subscriptions set up in previous years should be reviewed at the start of every new year. These would include gym memberships, entertainment streaming services or magazine subscriptions. Budgets, lifestyles and financial priorities change, and all these items need to be looked at closely to ensure they don’t place an unnecessary drain on finances. Brooke Salvini says finding and patching those leaks should “be part of your general new year clean-up, which feels so good and refreshing!”

Taxes – Calculate As Early As Possible

According to David Stolz, an esteemed member of the PFS Credential Committee and a CPA/PFS, the Tax Cuts and Jobs Act does not only have an impact on withholding. Taxpayers will also be affected by other important ramifications. It is most likely that the new tax bill has made significant changes to tax opportunities you might consider, and David’s advice is to ensure that you have a keen understanding of what those opportunities are well before April. The types of changes you may need to make in the light of these tax amendments could be anything from adjusting your withholding amount, reconsidering your strategy related to charitable giving, or taking advantage of new depreciation rules and tax brackets. Being familiar with your opportunities as early as possible allows you the most beneficial impact on your finances.

The Best Time for IRA Contributions is NOW

David Desmarais brings to light a unique perspective on Roth and IRA contributions that may benefit taxpayers. In David’s trusted capacity as a CPA/PFS and PFP Executive Committee member, taxpayers should take note of the fact that direct Roth contributions cannot be made by married couples with modified adjusted gross income that exceeds $203,000. There is, however, no income limitations on doing a non-deductible IRA contribution or Roth conversion. Making a non-deductible IRA contribution may be followed immediately by a roll-over to a Roth, otherwise known as a ‘backdoor Roth contribution’.

The immediate roll-over is to ensure that no earnings are gained on the IRA before it rolls over into the Roth, so that no income can be identified on the conversion at assessment. This can only benefit you, however, if you don’t have other traditional IRAs with untaxed earnings, whether from prior deductible IRA contributions or unrealized gains, because an aggregate has to be calculated on all of the IRAs in the process of determining the amount of taxable conversion.

Review your Current Allocation

Michael Landsberg further advises that taxpayers check their portfolios and ensure these are still allocated according to their financial plan. 2018 showed increased market volatility, which may have caused various asset classes to drift out of balance. According to Michael, the beginning of January is the best time to analyse these material shifts from 2018’s market performance. This is where diversification shows its value in managing portfolio risk, and this is what makes rebalancing necessary.

Now is The Time to Make Annual Exclusion Gifts to Heirs

If you are considering making an exclusion gift to an heir, the beginning of the year would be the best time to do so. Early gifting, according to Robert Westley, may enhance the value of the gifts. Gifts to beneficiaries at the beginning of the year benefit those looking to reduce their estate’s tax exposure. Gifts of up to $15,000, given by individuals to an unlimited number of beneficiaries annually, do not impact on the lifetime estate tax exclusion amount or incur a gift tax. The benefit to your beneficiaries in gifting them early in the year is that they receive a few extra months of potential appreciation from the early gift.

Readers should note that this article is only intended to convey general information on these issues and that FAS CPA & Consultants (FAS) in no way intends for the contents of this article to be construed as accounting, business, financial, investment, legal, tax, or other professional advice or services. This article cannot serve as a substitute for such professional services or advice. Any decision or action that may affect the reader’s business should not rely solely on the contents of this article, but should rather be consulted on with a qualified professional adviser. FAS shall not be responsible for any loss sustained by any person who relies on this presentation. This article is subject to change at any time and for any reason.

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Fulton Abraham Sanchez, CPA

Fulton Abraham Sánchez, CPA I am Certified Public Accountant, specialized in Tax Planning & Offshore Strategies for Real Estate, Hedge/Equity Funds, Fintech, Crypto, Expats, IRS Debt Resolution. You can email me and follow us on Facebook : FAS CPA & Consultants.

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