2019 Tax Season Update for Individuals and Business Owners

Taxable Income	$0 - $18,650	$18,650 - $75,900	$75,900 - $153,100	$153,100 – $233,350	$233,350 - $416,700	$416,700 - $470,700	$470,700 - Above
2017	10%	15%	25%	28%	33%	35%	39.60%

Taxable Income	$0 - $19,400	$19,400 - $78,950	$78,950 - $168,400	$168,400 – $321,450	$321,450 - $408,200	$408,200 - $612,350	$612,350 - Above
2018	10%	12%	22%	24%	32%	35%	37%

Taxable Income

$0 - $18,650

$18,650 - $75,900

$75,900 - $153,100

$153,100 – $233,350

$233,350 - $416,700

$416,700 - $470,700

$470,700 - Above

2017

10%

15%

25%

28%

33%

35%

39.60%

Taxable Income

$0 - $19,400

$19,400 - $78,950

$78,950 - $168,400

$168,400 – $321,450

$321,450 - $408,200

$408,200 - $612,350

$612,350 - Above

2018

10%

12%

22%

24%

32%

35%

37%

	2017	2018
Child Tax Credit	$0	$6,000
Alternative Minimum Tax	$1,163	$0
Total Federal Taxes	$48,822	$36,819
Effective Tax Rate (gross income)	20%	15%

2017

2018

Child Tax Credit

$6,000

Alternative Minimum Tax

$1,163

Total Federal Taxes

$48,822

$36,819

Effective Tax Rate (gross income)

20%

15%

While the application of the basic changes noted above yields tremendous tax savings to a relatively straightforward situation, the TCJA also significantly changed certain above-the-line deductions and itemized deductions more widely applicable to high income individuals with more complex tax situations.

The following are a comparison of the major changes in itemized deductions from 2017 to 2018.

Itemized Deductions	2017	2018
+ Medical	Subject to 10% AGI floor	Subject to 7.5% AGI floor
+ Charitable contributions	50% AGI limitation for cash donations to public charities	60% AGI limitation for cash donations to public charities
- State & local taxes	Unlimited deduction (AMT add back)	$10K aggregate limit for income and property taxes
- Mortgage interest	$1MM mortgage debt limit	$750K mortgage debt limit (incurred after 12/15/17)
- Home equity interest	$100K limit (AMT add back depending on use)	Included in $750K limit and generally must be used to improve primary residence
- Miscellaneous deductions (i.e., tax fees, investment expenses)	Subject to 2% AGI floor (AMT add back)	Not deductible
+ Itemized Deduction Phaseout	Certain deductions reduced by 3% of amount over AGI threshold	Eliminated

Additionally, the above-the-line deduction for moving expenses has been eliminated (except for active-duty members of the armed forces). The deduction for alimony expenses has also been eliminated for agreements executed after December 31, 2018.

When we analyze the impact of these changes, the results aren’t nearly as favorable as they were for the taxpayer with the basic situation that we analyzed previously.

Case Study 2 – The Indifferent

Consider a taxpayer with the following fact pattern:

Married taxpayers with three children; New York residents
Spouse earning $600,000 per year
Charitable donations of $10,000
Mortgage balance of $1.5MM and interest paid of $74,000
Property Taxes of $30,000
Investment & Tax Fees $35,000
State income tax deduction of $37,000

	2017	2018
Child Tax Credit	$0	$0
Alternative Minimum Tax	$21,736	$0
Total Federal Taxes	$143,874	$140,262
Effective Tax Rate (gross income)	24.0%	23.4%

Finally, when we introduce the following changes to our assumption, the taxpayer starts to become worse off as a result of the TCJA changes. This is primarily because of the substantial tax benefit that they no longer receive for state and local taxes and miscellaneous itemized deductions. In prior tax years the taxpayer received a benefit from these deductions as their high income drove up their effective tax rate and kept them out of the alternative minimum tax despite the add backs.

Case Study 3 – The “Kind of” Ugly

Consider a taxpayer with the following fact pattern, modified from the previous example:

Married taxpayers with three children; New York residents
Spouse earning $2,000,000 per year
Dividends of $60,000 (½ qualified and ½ nonqualified)
Capital gain distributions of $50,000
Charitable donations of $10,000
Mortgage balance of $1.5MM and interest paid of $74,000
Property Taxes of $30,000
Investment and tax fees of $100,000
State income tax deduction of $144,000

	2017	2018
Alternative Minimum Tax	$0	$0
Total Federal Taxes	$681,038	$700,736
Effective Tax Rate (gross income)	32.30%	33.20%

Qualified Business Income Deduction

A significant focus of the TCJA was much needed corporate tax reform. Prior to 2018, the United States had one the highest corporate tax rates in the developed world. The reduction from 35% to 21% puts the U.S. on much more even footing with our counterparts around the world.

The U.S. economy is driven by many small and medium sized businesses in addition to our large corporations. These businesses are often organized as partnerships, LLCs and sole proprietorships, where income is not taxed at a corporate level but instead passed through to the owners. The Qualified Business Income (“QBI”) Deduction was enacted to effectively reduce the tax rate on passthrough income to owners by up to 20%, putting the tax rate on such income more in line with the corporate tax rate. For example, if a business owner had qualified passthrough income that would ordinarily be taxed at the highest marginal tax rate of 37%, the QBI deduction can reduce the rate on that income to closer to 30%. Although this is still higher than the 21% corporate tax rate, the 20% reduction is a significant decrease to the owners’ effective tax rate on the passthrough income. Owners whose income is taxed at lower marginal rates will get closer to that 21% corporate rate.

For 2018, after $147,500 of taxable income for single filers and $315,000 for married, the QBI deduction is subject to a variety of limitations based on the type of business, the wages paid by and the basis of property that is placed into service by the qualified business.

With the elimination of personal exemptions and many itemized deductions, coupled with the expansion of the standard deduction and virtual elimination of the alternative minimum tax, income tax planning has become centered on the following strategies for individuals.

Itemized Deduction Bunching – To the extent itemized deductions can be pushed into or “bunched” in a year where the taxpayer is over the standard deduction threshold, a tax benefit can be realized for the outlay of those expenditures (i.e., medical expenses, charitable donations, income and property taxes). This avoids the tax benefit from those items being partially lost in years where the standard deduction in marginally more beneficial and maximizes the “free” tax benefit from the standard deduction in years in which it is claimed.
AGI Management – Since many itemized deductions have been curtailed as a result of the TCJA, in order to achieve tax savings and perhaps receive a tax benefit from other deductions and credits that are subject to adjusted gross income limitations, taxpayers must become more savvy in managing their taxable income. In order to do so, taxpayers can better plan for the effectiveness of pretax deductions such as retirement plan and HSA contributions, the use of Qualified Charitable Distributions for their donations and the recognition of taxable income, through earnings management or tax efficient investment and withdrawal strategies.

For entrepreneurs and business owners, income tax planning will also focus on the following planning opportunities:

Section 199A Qualified Business Income Deduction – As previously discussed, the TCJA put into place an up to 20% deduction of QBI for business owners taxed as pass-through entities. For taxpayers with QBI under or near the income thresholds of $321,400 (married filing jointly) or $160,700 (single) for 2019, tax planning will be important to limit their exposure of the phase-out thresholds. Planning becomes even more important if they don’t otherwise qualify for the QBI deduction because of the nature of their business or if they would be severely limited in their deduction because of the wages paid and property used factors used in the computation. Owners with qualified businesses over the income threshold will be focused on maximizing their QBI deduction through the management of the wage and property basis factors.
Qualified Small Business Stock Gain Exclusion – For business owners meeting certain stock, asset and business requirements who have a liquidity event on the horizon, management of their existing or converted C-Corporation to achieve a 100% exclusion (subject to certain limitations) of the capital gain recognized on the sale of their business under Section 1202 has become a tremendous tax planning opportunity. The reduction of the C-Corporation tax rate to 21% has breathed new life into this long-standing section of the tax code even despite the continuing tax inefficiency from the double taxation aspect of C-Corporations when dividends are paid out to owners. Business owners otherwise fitting the profile for qualification for the QSBS 100% capital gain exclusion may find the short-term C-Corporation income tax inefficiencies acceptable when evaluating the totality of their tax situation after the full exclusion of the gain.

Summary.

The tax planning landscape for individual taxpayers and those with pass-through business income has been significantly changed by the TCJA. While many deductions have been taken away or eliminated, you can see through our example case studies that many taxpayers will be better off or in close to the same tax situation as before moving forward a result of the lower tax rates, expanded tax brackets and curtailment of the Alternative Minimum Tax. The “ugly” for most taxpayers will just be “kind of ugly”. Additionally, the Section 199A 20% QBI Deduction and new life of the Section 1202 Qualified Small Business Stock 100% gain exclusion may yield tremendous tax savings when properly planned for.

We look forward to guiding our Sanderson Wealth Management clients through these changes and helping them realize savings that will help them achieve their estate and wealth planning goals.

Disclosure

This publication contains general information that is not suitable for everyone. All material presented is compiled from sources believed to be reliable. Accuracy, however, cannot be guaranteed. Further, the information contained herein should not be construed as personalized investment advice. There is no guarantee that the views and opinions expressed in this publication will come to pass. Past performance may not be indicative of future results. All investments contain risk and may lose value. © October 2019 JSG

2019 Tax Season Update for Individuals and Business Owners

Summary.

Disclosure

Let’s talk about your future.

Filter Blog Posts

SUBJECT

AUTHOR

Put our experience to work for your wealth.

Background