Article Highlights:

• Covers information for 2018 and 2019 taxes, including a discussion about the potentially new and shortened Form 1040.
  
• Inflation adjustments range between 1.5% and 2.0% for many line items, though the changes differ for some.
  
• IRA contribution limits have been raised for the first time since 2013, though recharacterizations of Roth IRA conversions are now disallowed..
  

This will be the first time taxpayers will file returns reflecting the changes put into law by the Tax Cuts and Jobs Act (TCJA).

The new law’s impact is far-reaching, going well beyond the headline cuts to both individual and corporate tax rates. Individual taxpayers, for instance, now have altered tax brackets, a significantly higher standard deduction and fewer deductions and exemptions.

Because of the big changes, the Internal Revenue Service (IRS) has been encouraging working taxpayers to ensure that the correct amount is being withheld from their paychecks. One way to do this is to use the agency’s withholding calculator (www.irs.gov/individuals/irs-withholding-calculator). Even though it may be too late in the year to have much of an impact on your 2018 taxes, seeing the data will help you plan accordingly and make adjustments to withholdings that will impact your 2019 taxes. It may make sense to review your withholdings a second time after filing your 2018 taxes if your refund or amount owed is larger than expected.

Individuals will also likely use a new Form 1040. A draft released by the IRS over the summer revealed a single page form, apparently designed to be folded in half and thereby fulfilling the promise by some politicians for a postcard-sized tax return. The draft contained just 23 numbered line items to fill out, versus the 79 numbered line items on the 2017 Form 1040.

A change to a single form cannot alter the underlying complexity of the tax code, and the new 1040 is no exception. Potentially accompanying the new 1040 are six new forms. These supporting forms cover additional income and adjustments to income, the alternative minimum tax, nonrefundable credits, other taxes including for self-employment, other payments and refundable payments and foreign addresses and third-party designees.

Whether you will have to file those forms depends on your income and deductions. It also depends on how you file. Last year, 87% of all individual tax returns were filed electronically. Thus, those of you who will use a software program, a website or an app to complete and file your taxes may never notice either the new 1040 or its supporting forms.

One thing that has not changed is the deadline; it remains April 15 for most taxpayers. Unlike the past few years, there are no holidays or weekend days to give most of you extra time. You will have to file your taxes (or an extension) no later than April 15, 2019. (Residents of Massachusetts and Maine will get one extra day due to Patriots’ Day.)

Early statistics from CapGainsValet put 2018 on pace to have more large mutual fund distributions than 2017. As of November 12, 316 mutual funds announced estimated distributions over 10%, and 17 estimated distributions in excess 30% of their net asset value. In comparison, at this point last year, 257 announced estimated distributions in excess of 10%, including seven with distributions in excess of 30%. These distributions are taxable for shares held in a taxable account—even if you don’t sell your shares of the mutual fund issuing the distribution or choose to have the distributions reinvested.

Those of you who were affected by hurricanes or wildfires may be eligible for some form of tax relief. The IRS has a dedicated page on its website with links to specific pages for each disaster: www.irs.gov/newsroom/tax-relief-in-disaster-situations.

No matter how the tax laws (and tax forms) evolve in the future, one thing is constant: You will still have to pay taxes. Even with the TCJA, the tax code is complex; hence the need for tax guides. As has been the case in years past, our tax guide provides an overview of the tax rates and deductions likely to impact the majority of AAII members. Since there are many details, loopholes and pitfalls within the tax code, it is impossible for this guide to provide enough details to cover specific tax situations. If you have questions, consult a tax professional. It is your tax return, and the IRS will hold you responsible for any errors made on it.

Table 1. An Overview of Tax Changes in the Coming Years

Estimate Your Taxes on AAII.com

You can estimate your 2018 and 2019 tax liabilities our Tax Forecasting Worksheet. This downloadable Excel spreadsheet will calculate the results based on the date you enter and can be saved for your records. 

What’s New?

The TCJA altered the marginal tax brackets. The tax rates in effect from 2018 through 2025 are 10%, 12%, 22%, 24%, 32%, 35% and 37%.

As discussed, Form 1040 is being completely revised. A draft released by the IRS shows the form being significantly shortened, but potentially requiring six supporting schedules.

The limit on individual retirement account (IRA) contributions has been raised for the first time since 2013. In 2019, up to $6,000 can be contributed to a traditional and/or Roth IRA. This is a $500 increase over the 2018 limit. The additional catch-up contribution limit remains at $1,000.

Recharacterizations of Roth IRA conversions are now disallowed. The ban started on January 1, 2018. The deadline for recharacterizing a conversion made in 2017 has also passed. Now, when a traditional IRA is converted to a Roth IRA, the transaction is final.

Depending on the state you live in, more of your online purchases may be taxed. A U.S. Supreme Court ruling in South Dakota v. Wayfair allows states to collect taxes on sales made to their residents by a company without a physical presence or employees within the said state.

The deduction for state and local taxes (SALT) is capped at $10,000 for 2018. This limit applies to state and local income, property and sales taxes. It is not indexed for inflation and will remain at this level through 2025, barring a legislative change.

Social Security tax is 6.2% for employees and 12.4% for those working in self-employed positions on the first $128,400 of wages. In 2019, the cap on maximum taxable earnings will rise to $132,900, an increase of 3.5%. (In 2018, the cap was raised 1.2%; it was raised by 7.3% in 2017.) Retirees younger than full retirement age who have claimed Social Security benefits can earn up to $17,040 without benefits being withheld. This limit will rise to $17,640 in 2019.

The alternative minimum tax (AMT) exemption is $109,400 for married couples filing jointly and $70,300 for single filers in 2018. In 2019, the exemption will rise to $111,700 and $71,700, respectively. The phaseout levels for 2018 are $1 million and $500,000, respectively. They will increase to $1,020,600 and $510,300, respectively, in 2019. The TCJA’s higher levels are in effect through 2025 and are indexed to inflation.

The TCJA eliminated the personal exemption for the period of 2018 through 2025.

Married couples filing jointly can claim a standard deduction of $24,000, and single filers can claim a standard deduction of $12,000 on their 2018 tax returns. In 2019, the standard deduction will rise to $24,400 and $12,200 for married and single filers, respectively. The standard deduction was raised considerably by the TCJA with the adjustment for the so-called “marriage penalty” maintained. The higher level simplifies reporting for some taxpayers by making it more difficult to claim individual deductions. Depending on family size, it may or may not make up for the loss of the personal exemption.

The $2,000 maximum child tax credit is phased out for married couples filing jointly with modified adjusted gross income (MAGI) above $400,000 ($200,000 for all other filers). Both the credit and the phaseout amounts are in effect for the years 2018 through 2025 and are not indexed to inflation. The credit is refundable up to $1,400 in 2018. The refundable portion is indexed to inflation, but will remain at $1,400 in 2019. The refundable portion only applies when the full $2,000 credit cannot be fully used to offset the taxpayer’s tax liability. Qualifying children must have a Social Security number for the $2,000 credit to be claimed. See IRS Publication 972 for more information.

Alimony and separate maintenance payments remain deductible by the paying spouse and included in the income of the spouse receiving the payments in 2018. Starting on January 1, 2019, the paying spouse can no longer deduct such payments, while the payee spouse can no longer report the payments as income. This change applies to divorces and legal separations executed after December 31, 2018, and to previously executed agreements modified after December 31, 2018, that expressly state that the tax law change applies to the modification.
Revised 11/27/2018.

Whether you see a change in your long-term capital gains and dividend tax rates now depends on your taxable income instead of your tax bracket. Under the TCJA, married couples filing joint returns with taxable income below $77,200 ($38,600 if single) will not owe taxes on capital gains or qualified dividends. Couples with incomes of $77,200 to $479,000 ($38,600 to $425,800 for singles) will pay a 15% tax rate. Filers with income above those levels will pay a 20% tax on long-term capital gains and dividends. Those levels will rise in 2019: 0% tax up to $78,750/$39,375 for married and single filers, respectively; 15% up to $488,850/$434,550 for married and single filers; and 20% for those with taxable income above those levels.

To be eligible for the long-term capital gains rate, you must have owned the eligible asset for at least 12 months. The discounted qualified dividend tax rate applies to stock dividends and requires a holding period of at least 61 consecutive days during a 120-day period beginning 60 days before the ex-dividend date. (There is no capital gains tax or dividend taxes for securities held within a retirement account, such as an IRA. See Robert Carlson’s article, “Do’s and Don’ts of IRA Investing,” in the March 2010 AAII Journal for investments that can cause an unexpected tax problem.)

Collectibles, which include gold coins and bars, are taxed at a maximum 28% rate. Funds investing in precious metals, including exchange-traded funds (ETFs), may also be subject to the collectibles tax rate. Check with the fund company if you have questions about the tax status.

Short-term capital gains are taxed as ordinary income.

Married couples filing joint returns with net investment income and modified adjusted gross incomes above $250,000 and single filers with net investment income and modified adjusted gross incomes above $200,000 also must pay the additional 3.8% net investment income (NII) surtax on capital gains and dividends. Collectibles are also eligible for the 3.8% surcharge as well. The $250,000/$200,000 thresholds are not indexed to inflation and will remain the same in 2019.

Medical Insurance Mandate

The individual shared responsibility provision of the Affordable Care Act included a mandate requiring adults and children to have minimum essential health coverage. Both Medicare Part A and Medicare Part C (Medicare Advantage) qualify as minimum essential health coverage. Taxpayers who did not have qualifying coverage and did not qualify for an exemption in 2018 will be assessed a penalty of either the greater of 2.5% of household income above the gross income threshold for filing a tax return or $695 per adult ($347.50 per child) limited to a family maximum of $2,085. This levy is on top of the additional Medicare tax and the NII tax. Visit www.irs.gov/aca and www.HealthCare.gov for more information. The latter website also has a calculator for determining whether or not a person or family qualifies for Medicaid or subsidies for purchasing insurance. The shared responsibility mandate effectively expires on December 31, 2018; beginning in 2019, you will no longer be required to have health insurance.

Though the mandate has been repealed, the NII and the additional Medicare tax remain in effect. The 0.9% additional Medicare tax applies to wages, compensation and self-employment income above $250,000 for married persons filing jointly and $200,000 for single persons for both 2018 and 2019. More information about these taxes can be found in the box above.

Medical Expenses

The floor for deducting medical expenses is 7.5% of adjusted gross income for 2018. The previous 10% floor will be reinstated starting on January 1, 2019.

Medical insurance premiums for the self-employed are deductible and can be used to reduce adjusted gross income on Form 1040.

Workers participating in flexible savings accounts (FSA) can carry over up to $500 of unused amounts into the next plan year if their plan sponsor allows them to. Plan sponsors have the choice of either offering employees the ability to carry over up to $500 or allowing employees a grace period of up to two and a half months. Dependent care is also eligible for the grace period option, but not the carryover option.

Contributions to a health savings account (HSA) are allowed for those covered by a high-deductible health care plan (HDHP) and not enrolled in Medicare. The minimum annual deductible for self-only coverage is $1,350; it is $2,700 for family coverage. These amounts will remain unchanged in 2019.

The maximum limits for annual deductible and other out-of-pocket expenses in 2018 are $6,650 and $13,300, respectively. They will rise to $6,750 and $13,500, respectively, in 2019.

HSA contributions cannot exceed $3,450 for individual coverage and $6,900 for family HDHP coverage. In 2019, the maximum contributions will be $3,500 and $7,000 for individual and family coverage, respectively. See “Health Savings Accounts” in the July 2016 AAII Journal for more information about these accounts.

Inflation Adjustments for 2019

As previously stated, many deductions, exemptions and limits that are indexed to inflation under current tax law either will or are projected to increase between 1.5% and 2.0%. For example, the phaseout for deducting a traditional IRA contribution will increase 2.0% for married couples filing a joint return.

Some items will increase more on a percentage basis because of how adjustments are incremented. The maximum contribution limits for a traditional and Roth IRA will rise by $500 in 2019, to $6,000. This will be a 9.1% increase over the 2018 limit of $5,500.

Pay attention to the details, because the inflation adjustments are not being made uniformly. This can be particularly apparent when adjustments are made in round numbers. Plus, not all items are indexed to inflation.

Capital Gains Reporting

Brokers are required to report the cost basis for stocks purchased after January 1, 2011; mutual fund, ETF and dividend reinvestment program (DRP) shares purchased after January 1, 2012; and options and traditional bonds bought and sold by their clients on or after January 1, 2014. If you bought a stock, fund, option or bond before the aforementioned dates, your broker is not required to report the cost basis.

As previously mentioned, certain debt instruments, particularly those that are more complex than traditional bonds, purchased after January 1, 2016, fall under the cost basis reporting rules. These include variable-rate bonds (including inflation-adjusted bonds), stripped bonds and convertible bonds. Excluded from this rule are debt instruments where the principal is subject to acceleration (e.g., mortgage-backed securities) and debt instruments with a fixed-maturity date not more than one year from their date of issue.

If you sold a capital asset in 2018, you will need to fill out Form 8949. See the special write-up in the “Cost Basis” box for details on the reporting rules.

Tax Software, Books and Guides

If you use a software program (e.g., TurboTax), a book (e.g., “J.K. Lasser’s Your Income Tax 2019”) or a related aid, check for updates before filing. Doing so will help to ensure that you are using the most up-to-date forms and information.

Specific Tax Guidelines

Part of the complexity of the tax code is determining how taxes will be affected by certain situations. This section gives information on scenarios that potentially may be experienced by many individual investors.

Medicare Part B

The rule of thumb for how taxable income determines Medicare Part B premiums is that your modified adjusted gross income from two years prior will determine your premiums for the current tax year (e.g., 2019 premiums will be determined by 2017 income). See the box below for information about 2019 premiums.

Marriage, Widowhood and Divorce

Under the tax code, a couple is considered married for the whole year if, on the last day of the tax year, both people are married and living together, living together in a recognized common law marriage, married and living apart without being legally separated under a decree of divorce or separate maintenance or separated under an interlocutory (not final) decree of divorce.

Widow(er)s are considered married for the whole year in which their spouse died and can file a joint return with their deceased spouse. (If there is a dependent child, other filing statuses may be preferable.) For widow(er)s who remarry before the end of the same tax year, a joint return can be filed with the new spouse. The deceased spouse’s filing status would be married filing separately in this case.

A person’s filing status may be single if they were widowed before the start of the calendar year and did not remarry before the end of the calendar year.

A person who becomes divorced under a final decree by the last day of the year is considered to be unmarried for the whole year.

Same-sex couples are treated as being married for federal tax purposes if they were married in a U.S. or a foreign jurisdiction whose laws authorize the marriage of individuals of the same gender. As such, same-sex spouses must file using either married filing separately or married filing jointly status (certain exceptions apply). Same-sex couples may be able to file amended tax returns using married filing separately or married filing jointly status for prior-year returns up to the statute of limitations (which is generally three years).

Those in common-law marriages are treated as being married for federal tax purposes if they are living together in a common law marriage recognized in the state where they now live or in the state where the common law marriage began.

Couples in domestic partnerships, civil unions or other similar formal relationships recognized but not denominated as marriage under state law are not considered to be married for federal tax purposes.

Money Market Funds With Floating NAVs

The U.S. Securities and Exchange Commission (SEC) requires some money market funds, particularly institutional prime money market funds and tax-free institutional money market funds, to use floating net asset values (NAVs). This means that their NAVs are not pegged to $1 per share, but rather can move above or below that benchmark.

The IRS responded to the SEC’s ruling by saying “No gain or loss is determined for any particular redemption of a taxpayer’s shares in a floating-NAV money market fund. Without a determination of loss, a particular redemption does not implicate the wash-sale rules.” The wash-sale rules disallow a loss being claimed for tax purposes when an investment is sold and a substantially identical investment is purchased within 30 days of the sale.

IRA Rollovers

IRA rollovers are restricted to one per person per year. The limitation does not apply to trustee-to-trustee transfers, meaning you can move funds from broker to broker as many times as you would like. The key is that the funds are transferred directly from one broker to another without the assets being distributed to you. A check payable to you instead of the receiving custodian would trigger the 12-month rule.

Rollovers to or from a qualified plan [e.g., a 401(k) plan] are excluded from the rule. Roth IRA conversions are not subject to the one-year limitation and the IRS will disregard them in terms of applying the one-rollover-per-year limitation to other rollovers. Moving funds between Roth IRAs would, however, trigger the one-year waiting period if a check is made payable to you. (Roth IRA recharacterizations, which undid Roth IRA conversions, were banned by the TCJA effective at the start of 2018.)

There is a 60-day deadline for completing a rollover. Waivers to the deadline will be allowed if certain conditions are met, including, but not limited to, an error by the financial institution making or receiving the contribution, a misplaced distribution check, severe damage to the taxpayer’s principal residence and serious illness. Written certification to a plan administrator or IRA trustee must be submitted by the taxpayer within 30 days after being able to make the contribution to take advantage of the waiver. See IRS Rev. Proc. 2016-47 for more information.

Pretax and aftertax contributions from defined-contribution plans, [e.g., 401(k), 403(b) and 457(b) plans] can be assigned to different accounts as long as directions are given to the plan administrator in advance of the distribution. See IRS Notice 2014-54 for more information and examples of various scenarios.

The IRS’ Rollover Chart shows the types of retirement savings accounts funds can be rolled over from and into a different type of retirement savings account. The chart was recreated in the July 2016 AAII Journal (“IRA Rollover Chart: Rules Regarding Rollovers and Conversions”).

Be Vigilant About Tax Scams

The IRS continues to warn about tax scams. An ongoing common scam is a phone call requesting immediate payment, commonly via prepaid debit cards and/or a money wire. The fraudster will often threaten a lawsuit, to call the police or involve federal authorities. Hang up if you receive such a call even if your caller ID suggests the phone number is from emergency services or a law enforcement agency; the IRS never initiates contact via a phone call or an email. If the IRS wants to contact you about a tax matter, you will receive a physical letter sent through the U.S. postal service.

Always restrict access to your Social Security number, monitor your credit reports regularly, consider freezing your credit report and use anti-virus and firewall software on your computer. Filing your tax return as early as is reasonably possible can also help. Those in their retirement years should be especially on guard, as the fraudsters are targeting your demographic group. See the box on page 28 for more information on how to protect yourself against fraud attempts.

Useful Tax Numbers

Here is a list of the tax rates, deductions, exemptions, credits and other related items that may apply to your 2018 and 2019 taxes. These numbers reflect the changes made by the American Taxpayer Relief Act of 2012 (ATRA) and the 2017 TCJA and the 2019 adjustments released by the IRS as of November 15.

Standard Deduction

For 2018, the standard deduction is $24,000 for married couples filing a joint return, $12,000 for those who are single or those who are married filing separate returns and $18,000 for heads of household.

For 2019, the standard deduction will increase to $24,400 for married couples filing a joint return, $12,200 for those who are single or those who are married filing separate returns and $18,350 for heads of household. The now higher standard deduction is adjusted for inflation (in $50 increments) but will revert back to pre-TCJA levels at the end of 2025 if the legislation is not renewed.

The additional standard deduction of $1,300 for the elderly and the blind who are married still applies in 2018 and 2019, but for single taxpayers who are elderly or blind, the additional standard deduction is $1,600 in 2018 and $1,650 in 2019.

Personal Exemptions

The TCJA suspended the personal exemption for the years of 2018 through 2025.

Individual Retirement Accounts and 401(k) Plans

The maximum allowed IRA contribution for 2018 is $5,500 ($6,500 for individuals age 50 or older). The contribution limits will rise to $6,000 ($7,000 for individuals age 50 or older) in 2019. Though the limits on annual contributions are indexed to inflation, this is the first increase since 2013. The additional catch-up contribution limit of $1,000 is not indexed to inflation and will be unchanged next year. The contributions can be fully deducted for modified adjusted gross incomes (MAGIs) below $101,000 and $63,000 for married filing joint and single household returns, respectively, for the 2018 tax year. The 2018 exemption is $189,000 for a person filing a married joint return who is not covered by a workplace retirement plan but whose spouse is. In 2019, the phaseout levels for deducting contributions will increase to $103,000 for married filing jointly and $64,000 for singles. It will be $193,000 for those married filing a joint return not covered by a workplace retirement plan but whose spouse is.

In 2018, the maximum annual contribution limit to a 401(k) plan or similar type of defined-contribution plan is $18,500 ($24,500 if you are age 50 or over). The maximum contribution limit will rise to $19,000 (plus the $6,000 catch-up contribution) in 2019.

In 2018, the maximum annual contribution for SIMPLE (savings incentive match plan for employees) plans is $12,500 (those age 50 or over can make a maximum catch-up contribution of $3,000). The contribution limit will rise to $13,000 (plus the $3,000 catch-up) in 2019.

Qualified Plan Contributions

In 2018, the maximum annual contribution for qualified plans, including SEP and Keogh plans, is $55,000 or 25% of your compensation, whichever is less; in 2019, the maximum contribution will rise to $56,000 or 25% of your compensation, whichever is less.

Estate and Gift Tax Limits

The estate tax exemption is both portable and indexed to inflation. The exemption is $11.18 million in 2018. The exemption will rise in 2019 to $11.40 million. The basic exclusion amount will remain at the higher level through 2025, though increasing by the chained consumer price index, a slower inflation measure. This is a per-spouse exclusion and it is portable, meaning that if one spouse passes away, the surviving spouse can claim the exclusion, resulting in a total effective exclusion of $22.36 million in 2018 and $22.80 million in 2019. The large figures will prevent most families from having to pay estate taxes.

The estate tax rate is 40%. The step-up basis rule applies when an inherited asset is sold: The capital gain resulting from the sale is calculated as the difference between the proceeds at the time of the sale transaction and the value of the assets at the time of the inheritance.

Executors have to report the fair value of the property included in the gross estate to both the IRS and to the heirs. Beneficiaries claiming a basis for inherited property above the reported value may be subject to a 20% penalty.

The annual gift tax exclusion in 2018 is $15,000 and $30,000 for consenting couples. (You will need to file Form 709.) These limits will be unchanged in 2019.

Required Minimum Distributions (RMDs)

Individuals age 70½ and older are required to take a distribution from their retirement accounts by December 31, 2018. These accounts include 401(k) plans, 403(b) plans, 457(b) plans, traditional IRAs, SEP IRAs, SARSEP IRAs, SIMPLE IRAs and Roth 401(k) plans. RMDs from defined-contribution plans, such as 401(k) plans, can be postponed beyond age 70½ for those who are still working, contributing to a defined-contribution plan and own less than 5% of the company. Roth IRA plans are exempt from the RMD rules while the owner is alive.

If you turned 70½ in 2018, you have until April 1, 2019, to take your first RMD. You will need to take a second RMD no later than December 31, 2019, to satisfy that year’s distribution requirement.

According to the IRS, “Generally, an RMD is calculated for each account by dividing the prior December 31st balance of that IRA or retirement plan account by a life expectancy factor that the IRS publishes in tables in Publication 590-B, Distributions From Individual Retirement Arrangements (IRAs).”

Child Tax Credit

The TCJA set the maximum child tax at $2,000 for the years 2018 through 2025. In 2018, the credit is refundable up to $1,400. The refundable portion is indexed to inflation but will remain at $1,400 in 2019.

Kiddie Tax

The “kiddie tax” applies to children up to age 18 and could apply to children up to age 23—depending on how much earned income they have and whether or not they are full-time students.

Under the kiddie tax rules, children with 2018 investment income above a certain amount may have part or all of their investment income taxed at their parents’ income tax rate. Between 2018 and 2025, the trust tax rates will apply to such income.

The kiddie tax applies if the child is age 17 or younger by the end of the year. In 2018, the kiddie tax will apply if the child’s total investment income exceeds $2,100. The exemption is indexed to inflation and will be raised to $2,200 in 2019.

In addition, the kiddie tax can apply to older children, depending on how much earned income they have and whether or not they are full-time students.

• Starting in the year that your child turns 18, the kiddie tax will apply if your child’s earned income (including salaries and wages, commissions, professional fees and tips) does not exceed half of the child’s overall support.
  
• Starting in the year your child turns 19, the kiddie tax will apply if your child is a full-time student.
  
• The kiddie tax will stop applying in the year your child turns 24.
  
• The kiddie tax will also not apply if your child is married filing jointly.
  

Charitable Donations

Donations of clothing and other personal items must be in “good condition” or better in order to be deducted. Form 8283 must be filled out if your total deduction for all noncash contributions exceeds $500.

In addition, charitable contributions of cash (regardless of the amount) to any qualified charity must be supported by a dated bank record (such as a cancelled check) or a dated receipt from the charity that includes the name of the charity and date and amount of contribution.

Those age 70½ or older can distribute up to $100,000 from their traditional IRA to qualified charities in 2018 and 2019. The provision allowing qualified charitable distributions (QCDs) was permanently reinstated late in 2015; the cap on donations is not indexed to inflation. QCDs reduce required minimum distributions. See “The Tax Advantages of Qualified Charitable Distributions From IRAs” in the October 2016 AAII Journal for more information.

Medicare

Taxpayers who itemize deductions can deduct (as a medical expense) the premiums they pay for Medicare Part B supplemental insurance and Medicare Part D prescription drug insurance. Premiums for voluntary coverage under Medicare Part A are only deductible by those over the age of 65 and not covered by Social Security.

Medicare Part B premiums are based on MAGI as reported on returns from two years ago. As such, the Medicare Part B premium will be $135.50 in 2019 for taxpayers who file married joint returns with 2017 MAGI of $170,000 or less and single filers with 2017 MAGI of $85,000 or less.

The floor for deducting medical expenses is temporarily at 7.5% of adjusted gross income for 2018. It will revert back to 10% in 2019.

Itemized Deduction Phaseouts

The phaseout of itemized deductions (the “Pease” limitation) was suspended for the years 2018 through 2025 by the TCJA.

State, Local and Sales Taxes

Taxpayers who itemize deductions have the option of choosing between a deduction of sales taxes or income taxes when claiming a state and local tax deduction. Taxpayers cannot deduct both. A $10,000 limit ($5,000 for married filing separate returns) on state and local tax deductions is in effect from 2018 through 2025. This cap is not indexed to inflation.

Tax-Exempt Interest Reporting

State and local governments are required to report interest paid on tax-exempt state and local bonds on Form 1099-INT, Interest Income. This amount must be shown on your tax return. While this income is generally exempt from federal income tax under the current tax law, it is used for determining how much of Social Security income is taxable. Income from private activity bond interest is included in alternative minimum tax calculations.

Health Savings Accounts

The 2018 minimum annual deductible for self-only coverage is $1,350; it is $2,700 for family coverage. Though indexed for inflation, the minimum deductible will remain at these levels in 2019. The 2018 maximum limits for annual deductible and other out-of-pocket expenses are $6,650 and $13,300, respectively. They will rise to $6,750 and $13,500, respectively, in 2019.

HSA contributions cannot exceed $3,450 for individual coverage and $6,900 for family HDHP coverage in 2018. In 2019, the maximum contributions will be $3,500 and $7,000 for individual and family coverage, respectively.

More information on this can be found here.

Education Savings

The maximum Hope Scholarship Credit (the American Opportunity education credit) of $2,500 per year for the first four years of post-secondary education for tuition and related expenses (including books) was made permanent by the Consolidated Appropriations Act of 2016. As such, this credit can be claimed in both 2018 and 2019.

The Lifetime Learning Credit can be claimed for education expenses beyond the fourth year of post-secondary education and for non-degree courses intended to improve job skills. The maximum credit is $2,000 annually and is subject to income phaseouts.

You can make nondeductible contributions to qualified tuition plans, also known as section 529 plans. (However, the contributions may be deductible from your state income tax, depending on where you live.) These accounts, offered by states or their designees, are maintained solely for the qualified higher education expenses of a beneficiary. Distributions are tax-free, provided that the distributions are used to pay qualified expenses.

The ATRA made the $2,000 per beneficiary contribution limit to a Coverdell Education Savings Account permanent. The contributions are not deductible, but they grow tax-free in the IRA. Coverdell accounts may be used to fund qualified elementary, secondary and higher education expenses. However, the amount that can be contributed is limited for higher-income taxpayers and the phaseouts are not adjusted for inflation.

Investment Strategies: 2019 and Beyond

Though the ATRA and the Consolidated Appropriations Act of 2016 provided clarity in terms of current legislation, the TCJA had a much bigger and broader impact on the tax code. Not only have the tax brackets for individuals changed, but so have many deductions and exemptions.

Listed below are traditional tax planning strategies that can help keep your tax bill down. It is important, however, to keep in mind that your goals and risk tolerance, not just the income tax impact of an investment, should drive your investment decisions.

Consider Roth IRA Conversion Opportunities

You have the option of converting all or part of your traditional IRA into a Roth IRA, regardless of your adjusted gross income under existing law. Roth IRAs can provide certain advantages: The converted assets can be withdrawn tax-free at any time, future earnings are also tax-free (with some limitations) and Roth IRA owners are not required to take any minimum distributions in retirement. The downside, however, is that the conversion amount is taxable in the year it occurs.

While the benefits of a Roth IRA conversion could be considerable, taxpayers must carefully weigh the upfront tax costs against the long-term tax advantages. For more on this, see “Retirement Planning Strategies Following the 2017 Tax Act” and “Social Security and Medicare Can Raise Retirees’ Tax Rates” by William Reichenstein and William Meyer in the March 2018 and April 2018, respectively, AAII Journal. You may also want to consult a tax professional.

Conversions can no longer be undone (a “recharacterization”); this was ended by the TCJA.

You cannot convert required minimum distributions from your traditional IRA for a particular year (including the calendar year in which you reach age 70½) to a Roth IRA. IRS Publication 590-A explains the rules for Roth IRA conversions and Publication 590-B covers the rules for RMDs.

Take Advantage of Lower Marginal Rates

Deferring income that is taxed at higher ordinary tax rates makes sense. Most taxpayers will pay long-term capital gains tax rates of 0% or 15%. For married couples filing jointly with income above $479,000 and single filers with income above $425,800 in 2018, the long-term capital gains rate is 20%. In 2019, the 20% long-term capital gains tax rate will apply to married couples filing jointly and single filers with incomes above $488,850 and $434,550, respectively. Short-term capital gains, in contrast, are taxed at ordinary income tax rates of 37% in 2018 and 2019. The 3.8% net investment income (NII) surtax applies to taxpayers with income above the $250,000/$200,000 thresholds. This tax applies to both short- and long-term capital gains, as well as taxable interest, dividends, non-qualified annuities, rents and royalties and passive income from partnerships. The NII surtax is not indexed to inflation, and the $250,000/$200,000 thresholds are effective for both 2018 and 2019.

Similar rules apply to qualified dividends. For married couples filing jointly with income above $479,000 and single filers with income above $425,800 in 2018, dividends are taxed at 20%. In 2019, the 20% qualified dividend tax rate will apply to married couples filing jointly and single filers with incomes above $488,850 and $434,550, respectively.

Though tax considerations should never be the primary reason for selling a security, if you have large positions in either gifted or inherited stocks, or stocks received from a sale of a business, you should consider whether it makes sense to sell shares over a period of time to take advantage of the long-term capital gains rates and use the proceeds from selling the stock to diversify your portfolio. This is particularly the case if a large portion of your wealth is concentrated in just a few securities.

Use Losses Carefully

While tax considerations should not drive your investment decision, you can take advantage of losses in holdings that you would prefer to either sell or reduce from an investment standpoint.

Capital losses first reduce capital gains: long-term losses reduce long-term gains first, and short-term losses reduce short-term gains first. Any long-term losses left over reduce short-term gains, and vice versa. If you still have losses remaining after offsetting capital gains, you can reduce your “ordinary” income by up to $3,000. Losses not used this year can be carried forward to future years until they are used up. For more information, see “Capital Pains: Rules for Capital Losses” by Julian Block in the September 2010 AAII Journal.

When planning, make sure you don’t run afoul of the wash-sale rules. If you sell an investment at a loss and then acquire a substantially identical security during the 30-day period prior to or the 30-day period following the sale, the loss will be disallowed. If your loss is disallowed by the wash-sale rule, you can increase the cost basis of the new position of the substantially identical security by the amount of the disallowed loss. The holding period for the new position is also adjusted to include the holding period of the position sold at the disallowed loss. You cannot adjust the cost basis or holding period if you acquire the investment in an IRA or Roth IRA, however. For more information, see “Keeping Transactions Clean From the Wash-Sale Rules” by R. Kevin Trout in the December 2014 AAII Journal.

Be Aware of Holding Periods for Qualified Dividends

In order to qualify for the reduced 15% (20% for higher earners) tax rate on qualified dividends for common and preferred stocks, a holding period must be satisfied. Specifically, common stocks must be owned for more than 60 days during the 121-day period that begins 60 days before the ex-dividend date. (The holding period is more than 90 days out of a 181-day period for preferred stocks with dividends attributable to periods aggregating more than 366 days.) The ex-dividend date is generally one trading day prior to the record date.

Not all dividends are qualified. Qualified dividends are paid by common and preferred stocks. Real estate investment trust (REIT) distributions and master limited partnership (MLP) distributions do not qualify for the discounted taxed rate. Contact the investor relations department of the specific company if you have questions about the tax treatment.

Consider the Impact of Taxes on Mutual Fund Investments

Selecting tax-aware managers of mutual funds may be important to maximizing your aftertax rate of return in your taxable investment portfolio.

You may choose when to sell specific shares of the fund and may, therefore, create long-term versus short-term capital gains, as long as you notify the fund family or your broker in writing with specific instructions. But you don’t control the investments within the fund. Should an equity manager fail to extend the holding period on a stock, it could cost you as much as 17.0% of your gain (37.0% ordinary rate for short-term capital gains versus the 20% long-term capital gains rate) between now and 2025.

Some mutual fund distributions can be treated as qualified dividends and therefore eligible for the reduced tax rate, while others will not qualify. Dividends paid by stocks held by the fund and passed through to the shareholder are eligible for the qualified dividend tax treatment. However, capital distributions and interest from bonds are not. These payments are reported on Form 1099, which specifies the type of distribution.

You can read more on mutual fund distributions here.

Reconsider Taxable Versus Tax-Free Bonds

Interest from tax-free municipal bonds is generally exempt from federal income taxes, unlike the interest from taxable bonds, which is taxed as income. Like any bond, credit quality matters, as you want to ensure that the issuer will not default. Changing yields can also alter the aftertax yield advantage, making municipal bonds more or less attractive to taxable bonds.

Additionally, private-activity bonds (a type of tax-free bond) could increase your exposure to the alternative minimum tax since their interest income is taxable for purposes of the alternative minimum tax. There are exceptions, including qualified 501(c)(3) bonds, New York Liberty bonds and Gulf Opportunity Zone bonds. Furthermore, the interest on qualified bonds issued in 2009 and 2010 is not subject to the alternative minimum tax. Check with the bond issuer to find out the bond’s tax status.

You should review your bond and money market accounts to make sure that you are earning the highest aftertax return. But don’t forget to consider the state tax implications of switching from tax-free to taxable bonds before making any final portfolio decisions.

Consider Increasing Retirement Savings

Increasing retirement savings makes sense from a financial planning standpoint and, depending on your adjusted income, may reduce your tax bill. You have until April 15, 2019, to make an IRA contribution for the 2018 tax year. See the box on page 16 for yearly contribution limits to various types of retirement plans.

Review Tax Implications of Taxable Versus Tax-Deferred Accounts

The spread between capital gains and ordinary income rates has important implications with respect to your asset allocation between taxable and tax-deferred (retirement) accounts.

For example, from a tax perspective, holding individual stocks in tax-deferred accounts and bonds in taxable accounts could be expensive because the long-term gains resulting from stocks held in tax-deferred plans such as IRAs or 401(k) plans will be taxed at ordinary rates when taken as a distribution. By reversing that structure, taxable bonds and other tax-inefficient assets will be shielded from taxation in the deferred accounts, while equities will enjoy the reduced rates for capital gains in personal accounts.

Tax-free municipal bonds should remain outside of retirement accounts. Individuals should also consider the cost of commissions and taxes, current cash flow needs, and the 0.9% additional Medicare tax and 3.8% NII surtax before making any investment moves between taxable and tax-deferred accounts.

Protect Social Security Benefits

If you are receiving Social Security benefits, you may have to pay taxes on them if your combined income (primarily your adjusted gross income plus any tax-exempt interest income plus half of your Social Security benefits) exceeds certain levels.

To protect your benefits, watch the amount of interest you receive from municipal bonds, since this amount is included in your modified adjusted gross income when determining the Social Security benefit taxability. In addition, you may want to delay discretionary taxable distributions from a retirement plan or IRA.

Conclusion

It is important to remember that taxes should not be the primary driver of your investing decisions. Taxes do, however, play a role in wealth management. As the tax code continues to evolve, everyone should consider how the changes directly affect their overall tax and investment strategies.

Tax Planning Strategies

All Taxpayers: Determine Where You Are at the End of the Year

At the end of each year, you should take the time to assess your tax situation. Doing so will give you the opportunity to shift certain items around, should that be beneficial in terms of your tax liability. Taking a few initial steps now and using year-end planning strategies can result in significant tax savings.

Here are the basic steps you should take to help start your personal tax planning:

• Estimate your income, deductions, credits and exemptions for 2018 and 2019 using the Tax Forecasting Worksheet;
  
• Identify items that you can shift from 2018 into 2019 and beyond (or vice versa);
  
• Determine your marginal tax rate—the rate at which your next dollar of income will be taxed—for 2018 and 2019;
  
• Determine how much tax you owe and when you must pay it to avoid underpayment penalties;
  
• Determine whether you are subject to the alternative minimum tax (AMT);
  
• Consult with your tax professional, and then take the actions needed to make the best of your tax situation.
  

To minimize your taxes, consider both short-term and long-term tax planning issues and strategies. Starting early will give you extra time to obtain additional information about items that concern you and to investigate additional ideas for tax savings or deferral. The Tax Forecasting Worksheet will provide a starting point for evaluating the tax effects of various strategies.

Avoiding Tax Underpayment Penalties

Make sure you determine your 2019 tax liability as early as possible, as well as the due dates for paying those taxes (including the self-employment tax and the AMT), so that you avoid underpayment penalties.

Federal tax law requires the payment of income taxes throughout the year as you earn your income. This obligation may be met through withholding, quarterly estimated tax payments or both. If you do not meet this obligation, you may be assessed an underpayment penalty.

If your total tax due minus the amount you had withheld is less than 10% of your total tax due, you will not be assessed an underpayment penalty. The disadvantage of overpaying throughout the year, though, is that you are in effect making an interest-free loan to the government. However, the underpayment penalty can be high, and it is calculated as interest on the underpaid balance until it is paid, or until the regular filing date for the final tax return, whichever is earlier.

You can avoid underpayment tax penalties by adopting one of the safe harbor rules. The basic rule is to pay the required amount by the end of the year through withholding and quarterly estimated payments. The required amount will be one of the following, depending on your individual situation:

• 90% of the current year’s tax liability;
  
• 100% of the prior year’s tax liability (increases to 110% for taxpayers who had 2018 adjusted gross income in excess of $150,000, or $75,000 for those married filing separately); or
  
• 90% of the tax liability based on a quarterly annualization of current year-to-date income (see IRS Form 505 and IRS Publication 505 for worksheets).
  

Penalties are based on any underpayment, which is the difference between the lowest amount required to be paid by each quarterly payment date and the amount actually paid by that date. The annual required amount, based on either of the first two alternatives, is paid in equal installments. In the case of the third method, which is based on annualized income, the amount due each quarter is based on actual income received for each installment period. The third method is typically more beneficial if you do not earn income evenly throughout the year (e.g., you operate a seasonal business) or had an unexpected increase in income because it allows for lower required payments in the early quarters.

Income tax payments made through withholding from your paycheck (or from your pension or other payments) are given special treatment. The IRS treats income tax that is withheld as having been paid equally throughout the year (unless you prefer to use actual payment dates). This lets you make up for underpaid amounts retroactively because amounts withheld late in the year may be used to increase the amounts paid in earlier quarters.

State and Local Rules: Many states have underpayment rules that vary from the federal requirements.

Timing: Income & Deductions for Taxpayers Not Subject to AMT

You have opportunities to reduce your taxes if you can control the timing of either your income or expenses. However, it is important to make sure you understand whether you may be subject to the AMT before adopting these strategies. Though the TCJA retained the alternative minimum tax, it will not apply for 2019 incomes below $1,020,060 for married couples filing joint returns and $510,300 for others. (See the box below for more information.)

Income

Your income is generally taxed in the year of receipt, so having the ability to control when you receive it affords a strategic tax planning opportunity. Deferring income until a later year will, in most cases, delay the payment of tax. You cannot defer taxation by merely delaying receipt of the income if the funds are available to you and the time of payment is subject to your unrestricted discretion. Any decision to defer income must be weighed with the lost time value of the money and other risks that could alter or forfeit your right to the income.

The timing of bonuses, recognition of capital gains from the sale of stocks, and the exercise of non-qualified stock options are all events that can easily be delayed into a subsequent year.

Consider the deferral of compensation through the use of various retirement plans and deferred-compensation arrangements. If you operate a business or collect rental income and report that income on the cash receipts and disbursements method, you have an opportunity to delay or accelerate the billing to your customers or tenants and determine the timing of the related income.

Deductions

You can reduce taxes by controlling the payment of deductible expenses. If paid by December 31, you may deduct certain expenses that are due the following year on your current year tax return. (Property taxes prepaid in the current year can be deducted if assessed in the current calendar year and if the $10,000 limit on state and local taxes has not been reached.) This strategy helps when you have a higher tax liability in the current year than you expect to have in the coming year. Again, you must balance this decision with the time value of money and other inherent risks.

For example, if you pay a deductible expense in December 2018 instead of April 2019, you reduce your 2018 tax instead of your 2019 tax, but you also lose the use of your money for three-and-one-half months. Generally, this will be to your advantage, unless you have an alternative use for the funds that will produce a very high return in that three-and-one-half-month period. You must decide whether the cash used to pay the expense early should be used for something more urgent or more valuable than the accelerated tax benefit.

For those who will pay 2019 estimated taxes based on their 2018 tax liability, reducing your 2018 taxes has another advantage: Your 2019 estimated tax payments may be smaller.

State Taxes

If accelerating deductions makes sense for you and you choose to claim a deduction on your state and local income taxes, you may want to prepay the balance on your estimated state tax liability in December 2018, rather than waiting until 2019, if the taxes were assessed in 2018. This secures that deduction on your 2018 tax return, even though the payment might not be required by the state until January 15, 2019, or April 15, 2019. The deductibility of these taxes is subject to a $10,000 cap on state and local taxes in 2018. The cap is not indexed to inflation and will remain at $10,000 per year through 2025.

Charitable Contributions

If you are planning on making a gift to a charity in 2019, consider making the gift in 2018 to accelerate the tax benefit of the contribution if you have enough deductions to exceed the $24,000/$12,000 standard deduction. However, it is important to note that certain limitations exist with respect to deductions for charitable contributions.

You should also consider the benefits of gifting appreciated stock to a charity. If you donate long-term appreciated stock directly to the charity, you get a deduction for the full fair market value of the stock, whereas if you sell the stock first and donate cash, you only get a deduction for the aftertax cash donated. (If you have an unrealized loss in the stock, however, it might be more beneficial from a tax standpoint to sell the stock and then donate the cash proceeds. Doing so would give you deductions for both the capital loss and the charitable donation.)

When making a gift to a charity, you must have an appropriate record of the gift in order to properly support the deduction.

In addition, cash contributions of any amount must be supported by a written record, either in the form of a bank record (for example, a cancelled check) or a written receipt from the charity. The record must include the name of the charity, the date and the amount of the contribution.

The higher standard deductions under the TCJA raised the threshold for deducting donations. As such, you may want to double-up donations in a particular year rather than making them over two separate years.

Prepaid Interest

A cash basis taxpayer may not deduct prepaid interest before the tax year to which the interest relates. However, there is some flexibility to prepay year-end interest that is due early in the following year.

For example, if a mortgage payment is due on January 10, a taxpayer can accelerate the deduction of the portion of the interest relating to the period up to January 1 by mailing the check in December.

The most significant interest deductions currently available are for home mortgage interest and for investment interest expense to the extent of current-year investment income. Interest paid in relation to investments that earn a tax-free return is not deductible.

Medical Expenses

If the timing of certain medical and dental expenditures is flexible and your overall medical expenses are high in the current year, you may want to accelerate the timing of these expenses.

Because unreimbursed medical expenses are only deductible to the extent that they exceed 7.5% of adjusted gross income in 2018, it is best from a tax standpoint to incur expenses—such as replacement eyeglasses or contact lenses, elective surgery, dental work and routine physical examinations—in a year in which you have already gone over (or in which the added expenses would take you over) the 7.5% threshold. Beginning on January 1, 2019, the threshold will revert back to 10%.

Miscellaneous Itemized Deductions

Miscellaneous itemized deductions exceeding 2% of adjusted gross income can no longer be claimed as of January 1, 2018. The suspension of the ability to claim such deductions lasts through 2025.

This category is large but includes:

• Tax preparation fees such as tax preparation software, tax publications and any fee paid for electronic filing; and
  
• Investment fees, custodial fees, trust administration fees and other expenses paid for managing your investments that produce taxable income.
  

Uninsured Personal Casualties

Uninsured personal casualties can be deducted only if they are attributable to a federally declared disaster and exceed 10% of adjusted gross income. Losses to theft are no longer deductible. The new rule is in effect from 2018 through 2025.

Timing Caution for Taxpayers Subject to AMT

The alternative minimum tax (AMT) was originally designed to ensure that everyone would pay their fair share of income taxes. The measure has since evolved into a separate tax regime that required a permanent fix in the ATRA to prevent it from ensnaring millions of Americans.

The wisdom of conventional tax planning advice to defer income and accelerate certain types of deductions may not hold true if an individual expects to be subject to the AMT. Accordingly, during the tax planning process, it is critical that you determine whether you are subject to the AMT in both the current year and the following year.

If you are continuously subject to the AMT, avoid investing in private-activity (municipal) bonds. Income from these bonds is taxable for AMT purposes. [There are exceptions, including qualified 501(c)(3) bonds, New York Liberty bonds and Gulf Opportunity Zone bonds. Also, the interest on qualified bonds issued in 2009 and 2010 is not subject to the AMT. Check with the bond issuer for the bond’s tax status.] Furthermore, you should be aware that unusual combinations of income and deductions might require AMT planning that runs contrary to conventional tax-planning advice.

Although the exercise of an incentive stock option (ISO) does not give rise to regular taxable income for the employee, the difference between the exercise price and the market price of a stock must be recognized for AMT purposes for the year in which the option is exercised. Accordingly, the exercise of incentive stock options with a large bargain element often causes a tax liability under the AMT regime.

The AMT arena is extremely complex, so generalizations are difficult to make. If you think you may be subject to the AMT, you should consult a tax professional to determine how best to minimize your exposure to it.

As stated previously, the TCJA retains the alternative minimum tax, though with higher exemptions and income limits for the years of 2018 through 2025.

Year-End Estate and Gift Tax Planning

Year-end planning from an estate planning perspective typically involves ensuring that “annual exclusion” gifts are completed by the end of a calendar year.

Under the federal gift tax system, each donor is permitted to make non-taxable gifts of a certain amount each year to any donee. These gifts are called “annual exclusion” gifts and do not count against the donor’s lifetime gifts exemption. The annual gift tax exclusion level is $15,000 for 2018 and 2019. To the extent that it is not used, the annual exclusion evaporates at the end of each calendar year.

Annual transfers that take advantage of this exclusion can both diminish the donor’s estate tax liability and improve the lives of the recipients. These gifts can take many forms (such as cash, stocks, real estate, partnership interests) and can be given outright through Uniform Transfers to Minors accounts, and even through a trust—provided it contains special provisions designed to allow the gift to qualify for the annual exclusion.