The IRS recently issued guidance to help taxpayers in high-tax states understand how the new tax law’s $10,000 annual limit on deductions for state and local taxes (SALT), and property and real estate taxes affects the tax treatment of SALT refunds they receive beginning in tax year 2019.
In general, taxpayers may exclude from their taxable income any dollar amount they receive as a refund for SALT paid in a prior year in which they claimed a standard deduction, which for 2018 is $12,000 for single filers or $24,000 for married couples filing jointly. This is not the case when taxpayers itemize their deductions. Rather, when itemizers receive a refund for all or a portion of the state and local taxes they paid in a previous year, they must report the recovered amount the following year on their federal returns as taxable income, to the extent the taxpayer received a tax benefit from the deduction in the prior year. The legal theory behind this rule is that taxpayers who receive a tax benefit in one year (in the form of a SALT deduction) should not be permitted to also benefit from a refund they receive for that tax benefit in a future year.
Taxpayers in high-tax states, such as New York, New Jersey, Connecticut and California, who paid state and local taxes, property taxes and real estate taxes in excess of the $10,000 cap in 2018 and who subsequently receive a SALT refund in 2019 will need to determine how much of that refunded amount they must include as taxable income when they file their 2019 tax returns in 2020. After all, if taxpayers received a tax benefit from deducting state or local taxes in 2018, they may not receive a second benefit in the form of a tax refund in 2019. Instead, the taxpayer who recovers any portion of state or local state or local tax, including state or local income tax and state or local real or personal property tax, must include in gross income for 2019 the lessor of 1) the difference between the taxpayer’s total itemized deductions taken in the prior year and the amount of itemized deductions the taxpayer would have taken in the prior year had the taxpayer paid the proper amount of state and local tax or (2) the difference between the taxpayer’s itemized deductions taken in the prior year and the standard deduction amount for the prior year, if the taxpayer was not precluded from taking the standard deduction in the prior year.
The IRS’s revenue ruling illustrates the recovery of tax benefits with four examples, including one in which a taxpayer paid local real property taxes of $4,250 and state income taxes of $6,000 in 2018. Due to the SALT cap, the taxpayer could deduct on his 2018 federal income tax return only $10,000 of the total $10,250 he paid in state and local taxes. Including other allowable itemized deductions, the taxpayer claimed a total of $12,500 in itemized deductions in 2018. In 2019, the taxpayer received a $1,000 state income tax refund due to an overpayment of state income taxes in 2018. Had the taxpayer paid only the proper amount of state income tax in 2018 ($5,000 instead of $6,000) his state and local tax deduction would have been reduced from $10,000 to $9,250, and his itemized deductions would have been reduced from $12,500 to $11,750, which is less than the standard deduction of $12,000 that he would have taken in 2018. The difference between the taxpayer’s claimed itemized deductions ($12,500) and the standard deduction he could have taken ($12,000) is $500. Therefore, the taxpayer received a tax benefit from $500 of the overpayment of state income tax in 2018, and he must include that $500 in his taxable gross income in 2019.
About the Author: Karen A. Lake, CPA, is state and local tax (SALT) specialist and an associate director of Tax Services with Berkowitz Pollack Brant, where she helps individuals and businesses navigate complex federal, state and local tax laws, and credits and incentives. She can be reached at the firm’s Miami office at (305) 379-7000 or via email at firstname.lastname@example.org.
Many individuals filing their first federal income tax returns since the enactment of the new tax law are surprised to learn that they were not able to write off the donations they made to non-profit organizations in 2018. While few people give to charity solely for a tax break, much ink has been spilled over whether the potential loss of the charitable deduction will cause taxpayers to cut back on their generosity or stop giving to charity altogether. The fact is the Tax Cuts and Jobs Act provides some philanthropic-minded taxpayers with an opportunity to change their giving strategies for greater tax efficiency and charitable impact.
The New Tax Law
Under tax reform, the charitable deduction is available only to those taxpayers who itemize their deductible expenses. With a near doubling of the standard deductions to $12,200 for individuals and $24,400 for married couples filing jointly in 2019, it is estimated that the number of households clearing this threshold and itemizing deductions for charitable contributions in 2018 is approximately half of what it was in 2017, before the passage of the TCJA.
On the other hand, the law provides taxpayers whose deductible expenses exceed the cutoff and are able to itemize their deductions greater tax savings for their charitable contributions. For tax years 2018 through 2025, the amount of the deduction itemizing taxpayers may claim for charitable cash gifts increases to 60 percent of adjusted gross income (AGI) while keeping the current deduction for gifts of appreciated assets at 30 percent of AGI. Moreover, the TCJA’s repeal of the Pease limitations means that high-income households can deduct significantly more of their qualifying itemized expenses through 2025.
Unfortunately, many taxpayers do not have a well-though-out giving strategy; they merely write checks to non-profit organizations here and there. The new law provides an opportunity for families to create a giving plan that allows them to make a greater impact on their favorite charities while at the same time improving their own tax circumstances.
The Solution: Bunching Charitable Gifts
One tactic families can employ to ensure they receive the full tax benefit of their philanthropic efforts is to bundle together two or more years of charitable donations into a single year. This strategy of “bunching” several years of charitable gifts into one year can push taxpayers above the threshold for itemizing deductions in that year and provide them with a deduction for the full value of their donation. In alternate years, taxpayers could give less and simply claim the standard deduction.
As simple as this may sounds, bunching deductions requires careful planning and timing of expenses. After all, philanthropy involves far more than making donations to non-profit organizations in exchange for tax savings. Rather, philanthropy is a state of mind and long-term commitment of time, money and resources to effectuate a positive change in communities around the world and the lives of the people who live there. It is a code of ethics and guiding principle that families share and pass down from one generation to the next. Therefore, philanthropic-minded families want their charitable giving to make a measurable impact on the organizations and people who receive their gifts. To best accomplish this goal, taxpayers may want to consider directing their bunched charitable gifts to donor-advised funds (DAF) that support the specific charities that matter most to them.
More about Donor Advised Funds
DAFs are savings accounts controlled by sponsoring organizations, such as financial services firms or community foundations, that accept and invest taxpayers’ irrevocable charitable donations and later distribute those funds via grants to designated charities. The funds themselves are 501(c)(3) charities that act as turnkey solutions to help taxpayers manage and maximize their charitable giving and tax efficiency. Because DAFs invest donations for tax-free growth, a gift to a DAF in one year can result in a larger grant to a recipient charity in future years.
In return for their multi-year, bunched gifts to DAFs, taxpayers receive an immediate tax deduction for the full amount of their gift in the year of contribution. For cash gifts, the annual deduction can be as much as 60 percent of the taxpayers’ annual AGI in tax years 2018 through 2025, or 30 percent of AGI for gifts of appreciated assets, such as securities, real estate or interest in a family business held for more than one year. By comparison, taxpayers who make charitable contributions to a private foundation can deduct up to 30 percent of AGI for cash gifts and only 20 percent of AGI for appreciated assets. These types of non-cash donations to DAFs or private charitable foundations also provide taxpayers with the ability to reduce or eliminate their exposure to capital gains tax on the appreciation of those assets while also giving a much larger gift to charity. When DAF contributions surpass the IRS limits, taxpayers may carry the deduction forward five years.
For example, a taxpayer who gives $6,000 to charity every year may not receive the benefit of a full tax deduction in each of those years. However, if the taxpayer gives $12,000 to a DAF every two or three years, he or she is more likely to clear the standard deduction ceiling and qualify to write off the full value of his/her bunched charitable gifts in those years. Moreover, because the DAF invests the taxpayer’s $12,000 gift, the recipient non-profit entity will receive the appreciated value of that gift.
The requirements for participating in donor advised funds varies from one sponsor to the next. Even though there is no law governing when or how often a DAF must grant assets to qualifying charities, most have policies in place requiring account owners to grant minimum gifts to nonprofits every few years to ensure that funds are put to work for charitable causes. However, DAF participants should note that while they will receive a tax deduction in the year of their contribution, their donations may not reach the intended charities in the same year. As a result, donors should investigate DAFs before making contributions to ensure that the selected fund squares with the donor’s unique philanthropic goals and philosophies.
Another Solution for Older Taxpayers
Charitable-minded taxpayers over the age of 70½ who are financially comfortable and do not need their individual retirement account (IRA) savings to fund their later years have another giving strategy available to them. More specifically, these taxpayers may make qualified charitable distributions (QCDs) from their traditional IRAs directly to certain non-profit organizations to satisfy their annual IRA required minimum distribution (RMD) obligations. While taxpayers will avoid income tax on the transferred amounts to non-profit entities, their QCDs will not qualify for a charitable deduction. Moreover, taxpayers should be aware that are specific rules prohibiting them from making QCDs to donor advised funds or private foundations or from SEP IRAs, SIMPLE IRAs or 401(k) plans.
Despite the changes that the new tax law brings to charitable deductions, most people will continue to give generously to those in need and carry on their philanthropic traditions. Yet, it behooves taxpayers to examine their existing giving strategies in light of tax reform and consider employing different methods to improve the charitable impact of their gifts and their potential tax savings.
About the Author: Joanie B. Stein, CPA, is a senior manager with Berkowitz Pollack Brant’s Tax Services practice, where she works with individuals and closely held businesses to implement sound strategies that are intended to preserve wealth and improve tax-efficiency. She can be reached at the CPA firm’s Miami office at (305) 379-7000 or via email at email@example.com.
Information contained in this article is subject to change based on further interpretation of tax laws and subsequent guidance issued by the Internal Revenue Service.
By Edward N. Cooper, CPA
The IRS has issued its annual list of the Dirty Dozen scams that taxpayers should look out for in 2019. Under U.S. laws, taxpayers are legally responsible for the information contained in their tax returns, even when those documents are prepared by someone else. Therefore, it is critical that you take special care when selecting a tax preparer and reviewing your returns for errors. Your best defense to avoid falling victim to these scams is to learn how to spot them and remain vigilant throughout the year.
Phishing Attempts. Criminals are skilled as creating official-looking emails and websites that trick individuals into divulging their personal information. Taxpayers should be wary of all emails and text messages that request they log in to an established account or that ask for sensitive information, such as their social security or tax ID number. Moreover, remember that the IRS will never contact you via email or text, and any message purporting to come from the agency is most likely a scam.
Phone Scams. There has been a steady increase in phone scams in which criminals impersonate the IRS or claim to be IRS debt collectors in order con taxpayers into sending them bogus tax payments. Learn how to recognize these schemes and take extra precautions to protect yourself.
Identity Theft. Tax-related identity theft occurs when someone uses a stolen Social Security number or Individual Taxpayer Identification Number (ITIN) to file a fraudulent tax return and claim a refund. Safeguard your personal information and regularly review your credit report for signs of theft.
Tax Preparer Fraud. While the vast majority of tax professionals provide honest, high-quality service, there are some prepares who operate solely for the purpose of scamming taxpayers, perpetuating identity theft and reaping the benefits of refund fraud.
Inflated Refund Claims. Be wary of tax preparers who ask you to sign blank tax returns, promise you a refund before looking at your records or charging you fees based on a percentage of the refund. Do your homework and check references before selecting a tax preparer.
Falsifying Income to Claim Credits. Con artists have been successful in convincing taxpayers to invent income to erroneously qualify for tax credits, such as the Earned Income Tax Credit. To avoid significant tax bills and penalties and interest, make sure that you verify the accuracy of the information contained in the tax return you file with the federal government.
Falsely Padding Deductions on Returns. Think twice before overstating deductions, such as charitable contributions and business expenses, or improperly claiming credits, such as the Earned Income Tax Credit or Child Tax Credit, in an effort to reduce your bill or inflate the amount of your tax refund.
Fake Charities. Before making donations to charitable organizations, take the extra time to confirm that the group asking for a contribution is, in fact, a qualified and legitimate non-profit agency. A complete search is available on the IRS website.
Excessive Claims for Business Credits: Avoid improperly claiming tax credits, such as the fuel tax credit and the research credit, unless you satisfy the requirements to legitimately use them.
Offshore Tax Avoidance. Hiding money and income offshore has been the target of a wide sweep of successful enforcement actions. The best option for avoiding penalties and potential criminal prosecution is to come clean and voluntarily report offshore assets.
Frivolous Tax Arguments. While taxpayers do have a right to contest their tax liabilities, they should avoid using frivolous tax arguments or other unreasonable schemes to avoid their tax liabilities. The penalty for filing a frivolous tax return is $5,000 and felony prosecution.
Abusive Tax Shelters. The vast majority of taxpayers pay their fair share to the federal government. However, it is not uncommon for individuals to fall victim to con artists who scam them into using abusive tax structures. Always seek the opinion of professional counsel when faced with a complex tax-avoidance product.
About the Author: Edward N. Cooper, CPA, is director-in-charge of Tax Services with Berkowitz Pollack Brant, where he provides business- and tax-consulting services to real estate entities, multi-national companies, investment funds and high-net-worth individuals. He can be reached at the CPA firm’s Ft. Lauderdale, Fla., office at (954) 712-7000 or via email at firstname.lastname@example.org.
Information contained in this article is subject to change based on further interpretation of tax laws and subsequent guidance issued by the Internal Revenue Service.
In response to a chorus of concerned taxpayers and tax preparers, the IRS is providing additional penalty relief to taxpayers who have found that they did not pay enough in federal taxes in 2018 through W-2 withholding, quarterly estimated tax payments or a combination of the two.
Effective immediately, individual taxpayers, trusts and estates that paid at least 80 percent of their total tax liabilities during 2018 will escape penalties when filing their tax returns before the 2019 deadlines. In January, the IRS first lowered the penalty percentage threshold from 90 percent to 85 percent. Individuals who already filed their tax returns for 2018 but qualify for this expanded relief may claim a refund by filing on paper IRS Form 843, Claim for Refund and Request for Abatement, and include the statement “80% Waiver of estimated tax penalty” on Line 7. This form cannot be filed electronically.
Generally, the U.S.’s pay-as-you-go tax system requires taxpayers to pay at least 90 percent of their tax obligations during the year, as they earn income, or risk an underpayment penalty and interest on the unpaid amount. However, many taxpayers who took home larger paychecks in 2018, thanks to the new tax law, are now finding that they owe the government money because the IRS withholding tables did not reflect all of the changes contained in the new law.
To avoid an unexpected tax bill in future years, taxpayers should meet with their advisors and accountants during the first half of 2019 to confirm the accuracy of their estimated tax payments and to check the withholding on their most recent paychecks to ensure they are having enough tax withheld from their wages based on their filing status, number of dependents and other factors.
About the Author: Jeffrey M. Mutnik, CPA/PFS, is a director with the Taxation and Financial Services practice of Berkowitz Pollack Brant Advisors and Accountants, where he provides tax and estate-planning counsel to high-net-worth families, closely held businesses and professional services firms. He can be reached in the CPA firm’s Ft. Lauderdale office at (954) 712-7000 or via email at email@example.com.
Taxpayers who turned 70½-years-old during the 2018 calendar year have until April 1, 2019, to take their first required minimum distributions (RMDs) from their individual retirement accounts (IRAs) and workplace retirement plans.
In general, retired individuals age 70½ and older have a deadline of December 1 to take their annual RMDs from retirement savings accounts that include Simplified Employee Pension plans (SEP IRAs) and Savings Incentive Match Plans for Employees (SIMPLE IRAs) as well as of 401(k), 403(b) and 457(b) plans. Because RMDs are considered taxable income, they do not apply to individuals’ Roth IRA. Failure to take a required minimum distribution and pay the taxes on the distributed amount can result in penalties as high as 50 percent of the undistributed amount. However, the law carves out two exceptions to this rule.
The first exemption applies to working taxpayers who may postpone their RMDs until April 1 of the year in which they actually retire from work.
Secondly, taxpayers have a one-time opportunity to defer until April 1 of the following year their very first RMD in the year they turn 70½. When this occurs, taxpayers must then take a second catch-up RMD by Dec. 31 of that same year. Therefore, a taxpayer who was born between July 1, 1947, and June 30, 1948, and who turned 70 ½ in 2018, may elect to delay his or her first RMD until April 1, 2019. While this will effectively allow the taxpayer to defer recognition of the RMD amount as income until 2019, he or she should be prepared for the tax liabilities he or she will incur by taking two taxable RMBs in 2019. The only way for taxpayers to avoid having both amounts included in their income for the same year is to make their first withdrawal by Dec. 31 of the year they turn 70½ instead of waiting until April 1 of the following year.
The amount of a taxpayer’s RMD in any given year is based on a variety of factors, including the balance in their retirement accounts as of the end of the immediately preceding calendar year divided by a distribution period from the IRS’s “Uniform Lifetime Table.” Taxpayers preparing to file their tax returns can find the RMD amount by looking at IRS Form 5498 that they should receive from the trustee, bank or brokerage that holds the accounts.
About the Author: Rick D. Bazzani, CPA, is a senior manager with Berkowitz Pollack Brant’s Tax Services practice, where he provides individuals with a broad range of tax-efficient estate-, trust- and gift-planning services. He can be reached in the CPA firm’s Ft. Lauderdale, Fla., office at (954) 712-7000 or at firstname.lastname@example.org.