Year-End Tax Strategies for Individual and Families

EisnerAmper’s Cindy Feder, Lisa Herzer and Patricia Kiziuk recently presented on year-end tax strategies with a focus on individuals and families. The following strategies were discussed:

Retirement Plans:

The age for taking mandatory required minimum distributions (“RMDs”) has changed from 70½ to 72 with the passage of the Secure Act. For distributions beginning in 2020, individuals who attain age 70½ after December 31, 2019 must commence taking distributions at age 72. For planning purposes, taxpayers may consider making a qualified charitable distribution (“QCD”) of $100,000 (per taxpayer) directly to a qualified charity, thereby removing $100,000 ($200,000 if married filing jointly) from taxable income in that year. Making the QCD can satisfy RMD requirements.

Using the “backdoor IRA” by contributing to a non-deductible IRA and shortly thereafter converting it to a Roth IRA is another viable planning technique. Over several years this can add significant value since distributions from Roth IRAs are not taxable and there are no required minimum distribution requirements. This technique will have an income inclusion in the year of conversion but will reduce or eliminate taxable income in future years.

Tax Loss Harvesting:

When reviewing your current portfolio with the intention of realizing losses to offset capital gains, taxpayers should be aware of the wash-sale rule which disallows any losses where the investment is replaced with the same or “substantially identical”’ investment 30 days before or after the sale. Often, taxpayers are surprised when it is determined that the losses are disallowed.

Charitable Contributions:

Patricia noted the importance of understanding the rules around charitable giving when performing tax planning, especially with respect to the type of donation (cash/ordinary income property/capital gain property), the organization receiving  the donation (public charities/private foundations/private operating foundation), your adjusted gross income (“AGI”) to see that there are no limitations, and the ordering rules that come into play when you are donating different types of property to different charities. Another planning tip is to consider bunching charitable contributions in one year and taking the standard deduction in the following years to maximize your deduction over a period of years.

The CARES Act allowed “qualified contributions” (typically cash donations to public charities) to 100% of the taxpayer’s AGI, effectively suspending any limitation for 2020 and 2021 only. This no longer applies for 2022 and beyond.

Another tax planning idea includes donating artwork to a public charity such as a museum or university with public charity status. If the donated artwork is used in connection with the charity’s exempt purpose (the so-called “related use” rule), the donor is entitled to a deduction of the artwork’s fair market value. If this artwork is donated to a private foundation, or to a public charity that will not utilize the artwork to deploy its exempt purpose, the deduction is limited to the cost. A donor can also consider fractional interest of the artwork and still receive a charitable deduction. There are tax implications to the donor if the charity disposes of the artwork within three years.

Limitation on Business Losses:

The Tax Cuts and Jobs Act introduced a limitation on business losses which applies to noncorporate taxpayers (individuals/trusts/estates) and does not allow a “business loss” in 2022 to exceed $270,000 for single filers and $540,000 for married filing joint filers. Understanding what losses are included is important when timing these losses in order to maximize savings.

Estate & Gift Tax:

The annual gift tax exclusion is currently $16,000 has and will increase to $17,000 for 2023 while the gift and estate basic exemption increases from $12.06 million in 2022 to $12.92 million in 2023, which also includes the generation-skipping transfer tax exemption. These exemptions will revert back in 2026 to $5 million (indexed for inflation). An effective estate tax plan should include techniques to utilize these exemptions before they are gone.

Some effective techniques include:

• Forgiveness of family loans
• Sale to defective grantor trusts: forgive loan
• Top off existing trusts
• Reconsider insurance needs
• Pre-fund life insurance trusts
• Consider late allocation of GST exemption to existing trusts

Spousal lifetime access trust (SLAT):

This is a type of trust where one spouse or both spouses set up trusts for their children/grandchildren allowing them to give away property but retain indirect access. These are grantor trusts and the donor-spouse, rather than the trust, pays the income tax (which is also an additional tax-free gift).

Qualified personal residence trust (QPRT):

In the current environment when the interest rate is high, the QPRT becomes a more attractive trust when doing tax planning. This is used to transfer a personal residence to beneficiaries of the trust, including vacation homes. After several years, the residence passes outright to the beneficiaries or remains in the trust. During the initial term the grantor uses the residence, while after the initial term ends the grantor can rent the residence from the trust at FMV. The initial transfer of the residence into the trust is a taxable gift, and the value is the remainder interest using the IRC Sec. 7520 rate. Therefore, the higher the rate, the lower the value of the gift. That is why this is used in a high interest environment. There are a few risks when dealing with a QPRT – one of which is the mortality risk, the grantor must survive the initial trust term otherwise the residence is included in the estate. Additionally, if the beneficiary decides NOT to keep the residence and sells the property, there are income tax consequences.

Charitable remainder trust (CRT) and Charitable lead trust (CLT):

A CRT provides an income stream to non-charitable beneficiaries during the term of the trust and the remainder is distributed to a specific charity while a CLT pays an annuity to the charity during the term of the trust and the non-charitable beneficiaries receive the remainder interest. With both trusts there is the ability to diversify the portfolio, defer capital gain and create an annuity stream. Additionally, the grantor receives a charitable deduction in the year established for both types of trusts if the CLT is set up as a grantor trust.

Private foundations vs. donor-advised funds (DAF):

Taxpayers may also opt to use private foundations or DAFs for charitable giving, but they should understand the different implications of each. While private foundations allow a deduction of 30% of AGI for cash and 20% for securities vs. 60% for cash and 30% for securities with a DAF, the cost of set-up and administrative responsibilities and required annual distributions may outweigh the benefit of the higher deduction. Additionally, with private foundations, gifts in excess of $5,000 are required to be reported with the annual form 990-PF. Because the form 990PF is a public document, such contributions are  no longer anonymous. An excise tax of 1.39% is also imposed on net investment income earned by the private foundation.

Some final planning tips include understanding your assets, organizing your tax information and financial documents, reviewing all income sources and deductions, consider gifting before year-end and determining if you might be entitled to any education or energy credits.