With the April 15 deadline for filing your 2019 Form 1040 still a few weeks away, you have time to make some moves that will save taxes on last year’s return. And maybe on your 2020 return too. But it’s time to get serious, because the clock is ticking. Here are five tax-smart ideas to consider right now.
1. Turn your taxable IRA required minimum distribution into a tax-free charitable donation
If you turned 70½ last year and have not yet taken your initial IRA required minimum distribution (RMD) for calendar year 2019, you are not alone. Thanks to a special tax-law exception, you can take that initial RMD as late as April 1 of this year. But you’ll have to take a second RMD by December 31 (for the 2020 calendar year). Since all or a portion of your RMDs count as taxable income, taking a double dip of RMDs this year could push you into a higher tax bracket and cause you to lose tax breaks that are phased out at higher income levels. Not good. Here’s one way to beat the system.
The qualified charitable distribution (QCD) alternative
You can take qualified charitable distributions (QCDs) out of your traditional IRA(s) free of any federal income tax hit. In contrast, other distributions from traditional IRAs are wholly or partially taxable, depending on whether you’ve made any nondeductible contributions over the years.
Unlike garden-variety charitable donations, you can’t any claim itemized deductions for QCDs. But the tax-free treatment of QCDs equates to a 100% deduction — because you’ll never be taxed on those amounts. And you don’t have to worry about tax-law restrictions that apply to itemized charitable write-offs.
To be a QCD, and IRA distribution must meet all the following requirements.
1. It cannot occur before you, as the IRA owner or beneficiary, are age 70½.
2. It must meet the normal tax-law requirements for a 100% deductible charitable donation. If you receive any benefits that would be subtracted from a donation under the normal charitable deduction rules, (such as free tickets to an event), the distribution cannot be a QCD. Beware of this rule!
Key Point: Arranging for QCDs won’t reduce last year’s tax bill, but it will reduce this year’s bill. The April 1 deadline means you should consider this idea as part of your tax-return-time drill.
$100,000 annual limit
There is a $100,000 limit on total QCDs for any one year. But if both you and your spouse both have IRAs set up in your respective names, each of you is entitled to a separate $100,000 annual QCD limit.
If you inherited an IRA as an account beneficiary, you too can do the QCD drill with the inherited account after reaching age 70½.
2. Make deductible IRA contribution
If you’ve not yet made a deductible traditional IRA contribution for your 2019 tax year, you can do so between now and April 15 and claim the resulting write-off on your 2019 return — assuming you qualify. If so, you can potentially make a deductible contribution of up to $6,000 or up to $7,000 if you were age 50 or older as of 12/31/19. Ditto for your spouse if you are married.
There’s a catch: you must have had enough 2019 earned income (from jobs, self-employment, or taxable alimony received) to equal or exceed your IRA contribution(s) for the 2019 tax year. If you’re married, either you or your spouse (or both) can have the necessary earned income.
The other catch: deductible IRA contributions are phased out (reduced or eliminated) if last year’s income was too high and you and/or your spouse participated in a tax-favored retirement plan last year. See the sidebar below for more info.
3. Make deductible Health Savings Account (HSA) contribution
If you had qualifying high-deductible health insurance coverage last year, you can make a deductible HSA contribution of up to $3,500 for self-only coverage or up to $7,000 for family coverage. I covered this possibility in an earlier column. See here. Note that the numbers in that column have been increased by inflation adjustments.
4. Add up health insurance premiums and medical expenses to see if you can claim a write-off
If you are an itemizer for 2019, you can potentially claim a deduction for qualifying medical expenses, including premiums for private health insurance coverage and premiums for Medicare health insurance. Specifically, you can claim an itemized medical expense deduction to the extent your total qualifying expenses exceed 7.5% of your adjusted gross income (AGI) for the year.
Since the TCJA greatly increased the standard deduction amounts for 2018-2025, fewer individuals will be itemizing on their 2019 returns. But having significant medical expenses may allow you to itemize and collect some tax savings. (For 2019, the standard deduction amounts are generally $12,200 for single filers and those who use married filing separate status, $24,400 for married joint-filing couples, and $18,350 for heads of households.)
Key Point: If you are self-employed or an S corporation shareholder-employee, you can probably claim a deduction for your health insurance premiums — including Medicare premiums. And you don’t need to itemize to get the tax-saving benefit. Ask your tax adviser for details on this write-off.
5. Choose to deduct state and local sales taxes
If you live in a jurisdiction with low or no personal income tax or if you owe little or nothing to the state and local income tax collectors, you have options. You can potentially claim itemized deductions on last year’s return for either: (1) state and local general sales taxes or (2) state and local income taxes. But not both.
However, this option only applies if you will have enough itemized deductions to exceed your allowable standard deduction for 2019 (generally $24,400 for married joint-filing couples, $12,200 for singles and those who use married filing separate status, and $18,350 for heads of households).
The other X factor: Thanks to the Tax Cuts and Jobs Act (TCJA), you cannot deduct more than $10,000 for all categories of state and local taxes combined or $5,000 if you used married filing separate status.
If you would benefit from choosing the sales tax option, you can use an IRS-provided table (based on your income, family size, and state of residence) to figure your allowable sales tax deduction. But if you hoarded receipts from your 2019 purchases, you can add up the actual sales tax amounts and deduct the total (subject to the overall $10,000/$5,000 limitation) if that gives you a bigger write-off.
Even if you use the IRS table, you can add on actual sales tax amounts from major purchases like motor vehicles (including motorcycles, off-road vehicles, and RVs), boats, aircraft, and home improvements. In other words, you can deduct actual sales taxes for these major purchases on top of the predetermined amount from the IRS table.
The bottom line
I hope you can use at least one of these ideas on your yet-to-be-filed 2019 return. If so, and if you are pressed for time, you can always extend your return to 10/15/20 by filing IRS Form 4868. You can print it out from the IRS website at www.irs.gov.
Sidebar: Ground rules for deductible IRA contributions
* You and/or your spouse, if you are married, must have 2019 earned income at least equal to what you contribute for the 2019 tax year.
* If you were age 70½ or older as of 12/31/19, you cannot make an IRA contribution for the 2019 tax year. However, thanks to a recent law change, you can make contributions for 2020 and beyond.
* If you are unmarried and in 2019 participated in a tax-favored retirement plan (an employer-sponsored plan or a self-employed plan like a SEP or SIMPLE-IRA), your eligibility to make a deductible IRA contribution the 2019 tax year is phased out between adjusted gross income (AGI) of $64,000 and $74,000. AGI includes all taxable income items and selected deductions such as the ones for self-employed health insurance premiums and HSA contributions.
* If you are married and both you and your spouse participated in retirement plans in 2019, your eligibility to make a deductible contribution for last year is phased out between joint AGI of $103,000 and $123,000. Ditto for your spouse’s ability to make a deductible contribution.
* If you are married and only one spouse participated in a plan in 2019, the participating spouse’s eligibility to make a deductible contribution for last year is phased out between joint AGI of $103,000 and $123,000. The non-participating spouse’s eligibility is phased out between joint AGI of $193,000 and $203,000.
* If you are unmarried and did not participate in a plan last year, you can make a fully deductible contribution for the 2019 tax year, assuming you had enough earned income last year to cover it. In this scenario, high AGI does not limit your right to make a deductible IRA contribution for your 2019 tax year.
* If you are married and neither you nor your spouse participated in a plan last year, you can both make fully deductible contributions for the 2019 tax year, assuming you had enough earned income to cover them and assuming you both have IRAs set up in your respective names.