Although the official tax-planning season starts in January, you can consider some year-end moves now to help cut your tax burden come April 15, 2019. Since the deadline for most strategies is Dec. 31st, take time now to review this checklist.
1. Review your income and portfolio
· Work with your Financial Advisor to consider a tax-planning move known as tax-loss harvesting. “Harvesting" all of your losses, including unrealized losses, allows you to offset taxes on gains and income. You can do this in several ways. For example, you can sell the original holding, then buy back the same securities after a minimum of 31 days. Be sure to look at all sources of income, including businesses, outside sales and private partnerships. Morgan Stanley can provide this service to you through Tax Management Services for Select Unified Managed Account.
· Take inventory of any assets that have appreciated substantially in value. If you choose to sell them, consider offsetting any gains against losses in your portfolio. You may also consider donating the appreciated securities to potentially secure a charitable deduction and avoid paying capital gains taxes on the sale proceeds. As an added benefit, charitable organizations will not owe any taxes on the securities if they choose to sell them.
· When you realize capital gains, timing can have a significant impact on your overall tax liability. If you’re expecting relatively large gains from the sale of a highly appreciated security, consider spreading that income realization across multiple tax years, which can reduce the overall taxes you owe on any potential gains.
· Keep track of capital-loss carryovers from prior years. If your capital losses exceed your capital gains in a given year, you can carry over those excess losses to offset capital gains in subsequent years, until the losses are used up. After losses offset capital gains, up to $3,000 of net capital losses can be used to offset ordinary income each year.
· Make your investment portfolio as tax efficient as possible. This may or may not put a dent in your tax bill this year, but it can make a big difference for 2019 and beyond. Holding dividend paying stocks, for instance, might not make sense if the income they produce considerably adds to your tax burden.
· Tax reform passed in late 2017 is expected to reduce the number of taxpayers subject to the Alternative Minimum Tax (AMT). Still, work with your tax advisor to estimate your adjusted gross income to determine if you will still be subject to AMT, which sets a limit on certain tax benefits. There are strategies to reduce this liability, such as by deferring or accelerating income.
· Do you hold international securities in your investment accounts? Investors holding international securities are often subject to withholding tax by a foreign government on investment income (dividends and interest). If double taxation treaties exist between the country where the investor resides and where the issuer of the security is based, investors are entitled to reclaim all or some of this money, but must do this within the statute of limitations. Talk to your Financial Advisor about tax-reclaim services.
· If you established a Health Savings Account (HSA) in 2018, you have until tax day 2019 to contribute funds to the account. The funds you contribute to an HSA are tax deductible, any earnings are federal tax-free, and distributions may be tax free if used to pay for qualified medical expenses. HSA funds may roll over year-to-year if they aren’t spent. For 2018, if you have self-only HDHP (high-deductible health plan) coverage, you can contribute up to $3,450. If you have family HDHP coverage, you can contribute up to $6,900. There is also a catch-up contribution limit of $1,000 for those who are 55 or older.
2. Review your retirement accounts
· Consider contributing to an IRA: The deadline to make a contribution to an Individual Retirement Account (IRA) for 2018 is April 15, 2019. Note the two primary types of IRAs:
(1) Traditional IRAs, contributions to which may be tax deductible; or
(2) Roth IRAs, for potential tax-free income if certain conditions are met.1 Roth IRAs are funded with after-tax dollars.
The maximum contribution is the lesser of (a) your taxable compensation for 2018, or (b) $5,500 (or $6,500 if you are age 50 or older) for 2018. These limits apply to all your IRAs combined.2
If you are self-employed or a small business owner, consider establishing and funding a Simplified Employee Pension Plan (SEP IRA). For 2018, the maximum contribution to a SEP IRA is $55,000, and the deadline to contribute is the due date of the federal income tax return for your business, generally April 15, 2019 for self-employed individuals.3
· If you’re at least 70 1/2, you have the ability to make charitable contributions of up to $100,000 per year directly from your IRAs to an eligible organization, without incurring any adverse federal income tax consequences.
· Consider a Roth IRA conversion. High-earning individuals can't invest directly into Roth IRAs, but can transfer assets from a traditional to a Roth IRA. The amount converted is subject to ordinary income tax but provides future tax-free growth potential. This strategy can work for taxpayers who will not need minimum distributions from their retirement account during retirement and plan to leave their retirement accounts to their children. Keep in mind, however, that such a conversion will increase your adjusted gross income for 2018. Also, due to changes in tax law, a Roth IRA conversion made on or after January 1, 2018 cannot be recharacterized. Roth conversions may no longer be “undone.”
· If you are older than 70 1/2, you need to take required minimum distributions (RMD) from your retirement plans, which include any IRAs4 as well as employer-sponsored retirement plans like a 401(k) by Dec. 31st. Failure to take an RMD by the deadline can result in a substantial tax penalty. If you turned 70 1/2 in 2018, you are required to start taking RMDs, although your first distribution may be delayed until April 1, 2019. Note that if you choose this option, you must take a double distribution in 2019—the amount required for 2018 plus the amount required for 2019. Speak with your Financial Advisor about how you should approach taking RMDs in the context of your overall retirement plan.
· If you’ve maxed out how much you can contribute to 401(k)s, IRAs and other retirement accounts, consider putting additional savings into variable annuities. Assets in a variable annuity maintain tax-deferred growth potential until they are withdrawn by the contract owner. When you retire, you can elect to receive regular income payments for a specified period or spread over your lifetime. Many annuities also offer a variety of living and death benefit options, usually for additional fees.
3. Take advantage of smart gifting
· Appreciated investments that you have owned for more than a year can be donated to “qualified charitable organizations.” A donor advised fund (DAF) is one option for gifting such appreciated investments. A DAF, such as the Morgan Stanley Global Impact Funding Trust (MS GIFT), gives taxpayers a tax-efficient way to donate stock, mutual funds or other assets and claim a tax deduction.5
· Make financial gifts before year end to help reduce estate taxes. You can gift up to $15,000 to an unlimited number of individuals, without incurring a gift tax. Note that you can’t carry over unused exclusions from one year to the next. The transfers may help your family as a whole pay fewer taxes if you give income-earning property to family members in lower income tax brackets. The $15,000 annual exclusion doesn’t count against the estate-tax exemption of $11.18 million, or $22.36 million for a married couple.
· Consider giving gifts through a 529 education plan. The tax code allows up to five years of gift-tax exclusions in a single year, which is as much as $75,000 per recipient or $150,000 per recipient for married couples.6
4. Finalize Your Divorce in 2018
· As a result of tax reform, a person who gets divorced after Dec. 31, 2018, will no longer be able to deduct alimony payments against income on a tax return. If you are in the midst of divorce negotiations and expect that you will have to pay alimony to your ex-spouse, you may want to accelerate the proceedings to finalize the divorce before year end to preserve your ability to claim the alimony deduction in future years.
Speaking of tax reform: Note that other elements of the 2017 changes may affect your 2018 return.
Speak with your Morgan Stanley Financial Advisor or Private Wealth Advisor and your personal tax and legal advisors to determine which strategies might be appropriate for you.
1 Restrictions, tax penalties and taxes may apply. For a distribution to be an income-tax-free qualified distribution, it must be made (a) on or after you reach age 59½, due to death or qualifying disability, or for a qualified first-time homebuyer purchase ($10,000 maximum), and (b) after the five tax year holding period, which begins on January 1 of the first year for which you made a regular contribution (or in which you made a conversion or rollover contribution) to any Roth IRA established for you as owner.
2 Other limitations may apply (e.g., age restrictions for traditional IRA contributions and income restrictions for Roth IRA contributions).
3 A SEP contribution for 2018 may be made through the filing extension deadline (generally 10/15/19 for self-employed individuals), provided the client or their tax advisor has obtained an extension to file the federal income tax return for the business.
4 Not including Roth IRAs.
5 The maximum deduction for a gift to a DAF is limited to 60 percent of adjusted gross income (AGI); deductions exceeding AGI limits may be carried forward for up to five years. Grants can be made over time to any U.S. organizations that are tax-exempt public charities, U.S. religious houses of worship, U.S.-qualified foreign charitable organizations and at an additional cost other domestic and foreign organizations that do not qualify as U.S. public charities.
6 This assumes there are no gifts made by the gift giver to the beneficiary in the prior five years. Any gifts made in the five years prior to or the four years after an accelerated gift is made may result in a taxable event.
Tax laws are complex and subject to change. Morgan Stanley Smith Barney LLC (“Morgan Stanley”), its affiliates and Morgan Stanley Financial Advisors and Private Wealth Advisors do not provide tax or legal advice and are not “fiduciaries” (under ERISA, the Internal Revenue Code or otherwise) with respect to the services or activities described herein except as otherwise provided in writing by Morgan Stanley and/or as described at www.morganstanley.com/disclosures/dol . Individuals are encouraged to consult their tax and legal advisors (a) before establishing a retirement plan or account, and (b) regarding any potential tax, ERISA and related consequences of any investments made under such plan or account.
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