- December 3, 2019
In December 2017, Congress passed and the President signed the Tax Cut and Jobs Act (the “2017 Act”) making significant changes to the tax laws, including provisions related to individual taxation. Most of these changes became effective in 2018.
We saw very few changes to the tax laws in 2019 and, with 2020 being an election year, it is unlikely that we will see any substantive tax legislation enacted between now and the election in November 2020. That said, some Democratic presidential candidates have proposed rolling back large sections of the 2017 Act and instituting a variety of new taxes.
As is true each year, we recommend taxpayers take steps at the end of 2019 to assess their current tax situation and take steps to better position themselves for 2019 and the coming year.
The current tax rates include a top marginal rate of 37%. As has been true for some time, short-term capital gains continue to be taxed at ordinary rates. Long-term capital gains and qualified dividends continue to be taxed at rates of 0%, 15% and 20%. However, these rates now have their own brackets and are no longer tied to the ordinary income brackets. For 2019, the ordinary and long-term capital gain rates are:
Long-Term Capital Gain Rates
$0 - $19,400
($0 - $9,700)
$0 - $78,750
($0 - $39,375)
$19,401 - $78,950
($9,701 - $39,475)
$78,951 - $168,400
($39,476 - $84,200)
$78,751 - $488,850
($39,376 - $434,550)
$168,401 - $321,450
($84,201 - $160,725)
$321,451 - $408,200
($160,726 - $204,100)
$408,201 - $612,350
($204,101 - $510,300)
* Married couples filing a joint return are subject to an additional 0.9% Medicare tax on aggregate wages, other compensation, and self-employment income over $250,000. For individuals, the additional Medicare tax applies to aggregate wages, other compensation, and self-employment income over $200,000.
** Married couples filing a joint return are still subject to a 3.8% surtax on net investment income (interest, dividends and capital gains) if their income exceeds $250,000. For individuals, the surtax applies if an individual’s income exceeds $200,000.
Standard Deduction versus Itemized Deduction
When filing your personal income tax return, taxpayers have the option of claiming either a standard deduction or itemizing their deductions. The 2017 Act essentially doubled the standard deduction. For 2019, the standard deduction is $24,400 for married couples, $12,200 for single filers; and $18,350 for individuals filing as head of household.
Due to the substantial increase in the standard deduction made by the 2017 Act, a much larger percentage of the population finds themselves claiming the standard deduction. If you find that your itemized deductions are roughly equal to your standard deduction, consider accelerating some of your itemized deductions into 2019. This will allow you to enjoy a tax benefit for these deductions in 2019 while simply being able to claim the standard deduction in 2020. For example, if you planned to make certain charitable gifts in early 2020, you may consider accelerating those gifts into 2019. Likewise, you may consider accelerating certain state tax payments, such as state estimated tax payments. Keep in mind, however, that the 2017 Act limited the deduction for state and local taxes to $10,000 annually.
Review Capital Gains and Losses
Each year, we recommend taxpayers review their portfolio to determine the amount of capital gains and losses they have recognized during the year. 2019 has been another strong year for the stock market. If you find that you have significant exposure to tax on capital gains, review your portfolio for possible capital losses that can be used to offset the gains. If you have any capital loss carryforwards, you should review your portfolio for capital gain opportunities to make use of such carryforwards. In general, net capital losses are deductible dollar-for-dollar against net capital gains. Excess losses are allowed to offset up to $3,000 ($1,500 for individuals filing married filing separate tax returns) of ordinary income per year. Losses over and above the limit may be carried forward indefinitely.
Changes in 2017 Act that became effective in 2019
While most of the changes from the 2017 Act became effective in 2018, a handful of changes did not take effect until 2019.
Elimination of the Personal Mandate
The Affordable Care Act (the “ACA”) generally requires that U.S. citizens and permanent residents maintain health insurance. One of the cornerstones to the enforcement of ACA was the individual mandate. The individual mandate imposed a tax on individuals who failed to maintain required insurance. Beginning with 2019, the 2017 Act eliminated the individual mandate.
While the federal individual mandate has been eliminated, certain states have imposed their own individual mandate. Illinois does not currently have an individual mandate, but New Jersey, Washington D.C., and Massachusetts do. Vermont, Rhode Island and California are currently considering a state individual mandate.
Previously, the recipient of alimony payments included such payments in his or her taxable income, while those making alimony payments were allowed a deduction for the payments. The 2017 Act provides that, for divorces or separation agreements executed after December 31, 2018, alimony recipients no longer include alimony payments received in taxable income. Conversely, those making alimony payments are not allowed a deduction. Child support payments remain non-deductible by the payor.
Beginning in 2019, taxpayers may deduct only the amount of unreimbursed medical care expenses for the year that exceed 10% of their adjusted gross income. In 2018, the deduction was limited to only 7.5% of a taxpayer’s adjusted gross income.
IRA Charitable Rollover (THIS PARAGRAH IN A BOX)
In 2016, the provision allowing individuals age 70½ and older the ability to distribute up to $100,000 annually from an IRA to a charitable organization was made permanent. By distributing funds directly from an IRA to charity, the distribution is not included in the account owner’s taxable income (and the account owner is not allowed to claim a tax deduction for the charitable contribution). The IRA Charitable Rollover remains available after passage of the Act.
Estate & Gift Taxes
The 2017 Act essentially doubled the unified exemption amount. For 2019, the exemption amount is $11.4 million ($22.8 million for married couples; and, for 2020, the exemption increases to $11.58 million ($23.16 million for married couples)). The top tax rate for estate and gift tax purposes remains at 40%.
The generation-skipping transfer (“GST”) tax is still in place. Generally, the tax applies to lifetime and death-time transfers to or for the benefit of grandchildren or more remote descendants. For 2019 and 2020, the rate is a flat 40 percent. The tax is in addition to any gift or estate tax otherwise payable. As with the gift and estate tax, each taxpayer is allowed an $11.4 million GST tax exemption for 2019; and $11.58 million for 2020.
While there have not been changes to the estate and gift tax regime since passage of the 2017 Act, the estate and gift tax has been prominently mentioned by several Democratic candidates for President as an area which should be reformed, with many candidates suggesting that the exemption amount be substantially reduced. While we do not anticipate any significant changes to the estate and gift tax until after the 2020 Presidential election, many individuals are acting now to take advantage of the current lifetime exemption amount and to better position themselves in the event significant changes are made to the estate and gift tax.
Consider Lifetime Gifts that take Advantage of both the Gift Tax Exemption and GST Exemption
Many clients utilize a portion or all of their gift tax exemption by structuring long-term GST exempt trusts benefiting multiple generations. Such trusts will remain exempt from all gift and estate tax as long as the trust remains in existence. Under Illinois law, such trusts can last in perpetuity, thereby allowing you to create a family "endowment fund" for your children, grandchildren and future descendants.
Annual Exclusion Gifts
In 2019, you may make a gift of $15,000 to any individual and certain trusts without any gift tax consequences. Married individuals may make gifts of up to $30,000 per donee. Gifts may be made outright or in trust and may be in the form of cash, securities, real estate, artwork, jewelry or other property. Giving property that you expect to appreciate in the future is an excellent way of utilizing your annual gift tax exclusion because any post-gift appreciation is no longer subject to gift or estate tax. To take advantage of the gift tax annual exclusion for 2019, gifts must be made by December 31. Gifts over $15,000 or gifts that will be “split” between spouses must be reported on a gift tax return, which must be filed in April 2020. The annual exclusion amount is expected to remain at $15,000 in 2020, and $30,000 for married couples.
Payment of Tuition and Medical Expenses
In addition to annual exclusion gifts, you may pay tuition and medical expenses for the benefit of another person without incurring any gift or GST tax or using any of your gift or GST tax exemption. These payments must be made directly to the educational institution or medical facility. There is no dollar limit for these types of payments, and you are not required to file a gift tax return to report the payments.
Take Advantage of Today’s Low Interest Rates
Interest rates continue to remain at historically low levels. In fact, they have declined over the past several months. Low interest rates enhance the benefits of several gift and estate planning strategies. One such strategy is the “grantor retained annuity trust” or GRAT. A GRAT is an irrevocable trust to which a donor transfers property and retains the right to receive a fixed annuity for a specified term. At the expiration of the term, the property usually passes outright or in trust for the benefit of descendants or other named beneficiaries. The amount of the gift resulting from the transfer of the property to the GRAT is the present value of the remainder interest that passes to the beneficiaries at the end of the term. Under the valuation methods adopted by the IRS, the lower the interest rate at the time of the gift, the lower the present value of the remainder interest and the smaller the amount of the gift that must be reported to the IRS. Interests in marketable securities with high growth prospects are often ideal properties to transfer to a GRAT. While there has been considerable discussion about disallowing “zeroed-out” GRAT’s and requiring a minimum GRAT term of 10 years, Congress has not taken any action in this respect. As a result, GRAT’s remain a very attractive planning opportunity.
THIS PARAGRAPH IN A BOX
Example –Individual funds a GRAT with $1 million. The GRAT’s term is 5 years and its assets appreciate at a rate of 6%. Assuming the applicable IRS interest rate is 2.0% (the rate in effect for December 2019) and the GRAT is “zeroed-out”, the remainder value of the GRAT assets at its termination would be approximately $142,000. In other words, the GRAT structure would have allowed the individual to transfer assets valued at approximately $142,000 to his or her children or designated beneficiaries without incurring any gift tax obligation or utilizing any of his or her lifetime exemption amount. If the assets inside the GRAT were to appreciate at a rate of 8%, the remainder available to the trust’s beneficiaries would be approximately $225,000.
Low-interest rates also make sales to “defective” grantor trusts more attractive. Under this strategy, a taxpayer creates a trust, typically for his or her spouse and descendants. The taxpayer then sells assets to the trust taking back a note requiring the trust to repay the taxpayer in installments. The trust is structured so that it is ignored for income tax purposes, resulting in no income tax consequences upon the sale. The interest paid on the note is typically at the applicable federal rate in effect at the time of the sale. The lower the interest rate on the note, the greater the amount of assets that will accumulate in the trust free of estate, gift and GST taxes.
This article was prepared by tax partner Greg Winters. He can be reached at (312) 840-7059 or firstname.lastname@example.org.