Here is a transcript of the webinar:
Cindy Grether:
Okay, well, I want to introduce everybody to our presenter today Hratch Karakachian. Hratch has been teaching with Cal Lutheran University for the past seven years and he’s been mainly teaching in the financial planning program, although he’s taught at Cal Lutheran in other programs and in the MBA program also.
You know Hratch, is a CPA, he has a Masters of Business Taxation from USC. So that’s some of his background. He’s also a Juris Doctorate, he has a Juris Doctorate so we’re lucky to have him in our program because he can teach a lot of different classes like the estate planning class, the tax class and any of our accounting type classes. So we’ve been really lucky to have him working with us.
You know, I think I read in your bio since 2012 you’ve been providing legal services, with an emphasis in taxation estate planning, real estate and business advisory services and so that’s what you do mainly, but on the side you work with us and we’re really privileged to have you working with us, so I’m going to go ahead Hratch and you can start your presentation on year-end taxation.
Hratch Karakachian:
Thank you, Cindy for that kind introduction and welcome everyone. Okay, I’ll go ahead and get started because we have a lot to cover. And we don’t have too much time. As people start trickling in, I think it everybody can see the slides here?
Cindy Grether:
I can see them, fine.
Hratch Karakachian:
Let’s spend just a few seconds on the agenda. I’m going to cover some preliminary matters, then we’ll get into some tax planning ideas for individuals and some separate and distinct ideas for businesses, you’ll have my contact information we will have a Q&A session.
I’ve only been a lot of 20 minutes and covering all of this information 20 minutes is a virtual impossibility. So, I beseech you to hold your questions until the end. So I can at least spend a few seconds on each subject, to give you some background.
On this, so my preliminary matters is timing is really important. I’m very glad that all of you are here attending this, we only have about 47 days left until the end of the year, when the year closes and the New Year rolls around it’s too late to do any planning. So now’s the time and some important items, I’m sure you know a lot of this stuff, for this is a quick review for you.
Accumulating the financial information for you and or your clients if you’re a financial advisors. Accumulating the financial documents or assisting your clients to gather this information and then reviewing any closed transactions or open transactions to see if they’re going to be closing before the end of the year, whether you want you or your clients want them to close or keep them open, and maybe push them in as 2020 transactions.
The other item that I wanted to mention briefly is analyzing these financial transactions. It’s not fun work. Someone has to dig into the, the numbers and prepare projections look up the transactions analyze them and also keeping an eye on what is happening in 2020 or 2021 in terms of transactions that taxpayers are contemplating or would come up
The tax cuts and jobs act, I think will be with us for the near future, unless there’s a major impact and major shift in congress next year. We can see some changes there, but for the most part 2019 and 2020 I don’t expect any changes from a tax perspective and also coordinating all of this information with the tax advisors is very, very important.
So let’s get straight into the planning for individuals. The two key items here deferring income to a future year by either planning for something not to close in or opening a transaction in December and then waiting and not doing anything until it’s formally closed in January.
So what type of things will taxpayers do in terms of differing income to a future year?
Maxing out pre retirement plans. So if clients have not maxed out their retirement plans. This is a pre tax retirement plans, it’s a good time to increase their contributions, to reduce their income. Also looking into IRA contributions, even if they’re members of a defined contribution or defined benefit plan. There’s always an opportunity to make non deductible contributions and there’s in certain circumstances with lower AGI’s individuals can get a deduction for some IRA contributions.
Roths are very, very big and they’re gaining in popularity every day. So that’s always something to look into it to consider. There’s some limitations on IRA contributions, income limitations. So for those who are moderate or high income earners who do not qualify for an outright graph contribution.
There’s a potential doing a backdoor Roth, which includes opening up traditional IRA and converting those funds into a Roth. There are some rules that need to be followed in the conversion, specifically with the backdoor Roth. Having those thinking about those couple of few rules is very, very important to make sure that the backdoor roth work smoothly.
Also Roth conversions and Roth conversions obviously increases income because the pre tax contributions sending in defined contribution plans or 401K plans that are going to be converted into a Roth. The individual converter, if you will, has to recognize all of those funds as income and you’re probably thinking, well, why would somebody do that because the first bullet point here says deferring income to a future year.
Well there’s some advantages. It’s very, very fact and circumstances specific. So the numbers have some projections that have to be done and it would make sense for certain individuals to do Roth conversion specific especially if they have years where they’re going to be in a lower income tax bracket. Or there’s an expectation that they’re going to be in higher tax brackets in the future. Or if you believe that the rates are going to be much higher several years down the line, which is a time period where individuals would have to withdraw or take out their distributions out of their retirement plans. Of course, with Roth’s, Roth owners do not have to take out distribution so long as they’re alive. So there’s one advantage, they’re allowing the rock to grow.
Keep the NIT, the net investment tax in the back of your mind. That’s the 3.8% tax that came about during the Obama administration. There’s quite a large number of taxpayers, especially those earning portfolio type income who gets stung by this tax and it’s an additional tax that could be managed under certain circumstances.
Qualified opportunities zones this came out in the tax cuts and jobs act, it’s still, it’s, it’s an early stages. These investments allow individuals to rollover their gain from the sale of their capital gains from the sale of securities or the sale of real estate into the so called opportunities own investments, and that allows the taxpayer the differ and to a certain extent, eliminate some of that game.
The IRS has issued some rulings and regulations clarifying some points, but there’s still some information that’s not clear on these investments and there’s a couple of senators asking the IRSto issue additional guidance and information.
The secure app which overwhelmingly passed the House this year, made some significant changes to defined contribution plans. One of the changes is it’s going to get rid of, if it passes the Senate and signed by the President that has not happened yet, but if it does the Security Act as it passed the House will eliminate the opportunity for individuals who inherit an IRA. To be required to be forced to take out distributions of the entire balance over a 10 year period.
If this rule passes, the laying or deferring distributions from an IRA is going to be very, very difficult to do. So if there’s individuals who have trusts either look through trust or accumulation trusts. As the beneficiaries of IRAs, those are the folks that should be very, very cognizant of this week. Because if this passes non spouse beneficiaries will be forced to distribute the funds within a 10 year period, which is going to delay the future appreciation of funds in IRAs and these pension plans.
Now let’s shift over to the deductions.
I talked about deferring income and the previous slide, which makes sense in certain circumstances. Here we talk about accelerating the deductions. In other words, taking the actions in 2019 to reduce the adjusted gross income for individuals and also their taxable income.
Before the tax cuts and jobs act a lot of people prepaid their state income taxes, they prepaid their property taxes. That planning option is pretty much on because of the $10,000 cap and for most people who live in high tax jurisdictions in New York, California, New Jersey, Massachusetts are way over this 10,000 tax cap. So now the option is not to accelerate the payment of property taxes and the delay them into a future year with the hope and the goal to temper this kappa of this $10,000 account.
Charitable contribution planning with the increase in the itemized deductions. A lot of taxpayers are taking the standard deduction. So most of them don’t have to itemize but there’s some planning that could be done.
With respect that a charitable contribution planning also health care expenses. So if you have clients were charitably inclined or clients or tax peers who are spending or will be spending large amounts on health care expenses, there might be some planning opportunities to prepare those expenses ahead of time to take advantage of those deductions, if in total those deductions are higher than the standard deduction. As remember you take the higher of the two. Either the standard deduction or itemized deduction and itemize adoptions, whichever is more beneficial to the tax.
But what are some of the charitable contribution planning points?
Qualified charitable deduction is when an individual can direct their required minimum distribution out of an IRA to a qualified charity. The funds can’t be coming to the owner of the IRA, they have to go directly to charity, but the check can be sent to the owner of the IRA. The owner can either deliver it or send it off to the charity.
Now, this point is helpful because it prevents or helps the taxpayer from not reporting the income. They don’t get a tax deduction for QCD, but then again, they don’t have to report the income which keeps their adjusted gross income low, which helps with some of the either other itemize deductions. There’s the bunching where individuals could contribute more in one year and less than the following year and so on so forth. By making higher contributions, so that they can take advantage of the itemized deductions. Donor advised funds are very popular. I read something yesterday one of the business bulletins, maybe it was Forbes or The Times, that as a result of the tax cuts and jobs act, donor advised funds donations has increased dramatically over the last year or so.
Also donations of marketable securities helps because it prevents the taxpayer from reporting and again on sale of the securities and there’ll be more bank for the buck and more funds would go to the charity and the taxpayer would end up paying less taxes.
Health care expenses now there’s a limitation the threshold has gone up to 10% of AGI.But if you have older taxpayers who spent substantial funds on healthcare medical expenses, they could take advantage of this, especially if they have relatively lower AGI’s. Doctors, dentists, health insurance, premiums prescription medication, also caregiver salaries.
Taxpayers and I have a couple of clients in this situation who need 24 hours, seven days a week care because they need assistance with their activities of daily living. A caregiver salaries can be deducted as medical expenses so keep that in mind as you’re working with clients and taxpayers.
Another thing that employees can do before your end is to double check their tax withholdings make sure that they have enough tax withheld. Of course, that requires doing a projection, trying to figure out where they’re at with respect to their income and their tax liabilities and there’s enough information now because the October 31, ten months of information would give individuals a good idea where they stand for 2019 from a taxable income perspective. So that would be a good opportunity for individuals to run their numbers to see where they are and to see if they need to send in more and to have additional withholdings or make estimated tax payments, if they prefer. Of course, then that employees can do both. They can submit taxes withholdings or make estimated taxes. Where self employed individuals are required to send in their estimated tax payments, the estimates and there’s no withholding opportunities.
Required minimum distributions for those who are over 70 and a half is something to keep in mind, the penalties on not taking out distributions are severe so I recommend everybody to double check and make sure that those distributions are taken.
Health savings accounts, contributions, this provides a triple benefit. There’s a tax deduction upfront when the contribution is made. The funds grow on a tax deferred basis and when the funds come out to pay from a qualified medical expenses, make them on a tax free basis. This requires having a high deductible plan and for the most part, that’s reasonably easy to determine if have been individually as a high deductible plan or not. If they don’t, they have a high deductible plan and they don’t have an H an HSA. This is another way of creating additional deductions and reducing their income.
Loss harvesting rule, even though only $3,000 of capital losses are allowed against the offset. Portfolio and ordinary income. This is still a good planning option, given how the stock market has done over the last year or so. Most portfolios have built in appreciation, but if there’s some some positions that have built in losses, one could consider selling those, but keep the wash sale rules in the back of your mind when you do that or when your clients do that. One option would be to take the wait and see approach to roll the dice to sell the last position. Wait 31 days and then buy it back.
The other thing to think about is if you have individuals or clients who have multiple accounts with different brokerages and they’re trying to do some loss harvesting, you have to make sure that it the other investment advisor or the other broker is not buying the same stock. That requires reviewing the monthly statements to make sure that that hasn’t happened. If all of the investments are at one financial institution, it’s a little bit easier to do. But if there are multiple institutions, you have to double check to make sure that the exact same stock has not been purchased within the 31 day window.
A few additional comments regarding the estate and gift tax, the exclusion is pretty high. So they’re very, very few people who will be impacted by this.
The high estate and gift tax exclusion will be with us until the end of 2025, unless Congress changes the rules. For the last several years, three and a half million dollars is the amount that is the sweet spot that a lot of politicians like. It’s high enough to help certain tax bearers but it’s not too high. There’s a big movement now to come up with a wealth tax or an estate tax, to force people to pay tax on their wealth, their fair share so to speak.
But let me make one point even if you have clients who are below this amount it is possible if there’s a change in the law and the exclusion drops down to, let’s say, the original amount which was 5 million adjusted for inflation, that amount could be somewhere in the neighborhood of five and a half to six and a half. So if nothing happens as of January 1, 2026, this 11.4, 11.58 million. (these are the amounts for 2020) it’s 11.4, 22.8 for 2019 those these amounts, these exclusion amounts are going to drop down to the six, five and a half million neighborhood.
The IRS has come on and said that if there are individuals who take advantage of these higher amounts will not have to pay a penalty if the amounts are dropped down to lower levels at some point in the future.
Access business loss and changes to net operating losses is something that was put in place by the tax cuts and jobs act. That limits individual taxpayers from taking advantage of their losses.
Not operating loss can only shelter 80% of someone’s taxable income and in the access business loss, there are some limits where business losses cannot be used to offset all of an individual’s ordinary income.
So let me give you a quick example. I know I’m running out of time, so bear with me for just a few more minutes. If you have an individual who has W-2 income but has some investments, some active in an S corporation or partnerships that are generating losses.
Before the tax jobs and jobs act if those losses were more than the W-2 income of this specific taxpayer, taxable income would be zero because that individual would be allowed to offset their entire income. But now, under this excess business loss rule, they’re limited and they will not be allowed to use their otherwise active operating losses to offset all of their income.
For the higher wealth, folks, the annual gifting is still an option $15,000 per year. Funding 529 plans also paying tuition for children and grandchildren. Tuition directly to the educational institution and the payment of health care expenses directly to the medical service provider are not treated as taxable gifts requiring the filing of the gift tax return.
Insurance check up, I have this point here, just as a reference and as a reminder. It’s always a good idea to at least once a year to sit down and talk with an insurance agent to go over the insurance policies, liability insurance, health insurance, malpractice insurance, etc.
There is a California Healthcare mandate now that will be effective as of January 1, 2020. The federal health care mandate has pretty much gone but California and some other states, including New York and I believe, New Jersey, have a state healthcare mandate now and for those individuals who do not have healthcare insurance there’s going to be a $695 penalty or a tax charged by the franchise tax board and this would apply to California residents in California taxpayers, obviously. There’s some benefits that are still in place for teachers $250 for eligible educators, including K through 12 system.
If they purchase supplies and items to be used in the classroom, they can deduct $250. There’s also the education credits that are still available but their restrictions on the amount of income individuals have to be able to take advantage of these credits.
Sometimes it’s more advantageous for children to take the credits instead of the parents, but you have to look at the circumstances and see which one would benefit the other.
A few comments for businesses, just a couple of points that I talked about deferring income and accelerating deductions, specially for tax cash basis taxpayers where if their purchases have to be made, supply type purchases. They can be made in November, December of 2019 and be written off as deductions against the income of 2019. So long as they’re used within one tax year.
Vehicle expenses require some documentation. Personally I take advantage of the vehicle expense because I keep track of my mileage driving, etc. and that generates a substantial tax deduction for me. I recommend it to everybody. It’s the very tedious approach to keep track of the daily trips and the mileage, but it adds up very, very quickly if you’re doing a lot of driving
$1.99 A is the is the qualified business income deduction. That came about what the tax cuts and jobs act also it was first tax return applied to us 2018. There’s some calculations and there’s some restrictions on taking advantage of that qualify business income deduction, especially with specialized service trader businesses, the SSTB’s. These are predominantly the service providers, medical professionals, doctors, lawyers, accountants, insurance professionals, for some reason, architects and engineers are not treated as SSTB’s.
But there are thresholds for individuals to take advantage. These are the threshold amounts for single and married individuals, if your taxable income is higher than those amounts and if you’re running a service business, you’re not going to be able to take advantage of the qualified business income that action. The qualified business income deduction allows a 20% reduction of your of your qualified business income which reduces the tax rate.
From a high of 37% down to 29.6% and even if you don’t have a service business there’s some limitations as well. W2 limitations and also cost basis limitations of assets used in a trade or business. This requires some thinking and analysis as well. But there’s a lot of businesses that take advantage of this and which is helpful for a lot of businesses.
The state and local tax deduction. There’s a $10,000 cap for individuals, but for businesses. If have a rental real estate or real estate investments, property taxes are allowed 100% against the rental income. So there’s no cap for businesses that incur state and local and property taxes.
The other item for businesses is bonus depreciation, which is 100% for shorter life assets. For 2019, 2020 and 2021 shorter life assets, five, seven, and 15 year property will be allowed to take a 100% depreciation deduction.
So for example, if you buy a computer used in your trade of business for $5,000, this rule, this bonus depreciation rule, will allow you to write off the entire $5,000 in year one in the year it’s purchase. The goal behind this rule was to promote and help in the investments in businesses to acquire property.
This does not apply to longer life, real estate assets, residential real estate or commercial real estate, but it does apply to shorter life assets.
It is an election so there has to be a filing with the return for purposes of bonus depreciation. There’s also the section 179, those limits have been increased, but since bonus depreciation is around section 179, it will not be used because it gets you the same place. Section 179 also allows for 100% deduction for purchases of shorter term property, 5, 7, 10 and 15 year property.
This was heavily used by businesses, smaller businesses because there were some limitations on this rule that since bonuses are in there, ost people would use the bonus depreciation rules as opposed to section 179.
Here’s some background information about me and my contact info. I’ll stick around for a few minutes here to answer any specific questions you have, or feel free to connect with me offline. Thank you everyone for your attention and I’m all yours starting right now.
Marcus has a question. Let’s look at that first
Question:
Is your physician client active in the S corp business? Is it unrelated to the medical practice?
Karakachian’s Answer:
So, the limit is 250 for single taxpayers, 500,000 for married taxpayers. The losses from the active business cannot reduce the income by more than $500,000 for married taxpayers. So for example if we look at this fact pattern you gave me a 565 that we do. If your client has $500,000 lot of losses from somewhere else, from another business, then he could reduce this taxable income down to 65. If, for example, he’s got losses of 600 he can only reduce his tears W-2 income down to 65 and the $100,000 of excess loss, is not lost. That will be carried over 2020 as a net operating loss. Does that answer your question Marcus?
By unrelated business, I meant if this was another trader business that the individual was involved in. The example above, Andrew, if you look at the example Marcus posted a 565 if this individual, this physician is incorporated and they’re taking out a salary out of the corporation. That corporation is going to have an income or a loss driven by the W-2 income. Okay? So that analysis here, in that case, the physician is not going to be able to pay themselves a 565.
Question: If the W-2’s from the S corp, they must be going to qualified plan contributions?
Karakachian’s Answer: Perhaps I don’t know. You can have a W-2 to 565 coming from their own S corp and still generate a loss in the S corp somebody’s going to be funding that S corp somehow.
Question:
You have an individual who has a W-2 from their employer. Then they have another side business where their partner is an individual who is a shareholder in an S corporation, a separate S corporation, a separate partnership with a separate trader business and that entity is generating the loss. It also applies to individuals who have high portfolio income. Where the losses will not be allowed to eliminate a portfolio income.
Yeah, Brett had a comment earlier. About the 75.8 discount rate regarding charitable remainder trusts and charitable lead trusts. Those are helpful, but they have some brilliance. There’s some compliance issues with forming a charitable trust. There’s some legal fees. An attorney has to draft a documents to set one up and there’s also annual compliance costs, the trust have to fall returns on an annual basis, and those returns can get pretty complicated.
Question:
Brent has another comment here- credit cards work for cash basis taxpayers?
Answer:
Yes, that’s correct. So if you charge something on December 31 even though you’re not going to pay for it until sometime in January, you could still take it as a deduction for 2019 because the charge was made in 2019 and the credit card holder is obligated to pay for that charge
Question:
There is a question about homeschoolers
Answer:
I’m not sure, but I don’t think so. I think that K to 12 is for the supplies to be used at a school. At an actual, physical school where there are students and a full time faculty, but I’m not a hundred percent sure.
Any questions, any additional comments, questions? No? Great. Well, thank you everybody for your time and attention. I’m always available if you want to run things by me, give me a call or send me an email or connect with me through LinkedIn.
Your calls are always welcome and I’d be happy to share my thoughts and impressions with you. Have a good afternoon everybody and have a productive rest of the year. Bye.
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