If you haven't filed your individual federal income tax return yet, there still may be opportunities to lower your tax bill for the 2019 tax year.
Though most tax-planning moves must be completed by the end of the tax year, a few options remain available. Here are some options to consider before the April 15 filing deadline.
State and Local Income Taxes vs. State and Local Sales Taxes
Individuals who claim itemized deductions have the option to deduct either 1) state and local income taxes, or 2) state and local general sales taxes. In other words, if you live in a state with low or no personal income tax or if you owe little or nothing to the state tax collector, you can elect to deduct state and local general sales taxes in lieu of state and local income taxes.
If you choose the sales tax option, your tax preparer will use an IRS-provided table to calculate your state sales tax deduction. That table bases your deduction on three factors:
- Family size, and
- State of residence.
Local general sales taxes are added to the state sales tax figure.
However, if you kept receipts from your 2019 purchases, you can add up the actual sales tax amounts paid and deduct the total — 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, such as 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.
Important: Under current law, through 2025, the deduction for state and local taxes — including income (or sales) taxes and property tax — is limited to $10,000 annually ($5,000 if you're married and file separate tax returns). Also under current law, the standard deduction is much larger than it used to be so fewer taxpayers are itemizing deductions.
Deductible IRA Contributions
If you've not yet made a deductible traditional IRA contribution for the 2019 tax year, and you qualify for one, you can do so between now and the tax filing deadline of April 15, 2020, and claim the write-off on your 2019 return. You can potentially make a deductible contribution of up to $6,000 (or $7,000 if you were age 50 or older as of December 31, 2019). If you're married, your spouse can potentially do the same, thereby doubling your write-off.
There are three ground rules for deductible IRAs. First, you must have enough 2019 earned income (from jobs, self-employment or taxable alimony received) to equal or exceed your IRA contributions for the 2019 tax year. If you're married, either spouse (or both) can provide the necessary earned income. Second, you can't make a deductible contribution for the 2019 tax year if you were 70½ or older as of December 31, 2019.
Important: The Setting Every Community Up for Retirement Enhancement Act repeals the age restriction on contributions to traditional IRAs for tax years beginning after 2019. So, unfortunately, the age limit on traditional IRA contributions isn't lifted until tax year 2020. Learn more about the SECURE Act changes here.
Third, deductible IRA contributions are phased out (reduced or eliminated) if last year's income was too high. The phaseout ranges have increased in recent years. Here are the phaseout ranges for 2019:
- If you're single (or file as a head of household) and were covered by a retirement plan in 2019 (whether an employer-sponsored plan or a self-employed plan), your eligibility to make a deductible contribution for last year is phased out between adjusted gross income (AGI) of $64,000 and $74,000. For married filing separately, the phaseout range is $0 to $10,000.
- If you're unmarried and weren't covered by a plan, your eligibility to make a deductible contribution isn't affected by your AGI. You can make a fully deductible contribution up to the applicable limit, assuming you have enough earned income.
- If you're married and both you and your spouse were covered by retirement plans in 2019, the eligibility of both you and your spouse to make deductible contributions for last year is phased out between joint AGI of $103,000 and $123,000.
- If you're married and weren't an active participant in an employer-sponsored retirement plan for 2019, but your spouse was, your deductible IRA contribution phases out with AGI of between $193,000 and $203,000.
If neither you nor your spouse were covered by a plan, your eligibility to make a deductible contribution isn't affected by your AGI. You and your spouse can both make fully deductible contributions up to the applicable limit, assuming you have enough earned income.
For example, let's suppose you're a married individual in the 22% federal bracket. Making a $6,000 deductible IRA contribution between now and April 15 would reduce your federal income tax bill by $1,320 (plus any state income tax savings). If you and your spouse were both over age 50 as of December 31, 2019, two $7,000 deductible IRA contributions (a total of $14,000 in deductible IRA contributions) would reduce your federal income tax bill by $3,080 (plus any state income tax savings).
If you operate a small business and you don't have a tax-favored retirement plan, you might consider setting up a simplified employee pension (SEP). Unlike other types of small business retirement plans, a SEP can be established as late as the extended deadline for your 2019 tax return, and your deductible contribution for the 2019 tax year can be made as late as that extended due date. So, if you're self-employed and extend your 2019 return, you have until October 15, 2020, to establish a SEP and make a deductible contribution for last year.
How much can you contribute to a SEP? Your deductible contribution can be up to 20% of your 2019 self-employment income or up to 25% of your 2019 salary if you work for your own incorporated business. The absolute maximum amount you can contribute for the 2019 tax year is $56,000. So, the tax savings can potentially be substantial.
For example, let's suppose you're self-employed and in the 24% federal tax bracket. If you make a $25,000 deductible SEP contribution on April 1, 2020, you could lower your 2019 federal income tax bill by $6,000 (plus any state income tax savings). In fact, the tax savings could finance a big chunk of your contribution.
Important: You may not want to establish a SEP if your business has employees. Why? The tax rules may require you to also make contributions to their accounts. If you have employees, discuss the pros and cons with us and your legal advisors before setting up a SEP.
The federal income tax filing deadline for individuals is coming up quickly. So, if you haven't yet filed (or extended) your 2019 return, contact us. We can help soften your tax hit with these and other planning moves.