With the end of the year fast approaching, you might be starting to think about your tax situation. But as you will soon find out, it’s best to do tax planning year-round.
In this episode, Marc Bautis welcomes guest Kenneth Lam, the CPA, CEO, and founder of CPA Tax & Financial Planning, to discuss ways you can improve your tax situation by planning throughout the year and not just at the end.
In this episode, you will learn:
- The difference between tax deductions and tax credits
- Reasons to use capital gains towards opportunity zones
- About new deductions available to all business owners
- About the W-4 withholding allowance
- And more!
Tune in to learn how tax planning year-round can benefit you or your business.
Hello and welcome to the Agent of Wealth with Marc Bautis of Bautis Financial. Today we are welcoming a special guest into the studio and that is Kenneth Lam.
We have Kenneth Lam on the show today. Ken is a CPA, and the founder and owner of CPA Tax and Financial planning out of Edison in the same state as me (New Jersey). Ken, welcome to the show. Thank you. We brought Ken on today to talk about some tax planning strategies.
We’re in the fourth quarter, and people should be meeting with their CPAs prior to the end of the year. Ken, what should people be talking to their CPAs about from now until the end of the year, to try and optimize their tax situation?
I look at it as tax planning, not just a year-end thing. It should be from first quarter to the end of the year. So, it should be consistent throughout the year; not just at the first, last few months of the year. So when I sit with a client, I normally ask them: how their lifestyle has changed, how their income and expenses have changed, and what are the things that we will be looking for that will have a big impact when they file their tax return for next year. So basically, we will begin by looking at the income. Has their income changed or decreased? Or do they expect to get a substantial increase at the end of the year that we should anticipate? So, we would need to take into consideration and also any other expenses that came up that we can see; we can deduct that off of their tax return. Also, we can look at other things and we can plan ahead to see: are they on the same path as they wanted to be towards the retirement age and do they have enough saved up each year to meet their goal when they actually retire?
You mentioned expenses and deductions. I know that’s one of the things that changed with the tax cut and Job Act. Have there been big changes to deductions?
Changes to Deductions under the Tax Cuts and Jobs Act (TCJA)
There are some changes to deductions. Certain deductions are no longer allowed like educational expenses. If you’re a teacher, you can not deduct those expenses above the adjusted income. And, certain moving expenses you are no longer able to deduct. The biggest change we see is due to the itemized tax deduction because they took out the personal exemption and they increased the standardized deduction, which means a lot of people do not have to take itemized deductions.
We also want to talk with a client to see what kind of itemized deductions they have that will be able to push them over the standardized deduction in order for us to take those.
You mentioned the standard deduction and I think I saw somewhere that now 90% of the people are going to be on the standard deduction, which, what is it up to what now after the change?
The IRS doubled the amount of the standard deduction. For a married couple filing jointly, it used to be $12,000 and now it’s at $24,000. It’s harder for someone to come up with itemized deductions to actually go over that. We sit down with the client to see what kind of deductions they have to see if they qualify for those deductions. If we can push them over the limit, then we will be able to file those.
What are some of the things that go into that bucket of deductions that they can try and tally up to get over the 24,000? Is a retirement contribution an example of one?
EXAMPLES OF ITEMIZED DEDUCTIONS
- Retirement Contributions
- Residential Home Mortgage Interest
- State and Local Tax
One of the big changes that affects the itemized deduction is that the IRS put a SALT (state and local tax) cap at $10,000. As you know, we live in New Jersey and a lot of our property taxes are more than that. You can’t deduct anything over $10,000. So that means if your property taxes are $15,000, you’re only able to deduct $10,000 and then that doesn’t even include what you’re paying as far as state income tax.
It’s funny; in the news yesterday, I saw that President Trump changed his residence from Manhattan to Florida. There is no state income tax in Florida, so he’s trying to do his own thing to convert that. One of the other things that was in the news about the SALT taxes is that some of the states: NJ, Connecticut, and New York- were trying to pass a law where taxpayers could use charitable contributions to bypass that $10,000 limit and pay their property taxes as charitable contributions. That got struck down.
Are people just going to take the standard deduction or are there any strategies to try and get over over that 24,000 if they’re a married couple?
If they are married, that also depends on when we tally up all the expenses, where are they at? How much are we not being able to meet that 24,000 or be able to go over that? It could be that we can just look at the expenses. A lot of the people that do charity contributions, what they do is they bundle the contribution into one year.
If they used to contribute every year, one thousand, maybe they can bundle up for five or six years in one lump sum payment to be able to push the itemized deduction over that $24,000 standardized deductions for that year. That’s one of the ways that we can do it, but if they are not big on charity contribution, we can also look at some IRA or employee contribution plan
With the bunching of the charitable contributions: is that basically, let’s say that example that you gave where they’re contributing $1,000 a year. If they take, let’s just use 2019 as an example, they contribute 5,000 in 2019 in the hopes that just goes into the bucket and that brings them over 24,000 where itemizing now makes sense. And then, for the next couple of years, they’re probably going to go back to taking the standard deduction because they’re probably going to be under the $24,000.
That’s correct. We also want to look at what tax bracket they’re in. Most of the time we will sit down with a client to see what the fluctuation between the tax bracket is. If there’s anything we can do there to get a more favorable outcome.
If they anticipate their tax bracket to be lower, maybe we can do some IRA to Roth conversion to get a favorable tax. So this way, they actually pay less on any amount that they converted from an IRA to a Roth IRA.
Roth Conversions are one of my favorite strategies. We’ve been looking at it as trying to fill the tax bucket up. You look at what tax bracket they’re in, did they have any room before they go up to the next tax bracket? That might be an opportunity to convert part of their IRA into a Roth and they’re still back doing that conversion at the lower tax bracket, it’s not forcing them into the next bracket up. That’s definitely one strategy that everyone should look at. You mentioned the retirement accounts, could they do the same thing with bunching retirement contributions? For example, like a business owner that has a SEP IRA; would you be able to contribute up to $56,000 or 25% of their income? Sometimes they may not have all that cash available to contribute in one year, but what if they did it one year and then the next year? The SEP IRA is flexible enough.
If you have a high deductible health plan. The one thing I like the most is the health saving account because it has the triple benefit. And what I mean by triple benefit is any money you contribute to the health saving account is tax deductible, and it continues to grow tax-free and when you finally withdraw the money it is also tax free. So there’s a big tax savings. I recommend it to my client if they are young and healthy, that’s what I would suggest that they do.
Marc: Yeah, I think it’s one of the few types of vehicles where you get the tax benefit on the front and on the back when the money comes out. Usually the IRS will give you one or the other as a benefit.
So yeah, I agree with you that those are great. We’re actually in the middle of open enrollment for a lot for employer plans and even for the affordable care act exchanges. One of the things I always recommend is to take a look at your healthcare plan. You know there’s probably different options you have.
And like you said, that high deductible plan with the HSA is potentially a good option. You just have to understand how it works and what’s different, if you have a different type of plan. Saving up in an HSA is also great for having that pool of money in retirement to pay for health care expenses.
Ken: Yes and the money can sit there. It’s not something that is use it or lose it. A family can contribute up to $7,000 a year. On top of that, if you have a separate IRA, you can also contribute up to $6,000 each year. That does add up and it will reduce your adjustable income.
Marc: Yeah I think there’s a little bit of confusion between the FSA (flexible spending account) and the HSA, and like you said, the HSA, it’s not a use it or lose it. You can carry that over for as long as you want, whereas the FSA, for the most part, you have to spend it by the end of the year, or there are some that have a little bit that you can carry over, but for the most part you do have to spend it.
Ken: That’s correct Marc.
Marc: Yeah. What, what else? I know there was that big tax law change in 2017 and I think a lot of it’s still not understood by taxpayers. Are there any changes in there that you may want to highlight – things that have changed and things people should be aware of?
Ken: The most important of the changes is the tax bracket. As you can see, they reduce a lot of the tax bracket. It used to be, you have 15% all the way up to 39.6%. Now the new tax bracket is only from 10% to a maximum of 37%, so each bracket gets a few percentages off. So you’ll see a little bit tax saving there.
In terms of the new standard deduction we mentioned that it’s being increased for single, married filing jointly, and head of household. That also can translate to some substantial tax savings as well. Also, the other thing that I want to mention is the qualified dividend and capital gain tax rate.
As you know, depending on which tax bracket you’re in, you can either qualify for 0% tax on these qualified dividends or capital gains and up to 20% tax on those qualified dividends and capital gains. So that’s a really good point that, Marc, you probably would want to mention to your clients because a lot of those people, when they look at their investment account, they want to be able to tell which way their investment income will be taxed.
Marc: Yeah, whenever you’d look at any income you want to look at it and see if it’s dividend income and what’s the tax rate on it versus is it interest income and is it paid at the ordinary income tax rate with the tax brackets coming down a little bit.
Another thing we’ve been looking at just in general is if Roth conversions make sense because you are paying the tax now, but you’re saving for the future when potentially the tax brackets may go up. There’s probably a good chance that they’re going to be higher in the future than they are now.
Ken: Yes, that’s correct. I don’t see the tax bracket ever being this slow again.
Marc: One thing that is a bit misunderstood is the difference between deductions and credits and how the taxpayer is affected by them. Can you go over what the difference is between the two?
Ken: A deduction is what you can deduct off of your AGI (adjusted gross income). After you deduct it off your adjusted gross income your tax rate will be applied depending on what tax bracket you are in. That will apply to your AGI.
In terms of a tax credit it’s a little bit different. The government is trying to push you to save for the future. If you are a low income family, if you contribute like for single. They will give you $1,000 back. If you are married and file jointly they will give you $2,000 back as long as your AGI is within that threshold. It’s like free money that I suggest clients take advantage of.
Not only to plan for the future, but also get a full benefit from it. And that’s the tax credit. Let’s use an example to highlight the difference. If someone earns $100,000 per year and they are taking the standard deduction of $24,000 that means they’re going to have to pay tax on 76,000?
Let’s assume that that $76,000 of income translates to $15,00 of tax that they are going to have to pay. If they had a tax credit of $2000, instead of having to pay 15,000 they would only have to pay $13,000. That’s correct, but like I mentioned before, if you don’t owe any tax, that credit will come back to you.
That makes sense. Deductions are great, but credits sound like they’re even better because it’s an actual dollar reduction of the tax obligation that someone has.
You mentioned tax planning not being a once a year thing. What should people be doing throughout the year?
I see people really looking at at once a year in either January or February. And a lot of times I think that’s too late to do anything to improve your previous years taxes. The first step that I look at when planning is income and next you look at assets and liabilities which helps paint that current picture.
Once we have that down, where do you go next to see how you can optimize their tax situation? We talk about charitable contributions and we can also look at their investment accounts and try to capture their losses. This is when you sell your investments with a loss in it, because the IRS will allow you to take a deduction of up to $3,000 per year from any capital losses you have.
Anything that’s over the $3,000 limit can be carried over to the next year. I’m assuming, Marc, that you work with your clients all the time just to look at their investment accounts to see which ones make sense to keep and which ones are best sold.
How will that affect the income tax? Yeah, well, no, we only have gains in our accounts, but yeah, no, it’s, it’s, it’s a good point. And like you mentioned, even if there is someone has a $10,000 loss, the maximum that they can deduct is 3000 but they don’t lose that 7,000 they can carry that forward and either take it in a subsequent year or offset it against some gain going, going forward.
Keeping track of the carry losses forward. The custodians or of the accounts are doing a lot better job of it now. In the past investors would have these stock and fund positions from 30 years ago and they had no idea at what price they were purchased at.
We often had to go through the exercise of trying to really trace back when was this purchase that it go through any stock splits, dividends, and paint that cost basis picture. But it’s gotten a lot easier and it’s definitely a good planning strategy to do.
Since we are talking about that some time of client. Before those gain, like you probably would part to them and they will say, Oh, I want to inch. I’m interested in before my cane. So the way to do that, they can infest in any opportunity zone. So that was those funds. The government, once you invest in those, if you hold them for a certain amount of period, you can defer those gains. If you hold them for 10 years or longer, you don’t even have to pay taxes on those gains that you have from your previous transaction.
I do work with people who like to invest in real estate, so maybe we can dive into it a little bit with the opportunity zones and what they are doing there.
Can they defer gains on any asset or does it have to be a real estate asset that they sell? It could be any asset best identified by the IRS as an opportunity. The IRS categorizes different areas in the country as opportunities zones.
And what they’re basically doing is they’re rolling over proceeds from some other asset into the opportunity zone and doing that allows them to defer some of the capital gains on that asset that they’re selling? And it could be three year, five year and 10 year holding period.
Each one has a different percentage, but if you hold the fund for 10 years, the gain you have from your prior transaction gets wiped away.. They pretty much give you a free ticket there. This is the government’s way of trying to promote investing in what they call these opportunity zones in different areas of the country.
Is there any benefit on the capital gains side on the previous asset or is it just the capital gains on if they hold the opportunity zone investment for awhile? My understanding is it will actually apply to the first one that you have.
So whatever gain you from half from your first one, that’s going to move forward to your opportunity zone investment . And then from your opportunity zone, they have different ways of how you can categorize it, but eventually they will let you wipe off some of the gains. That’s definitely helpful, especially if you’re investing in real estate.
They give you a window of opportunity there. Okay. So if someone sold it now, they’d have six months from today. And then to make that, to make that opportunity zone investment. A lot of what we talked about was on the individual side. What changes in the tax code impact business owners.
It affects both sides. On the small business side, one of the biggest impacts is the section 199a deduction. It allows businesses to deduct 20% of their qualified business income.. With the new tax law, the corporate tax rate moved to 21%.
In order to entice other legal entities the IRS allows a 20% deduction of your business income with a certain threshold. This is basically like a standard deduction for businesses. It’s a big deal.
Are there any stipulations on income? If the business earns over a certain income, they’re not eligible or business type or the sector or industry that the businesses and certain sectors like health law, accounting are being excluded to a certain threshold. If your income is over $325,000 and you are married and filing jointly you wouldn’t be able to take the deduction.
It doesn’t matter how your entity is structured: S-Corp, LLC, Partnership, … anyone is potentially eligible for it.
As long as you own a business, even if you are structured as a sole proprietorship, you can take that deduction. Okay. Yeah. So that. That makes sense. Well, I think we’re winding down and just about out of time. I know we covered a lot with deductions, credits, tax brackets. One of the major themes is that tax planning is something that people should be doing throughout, throughout the year.
Is there anything else we didn’t cover that is important for people to know. Yes, one of the most important things I always bring to my client’s attention is that for your withholding allowances, I see a lot of the people that they have a huge refund at the end of the year. They seem to be so proud of it and I’m telling them, you are basically lending money to the IRS interest free, right? You need to adjust those. You need to adjust those. Any money you have, you need to reach out to people like Marc to be able to help you invest those funds, which will get you a much more favorable return than what the IRS is paying you, which is zero.
I guess that ties back to what you said originally was the first thing that we should talk about is income and any changes to income and knowing that you can help guide someone on what their withholdings should be on the form.
Yes. Depending on how many allowances you want to put on the form. I mean, the more allowance you put, let’s say you have a family of four. If you put in five or six allowance on the form, the tax withholding will be a lot less. So you want to be able to factor in your income, how much tax you’re going to be due at the end of the year.
It doesn’t have to be exact, but you don’t want to be able to at the end of the year, have a refund of $5,000 or $6,000. That makes sense. Aside from dependants, is there anything else that people use allowances for is it just a non-arbitrary number that someone can just say, I’m going to put five down or four down or six down on it?
That’s up to the taxpayer. So you look at it, if you have a family of four, most people would just put four. But if there’s, if they’re kind of worried that they will pay more taxes, they will probably put down three one less. So this way I R S withhold a little bit more each month. But they do give you a guideline based on how many people you have in your household, how many each one should count.