Tax Planning Mastery: 5 Strategies for Year-End Success

The word "Taxes" is seen on the facade of the Internal Revenue Service (IRS) headquarters in Washington, D.C., U.S. Photographer: Andrew Harrer/Bloomberg

While the new tax laws will complicate year-end planning, there are some moves you can make for your clients

As the end of 2018 approaches, the new tax laws will make year-end tax planning more complicated than usual. In spite of the complexity, there are several moves you can make for your clients to minimize their upcoming tax liabilities without getting stuck in the minutiae.

Not every option will work for every taxpayer, so be sure to look at each client’s situation individually. With that in mind, let’s take a look at some year-end tax planning strategies.

1. Bunch itemized deductions. When it comes to itemized deductions, 2018 is a different world compared to prior years. Not only are many deductions eliminated, but the standard deduction amounts have been increased. This means fewer taxpayers will be able to itemize deductions.

Unless the total itemized deductions exceed $12,000 for singles or $24,000 for marrieds (the new standard deduction amounts), none of these expenses will reduce taxable income. If your client’s deductions are just under these thresholds, they might benefit from postponing deductions one year and accelerating them in the next year. Methods of moving deductions between years include the following:

• Paying only half (one payment) of property taxes one year while making three payments the next year.

• Paying the December 2018 mortgage payment in January 2019, and then paying the December 2019 payment in December 2019.

• Doubling up on charitable contributions every other year while deferring contributions in the interim year.

2. Donor-advised funds. When discussing bunching deductions, I suggested doubling up on charitable contributions every other year. But most people don’t donate that way. For example, if your clients give $3,000 a year to church, they probably don’t want to give $6,000 one year and nothing the next.

The answer to this dilemma is a donor-advised fund. A DAF is essentially a charitable IRA. It can be opened with a local community foundation or even a custodian. With such a fund, the donor receives a deduction in the year of his or her contribution to the fund. The money stays in the fund and earns income tax-free until the donor decides to make distributions to charity, either right away or over time.

An especially tax-efficient way of contributing to a donor-advised fund or specific charity is to donate appreciated stock or mutual fund shares. The client will receive a deduction for the full fair-market value without paying tax on the appreciation. The adviser can provide essential assistance by identifying holdings with the greatest accumulation of unrealized gains. To supercharge charitable deductions, a DAF is the way to go.

3. Roth conversions. If you have clients in a low tax bracket, they might be able to convert a portion of their individual retirement accounts to a Roth account at little to no extra tax cost. Whenever IRA money is converted to a Roth IRA, tax is due on the amount of the conversion in the year of the conversion. The money in the Roth IRA will then grow tax-free for the remainder of the owner’s life and can pass to heirs income-tax free. Distributions from a Roth IRA are also tax-free, and there are no required minimum distributions.

4. Qualified charitable distributions. This strategy works even if your client doesn’t itemize. If your client is subject to required minimum distributions, or RMDs, instead of taking part or all of their RMD, they send the IRA funds directly to a charity (not a DAF). The RMD sent to charity is not taxable and there is no charitable deduction. However, it does reduce taxable income — and adjusted gross income.

5. Tax-loss harvesting. Given the recent market volatility, this could be an ideal time to recognize built-up losses in clients’ taxable accounts. Just remember that if you buy back the sold security (or something substantially identical) within 30 days, the loss is disallowed.

To avoid being out of the market during the 30-day period, replace the loss position with something similar (for example, a tax-managed large-cap fund versus an index fund).

Using these year-end tax planning strategies to proactively save clients’ tax dollars can up your game and increase client satisfaction.

(More: Tax reform: 7 essential strategies for financial advisers)

Sheryl Rowling is head of rebalancing solutions at Morningstar Inc. and principal at Rowling & Associates.