What to Know About Year-End Tax Planning

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. As we're well into the fourth quarter, many investors are thinking about year-end tax planning. I'm here today with Tim Steffen, he is the director of advanced planning at Baird, to look at some topics.

Tim, thanks for joining me.

Tim Steffen: Thanks, Jeremy.

Glaser: My first question for you is, looking at your tax return for next year, first year of the new tax laws, should investors really expect to see a big difference in their refund next year?

Steffen: The studies are showing that all things being equal from one year to the next, the vast majority of taxpayers are going to see a reduction in their total tax liability. There will be some who break even. There will be a small percentage who will pay more because of the level of their income and some of the deductions they claim. But most people on a total basis are going to pay less tax.

Where they might be a little surprised is when they get their final bottom line number in their tax term--what's their refund, what's their balance due. That may be different than what they expect. The reason being is that a lot of these tax cuts that were enacted this year were already paid back to taxpayers via lower withholding tables. Remember, earlier in the year, the withholding tables were all changed, and people noticed, my take home income has gone up a little because I'm not withholding as much tax. Well, that was the benefit of your tax cut right there. 

When you go to file your return, the refund you've gotten in prior years may not be the same refund you are used to getting. Or you may end up actually owing a little bit more than what you think. Again, not that your liability has gone up, but your payments went down as well. The bottom line is going to be a little different for folks this year than what they might expect.

Glaser: Oftentimes, tax experts recommend accelerating deductions, deferring income as much as possible. Is there anything under the new tax law that changes that? Should you be thinking about that differently toward the end of the year?

Steffen: Last year, that was certainly the case, at the end of 2017. Unfortunately, we didn't have a lot of time to react to that because it all happened so late in the year. For 2018, as we compare 2018 to 2019, at this point anyway, it doesn't look like there's going to be anything substantially different; that could change. We'll see what happens with the midterms and all of this other stuff. Assuming '18 and '19 tax laws are the same, then the old standby, as you said, defer income, accelerate deductions probably makes sense.

The exception to that would be, if your own personal situation changes. So, if your income is expected to jump up next year, for whatever reason, maybe your deductions are more valuables to you next year. You push those out into next year. But for most people whose income is pretty consistent from year to year, accelerate deductions into this year, defer income into next to the extent you have the ability to do that.

Glaser: Let's think about property taxes. There was a scramble at the end of last to prepay as much as possible. Anything this year that should be on your radar when it comes to property taxes?

Steffen: The issue there last year was the new limit on state and local tax deductions. So, that's $10,000 hard and fast ceiling on that. If you are getting to the $10,000 already because of your income tax withholding for your state, there's no rush necessarily to accelerate your property taxes into this year nor is there any reason to maybe accelerate next year's into this year. Not all states have the ability to do that. Where I live in Wisconsin we can, but a lot of other states can't. You may just have to pay them as the bill comes. If you have the ability to time them, then you need to talk with your tax advisor, figure out what makes sense. In most cases, there probably won't be a big advantage to accelerating or deferring. You just pay them each year as they come due.

You do want to take a look though some states offer incentives for the property taxes you pay that year. You want to make sure you get something paid every year as opposed to maybe having a year where there isn't any. You may lose out on a state incentive then in that case.

Glaser: How about medical deductions? Any changes on that front?

Steffen: Again, medical expenses is another area where you might have some flexibility in timing when you pay those expenses. You don't have a lot there, but you might have some. One of the things that is scheduled to change for 2019 is medical expenses will be harder to deduct next year. Right now, you can deduct medical expenses if they exceed 7.5% of your income. Next year, that's scheduled to go to 10%, which means, all things being equal, medical expenses will be harder to deduct next year. There may be an incentive for moving them into this year. Now, that could all change. That may go back to 7.5%. We probably won't know that until late 2019. That's how these things tend to work. If your income is going to be lower next year, 10% of a lower number might make it easier to deduct those expenses next year anyway. In general, you're better this year, but your situation might dictate that that's the opposite.

Glaser: Turning to investments, even with the volatility we've seen, you might still be sitting on quite a few gains. Anything that you can do to try to limit any sort of tax burden there?

Steffen: A few things we talk to folks about. One is, if you've realized some gains already this year, which you may have done, now may be the time to harvest some losses in the portfolio to offset some of those gains. If you want to get back into the position, be careful about the wash sale rule, that 30-day period you've got to wait to buy back in. But there may be some opportunity to net losses against gains. If you've got new money that you are looking to invest, you may want to be careful as we closer the end of the year about buying into mutual funds. As they get toward the end of the year, they tend to pay out their capital gain distributions for the whole course of the year. You might buy into a fund just before it pays out the capital gains for the whole year and then you are stuck paying tax on all that. As you get closer to year end, maybe be careful about new investments in funds and wait until those payouts are made.

Other than that, when it comes to investment income, we really talk to folks about managing the portfolio in a way that doesn't generate income you don't need. For example, if you are not living off your portfolio, you don't need dividends and interest, maybe avoid investments that create dividends and interest, because you don't want to pay tax on income you don't need.

Glaser: Anything else you should have in mind as the year ends?

Steffen: Year-end is a great kind of bellwether. It's the time that reminds you of everything else that you should be doing at this time of the year. We talk about things like review beneficiary designations on your retirement plans or your life insurance. Update your estate plans. If there's been a birth or a death in the family, a marriage or a divorce, maybe you moved to a new state, take a look at the estate documents and update those. Looking into your asset allocation. This is a great time to go back and update all those passwords you've got for online. In the era of cybersecurity, the more often you can refresh those passwords, the safer you will be. A lot of those kinds of things we talk about this time of the year.

Glaser: Tim, thank you.

Steffen: Thanks, Jeremy.

Glaser: For Morningstar, I'm Jeremy Glaser. Thanks for watching.