Tax Planning

Saving more in taxes requires tax planning during the year.

While TCJA did not change trader tax status, Section 475 MTM, wash-sale loss rules on securities, and more, there is still plenty to consider. There are 2019 inflation adjustments in income and capital gains tax brackets, various income thresholds and caps, retirement plan contribution limits, standard deductions, and more. See 2019 Tax Brackets.

Defer income and accelerate tax deductions

Consider the time-honored strategy of deferring income and accelerating tax deductions if you don’t expect your taxable income to decline in 2020. We expect tax rates to be the same for 2020, although the IRS will adjust the tax brackets for inflation. Enjoy the time-value of money with income deferral…

Accelerate income and defer certain deductions

A TTS trader with substantial ordinary losses that are not subject to the capital loss limitation should consider accelerating income to soak up the business loss, instead of having an NOL carryover. Try to advance enough income to use the standard deduction and take advantage of lower tax brackets. Be sure to stay below the thresholds for unlocking various types of AGI-dependent deductions and credits.

Roth IRA conversion: Convert a traditional IRA into a Roth IRA before year-end to accelerate income…

Sell winning positions: Another way a trader can accelerate income is to sell open winning positions to realize short-term capital gains…

ACA’s net investment tax: Investment fees and expenses are not deductible for calculating net investment income for the Affordable Care Act’s 3.8% net investment tax (NIT) on unearned income…

Business expenses and itemized deduction vs. standard deduction

Business expenses: TTS traders are entitled to deduct business expenses and home-office deductions from gross income… If you have TTS in 2019, considering going on a shopping spree before Jan. 1. No sense deferring TTS expenses, because you cannot be sure you will qualify for it in 2020.

Retirement plan expenses: If you engage outside investment advisors for managing your retirement accounts, try to pay the advisors from traditional retirement plans, but not Roth IRAs…

Employee business expenses: Ask your employer if they have an “accountable plan” for reimbursing employee-business expenses…

SALT: TCJA’s most contentious provision was capping state and local income, sales and property taxes (SALT) at $10,000 per year ($5,000 for married filing separately) – and not indexing it for inflation…

Estimated income taxes: If you already reached the SALT cap, you don’t need to prepay 2019 state estimated income taxes by Dec. 31, 2019. Pay federal and state estimated taxes owed by Jan. 15, 2020, with the balance of your tax liabilities payable by April 15, 2020. (You can gain six months of additional time by filing an automatic extension on time, but late-payment penalties and interest will apply on any tax balance due.)

AMT: In prior years, taxpayers had to figure out how much they could prepay their state without triggering alternative minimum tax (AMT) since state taxes are not deductible for AMT taxable income. It’s easier in 2019 with SALT capped at $10,000 and because TCJA raised the 2019 AMT exemptions to $510,300 single and $1,020,600 married filing jointly. Taxpayers subject to AMT should not accelerate AMT preference items.

Standard deduction: TCJA roughly doubled the 2018 standard deduction and suspended and curtailed several itemized deductions. The 2019 standard deduction is $12,200 single, $24,400 married, and $18,350 head of household. There is an additional standard deduction of $1,300 for the aged or the blind…

20% deduction on qualified business income

The IRS issued proposed reliance regulations (Proposed §1.199A) for the TCJA’s 20% deduction on qualified business income (QBI) in pass-through entities. The proposed regulations confirm that traders eligible for TTS are a “specified service activity,” which means if their taxable income is above an income cap, they won’t receive a QBI deduction. The 2019 taxable income (TI) cap is $421,400/$210,700 (married/other taxpayers). The phase-out range below the cap is $100,000/$50,000 (married/other taxpayers), in which the QBI deduction phases out for specified service activities. The W-2 wage and property basis limitations also apply within the phase-out range. Hedge funds eligible for TTS and investment managers are specified service activities. QBI likely includes Section 475 ordinary income, whereas, TCJA expressly excluded capital gains and losses from it.

Married couples should compare filing joint vs. separate

Each year, married couples choose between “married filing jointly” (MFJ) vs. “married filing separately” (MFS). TCJA fixed several inequities in filing status, including the tax brackets by making single, MFJ, and MFS brackets equivalent, except for divergence at the top rate of 37% for single filers, retaining some of the marriage penalty. See the 2019 tax brackets: MFS brackets are exactly half the MFJ brackets throughout all the rates, so MFS filers are not penalized on rates. There are other issues to consider, too.

Tax planning unique to traders

Wash sales: Taxpayers must report wash sale (WS) loss adjustments on securities based on substantially identical positions across all accounts, including IRAs. Conversely, brokers report WS only on identical positions per the one account. Active securities traders should use a trade accounting program or service to identify potential WS loss problems going into year-end…

Trader tax status: If you qualify for TTS (business expense treatment — no election needed) in 2019, accelerate trading expenses into that qualification period as a sole proprietor or entity. If you don’t qualify until 2020, try to defer trading expenses until then…

Section 475 MTM: TTS traders choose Section 475 on securities for exemption from wash-sale loss rules and the $3,000 capital loss limitation — and to receive the new 20% QBI deduction. Existing individual taxpayers need to elect Section 475 by April 15, 2019 for 2019 (March 15 for existing S-Corps and partnerships)…

Trading entities: A “new taxpayer” entity can elect Section 475 within 75 days of inception. That comes in handy if you missed the individual sole proprietor deadline (April 15, 2019) for electing Section 475. Once elected, and 475 applies in subsequent years in which taxpayers are eligible for TTS unless he revokes the election.

Net operating losses: Section 475 ordinary losses and TTS business expenses contribute to net operating loss (NOL) carryforwards, which are limited to 80% of taxable income in the subsequent year(s)…

Excess business losses: TCJA included an “excess business loss” (EBL) limitation of $500,000/$250,000 (married/other taxpayers) for 2018. (TCJA indexes it for inflation.)

Aggregate EBL from all pass-through businesses: A profitable company can offset another business with losses to remain under the limit. EBL is an NOL carryforward.

2019 S-Corp: TTS traders may use an S-Corp trading company to arrange health insurance and retirement plan deductions. The S-Corp must execute officer compensation, in conjunction with these employee benefit deductions, through formal payroll tax compliance before year-end 2019. Otherwise, traders miss the boat…

Solo 401(k): A Solo 401(k) retirement plan for a TTS S-Corp must be established (opened) with a financial intermediary before year-end 2019…

2020 S-Corp: If you missed out on employee benefits in 2019, then consider an LLC with S-Corp election for 2020…

Tax loss selling

If you own an investment portfolio, you have the opportunity to reduce capital gains taxes via “tax loss selling.” If you realized significant short-term capital gains year-to-date in 2019 and have open positions with substantial unrealized capital losses, you should consider selling (realizing) some of those losses to reduce 2019 capital gains taxes. Don’t repurchase the losing position 30 days before or after, as that would negate the tax loss with wash-sale loss rules.

Excerpt from Green’s 2019 Trader Tax Guide Chapter 9 Tax Planning. 

 

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