Here are five year-end tax-deduction strategies that apply if you are getting married or divorced, have children who did or could work in your business, and/or have situations where you give money to relatives and friends.
1. Put Your Children on Your Payroll
Did your children under age 18 help you in your business this year? Did you pay them for their work?
You should pay them for the work—and pay them on a W-2.
Why? First, W-2 wages paid by the parent to the parent’s under-age-18 child for work done on the parent’s Form 1040 Schedule C business are both
• deductible by the employer-parent, and
• exempt from federal payroll taxes for both the parent and the child.
Thus, if you operate your business as a sole proprietorship or single-member LLC taxed on Schedule C or as a spousal partnership, then you face no federal payroll taxes on the W-2 wages you pay your under-age-18 child. (And in most states, you also face no state payroll taxes.) Further, your child faces no federal payroll taxes.
If you operate as a corporation, your child and the corporation pay payroll taxes. But that does not eliminate the benefits; it simply reduces them.
Second, thanks to tax reform, your child can use the 2018 standard deduction to eliminate income taxes on up to $12,000 in wages.
Third, your child can contribute up to $5,500 to either of the following:
1. A tax-deductible IRA, and deduct that amount from federal taxation. This is the best strategy to use if the child has more than $12,000 in W-2 wages and you want the child to have more tax-free money.
2. A Roth IRA, which is not tax-deductible, but the child can (a) remove the contributions (money put in) at any time, tax- and penalty-free, and (b) remove the earnings tax-free after age 59 1/2. This is the best strategy to use if the child has less than $12,000 in total W-2 wages and other earned income, because the child has no need for a tax deduction.
2. Get Divorced after December 31
The marriage rule works like this: you are considered married for the entire year if you are married on December 31.
Although lawmakers have made many changes to eliminate the differences between married and single taxpayers, in most cases the joint return will work to your advantage. Thus, wait until next year to finalize the divorce if alimony is not involved.
Warning on alimony! The Tax Cuts and Jobs Act (TCJA) changed the tax treatment of alimony payments under divorce and separate maintenance agreements executed after December 31, 2018:
• Under the old rules, the payor deducts alimony payments and the recipient includes the payments in income.
• Under the new rules, which apply to all agreements executed after December 31, 2018, the payor gets no tax deduction and the recipient does not recognize income.
And if you are married on December 31, don’t file in April as married, filing separately. In most cases, this is a sure way to overpay your taxes.
3. Stay Single to Increase Mortgage Deductions
Two single people can deduct more mortgage interest than a married couple.
If you own a home with someone other than your spouse, and you bought it on or before December 15, 2017, you individually can deduct mortgage interest on up to $1 million of a qualifying mortgage.
For example, if you and your unmarried partner live together and own the home together, the mortgage ceiling on deductions for the two of you is $2 million. If you get married, the ceiling drops to $1 million.
If you bought your house after December 15, 2017, then the reduced $750,000 mortgage limit from the TCJA applies. In that case, your maximum deduction goes down to $1.5 million.
4. Get Married on or before December 31
Remember, if you are married on December 31, you are married for the entire year.
If you are thinking of getting married in 2019, you might want to rethink that plan for the same reasons that apply in a divorce (as described above). The IRS could make big savings available to you if you are married on December 31, 2018.
Again, you have to run the numbers in your tax return both ways to know the tax benefits and detriments for your particular case. A quick trip to the courthouse may save you thousands.
5. Make Use of the 0 Percent Tax Bracket
In the old days, you used this strategy with your college student. Today, this strategy does not work with the college student, because the kiddie tax now applies to students up to age 24.
But this strategy is a good one, so ask yourself this question: Do I give money to my parents or other loved ones to make their lives more comfortable?
If the answer is yes, is your loved one in the 0 percent capital gains tax bracket? The 0 percent capital gains tax bracket applies to a single person with less than $37,650 in taxable income and to a married couple with less than $75,300 in taxable income.
If the parent or other loved one is in the zero capital gains tax bracket, you can get extra bang for your buck by giving this person appreciated stock rather than cash.