It’s Not Too Late to Make a 2018 Retirement-Plan Contribution

Article Highlights:

  • Traditional IRAs
  • Roth IRAs
  • Spousal IRA Contributions
  • Simplified Employee Pension Plans
  • Solo 401(k) Plans
  • Health Savings Accounts
  • Saver’s Credit
  • Children with Earned Income

Have you been ignoring your future retirement needs? This tends to happen when people are young; because retirement is far in the future, they believe that they have plenty of time to save for it. Some people even ignore the issue until late in life, which causes them to scramble to fund their retirement. Others even ignore the issue altogether, assuming that they will qualify for Social Security and that the resulting income will take care of their retirement needs.

Did you know that you can make retirement savings contributions after the close of the tax year and that these contributions may be deductible? With the April tax deadline in the near future, the window of opportunity is closing to maximize contributions to retirement and special-purpose plans for 2018. Many of these retirement contributions will also deliver tax deductions or tax credits for the 2018 tax year.

Contribution Opportunities – Some 2018 retirement contributions are available after the close of the year.

  • Traditional IRAs – For 2018, the maximum traditional IRA contribution is $5,500 (or $6,500 if the taxpayer is at least 50 years old on December 31, 2018). A 2018 traditional IRA contribution can be made until April 15, 2019. However, for taxpayers who have other retirement plans, some or all of their IRA contributions may not be deductible. To be eligible to contribute to IRAs (of any type), taxpayers—or spouses if married and filing jointly—must have earned income such as wages or self-employment income.
  • Roth IRAs – A Roth IRA is a nondeductible retirement account, but its earnings are tax-free upon withdrawal—provided that the requirements for the holding period and age are met. Roth IRAs are a good option for many taxpayers who aren’t eligible for deductible contributions to a traditional IRA. For 2018, the contribution limits for a Roth IRA are the same as for a traditional IRA: $5,500 (or $6,500 if the taxpayer is at least 50 years old). A 2018 Roth IRA contribution can also be made until April 15, 2019.Caution: For those who have both traditional and Roth IRA contributions, the combined limit for 2018 is also $5,500 (or $6,500 if the taxpayer is at least 50 years old).
  • Spousal IRA Contributions – A nonworking spouse can open and contribute to a traditional or Roth IRA based on the working spouse’s earned income. The spouses are subject to the same contribution limits, and their combined contributions cannot exceed the working spouse’s earned income. Spousal IRA contributions for 2018 must also be made by April 15, 2019.
  • Simplified Employee Pension IRAs – Simplified Employee Pension IRAs are tax-deferred plans for sole proprietorships and small businesses. This is probably the easiest way to build retirement dollars, as it requires virtually no paperwork. The maximum contribution depends on a business’s net earnings. For 2018, the maximum contribution is the lesser of 25% of the employee’s compensation or $55,000. A 2018 contribution to such a plan can be made up to the return’s due date (including extensions). Thus, unlike a traditional or Roth IRA, a Simplified Employee Pension IRA can be established and funded for 2018 as late as October 15, 2019 (if an extension to file a 2018 Form 1040 has been granted).
  • Solo 401(k) Plans – A growing number of self-employed individuals are forsaking the Simplified Employee Pension IRA for a newer type of retirement plan called a Solo 401(k) or Self-Employed 401(k). This plan is available to self-employed individuals who do not have employees, and it is notable mostly for its high contribution levels.For 2018, Solo 401(k) contributions can equal 25% of compensation, plus a salary deferral of up to $18,500. The total contributions, however, can’t exceed $55,000 or 100% of compensation. Note that an individual must have established the Solo 401(k) account by December 31, 2018, to make 2018 contributions. However, contributions to an established account can then be made up to the return’s due date (which can be extended to October 15, 2019, for most taxpayers). Taxpayers who did not establish a Solo 401(k) account by the end of 2018 can still open one now for 2019 contributions.
  • Health Savings Accounts – Health savings accounts are only available for individuals who have high-deductible health plans. For 2018, this refers to plans with a deductible of at least $1,350 for individual coverage or $2,700 for family coverage. These accounts allow individuals to save money to pay for their medical expenses.Money that an individual does not spend on medical expenses stays in that person’s account and gains (tax-free) interest, just like in an IRA. Because unused amounts remain available for later years, health savings accounts can be used as additional retirement funds. The maximum contributions for 2018 are $3,450 for individual coverage and $6,900 for family coverage. The annual contribution limits are increased by $1,000 for individuals who are at least 55 years old. Contributions to a health savings account for 2018 can be made through April 15, 2019.

Please note that the information provided above is abbreviated. Contact this office for specific details on how each option applies to your situation.

Saver’s Credit – Low- and moderate-income workers are eligible for a saver’s credit that helps them offset part of the first $2,000 that they contribute to an IRA or a qualified employer-based retirement plan. This credit helps individuals who don’t normally have the resources to set money aside for retirement, and it is available in addition to the other tax benefits that are associated with retirement-plan contributions.

This credit is provided to encourage taxpayers to save for retirement. To prevent taxpayers from taking distributions from existing retirement savings and then re-depositing them to claim this credit, the qualifying retirement contributions used to figure the credit are reduced by any retirement-plan distributions taken during a “testing period”: the prior two tax years, the current year, and the portion of the subsequent tax year up to the return’s due date (including extensions).

Children with Earned Income – Many children hold part-time jobs, and after the recent tax reform, the standard deduction allows these children to earn $12,000 tax-free. This earned income also qualifies children for IRA contributions. Although children may balk at contributing their hard-earned income to an IRA, their parents or grandparents can gift Roth IRA contributions to children. That Roth IRA will significantly increase in value by the time the child reaches retirement age, 45 or 50 years later.

Individuals’ financial resources, family obligations, health, life expectancy, and retirement expectations vary greatly, and there is no one-size-fits-all retirement strategy. Events such as purchasing a home or putting children through college can limit retirement contributions; these events must be accounted for in any retirement plan.

If you have questions about any of the retirement vehicles discussed above or if you would like to discuss how retirement contributions will affect your 2018 tax return, please give this office a call.

Tax Reform Enables Deferral of Taxable Gains Into Investments in Opportunity Zones

Article Highlights:

  • Tax Cuts and Jobs Act
  • Reinvested Gains
  • Enhanced Basis
  • Qualified Opportunity Funds
  • Partnerships
  • Qualified Opportunity Zones

Those who have a large taxable gain from the sale of a stock, asset, or business and who would like to defer that gain with the possibility of excluding some of it from taxation should investigate a new investment called a qualified opportunity fund (QOF), which was created as part of the recent tax reform.

To help communities that have not recovered from the past decade’s economic downturn, lawmakers included in the Tax Cuts and Jobs Act the new code Sections 1400Z-1 and 1400Z-2, which are intended to promote investments in certain economically distressed communities through QOFs. Investments in QOFs provide unique tax incentives that lawmakers designed to encourage taxpayers to participate in these funds:

Reinvesting Gains – Starting in 2018, a taxpayer who has a gain (short-term, long-term, ordinary, or capital) from selling or exchanging any non-QOF property to an unrelated party may elect to defer that gain if it is reinvested in a QOF within 180 days of the sale or exchange. Only one election may be made with respect to a given sale or exchange. If the taxpayer reinvests less than the full amount of the gain in the QOF, the remainder is taxable in the sale year, as usual. The amount of the gain – not the amount of the sale’s proceeds, as in Sec 1031 deferrals – needs to be reinvested in order to defer the gain.

The gain income is deferred until the date when the QOF investment is sold or December 31, 2026 – whichever is earlier. At that time, the taxpayer includes the lesser of the following amounts as taxable income:

a. The deferred gain
b. The fair market value of the investment, as determined at the end of the deferral period, reduced by the taxpayer’s basis in the property. (Basis is explained below.)

A taxpayer who holds a QOF investment for 10 years or more before selling it can elect to permanently exclude the gain from the sale that is in excess of the originally deferred gain (i.e., the appreciation).

Qualified Opportunity Fund Basis – The basis of a QOF that is purchased with a deferred gain is $0 unless either of the following increases applies:

(a) If the investment is held for 5 years, the QOF’s basis increases from $0 to 10% of the deferred gain.

(b) If the investment is held for 7 years, the QOF’s basis increases from $0 to 15% of the deferred gain.

If a taxpayer holds a QOF that was purchased with deferred gains on December 31, 2026, the original deferred gain must be included as gross income on that taxpayer’s 2026 return; the basis of the investment will then be increased by the amount of this included gain.

If the QOF investment is held for at least 10 years before being sold, the taxpayer can elect to increase the basis to the property’s fair market value. This adjustment means that the QOF’s appreciation is not taxable when it is sold.

Example 1: On June 30, 2018, Phil sold a rental apartment building for $3 million, resulting in a gain of $1 million. Within the statutory 180-day window, he invested that $1 million into a QOF and elected to take the temporary gain deferral exclusion. On July 1, 2026, he then sold the QOF for $1.5 million. Because Phil held the investment for over 7 years, its basis is enhanced by $150,000 (15% of $1 million). Because the investment’s fair market value is greater than the original deferred gain, he must include a taxable gain of $1.35 million ($1.5 million – $150,000) in his 2026 gross income.

Example 2: The facts here are the same as in Example 1, except Phil waited to sell the QOF until 2030, meaning that he held it for nearly 12 years. Because he had the investment on December 31, 2026, he was required to include $850,000 ($1 million – $150,000) of deferred gain on his 2026 return, and his basis in the QOF was increased from $0 to $850,000. After selling the QOF for $1.5 million, Phil elected to permanently exclude the gain by increasing his basis to $1.5 million (the fair market value on the date of the sale). Thus, he has no gain ($1.5 million – $1.5 million) in 2030.

Mixed Investments – If a taxpayer’s investment in a QOF consists of both deferred gains and additional investment funds, it is treated as two investments; this provides the tax benefits of both types: the temporary gain deferral and the permanent gain exclusion (which applies only to the deferred gain).

Qualified Opportunity Funds – To defer gains-related taxes through the recently enacted opportunity-zone program, taxpayers must invest in a QOF – an investment vehicle that is organized as a corporation or a partnership for the purpose of investing in properties within qualified opportunity zones. These investments cannot be in another QOF, and the properties must have been acquired after December 31, 2017. The fund must hold at least 90% of its assets in the qualified-opportunity-zone property, as determined by averaging the percentage held in the fund on the last days of the two 6-month periods of the fund’s tax year. Taxpayers may not invest directly in qualified opportunity zone property.

Partnerships – Because a QOF that is purchased with deferred capital gains has a basis of zero, taxpayers who invest in QOFs that are organized as partnerships may be limited to deducting the losses that these partnerships generate.

Qualified Opportunity Zones – A low-income census tract can be specifically designated as a qualified opportunity zone after a nomination from the governor of that community’s state or territory. Once the qualified opportunity zone nomination is received in writing, the treasury secretary can certify the community as a qualified opportunity zone. Once certified, zones retain this designation for 10 years.

The Department of the Treasury and the Internal Revenue Service will provide further details regarding this new incentive in the near future, including additional legal guidance and an outline of the procedure for electing to defer a gain. If you have questions, please give this office a call.