2020 Year-End Individual Tax Planning

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2020 Year-End Individual Tax Planning

As we approach the end of an eventful year, it is important to take some time to think of planning moves that may help lower your 2020 income tax bill.

We continue to implement the Tax Cuts and Jobs Act of 2017 (TJCA) which contained major changes in tax rules and 2020 was not lacking of its own expansive legislative action. The passage of the SECURE Act (Dec 2019) and the CARES Act (March 2020) have added some additional opportunities as the purpose of the legislation was widely viewed as economic relief to businesses as well as individuals.

We would be remiss if we failed to consider the potential tax changes that may result in light of the elections.  Although we wait for certification of the presidential election results, there has been some focus on the Biden administration’s income tax proposals which have been reported to include the following:

  • Restoring the individual top tax rate of 39.6% for earnings in excess of $400,000 (currently 37%)
  • Increase in capital gains rates for top income tax bracket(s)
  • Phasing out of the Qualified Business Income Deduction (see below) for individuals with earnings in excess of $400,000

You may want to consider recognizing taxable income in the current year where rates are at historic lows versus deferring into later years where income tax rates could be higher under a new administration. Although this may be speculative at the current moment, maximizing the use of current low tax brackets may be a useful planning tool to free up needed cash flow in a year with much uncertainty.

Below we have compiled a list of items that may be helpful if taken into account before the end of 2020.  Of course, not all of the items will apply to your particular situation; therefore, we ask that you please review the following list and contact us to discuss the benefit and/or your eligibility before taking any action to save or defer taxes.

  • Qualified Business Income deduction (applies to rental property as well):  You may be eligible for a deduction of 20% of your self-employed business income, pass-through income from business operations, and/or rental real estate activities. There are limitations based on the type of business, wages paid by the business, basis of your property assets, and your total taxable income. Maximizing this opportunity requires careful planning and can be complex if you have one or more of these types of activities.
  • Roth IRA conversion:  Consider converting Traditional IRA funds to a Roth IRA before year end to accumulate earnings in a Roth IRA free from future income taxes.  Although the conversion to a Roth IRA may be taxable, timing the conversion in a tax year in which your total anticipated taxable income will be low may be beneficial in the long term.
  • Retirement contributions: Consider accelerating contributions to your employer provided retirement account up to the 2020 maximum of $19,500. Additionally, if eligible, make contributions to Traditional, Roth, and/or SEP IRA retirement accounts to maximize current and potential long term tax savings/deferrals.
  • Required Minimum Distributions (RMD): The SECURE Act delayed the requirement to take a distribution from any retirement account (IRA, 401(k), etc.) until you turn 72 years of age for eligible individuals.  Subsequently, the CARES Act then suspended all RMD requirements for 2020 providing you flexibility in determining the most tax advantageous timing to recognize income from your retirement distributions. Although you may not have a requirement to make distributions, in some instances it may be more beneficial to recognize taxable distributions in the current year when you may anticipate losses from other sources or recognition at lower income tax brackets.
    • If you are eligible, you may wish to consider a Qualified Charitable Distribution from your qualified retirement account to fulfill any RMD requirements and exclude the earnings from your taxable income concurrently. Keep in mind that this option may not be as beneficial this year due to the deferral of all RMD requirements.
  • Capital gains tips: Consider holding appreciated capital assets for at least 12 months to take advantage of preferential long-term capital gains rates.  In addition, consider utilizing any of the following methods to lessen your taxable gains prior to year-end:
    • Timing capital losses: Consider weighing the potential tax savings of disposing of securities or other capital assets with accumulated losses that you hold against taxable gains you may recognize in 2020.  
    • Contribution of appreciated stock: Avoid potential capital gains tax by contributing appreciated stock to charity. Donating appreciated stock entitles you to a charitable contribution at the fair market value of the stock, and also avoids the capital gains tax if you otherwise sold the stock.  Although achievable, there may be limitations associated with contributions of privately held stock.
    • Other: Consider ways to reduce your exposure to the 3.8% net investment income tax (NIIT) on passive income.  One option, if you intend to sell appreciated assets, is to consider structuring the sale as an installment sale so the gain recognized is spread over several years. Another option is to consider the advantages of a like-kind exchange.
  • Timing itemized deductions: The standard deduction in 2020 will be increased to $12,400 for single filers and $24,800 for taxpayers who are married filing jointly.  Applying a bunching strategy to defer or accelerate deductions into a tax year in which you plan to exceed these thresholds and itemize your deductions can be beneficial. Consideration should also be given to timing your state and local property tax payments, as the TCJA limit on state and local taxes remains at $10,000.
    • Arizona state tax credit contributions: In general, charitable contributions that provide for a dollar-for-dollar state tax credit remain non-deductible for federal tax purposes. However, you have flexibility in timing your tax credit contributions through April 15th, 2021 to still receive a 2020 tax credit.  For contribution limits and an overview of several popular Arizona tax credit programs, please review our summary on our website.
  • Gifts before year end: Make any gifts sheltered by the annual gift tax exclusion before the end of the year and thereby save gift and estate taxes. You can give $15,000 in 2020 to each of an unlimited number of individuals but you can’t carry over unused exclusions from one year to the next. The transfers also may save family income taxes where income-earning property is given to family members in lower income tax brackets (if they are not subject to the kiddie tax).
  • Kiddie tax: In 2020, children with greater than $2,200 in unearned taxable income may be subject to the higher of parent’s or child’s marginal tax bracket.  Deferring or moving taxable income to your children does require some thoughtful consideration but can have the added benefit of reducing your exposure to higher tax rates.
  • Investing in education: Consider utilizing a 529 Education Fund or Coverdell Education Savings account when planning for education related costs.  The TCJA and CARES Acts expanded qualified education expenses to include tuition for K through 12 education (annual cap of $10,000) and payments on student loan debt (lifetime cap of $10,000). Amounts contributed to a 529 plan grow tax-free and distributions from the plan are not treated as income to the extent they are used to pay for qualified education expenses.  Contributions to a 529 account may also qualify for a state tax deduction.
  • Withholding elections and exposure to underpayment penalties:  Consider a consistent or one-time increase to your income tax withholding elections from taxable wages, retirement distributions, or other sources that could minimize your exposure to underpayment penalties or need to make estimated tax payments.
  • Health Savings Account (HSA): Contributions to an HSA account are deductible (within IRS-prescribed limits), earnings on the account may avoid taxation, and distributions are tax-free if made for qualifying medical expenses. The CARES Act expanded the use of these accounts for nonprescription medical products and eligible contributions to an HSA account can be made through April 15th, 2021 to receive a deduction on your 2020 income tax return.
  • Flexible Spending Account (FSA): If you have an employer-provided FSA, be sure to check the balance in your account and spend any remaining funds before year end to avoid forfeiting the account balance. Contributions to FSAs provide use of tax-free dollars to pay medical expenses not covered by other health plans.  If you choose to participate in these plans, you can contribute up to $2,750 during the 2020 plan year.

Other items to consider in year-end planning

  • Maximize use of lower ordinary or capital gains tax brackets through careful planning, which may or may not include a combination of the factors above. For example, use of a 0% long term capital gains rate or avoiding jumps in marginal tax brackets that can result in an increase in federal income taxes of 8-10% on additional earnings.
  • Retirement account early withdrawal 10% penalty tax will not apply to coronavirus related distributions up to $100,000 in 2020 and are ratably allocated over three years to minimize the immediate income tax burden from the distribution (absent an election to recognize all in one year).
    • Penalty- free withdrawals from an individual’s retirement accounts are also allowed when there is a birth or adoption of a child/dependent, up to certain limits.
  • Contributions to a deductible Traditional IRA account are no longer limited for individuals over 70 ½ years old.
  • Track the miles you put on your personal vehicle for medical, charitable, and business purposes as each may be deductible to you based on published federal mileage rates.
  • Count the days in which your vacation home was used personally and rented to third parties as it may impact your ability to deduct the operating expenses for the home.
  • Economic impact payments paid to eligible individuals in 2020 were advances on a recovery rebate income tax credit to be claimed on your federal income tax return. To the extent you and/or a dependent were eligible for the payment but did not receive it during the year, you will receive the credit on your 2020 tax return.
  • $300 above-the-line charitable deduction for individuals who do not itemize their deductions is available for contributions made in 2020 as long as they are not state tax credit eligible contributions.

State income tax conformity – Each year, many states adopt federal changes to the laws governing income taxation. However, the laws vary by state and in some instances, may be unclear.  Due to the size and scope of the recently enacted legislation, some consideration may be warranted if you anticipate material change in your state income tax liability as a result of new income tax provisions or if you may have a requirement to file income tax returns in multiple states this year (i.e. due to a move, job change, remote work from another state, or change in state tax laws).

We strive to provide you with applicable and valuable tax planning opportunities although subsequent developments or a change by the taxing authorities may affect advice we provide.

We are happy to discuss any of the above items with you further and tailor a tax strategy that will work best for you; please contact us with any questions you may have.