2020 Individual Planning Guide
With year-end approaching, it is a great opportunity to evaluate strategies that might help reduce your 2020 tax bill. Year-end tax planning for 2020 requires a fresh approach in consideration of the impact of the COVID-19 pandemic on your personal and business finances. New tax rules that affect year-end tax planning have been enacted to help mitigate the financial impact of the pandemic.
Major tax changes from recent years generally remain in place, including lower income tax rates, larger standard deductions, limited itemized deductions, elimination of personal exemptions, an increased child tax credit, and a lessened alternative minimum tax (AMT) for individuals. Additionally, business tax changes from prior years are still in effect, including a major corporate tax rate reduction and elimination of the corporate AMT, limits on interest deductions, and generous expensing and depreciation rules for businesses. Non-corporate taxpayers with certain income from pass-through entities may still be entitled to a valuable deduction.
Below is a compiled list of actions based on current tax regulations that may help you save tax dollars if you act before year-end.
Tax Planning Strategies
Higher-income earners must be wary of the 3.8% surtax on certain unearned income. The surtax is 3.8% of the lesser of:
- Net investment income (NII), or
- The excess of modified adjusted gross income (MAGI) over a threshold amount ($250,000 for joint filers or surviving spouses, $125,000 for a married individual filing a separate return, and $200,000 in any other case).
As year-end nears, the approach that will be most beneficial to minimize or eliminate the 3.8% surtax will depend on your estimated MAGI and NII for the year. Below are a few strategies that may help minimize or eliminate the surtax on unearned income.
- Minimize (e.g., through deferral) additional NII for the balance of the year
- Reduce MAGI other than NII
- Minimize both NII and other types of MAGI
- An important exception is that NII does not include distributions from IRAs and most other retirement plans.
The 0.9% additional Medicare tax may require higher-income earners to take year-end action. The additional Medicare tax applies to individuals whose employment wages and self-employment income total more than a threshold amount ($250,000 for joint filers, $125,000 for married couples filing separately, and $200,000 in any other case).
- Employers must withhold the additional Medicare tax from wages in excess of $200,000 regardless of filing status or other income.
- Self-employed taxpayers must independently determine whether the tax applies to them.
- There could be situations where an employee needs to have more withheld at the end of the year to cover the tax.
- For example, if an individual earns $200,000 from one employer during the first half of the year and a like amount from another employer during the balance of the year, he or she would owe the additional Medicare tax. However, there would be no withholding by either employer for the additional Medicare tax since wages from each employer don’t exceed $200,000.
Long-term capital gain from sales of assets held for over one year is taxed at 0%, 15% or 20%, depending on the taxpayer’s taxable income. If you hold long-term appreciated-in-value assets, consider selling enough of them to generate long-term capital gains that can be sheltered by the 0% rate.
- The 0% rate generally applies to the excess of long-term capital gain over any short-term capital loss to the extent that, when added to regular taxable income, it is not more than the maximum zero rate amount (e.g., $80,000 for a married couple).
- If the 0% rate applies to long-term capital gains you took earlier this year, then try not to sell assets yielding a capital loss before year-end.
- For example, you are a joint filer who made a profit of $5,000 on the sale of stock held for more than one year and your other taxable income for 2020 is $75,000
- The first $5,000 of those losses won’t yield a benefit this year. (It will offset $5,000 of capital gain that is already tax-free.)
Postpone income until 2021 and accelerate deductions into 2020 to lower your 2020 tax bill. This strategy may enable you to claim larger deductions, credits, and other tax breaks for 2020 that are phased out over varying levels of adjusted gross income (AGI).
- These include deductible IRA contributions, child tax credits, higher education tax credits, and deductions for student loan interest.
- Postponing income also is desirable for those taxpayers who anticipate being in a lower tax bracket next year due to changed financial circumstances.
- Note, however, that in some cases, it may pay to accelerate income into 2020, such as when a person’s marginal tax rate is much lower this year than it will be next year.
Many taxpayers won’t be able to itemize because of the high basic standard deduction amounts that apply for 2020 ($24,800 for joint filers, $12,400 for singles and for married taxpayers filing separately, $18,650 for heads of household). Additionally, many itemized deductions have been reduced or abolished. Relevant changes to itemized deductions include:
- No more than $10,000 of state and local taxes may be deducted; miscellaneous itemized deductions (e.g., tax preparation fees and unreimbursed employee expenses) are not deductible; and personal casualty and theft losses are deductible only if they are attributable to a federally declared disaster and the $100-per-casualty and 10%-of-AGI limits are met.
- Medical expenses may be itemized if they exceed:
- 7.5% of your adjusted gross income, state and local taxes up to $10,000, your charitable contributions, plus interest deductions on a restricted amount of qualifying residence debt.
- Payments of the above items won’t save taxes if they don’t cumulatively exceed the standard deduction for your filing status.
- COVID – related changes to itemized deductions
- Individuals may claim a $300 above-the-line deduction for cash charitable contributions on top of their standard deduction.
- The percentage limit on charitable contributions has been raised from 60% of modified adjusted gross income (MAGI) to 100%.
Taxpayers may be able to work around deduction restrictions by applying a bunching strategy to pull or push discretionary medical expenses and charitable contributions into one year rather than splitting it between a two-year period.
- For example, a taxpayer who will be able to itemize deductions this year but not next will benefit by making two years’ worth of charitable contributions this year, instead of spreading out donations over 2020 and 2021.
- The COVID-related increase for 2020 in the income-based charitable deduction limit for cash contributions from 60% to 100% of MAGI assists in this bunching strategy, especially for higher income individuals with the means and disposition to make large charitable contributions.
Consider using a credit card to pay deductible expenses before the end of the year. Doing so will increase your 2020 deductions even if you don’t pay your credit card bill until after the end of the year.
If you expect to owe state and local income taxes when you file your return next year and you will be itemizing in 2020, consider asking your employer to increase withholding of state and local taxes (or pay estimated tax payments of state and local taxes) before year-end to pull the deduction of those taxes into 2020.
- State and local tax deductions are limited to $10,000 per year.
- This strategy may not be advantageous if it causes your 2020 state and local tax payments to exceed $10,000.
Consider increasing the amount you set aside for next year in your employer’s health flexible spending account (FSA) if you set aside too little this year and anticipate similar medical costs in 2021.
If you become eligible in December of 2020 to make health savings account (HSA) contributions, you can make a full year’s worth of deductible HSA contributions for 2020.
Make gifts sheltered by the annual gift tax exclusion before the end of the year if doing so may save gift and estate taxes.
- The exclusion applies to gifts of up to $15,000 made in 2020 to each of an unlimited number of individuals.
- You can’t carry over unused exclusions from one year to the next.
- Such transfers may save family income taxes where income-earning property is given to family members in lower income tax brackets who are not subject to the kiddie tax.
Consider decreasing your estimated tax payments based on lower 2020 income projections if overpayments are anticipated.
Retirement Plan/IRA Strategies
Required minimum distributions (RMDs) that usually must be taken from an IRA or 401(k) plan (or other employer-sponsored retirement plan) have been waived for 2020.
- This includes RMDs that would have been required by April 1 if you reach age 70½ during 2019 (and for non-5% company owners over age 70½ who retired during 2019 after having deferred taking RMDs until April 1 following their year of retirement).
- If you don’t have a financial need to take a distribution in 2020, you are not required to do so.
- Note that because of a recent law change, plan participants who turn 70½ in 2020 or later don’t need to take required distributions for any year before the year in which they reach age 72.
Consider making 2020 charitable donations via qualified charitable distributions from your IRAs if you are age 70½ or older by the end of 2020, have traditional IRAs, and especially if you are unable to itemize your deductions.
- These distributions are made directly to charities from your IRAs, and the amount of the contribution is neither included in your gross income nor deductible on Schedule A, Form 1040.
- You are still entitled to claim the entire standard deduction.
- Previously, those who reached reach age 70½ during a year weren’t permitted to make contributions to a traditional IRA for that year or any later year.
- While that restriction no longer applies, the qualified charitable distribution amount must be reduced by contributions to an IRA that were deducted for any year in which the contributor was age 70½ or older, unless a previous qualified charitable distribution exclusion was reduced by that post-age 70½ contribution.)
It may be advantageous to establish and contribute as much as you can to one or more traditional IRAs in 2020 if you:
- Are younger than age 70½ at the end of 2020,
- Anticipate that you will not itemize your deductions in later years when you are 70½ or older, and
- You don’t currently have any traditional IRAs.
If these circumstances apply to you, except that you already have one or more traditional IRAs:
- Make maximum contributions to one or more traditional IRAs in 2020.
- In the year you reach age 70½, make your charitable donations by way of qualified charitable distributions from your IRA.
- This will allow you to convert nondeductible charitable contributions that you make in the year you turn 70½ and later years, into deductible-in-2020 IRA contributions and reductions of gross income from later year distributions from the IRAs.
Take an eligible rollover distribution from a qualified retirement plan before the end of 2020 if you are facing a penalty for underpayment of estimated tax and having your employer increase your withholding is unavailable or won’t sufficiently address the problem.
- Income tax will be withheld from the distribution and will be applied toward the taxes owed for 2020.
- You can conduct a timely roll over the gross amount of the distribution, i.e., the net amount you received plus the amount of withheld tax, to a traditional IRA.
- No part of the distribution will be includible in income for 2020, but the withheld tax will be applied pro rata over the full 2020 tax year to reduce previous underpayments of estimated tax.
If you believe a Roth IRA is better than a traditional IRA, consider converting traditional-IRA money invested in beaten-down stocks (or mutual funds) into a Roth IRA, if eligible to do so.
- Keep in mind, however, that such a conversion will increase your AGI for 2020. Please consult with WellsColeman regarding the potential tax impact of such a move prior to taking action.
The CARES Act allows eligible individuals to withdraw up to $100,000 from qualified retirement plans during 2020 without incurring the 10% early distribution penalty.
- Individuals or their spouses, dependents or other household members affected by COVID-19 may qualify for this relief.
- Such taxable distributions can be included in gross income ratably over three years.
- Taxpayers may recontribute the withdrawn amounts to a tax-qualified plan or IRA at any time within three years after the distribution, which would necessitate amending your tax return.
- These repayments will be treated as a tax-free rollover and are not subject to that year’s cap on contributions.
The SECURE Act generally requires that designated beneficiaries of persons who die after December 31, 2019, take inherited plan benefits over a 10-year period.
- Eligible designated beneficiaries (i.e., surviving spouses, minor children of the plan participant, disabled and chronically ill beneficiaries and beneficiaries who are less than 10 years younger than the plan participant) are not subject to this rule.
- Conduit trusts and see-through accumulation trusts are required to use the 10-year payout rule unless the trust is for the sole benefit of a disabled or chronically ill beneficiary.
- Non-see-through accumulation trusts will continue to use the five-year payout period, which was required before the SECURE Act.
The SECURE Act eliminates the age cap, allowing individuals to contribute to their traditional IRAs in or after the year in which they turn 70½ as long as you have earned income.
Foreign Bank Account Reporting
The IRS has become increasingly aggressive at tracking down individuals who have not reported foreign bank accounts. If you have an interest in a foreign bank account, it must be disclosed; failure to do so carries stiff penalties.
You must file a Report of Foreign Bank and Financial Accounts (FBAR) if:
- You are a U.S. resident or a person doing business in the United States;
- You had one or more financial accounts that exceeded $10,000 during the calendar year;
- The financial account was in a foreign country;
- You had a financial interest in the account or signatory or other authority over the foreign financial account.
If you are unclear about the requirements or think they could possibly apply to you, please let us know at your earliest convenience.
Home Office Deductions: In response to the COVID-19 pandemic many people who previously worked in an office were required to spend a significant part of this year working from home. While a deduction for home offices is available for self-employed individuals who use a portion of their home regularly and exclusively for their business, this deduction is not available for employees (i.e. those who receive a Form W2 at the end of the year). Previously, this was an allowable deduction for employees as a miscellaneous itemized deduction subject to the 2% of adjusted gross income limitation. However, the Tax Cuts and Jobs Act of 2017 repealed this deduction.
Excess Business Loss Limitation: A taxpayer will only be able to deduct net business losses of up to $262,000 (projected) in 2021 (joint filers can deduct $524,000 (projected) in 2021) for taxable years beginning after December 31, 2020, and before January 1, 2026. Excess business losses are normally disallowed and added to the taxpayer’s net operating loss carryforward, but the CARES Act suspends the application of this excess business loss rule for 2020, and retroactively suspends the excess business loss limitation rule for 2018 and 2019.
Estate and Gift Taxes: The unified estate and gift tax exclusion and generation-skipping transfer tax exemption is $11,580,000 per person in 2020. For 2021, the exemption is projected to increase to $11,700,000.
Kiddie Tax: The SECURE Act reinstates the “kiddie” tax previously suspended by the Tax Cuts and Jobs Act (TCJA). For tax years beginning after December 31, 2019, the unearned income of a child is no longer taxed at the same rates as estates and trusts. Instead, the unearned income of a child will be taxed at the parents’ tax rates if those rates are higher than the child’s tax rate. Taxpayers can elect to apply this provision retroactively to tax years that begin in 2018 or 2019 by filing an amended return.