Each individual taxpayer’s year-end planning should consider the unique challenges and opportunities that this year presents.
By the Numbers
- The tax rates for 2020 are 10%, 12%, 22%, 24%, 32%, 35%, and 37%.
- The standard deduction for 2020 is $24,800 for married filing jointly and surviving spouses, $18,650 for head of household, and $12,400 for all other taxpayers.
- The Qualified Business Income Deduction thresholds related to specified service trade or business (SSTB) phase-outs and wages and UBIA phase-in for 2020 are $326,600 for joint filers and $163,300 for all other taxpayers.
- The annual gift tax exclusion for 2020 is $15,000 per recipient.
- The annual deductible contribution limit for an IRA for 2020 is $6,000. A $1,000 “catch-up” contribution is allowed for taxpayers age 50 or older by the end of 2020.
- The 401(k) elective deferral limit is $19,500 for 2020. If the taxpayer’s 401(k) allows for catch-up contributions for 2020 and the taxpayer reaches age 50 by the end of 2020, an additional $6,500 may be contributed.
Higher-income earners must be wary of the 3.8% surtax on certain unearned income. As year-end nears, your approach to minimizing or eliminating the 3.8% surtax will depend on your estimated modified adjusted gross income and net investment income for the year.
The 0.9% additional Medicare tax may also require higher-income earners to take year-end action. There could be situations where an employee may need to have more withheld toward the end of the year to cover the tax.
Short-term capital gains are taxed at an individual’s ordinary rate. Long-term capital gains from the sale of assets held for over a year are taxed at 0%, 15%, or 20% in 2020, depending on taxable income. For lower-income taxpayers for which the 0% rate applies so far in 2020, it would not be advantageous to sell assets yielding capital losses, as they won’t yield a benefit in 2020. If long-term appreciated-in-value assets are held, consider selling enough of them to generate long-term capital gains sheltered by the 0% rate. For higher income taxpayers, consider selling underperforming investments to realize losses than can offset capital gains. Higher income taxpayers may also consider selling depreciated assets that have been held more than a year and contributing the proceeds to charity, as the losses can be harvested, plus charitable contributions can be deducted for the cash donations.
Investment Income Savings
An additional 3.8% Net Investment Income Tax (NIIT) is levied on certain unearned income for higher-income taxpayers. Year-end strategies to reduce exposure to the NIIT include the following:
- Timing of sales: Consider timing the sale of assets so as to have offsetting capital losses and capital gains. Capital losses may be fully deducted against capital gains and also may offset up to $3,000 of ordinary income. ($1,500 for single filers).
- Defer taxes by investing in Qualified Opportunity Fund (QOFs): A taxpayer who invests in Qualified Opportunity Zone property through a QOF can temporarily defer tax on the amount of eligible gains they invest.
- Exclusion of gain attributable to certain small business stock: 100% of the gain on the sale of qualifying small business stock is excluded from income. The stock must be held for more than five years to qualify for the exclusion.
- Installment sales: Generally, a sale occurs when property is transferred. If a gain will be realized on the sale, income recognition will normally be deferred under the installment method until payments are received, so long as one payment is received in the year after the sale. Thus, if a taxpayer expects to sell property at year-end, and it makes economic sense, consider selling the property using the installment method to defer payments (and tax) until next year or later.
Deferring Income and Accelerating Deductions
Postpone income until 2021 and accelerate deductions into 2020 if doing so will 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.
If AGI is expected to be higher in 2020 than in 2021 or you anticipate being in the same or a higher tax bracket in 2020, you may benefit by deferring income to 2021.
- 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 are a self-employed taxpayer using the cash-basis of accounting, consider delaying year-end billing to clients so that payments will not be received until 2021.
- It may be advantageous to try to arrange with your employer to defer until early 2021 a bonus that may be coming your way.
In limited circumstances, you may benefit by accelerating income into 2020, for example, if you anticipate being in a higher tax bracket in 2021 or will need additional income to take advantage of an offsetting deduction or credit unavailable in future tax years. Accelerating income will be disadvantageous if the taxpayer expects to be in the same or lower tax bracket for 2021.
- If you are a self-employed taxpayer reporting income and expenses on a cash basis, consider issuing bills and attempting collection before the end of 2020.
- If your employer pays bonuses after the end of the current year, consider asking to have the bonus paid before the end of 2020.
- If you are over age 59 ½ and participate in an employer plan or have an IRA, consider making any taxable withdrawals before 2021.
- Consider making a Roth conversion.
Economic Impact Payment
If an individual missed the extension for non-filers, the credit may be taken on the 2020 Form 1040 for the full amount to which they are entitled. Taxpayers who received more than the amount to which they are entitled do not have to repay it unless they were not eligible to receive it in the first place, e.g. deceased individuals or non-resident aliens. A person claimed as a dependent in 2018 or 2019 may also be entitled to the refundable credit if they are not claimed as a dependent in 2020 even though their parent received the $500 credit for the earlier year.
The CARES Act allows penalty free distributions made during the 2020 calendar year of up to $100,000 for COVID-related expenses. Any income attributable to an early withdrawal is subject to tax over a three-year period, and taxpayers may recontribute the withdrawn amounts to a qualified retirement plan without regard to annual caps on contributions if made within three years.
The maximum loan amount from a retirement account is increased from the lesser of $50,000 or 50% of vested balance to the lesser of $100,000 or 100% of vested balance for qualified individuals. This increase applies to loans made between March 27, 2020 and December 31, 2020. In addition, qualified individuals may delay loan payments due after March 27, 2020 and before December 31, 2020 for one year. A qualified individual is an individual (or the spouse of an individual) diagnosed with COVID-19 with a CDC-approved test, or who experiences adverse financial consequences as a result of quarantine, business closure, layoff, or reduced hours due to the virus.
There is a temporary waiver of required minimum distributions for the 2020 calendar year. However, because of recent changes to retirement accounts, such as the increased age to begin RMDs, the end to the 70 ½ age limit for contributions to an IRA, and the shortened distribution period for non-spouse inherited IRAs, taxpayers are encouraged to review strategies for continuing to make IRA contributions and to reevaluate their beneficiary designations.
If itemized deductions are relatively constant and are close to the standard deduction amount, little or no benefit will be gained from itemizing deductions each year. However, simply taking the standard deduction each year means the loss of the benefit of itemized deductions that exceed the standard deduction. To maximize the benefits of both the standard deduction and itemized deductions, consider adjusting the timing of deductible expenses, i.e. “bunching,” so that they are higher in one year and lower the following year. This can be accomplished, for example, by pulling deductible expenses into 2020, such as property taxes or state estimated tax payments due in early 2021, doubling up on charitable contributions every other year, or pushing/pulling discretionary medical and dental expenses into one year.
For 85% of taxpayers who do not itemize, a $300 above-the-line deduction for cash contributions is available for 2020. However, the law is unclear if the $300 amount applies for both individual and joint returns or whether it is available beyond 2020. Contributions made to private non-operating foundations, supporting organizations, and donor-advised funds do not qualify for this provision.
For 2020 only, the limit for itemized charitable deductions is increased from 50% to 100% of adjusted gross income. Contributions made to private non-operating foundations, supporting organizations, and donor-advised funds do not qualify for this provision; however, they remain deductible up to the existing limit.
Although the CARES Act eliminated the required minimum distribution for 2020, taxpayers over age 70 ½ may still make a direct contribution to a charity from their IRA of up to $100,000 in 2020 and thereby reduce their adjusted gross income.
For payments made before January 1, 2021, employers may reimburse employees for principal and interest on student loans of up to $5,250 as part of an education reimbursement program.
Changes under the Tax Cuts and Jobs Act (TCJA), that were meant to simplify the application of the kiddie tax, had the unintended consequence of increasing the tax on the unearned income, such as military death benefits, of children in low-income families. As a result, the kiddie tax reverts to rules prior to TCJA, using the parents’ tax rate for tax years after 2019. However, a taxpayer may elect to apply the parents’ tax rate to 2018 and 2019, thereby providing an opportunity to amend a prior year’s return.
Several tax law provisions may help taxpayers recover financially from the impact of a disaster, especially when the federal government declares their location to be a major disaster area. Depending on the circumstances, the IRS may grant additional time to file returns and pay taxes. Both individuals and businesses can elect to claim casualty losses related to a disaster on the tax return for the previous year and thereby receive needed funds more quickly. Although the Covid-19 pandemic is a federally declared disaster and qualifies for a casualty loss deduction in 2020 (or the prior year, if elected), the IRS must provide further clarification on what losses qualify and for what time period.
Taxpayers might consider taking advantage of these tax benefits in 2020 before they expire. In some cases, these benefits were retroactively applied. In which case, it might be useful to amend prior years’ returns if the savings are significant enough.
- Exclusion from income for the forgiveness of debt on a principal residence. The exclusion now applies to discharges of qualified principal residence indebtedness occurring before January 1, 2021, or discharges that are subject to an arrangement that is entered into and evidenced in writing before January 1, 2021.
- Mortgage insurance premium deduction. Premiums paid or accrued after January 1, 2018, for qualified mortgage insurance in connection with acquisition indebtedness are deductible as home mortgage interest (qualified residence interest). The deduction is subject to the taxpayers adjusted gross income (AGI) limits.
- Above-the-line deduction for tuition and fees. The tuition and fees deduction may be claimed for qualified tuition and related expenses paid for the enrollment or attendance at an eligible education institution. The student may be the taxpayer, the taxpayer’s spouse, or the taxpayer’s dependent.
- Nonbusiness energy property credit. The nonrefundable nonbusiness energy property credit is available for qualified energy efficient improvements or property placed in service before January 1, 2021. Qualified energy efficiency improvements include energy-efficient exterior windows, doors and skylights; roofs (metal and asphalt) and roof products; and insulation. Residential energy property includes energy-efficient heating and air conditioning systems; water heaters (natural gas, propane or oil); and biomass stoves.
- Reduced 7.5 percent threshold for medical expense. If it is possible and the expenses are significant, accelerate the payment of medical expenses into 2020. The threshold rises to 10% of adjusted gross income in 2021.
- Health coverage tax credit (HCTC). Eligible individuals can receive a tax credit to offset the cost of their monthly health insurance premiums for 2020 if they have qualified health coverage for the HCTC.
In addition to the individual mandate tax penalty, the Affordable Care Act introduced the 3.8 percent net investment income tax and the .09 percent Medicare tax. If the Supreme Court determines the ACA to be unconstitutional, there is a potential for a refund for taxpayers subject to these taxes. Taxpayers should consider filing a protective claim for any open tax years.
Because of potential retroactive changes to tax rules, the possibility of more changes with the change in the administration, and the continuing challenges of the pandemic, there is no one-size-fits-all for tax planning. Any strategy may have unintended consequences if the taxpayer’s situation is not evaluated holistically given the changing landscape. Please call our office to schedule an appointment to discuss your year-end strategy.