2020 Year-End Tax Planning For Individuals & Pandemic Tax Changes
Lucy Luo, CPA
1 December 2020
Year-end planning for 2020 takes place during the COVID-19 pandemic. Several tax provisions were enacted to help individuals deal with this pandemic and its economic disruption. This article is an overview of provisions that impact income tax rules and year-end individual tax planning moves for individuals to consider.
RECENT LEGISLATION OVERVIEW
Families First Coronavirus Response Act (FFCRA) Congress passed the FFCRA in March 2020. The FFCRA provides certain small employers with payroll tax credits that equal 100% of COVID-19-related qualified family leave wages and 100% of COVID-19-related qualified sick leave wages paid by employers.
Coronavirus Aid, Relief, and Economic Security Act (CARES) Following the FFCRA, Congress passed the CARES Act. The CARES Act is the most substantial federal legislation in response to the coronavirus pandemic. The Act includes the Paycheck Protection Program (PPP) and related loan forgiveness; the employee retention credit; stimulus checks; an above-the-line $300 deduction and waiver of AGI limit for charitable donations; the removal of 10% penalty for early COVID-related retirement plan distributions; a waiver of required minimum distributions for 2020; the temporary repeal of excess business loss limitation; and the revival of net operating losses (just to name a few).
Setting Every Community Up for Retirement Enhancement Act (SECURE) The SECURE Act, which passed in late 2019, repeals the maximum age for traditional IRA contributions and raises the required minimum distribution age from 70½ to 72. The Act also changes the kiddie tax back to pre-Tax Cuts and Jobs Act rules where income is subject to the parents’ tax rates if the parents’ tax rates are higher than the tax rates of the child. Additionally, the Act expands Section 529 education savings plans to cover registered apprenticeships and distributions to repay certain student loans.
YEAR-END TAX PLANNING MOVES
Be Wary of the 3.8% Net Investment Income (NII) Tax Higher-income taxpayers should be conscious of the 3.8% NII tax on certain investment income. Your approach to minimizing or eliminating the 3.8% surtax will depend on your estimated modified AGI (MAGI) and NII for the year. You should consider ways to minimize (e.g., through deferral) additional NII for the rest of the year, or otherwise reduce your MAGI to avoid the tax.
Manage Your Long-Term Capital Gains (LTCG) LTCG from sales of assets held for over one year are taxed at 0%, 15% or 20%, depending on your taxable income. 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, if you are a joint filer with $5,000 LTCG and other taxable income in 2020 of $75,000, recognizing capital losses to offset this gain will yield no benefit since the $5,000 is already subject to the 0% rate.
Convert Ordinary Income to Qualified Dividend Income You may consider shifting investments from those where the income is taxed at ordinary rates, such as bonds, to stocks that pay qualified dividends. If the dividend income is qualified, the income will be taxed at long term capital gains rates.
Minimize Tax on Social Security Benefits When a Social Security recipient’s MAGI plus 50% of Social Security benefits exceeds certain base amounts, the benefits can be taxable. The MAGI thresholds are $25,000 for single individuals, $32,000 for married taxpayers filing a joint return, and zero for married individuals filing separately. If your income is close to these thresholds, you should consider deferring income to avoid taxes on the Social Security benefits.
Plan Your Retirement Accounts Before 2020, traditional IRA contributions were not allowed once an individual attained age 70½. The SECURE Act removed the maximum age for traditional IRA contributions. Starting in 2020, the new rules allow you to make contributions to a traditional IRA regardless of your age if you have compensation, which generally means earned income from wages or self-employment.
The SECURE Act also changed the age at which required minimum distributions (RMD) must be taken from an IRA or 401(k) plan from 70½ to 72. Meanwhile, the CARES Act waived RMDs for the year 2020, including an RMD that would have been required by April 1 if you hit age 70½ during 2019. So, if you don’t have a financial need to take a distribution in 2020, then you don’t have to take one.
Although the RMD requirement is waived for 2020, there are still some benefits for charitable IRA rollovers. If you are 70½ or older, consider making a qualified charitable distribution (QCD) from your IRA directly to a charity (the age for QCDs remains at 70½) and exclude the distribution from gross income up to $100,000 per year. Or, you may consider a smaller charitable contribution in 2020 and use the QCD in early 2021, allowing you to offset up to $100,000 of your 2021 RMDs.
Plan Your Charitable Contributions There are two major COVID-related changes for 2020: (1) up to $300 above-the-line deduction for charitable contributions for taxpayers who take the standard deduction; (2) for taxpayers who take itemized deduction, the percentage limit on charitable contributions has been raised from 60% of modified adjusted gross income (MAGI) to 100% for 2020. Both are for cash donations made in 2020 only. Contributions to non-operating private foundations, support organizations and donor-advised funds do not qualify.
Typically, there is no tax benefit for giving to charity unless you itemize deductions. However, since the CARES Act creates an above-the-line deduction of up to $300 for contributions for taxpayers who don’t itemize, everyone is entitled to a charitable deduction for 2020. If you would like to take advantage of this provision, make sure to donate before the end of the year.
Review Your Carryovers Review tax carryovers you may have from previous years to use in 2020 or future years, such as passive loss carryovers, capital loss carryovers, and basis limitation carryovers.
If, for example, you have carrying passive losses from a rental activity or investment in a partnership as a limited partner, you might want to dispose of the passive activity before the end of the year. Suspended passive losses are deductible in the year during which the passive activity is disposed of by the taxpayer. If losses from your pass-through entities were limited in the past due to basis, consider making a capital contribution to utilize the losses.
Time Your Income and Expenses Postpone income until 2021 and accelerate deductions into 2020 if doing so will enable you to claim larger deductions, credits, and other tax. These deductions can include deductible IRA contributions, child tax credits, higher education tax credits, and deductions for student loan interest. Certain tax breaks are subject to phase-out if a taxpayer’s adjusted gross income is too high. Postponing income also is desirable if you anticipate a lower tax bracket next year due to changed financial circumstances. Note, however, that in some cases, you might be better off accelerating income into 2020. For example, if you have a more favorable filing status this year (e.g., head of household versus individual filing status), or you expect to be in a higher tax bracket next year, accelerating income into 2020 will be beneficial.
Review Your FSA and HSA Accounts Consider increasing your annual flexible spending account (FSA) amount for 2021 if you anticipate similar medical costs and ended up setting aside too little for 2020. 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 Gift Contribution and Leverage Generous Exemptions Before They’re Gone. 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. The historically low interest rates and high lifetime gift and estate tax exemptions present a powerful estate-planning opportunity. In addition, the economic fallout of COVID-19 is depressing many asset values. The current gift and estate tax exemptions are set to expire in a few years.
Careful planning and discussion around your current and future tax situation can help maintain an efficient tax strategy. Techniques discussed above are just some of the year-end steps you can take. Please contact us if you want to tailor your tax planning in a way that will work best for you.