By Stephanie Casey, CPA, Senior Tax Manager | Family, Executive & Entrepreneur Advisory Services
Tax Planning Strategies That May Help Lower Your Tax Obligation
As we approach the end of the year, now is a good time to think about planning strategies that may help lower your tax bill for this year and possibly the following as well. This year, year-end planning takes place during the COVID-19 pandemic, which in addition to its devastating health and mortality impact has widely affected personal and business finances. New tax rules were enacted this past spring to help mitigate the financial impact of the disease, some of which should be considered as part of this year’s planning, most notably the elimination of required retirement plan distributions, and liberalized charitable deduction rules.
Major tax changes from recent years generally remain in place for tax year 2020. However, despite the lack of major year-over-year tax changes, the time-tested approach of deferring income and accelerating deductions to minimize taxes still works for most taxpayers, as does the bunching of expenses into this year or next to avoid income tax phase-outs and maximize deductions.
We have compiled a list of potential year-end action items for individuals based on current tax rules that should be considered. Your Keiter tax advisor can narrow down the specific items relevant to your particular tax situation. In the meantime, please review the following list and contact us at your earliest convenience so that we can discuss what strategies might be beneficial to you:
Overview of Tax Planning Options for Family Offices, Executives and Entrepreneurs
1. Capital Gains & Losses
Long-term capital gain from sales of assets held for over one year are taxed at 0%, 15% or 20%, depending on the taxpayer’s income tax bracket. If you hold long-term appreciated capital assets, consider selling enough of them to generate long-term capital gains that can be sheltered by the 0% rate. Be sure you confirm with your tax advisor whether or not your projected income for 2020 will allow you to qualify for the 0% beneficial rate.
Consider recognizing any losses that you currently have in your stock portfolio to offset any capital gains if you are over the 0% LTCG rate. You can deduct a net $3,000 capital loss against ordinary income in the current year, and any additional losses carry forward indefinitely. Remember, taxpayers who liquidate their loss positions must wait at least 31 days after the sale date before buying the same security back if they want to deduct the loss on their tax returns. If they buy back in before that time, the loss will be disallowed under the IRS wash sale rule.
2. IRA Accounts & Retirement Assets
Consider converting traditional-IRA money invested in any depreciated stocks (or mutual funds) into a ROTH IRA in 2020 if eligible to do so. Keep in mind that such a conversion will increase your AGI for 2020, but could be a big tax saver in future years, as distributions will be tax free.
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 hit 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). So, if you do not have a financial need to take a distribution in 2020, you do not have to. Note that because of a recent law change, plan participants who turn 70½ in 2020 or later do not need to take required distributions for any year before the year in which they reach age 72.
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, consider making 2020 charitable donations via qualified charitable distributions from your IRAs. 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.
If you are younger than age 70½ at the end of 2020, you anticipate that you will not itemize your deductions in later years when you are 70½ or older, and are able to make deductible IRA contributions, establish and contribute the maximum amount allowed to one or more traditional IRAs in 2020. Then, in the year you reach age 70½, make your charitable donations by way of qualified charitable distributions from your IRA. Doing this will allow you, in effect, to convert nondeductible charitable contributions that you make in the year you turn 70½ and later years, into deductible-in-2020 IRA contributions and will also serve to reduce gross income from future year IRA distributions.
Consider a backdoor Roth contribution. If your income is too high to make a Roth IRA contribution and if you have no other IRAs, you can contribute the annual maximum amount of $6,000 or ($7,000 if you’re 50 or older) to a nondeductible traditional IRA. Then, immediately convert that to a Roth IRA. The conversion is nontaxable as you are using after tax dollars. If you have other IRAs, you have to consider those in the calculation of income upon conversion, so some of the converted amount could be taxable income.
3. Itemized Deductions
Many taxpayers won’t be able to itemize because of the high standard deduction amounts that apply for 2020 and because many itemized deductions have been reduced or abolished. Similar to last year, no more than $10,000 of state and local taxes may be deducted; “2%” miscellaneous itemized deductions are not deductible; and personal casualty and theft losses are deductible only if they are attributable to a federally declared disaster and only to the extent the $100-per-casualty and 10%-of-AGI limits are met. You can still itemize medical expenses but only to the extent they exceed 7.5% of your adjusted gross income.
Some taxpayers may be able to work around these deduction restrictions by applying a bunching strategy to pull or push discretionary medical expenses and charitable contributions into the year where they will do some tax good. For example, a taxpayer who will be able to itemize deductions this year but not the 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.
If you know you are itemizing in 2020, prepay your January mortgage and be sure to pay any margin interest on investments before year end.
If you are going to make larger charitable contributions, consider using long-term appreciated securities rather than cash. You receive a charitable deduction equal to the fair market value of the asset, not the cost basis, so you never pay tax on the appreciation.
Two COVID-related changes for 2020 may especially be relevant here: (1) Individuals may claim a $300 above-the-line deduction for cash charitable contributions on top of their standard deduction; and the percentage limit on cash charitable contributions has been raised from 60% of modified adjusted gross income (MAGI) to 100%.
4. Tax Deferred Accounts
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 next year.
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.
Consider funding Virginia 529 plans for high school and college savings. In a 529 account, your money can grow tax-free and be used to fund qualified higher education expenses at eligible educational institutions nationwide. Virginia taxpayers enjoy the additional benefit of a state income tax deduction on contributions to their Virginia529 accounts. A taxpayer can deduct $4,000 per account for a Virginia 529 plan. You can also use up to $10,000 per year in 529 funds toward a beneficiary’s private or religious K-12 school tuition.
5. Federal or State Credits
There are several federal and state credits available to help reduce taxes. On the federal level, the most common credits are for education, health, child and dependent care credits. But, there are federal credits for other items as well, such as for the elderly and disabled, adoption, residential energy and alternative motor vehicle credits.
Virginia has their own set of credits that offset state taxes. Some of these include fuel credits, land preservation, neighborhood assistance, historic rehabilitation and recycling credits. Many charities in Virginia offer state tax credits when contributing to their organization (note that the IRS requires you to reduce the charitable deduction at the federal level for any state tax credits received from the charity).
6. Use up your Gift Tax Exclusion
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.
These are just some of the year-end steps that can be taken to reduce your tax bill. Since every family, executive and entrepreneur has unique tax situations, we recommend you contact your Keiter Opportunity Advisor or Email | Call: 804.747.0000 to help determine which tax savings strategies might be right for you.
Additional tax Resources for Family offices, Executives and Entrepreneurs
The information contained within this article is provided for informational purposes only and is current as of the date published. Online readers are advised not to act upon this information without seeking the service of a professional accountant, as this article is not a substitute for obtaining accounting, tax, or financial advice from a professional accountant.