2020 has been a special year, to say the least. For many, it has brought with it changes unique to their own situations, while for everyone it has brought with it changes to the tax code. These changes have presented new opportunities to incorporate into your annual year end tax planning strategies.
We’ve compiled a list of several important topics and strategies to consider prior to December 31st:
For All Taxpayers
Retirement Account Contributions: increasing pretax retirement account contributions can be a great way to reduce your Adjusted Gross Income and your annual tax burden. If cash flow allows, consider increasing your contributions to enhance your tax efficiency, bolster your retirement savings and possibly increase the likelihood you will qualify for other tax credits or breaks available to those under certain income limits.
Harvest Capital Losses (or Gains!) depending on your tax situation: with higher volatility in financial markets this year, review your portfolio holdings to determine those trading at gains and losses and consider harvesting losses to offset capital gain distributions and/or up to $3,000 in ordinary income. Alternatively, for those who fall into the 12% marginal tax bracket or below, you may have the opportunity to realize capital gains at preferential tax rates of 0% on your Federal return. Note, while gains can be realized in some instances at 0% tax rates, state’s do not offer the same treatment so any gains realized would be subject to taxes at the state level.
Review your deductions: add up all expenses that count toward itemized deductions, including state taxes paid, mortgage interest and charitable donations. While approximately 90% of all taxpayers now utilize the Standard Deduction due to increases included with tax reform passes in 2017, it can still pay to review your itemized total to determine if you are close to the Standard Deduction threshold. For 2020, the Standard Deduction is $12,400 for single filers and $24,800 for those filing jointly.
- Charitable Giving
- Gift appreciated securities from your portfolio rather than giving cash
- Consider if opening and funding a Donor Advised Fund is appropriate for your tax situation
- Review the new Above the line Charitable Deduction for those who do not itemize their deductions
- If you are close to the threshold and expect to be in future years, consider making gifts you plan to make in future years prior to year end to put you over the Standard Deduction, also known as bunching, to increase the tax benefit of your gift.
CARES Act Economic Income Payments: many taxpayers received direct stimulus payments earlier this year shortly after the CARES Act was first passed. Payments were made based on taxpayer’s 2018 income, or 2019 income if their return had already been filed. If your income was too high to qualify based on 2018/2019 returns but you have seen income reductions this year, there is still a chance you may receive this as a refundable tax credit when filing your 2020 tax return. Consider how reducing your Adjusted Gross Income (such as increased retirement account contributions) or increasing your Adjusted Gross Income (such as realizing capital gains) may impact your credit.
Roth Conversions: typically, Roth conversion strategies are most preferential for those who have retired and seen a dramatic reduction in their income placing them in more favorable marginal tax brackets. Due to the pandemic, however, many taxpayers have seen material income reductions – due to pay cuts or layoffs. Prior to executing a Roth Conversion strategy, it is incredibly important to consider your income this year vs. future years and how realizing income may impact other areas of your tax plan – a comprehensive review of your entire situation is recommended.
Tax Withholding: review your tax withholdings to assure proper withholding has occurred. If not, in addition to having to pay tax due at filing, you may incur penalties and interest on the withholding shortfall.
For Those 50 and Older
Catch Up Retirement Account Contributions: in addition to maximum 401k/403b contributions of $19,500, those age 50 and older can contribute $6,500 to their 401ks/403bs under the Catch-Up provision. Note, even if you turn 50 during the year, you can make the full catch up contribution.
For Those 65 and Older:
Medicare IRMAA: prior to realizing additional income, consider how this may impact your Medicare premiums due to the Income Related Monthly Adjustment Amount.
For Those 72 and Older (or those with Inherited Retirement Accounts)
Required Minimum Distributions: the CARES Act waived RMD requirements for 2020, meaning if you are subject to taking RMDs each year, either due to being over 72 or having an Inherited retirement account, you are not required to take a distribution this year. Remember, many custodians have these set up to occur automatically, so if you do want to forego the distribution this year, check your account to assure the distribution does not occur.
It is important to remember your tax planning objective. Rather than focusing specifically on what can be done this year to lower your tax burden, first consider how actions this year will impact your tax picture in future years and how actions taken on one or more of these items can trigger unintended consequences in other areas of your tax situation.