The passing of key legislation over the past couple of years — particularly the Setting Every Community Up for Retirement Enhancement Act (SECURE Act) of 2019 and the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) of 2020 — has resulted in significant changes for individuals when it comes to tax planning strategies related to:
- Retirement planning benefits,
- Rules for kiddie tax,
- Charitable contribution percentages,
- Recovery Rebate Credit (stimulus check) and
- Unemployment income.
Additionally, the Tax Cuts and Jobs Act (TCJA) of 2017 continues to be a factor in planning for individuals’ tax return filings, namely as it relates to the:
- $10,000 cap on the state and local tax deduction,
- Qualified Business Income Deduction (Section 199A) and
- Qualified Opportunity Zone Program.
Although the TCJA eliminated some of the year-end tax strategies accountants traditionally discussed with clients, in the end, the SECURE and CARES Acts have still left a number of opportunities individual taxpayers can look forward to and maximize at the end of 2020. Below are our top 10 you may want to consider implementing this year.
1. Retirement Planning
Maximizing your retirement contributions allows you to contribute dollars pre-tax, lowering your overall taxable income. Take advantage of this opportunity as much as possible using this year’s new limits:
- If you are under age 50 you can contribute up to $19,500 to your 401(k) plan/year.
- If you are age 50 or older you can contribute up to $26,000/year.
- The 2020 traditional and ROTH IRA contribution limits are $6,000 for individuals under 50 and $7,000 for those above 50 years of age (although the amount you can contribute to a ROTH is reduced at higher incomes).
- Self-employed persons contributing to a solo 401(k) can contribute up to $57,000.
Another planning opportunity is a ROTH conversion. This allows you to convert a traditional IRA to a ROTH IRA and pay the tax on your retirement income now instead of when it is withdrawn. It could potentially provide the highest tax benefit for a couple reasons:
- You may have lower gross income this year as a result of the pandemic, and
- Even though the tax rates are scheduled to revert to pre-2018 levels after 2025, there is a chance they may increase sooner due to the large budget deficit.
Due to the tax law changes provided in the SECURE Act, if you have reached age 70 on July 1, 2019, or later, you are not required to withdraw your required minimum distributions (RMDs) from your IRA until age 72. In addition, individuals with traditional and ROTH IRAs can continue to make regular contributions to their plans since the 70 ½ age limit has been removed. Finally, the SECURE Act has placed a 10-year distribution time limit on those accounts inherited from a deceased IRA owner.
The CARES Act also provided some additional guidelines for retirement plans that apply to tax year 2020 only.
- You can waive your RMD to be made during 2020. Even though your RMDs may not be required, carefully consider your tax position before making this decision. It may be beneficial to take the RMD in 2020 while tax rates are relatively low.
- There is favorable tax treatment for COVID related distributions taking place between January 1, 2020, and December 30, 2020, of up to $100,000 for qualified individuals. These distributions are not subject to the 10% penalty if they are made by an individual before age 59 ½. This distribution can be included in income pro rata over a three year period. If you choose to repay the loan it can be done over the same three year period.
Read “6 Ways SECURE May Impact Your Retirement and Estate Plans”
2. Health Accounts
For Health Savings Accounts (HSAs), the 2020 annual contribution for a family has increased to $7,100 ($3,550 for individual). If you are 55 or older you can make a catch-up contribution of an additional $1,000. If you have a flexible spending account, monitor the balance in your account so you do not lose unused funds by the end of the plan year.
3. Charitable Contributions
The CARES Act increased the limitation on cash charitable contributions for 2020, from 60% of the adjusted gross income (AGI) to 100%. Any contributions over 100% of your AGI will be carried forward for use in a future year. Non-cash contributions made in 2020 will not qualify but can be claimed under the normal limits.
If you only itemize because you make charitable contributions, you may want to analyze your tax situation to determine if you should set up a donor advised fund, which would allow you to make a large, single-year contribution and maximize your tax deductions. This strategy allows you to “bunch” your contributions into one year, giving you the benefit of itemizing in that year and taking the standard deduction in the others. This would also be beneficial if you would like to take advantage of the CARES Act 100% cash deduction, but you do not know to which charities you would like to donate. You can donate the cash into a donor advised fund and receive the charitable deduction, then use the funds to donate to a charity at a later time.
If you are age 70 ½ or older and have traditional IRAs, consider making charitable donations directly from your IRA. Even though you may not have taken the RMD due to the CARES Act changes, you can still make a charitable contribution from your IRA. These donations are not included as an itemized deduction, but they are not included in your gross income either. It may be more beneficial to do this now since you will be depleting your IRA balance before tax rates potentially increase.
For those taxpayers who take the standard deduction, there is a $300 “above-the-line” deduction allowed for tax years beginning in 2020 as a result of the CARES Act.
4. Harvesting Capital Gains or Losses
If you are expecting a large capital gain in the current year, analyze your specific tax situation to determine the best course of action. You may want to:
- Harvest losses by offloading some of your underperforming stocks to offset this gain.
- Generate some gains to offset any capital loss carryforwards from prior years.
5. Net Investment Income (NII) Tax
As with previous years, reducing NII is important to lowering the related NII tax. Consider, where possible:
- Selling property with losses,
- Postponing net capital gains,
- Using an installment sale to spread a large gain over a number of years,
- Deferring gain using a Section 1031 exchange or donating appreciated securities to a qualified charity,
- Reducing modified adjusted gross income by maximizing retirement plan contributions,
- Contributing to your health savings account or
- Altering the tax characteristics of your investment.
6. Section 199A – Qualified Business Income Deduction (QBID)
Business owners (individuals, estates and trusts) of partnerships, S Corporations and sole proprietorships can take a maximum deduction of 20% of qualified business income. However, wage limitations apply, and if you are an owner of a specified service business, you are not eligible for the deduction if your taxable income exceeds a certain threshold. To qualify without limitation, owners may want to consider reducing their income to fall below the $163,300 phase-out threshold for individuals ($326,600 married filing jointly).
Read “IRS Finalizes Qualified Business Income Deduction Regs & Provides Guidance”
7. Taxes & Children
The SECURE Act repealed the TCJA kiddie tax rules. Starting in tax year 2020, the kiddie tax reverts to pre-TCJA rules, in which children with unearned income of more than $2,200 will be taxed at their parents’ marginal tax rate. This applies for all children who do not file a joint return and have at least one living parent at the end of the tax year. If children only have interest and dividend income of $11,000 or less, the parent may be able to elect to include that income on their return rather than filing a child’s return.
Additionally, the child tax credit remains $2,000 per qualifying child, and taxpayers filing jointly who have up to $400,000 of adjusted gross income are eligible.
8. Estate Tax Planning
The gift and estate tax and exemptions have been increased for inflation in 2020 to $11.58 million for individuals and $23.16 million for married filing jointly. Many taxpayers are no longer subject to the federal estate tax until at least 2026. Here are some items to consider:
- Continue making annual exclusion gifts — up to $15,000 to any individual per year.
- If you are under the exemption amounts, focus on income tax basis planning.
- Make sure all of your estate planning documents are up to date; non tax-related estate planning remains critical.
9. Qualified Opportunity Zones
The Qualified Opportunity (QO) Zone program, created by the TCJA, incentivizes long-term investment in low income and economically distressed communities by deferring capital gains tax when taxpayers invest those gains into QO Funds. A taxpayer with realized capital gains from an unrelated party has 180 days to invest in a QO Fund (read “Treasury Offers Opportunity Zone Participants Pandemic Relief in Notice 2020-39” for information on the extension of this period as part of the COVID-19 relief effort). An investor can defer their gain until whichever event occurs first: 1) the sale of the QO Fund interest, 2) the QO Fund ceases to qualify or 3) December 31, 2026. The original deferred gain is reduced based on how long the QO Zone Fund interest is held, and post-acquisition appreciation on the QO Fund interest is permanently excluded from tax if the QO Fund interest is held for 10 years or longer. As always, it is important to evaluate any investment carefully and discuss with your investment and tax advisers.
10. Unemployment Income
If you claimed unemployment in 2020, it’s important to determine how the payments are taxed both federally and by your state. For those who received unemployment as a result of the pandemic, the payments will be federally taxable and must be included in your gross income. In addition to the payments received from the state, under the CARES Act the federal government added an additional $600 per week until July 25, 2020, and an additional $300 per week for six weeks starting August 1. These two amounts combined may add up quickly, so make sure you are covered with respect to additional tax liability. In many cases you may not have had withholding taken out of your payments, so consult your tax adviser to see if a quarterly estimated payment is necessary — to avoid a tax bill surprise when filing in April.
Additional Items to Note for 2020 Tax Planning
- The standard deduction increased to $24,800 for married filing jointly, up from $24,400 in 2019.
- A one-time Recovery Rebate Credit (stimulus check) was issued to qualifying individuals in 2020. The amount received will be reported on the taxpayer’s Form 1040 and if the taxpayer’s credit exceeds the calculated amount on their 2020 tax return, the taxpayer will not be required to pay back the excess. If the credit received was less than the amount calculated, the taxpayer will be entitled to an additional credit on their 2020 tax return.
As only time will tell if the final results of our presidential and congressional elections could bring additional tax uncertainty in the near future, it’s important to work with your advisers now to take advantage of some of these simple yet effective strategies before December 31, 2020.
Contact Laura Sefcik at firstname.lastname@example.org, Nicki Rococi at email@example.com or a member of your service team to discuss this topic further.
Cohen & Company is not rendering legal, accounting or other professional advice. Information contained in this post is considered accurate as of the date of publishing. Any action taken based on information in this blog should be taken only after a detailed review of the specific facts, circumstances and current law.