Year-End Tax Planning for Individuals
By: Tax Hotline
Fall 2020 (Vol. 38, No. 3)
Don’t Miss Out. Implementing these strategies before the end of the year could save you money.
Do a quick analysis of your income and deductions for 2020 to see if accelerating income or deductions will benefit you more this year than next. Accelerating income in 2020 has several advantages. First, the Tax Cuts and Jobs Act reduced the maximum individual tax rate from 39.6% to 37%. Second, many taxpayers will be in a lower tax bracket this year from losses incurred in this economic downturn.
Review your investments. The tax-loss harvesting strategy helps you minimize what you pay in capital gains taxes by offsetting the amount you have to claim as income. Basically, you “harvest” investments to sell at a loss, then use that loss to lower or even eliminate the taxes you have to pay on gains you made during the year.
If you anticipate an increase in taxable income this year, in 2020, and are expecting a bonus at year-end, try to get it before December 31.
Bunching charitable deductions every other year is also a good strategy if it enables you to get over the higher standard deduction threshold. Under the CARES Act, eligible individuals may take an above-the-line deduction of up to $300 ($600 married, filing jointly) for charitable contributions made to qualified organizations. You can claim the deduction even if you do not itemize. Property can also be donated as well as charity-related travel expenses and some out-of-pocket expenses. If you itemize you can also to deduct cash donations to public charities in amounts of up to 100 percent of adjusted gross income (AGI).
Taxpayers age 70 1/2 and older can reduce income tax owed on required minimum distributions (RMDs) - a maximum of $100,000 or $200,000 for married couples - from IRA accounts by donating them to a charitable organization instead.
Medical expenses are deductible only to the extent they exceed 7.5 percent of your adjusted gross income (AGI), therefore, it may be to your advantage to bunch these expenses by paying medical bills in whichever year they would do you the most tax good.
If your company grants stock options, then you may want to exercise the option or sell stock acquired by exercising an option this year if you think your tax bracket will be higher in 2020.
If you’re self-employed and want to accelerate income, send invoices or bills to clients or customers this year to be paid in full by the end of December; however, make sure you keep an eye on estimated tax requirements. Conversely, if you anticipate a lower income next year, consider deferring sending invoices to next year.
In cases where tax benefits are phased out over a certain adjusted gross income (AGI) amount, a strategy of accelerating income and deductions might allow you to claim larger deductions, credits, and other tax breaks for 2020, depending on your situation. Roth IRA contributions, child tax credits, higher education tax credits, and deductions for student loan interest are examples of these types of tax benefits.
Pay close attention to “one-time” income spikes such as those associated with Roth conversions, sale of a home or any other large asset if your earnings are close to threshold amounts that make you liable for the Net Investment Income Tax ($200,000 for single filers and $250,000 for married filing jointly). The NIIT is a 3.8 percent tax that is applied to investment income such as long-term capital gains for earners above a certain threshold amount. Short-term capital gains are subject to ordinary income tax rates as well as the NIIT. If your income exceeds these threshold amounts, you are also liable for an additional Medicare tax of 0.9 percent.
High net worth individuals should consider contributing to Roth IRAs and 401(k) because distributions are not subject to the Medicare Tax. Also, if you’re close to the threshold for the Medicare Tax, it might make sense to switch Roth retirement contributions to a traditional IRA plan, thereby avoiding the NIIT as well.
It could be to your benefit to pay an estimated state tax installment in December instead of at the January due date or paying your entire property tax bill, including installments due in 2021, by year-end.
You may want to pay 2021 tuition and qualified expenses in 2020 to take full advantage of the American Opportunity Tax Credit, an above-the-line tax credit worth up to $2,500 per student. Forty percent of the credit (up to $1,000) is refundable, which means you can get it even if you owe no tax.
529 Education Plans. Maximize contributions to 529 plans, which can now be used for elementary and secondary school tuition as well as college or vocational school.
The alternative minimum tax (AMT) applies to high-income taxpayers that take advantage of deductions and credits to reduce their taxable income. The AMT ensures that those taxpayers pay at least a minimum amount of tax. The exemption amounts increased significantly under the TCIA, and the AMT is not expected to affect as many taxpayers. Also, in 2020 the phaseout threshold increased to $518,400 ($1,036,800 for married filing jointly). AMT exemption amounts are $72,900 for single and head of household filers, $113,400 for married people filing jointly and for qualifying widows or widowers and $56,700 for married people filing separately.
The federal gift and estate tax exemption is $11.58 million for 2020 and the maximum estate tax rate is set at 40 percent. Gifts to a donee are exempt from the gift tax for amounts up to $15,000 a year per donee in 2020 and remain the same for 2021. Husband-wife joint gift maximum is $30,000 ($15,000 each).
The Kiddie Tax rule is unearned income exceeding $2,200 is taxed at the rates paid by trusts and estates instead of the parent’s tax rate. For ordinary income (amounts over $12,950), the maximum rate is 37 percent. For long-term capital gains and qualified dividends, the maximum rate is 20 percent. Exception - if the child is under age 19 or under age 24 and a full-time student and both the parent and child meet certain qualifications, then the parent can include the child’s income on the parent’s tax return.
Converting to a Roth IRA from a traditional IRA in 2020 would make sense if you’ve experienced a loss of income (lowering your tax bracket) or your retirement accounts have decreased in value.
If you own an incorporated or unincorporated business, consider setting up a retirement plan if you have not already. It doesn’t need to be funded until April 15, 2021 but contributions will still be deductible on your 2020 return.
If you are an employee and your employer has a 401(k), contribute the maximum amount ($19,500 for 2020), plus an additional catch-up contribution of $6,500 if age 50 or over, assuming the plan allows this, and income restrictions don’t apply.
If you are employed or self-employed with no retirement plan, you can make a deductible contribution of up to $6,000 a year to a traditional IRA (deduction is sometimes allowed even if you have a plan). Further, there is also an additional catch-up contribution of $1,000 if age 50 or over.
Consider setting up a health savings account (HSA). You can deduct contributions to the account, investment earnings are tax-deferred until withdrawn, and any amounts you withdraw are tax-free when used to pay medical bills. To be eligible, you must have a high-deductible health plan (HDHP), and you must not be enrolled in Medicare. For 2020, to qualify for the HSA, your minimum deductible in your HDHP must be at least $1,400 for self-only coverage or $2,800 for family coverage.