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All About The Numbers
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We've found that it is not just the numbers that drive planning...
so here are some thoughts
we would like to share
that may help you on your financial journey.
10 End-of-Year Tax Planning Ideas for 2020
November 16, 2020
It sure has been a year full of the unexpected. Now may be a good time to focus on some things you can control. So let’s look at some ideas you may be able to implement that could have a positive impact on your tax liabilities for 2020.
Some of these suggestions need to be implemented before year-end to be effective. Not all these ideas will fit your situation, but they may be helpful for someone else you know. There were several changes in the tax laws this year and we have added some of these we believe to be most beneficial.
1. Incentives for Charitable Giving under the CARES Act
This Act was passed earlier this year in response to economic hardships caused by the coronavirus pandemic. These incentives are projected to expire at the end of this year and more detailed information can be found at www.irs.gov. It encourages increased charitable giving in three primary ways:
• Creating an above-the-line $300 deduction for qualified cash contributions to those taking the standard deduction.
• For those who will be using the itemized deduction, eliminating the 60% AGI deduction limit and increasing this to 100%. This provides a wonderful opportunity for those looking to give significant charitable contributions.
• Increasing the deduction limit for corporations, from 10% to 25% of taxable income.
2. Establish a Donor Advised Fund
A donor advised fund is a planning tool that may be used to reduce your current income taxes and help you to fulfill philanthropic goals you have been wanting to achieve. It’s an investment account specifically for charitable giving you establish with a foundation, church or school of your choice. As a donor, you get an immediate tax benefit for contributions that can be distributed to a qualified non-profit organization over time, on your schedule, even as a legacy. Contributions can be made in cash as well as highly appreciated assets.
3. Tax Loss Harvesting
Turning investment losses into tax savings or another way of saying this is making lemonade out of lemons. This technique is used to sell an investment at a loss for the purpose of offsetting taxable capital gains and up to $3,000 of ordinary income for a married couple (or $1,500 for an individual). If there is a net loss exceeding the annual limit, the net loss can be carried over to future years, so it's a gift that keeps on giving.
It is important to note that you do not want to reinvest these proceeds back into the identical investment you just sold, as this creates what is called a ‘wash sale”. This will negate any losses you have taken. As your advisor, we may use the cash from a sale to purchase a similar asset. This maintains the overall portfolio strategy so that we're not locking in an investment loss simply to reduce taxes.
4. Convert a Traditional IRA to a Roth IRA
When we run long-term scenarios for our clients, we often find that once a client turns 72 and is required to start taking their Required Minimum Distributions (RMD), they may be forced to take out more than they need. This can also bump them into a higher tax bracket and have an impact on the premium they will be charged for Medicare (IRMAA) beginning at age 65. Converting a portion or all of a traditional IRA to a Roth IRA over several years may reduce your income tax for years to come. Once you reach age 59½ and have had a Roth IRA account open for at least five years, this account generates tax-free income and is not subject to the RMD rules as a traditional IRA.
The downside is that you will owe income taxes based on the value of the assets at the time of conversion. Still, a Roth Conversion may be worthwhile if you expect to be in a higher tax bracket in the future.
5. Max-out your Retirement Plan Contribution
I say this with a grain of salt. If possible, contribute the maximum annual amount to an IRA, 401k, or other tax-deferred retirement plan. Some retirement plans allow an after-tax contribution or a Roth 401-K option as well. Too often we see clients who have only saved by putting funds into tax deferred vehicles and then have a tax issue getting the funds out of these pre-tax plans. Yes, additional contributions not only increase savings towards retirement, but also reduce your taxable income in the current year. It’s a great way to get started. Just make sure you take a look at the impact this may have once you have established the habit of saving on autopilot. Some other options may need to be added mid-way down the road to retirement.
6. Contribute or Fund Health Savings Accounts (HSA) or Flexible Spending Accounts (FSA)
Similar to contributing to a tax-deferred retirement account, pre-tax contributions to a Health Savings Account (HSA) or a Flexible Spending Account (FSA) can reduce your taxable income. These accounts can only be used for specific purposes, such as paying for qualified health care expenses, child or elder care. HSAs are available to those with high deductible health care plans. Contributions can be made annually up to age 65, the funds can be used over a lifetime and can also be invested. FSA funds must be contributed and spent in the same year.
7. Accelerate Other Deductions
Additional deductions you may be able to increase before year’s end include:
• Property tax bill due at the beginning of the following year
• Hospital or doctor’s bill
• Estimated state income tax bill due in January
IMPORTANT: Households that take the standard deduction probably will not benefit from accelerating these deductions.
• Increasing deductions leading up to 2021 could be a mistake if you’re already paying the alternative minimum tax (AMT). The AMT is separate from your standard tax liability and has different rules; property taxes and state and local income taxes, for example, aren’t deductible under AMT.
Tax Planning Strategies for Retirees
8. Review IRA Distributions
The CARES Act suspended required minimum distributions (RMD) from retirement accounts in 2020. So, if you don't need the money from an IRA account and don't want to pay the taxes, you don't have to.
It's still worthwhile, however, to compare your current tax bracket with the tax rates you expect to pay in the future. In the long run, it may be advantageous to get money out of the account and reduce your RMD in the future by making a qualified charitable distribution or converting a portion of the account to a Roth.
9. Charitable Giving with Qualified Charitable Distribution (QCD)
Even without RMD requirements in 2020, you can still use a QCD to direct IRA distributions to charities if you are above the RMD age. A QCD adjusts your gross income and reduces your taxes.
From a tax standpoint, a QCD is most beneficial when it makes your total itemized tax deductions higher than the standard deduction. Oftentimes, this is achieved by contributing an amount that would have been donated over the course of several years.
10. Itemize Deductions one year and take the Standard Deduction in the next – Bunching
Retirees might be able to use the concept of “bunching” by taking more charitable deductions, healthcare expenses and property taxes in one year and then take the standard deduction in the next year.
Regarding healthcare expenses, qualified healthcare expenses in excess of 10% of adjusted gross income are deductible for 2020. If your medical bills will be 10% of your income this year and 10% next year, you don't get a deduction. However, if you can combine those expenses into one year so that it's 20% this year and 0% next year, you would be over the 10% threshold and you would get a deduction on the expenses exceeding 10%.
Bunching expenses may allow you to itemize your deductions in one year and take the standard deduction in the next.
Now may be the time to determine if any of these strategies may be helpful. Waiting until the 15th of December may be too late to implement some of these techniques related to IRAs. Just getting your paperwork or records in order will go a long way in feeling a little bit more in control of something this year.
This material is distributed by Alexander Financial Planning, Inc. (AFP) and it is for information purposes only. Although information has been obtained from sources we believe to be reliable, we do not guarantee its accuracy. It is provided with the understanding that no fiduciary relationship exists because of this report. Opinions expressed in this report are not necessarily the opinions of AFP and they are subject to change without notice. AFP assumes no liability for the interpretation or use of this information. No portion of this writing should be construed as legal or accounting advice. All rights reserved.