Year-End Tax Planning

The window of opportunity for many tax-saving moves closes on December 31, so it is important to evaluate your tax situation now, while there’s still time to affect your bottom line for the 2020 tax year.

Timing is Everything

Consider any opportunities you have to defer income to 2021. For example, you may be able to defer a year-end bonus or delay the collection of business debts, rents, and payments for services. Doing so may allow you to postpone paying tax on the income until next year. If there’s a chance that you’ll be in a lower income tax bracket next year, deferring income could mean paying less tax on the income as well.

Similarly, consider ways to accelerate deductions into 2020. If you itemize deductions, you might accelerate some deductible expenses like medical expenses, qualifying interest, or state and local taxes by making payments before year-end. Or you might consider making next year’s charitable contribution this year instead.

Sometimes, however, it may make sense to take the opposite approach — accelerating income into 2020 and postponing deductible expenses to 2021. That might be the case, for example, if you can project that you’ll be in a higher tax bracket in 2021; paying taxes this year instead of next might be outweighed by the fact that the income would be taxed at a higher rate next year.

Factor in the AMT

Make sure that you factor in the alternative minimum tax (AMT). If you’re subject to the AMT, traditional year-end maneuvers, like deferring income and accelerating deductions, can have a negative effect. That’s because the AMT — essentially a separate, parallel income tax with its own rates and rules — effectively disallows a number of itemized deductions. For example, if you’re subject to the AMT in 2020, prepaying 2021 state and local taxes won’t help your 2020 tax situation, but could hurt your 2021 bottom line.

Special Concerns for Higher-Income Individuals

The top marginal tax rate (37%) applies if your taxable income exceeds $518,400 in 2020 ($622,050 if married filing jointly, $311,025 if married filing separately). Your long-term capital gains and qualifying dividends could be taxed at a maximum 20% tax rate if your taxable income exceeds $441,450 in 2020 ($496,600 if married filing jointly, $248,300 if married filing separately, $469,050 if head of household).

Additionally, a 3.8% net investment income tax (unearned income Medicare contribution tax) may apply to some or all of your net investment income if your modified AGI exceeds $200,000 ($250,000 if married filing jointly, $125,000 if married filing separately).

High-income individuals are subject to an additional 0.9% Medicare (hospital insurance) payroll tax on wages exceeding $200,000 ($250,000 if married filing jointly or $125,000 if married filing separately).

IRAs and Retirement Plans

Take full advantage of tax-advantaged retirement savings vehicles. Traditional IRAs and employer-sponsored retirement plans such as 401(k) plans allow you to contribute funds on a deductible (if you qualify) or pre-tax basis, reducing your 2020 taxable income. Contributions to a Roth IRA (assuming you meet the income requirements) or a Roth 401(k) aren’t deductible or made with pre-tax dollars, so there’s no tax benefit for 2020, but qualified Roth distributions are completely free from federal income tax, which can make these retirement savings vehicles appealing.

For 2020, you can contribute up to $19,500 to a 401(k) plan ($26,000 if you’re age 50 or older) and up to $6,000 to a traditional IRA or Roth IRA ($7,000 if you’re age 50 or older). The window to make 2020 contributions to an employer plan typically closes at the end of the year, while you generally have until the April tax return filing deadline to make 2020 IRA contributions.

Roth Conversions

Year-end is a good time to evaluate whether it makes sense to convert a tax-deferred savings vehicle like a traditional IRA or a 401(k) account to a Roth account. When you convert a traditional IRA to a Roth IRA, or a traditional 401(k) account to a Roth 401(k) account, the converted funds are generally subject to federal income tax in the year that you make the conversion (except to the extent that the funds represent nondeductible after-tax contributions).

If a Roth conversion does make sense, you’ll want to give some thought to the timing of the conversion. For example, if you believe that you’ll be in a better tax situation this year than next (e.g., you would pay tax on the converted funds at a lower rate this year), you might think about acting now rather than waiting. Whether a Roth conversion is appropriate for you depends on many factors, including your current and projected future income tax rates.  We recommend you talk with your financial advisor and/or tax professional.

Changes to Note

Recent legislation has modified many provisions, generally for 2018 to 2025.

  • Personal exemptions were eliminated.
  • Standard deductions have been substantially increased to $12,400 in 2020 ($24,800 if married filing jointly, $18,650 if head of household).
  • The overall limitation on itemized deductions based on the amount of adjusted gross income (AGI) was eliminated.
  • The AGI threshold for deducting unreimbursed medical expenses is 7.5% in 2020, it returns to 10% in 2021.
  • The deduction for state and local taxes has been limited to $10,000 ($5,000 if married filing separately).
  • Individuals can deduct mortgage interest on no more than $750,000 ($375,000 for married filing separately) of qualifying mortgage debt. For mortgage debt incurred before December 16, 2017, the prior $1,000,000 ($500,000 for married filing separately) limit will continue to apply.
  • A deduction is no longer allowed for interest on home equity indebtedness. Home equity used to substantially improve your home is not treated as home equity indebtedness and can still qualify for the interest deduction.
  • The top percentage limit for deducting charitable contributions was increased from 60% of AGI to 100% of AGI for certain direct cash gifts to public charities for 2020 only.
  • The deduction for personal casualty and theft losses was eliminated, except for casualty losses attributable to a federally declared disaster.
  • Previously deductible miscellaneous expenses subject to the 2% floor, including tax-preparation expenses and unreimbursed employee business expenses, are no longer deductible.

Extended Provisions

A number of provisions are extended periodically. The following provisions have been extended through 2020 and are not available for 2021 unless extended by Congress.

  • Above-the-line deduction for qualified higher-education expenses
  • Ability to deduct qualified mortgage insurance premiums as deductible interest on Schedule A of IRS Form 1040
  • Ability to exclude from income amounts resulting from the forgiveness of debt on a qualified principal residence
  • Nonbusiness energy property credit, which allowed individuals to offset some of the cost of energy-efficient qualified home improvements (subject to a $500 lifetime cap)

Talk to a Professional

When it comes to year-end tax planning, there’s always a lot to think about. A tax professional can help you evaluate your situation, keep you apprised of any legislative changes, and determine whether any year-end moves make sense for you.

In case you missed our Year-End Tax Planning webinar, check out the replay HERE. Many of these tax-saving moves are discussed in greater detail.

Prepared by Broadridge Investor Communication Solutions, Inc. Copyright 2020

2020 Year-End Planning Checklist

We are now a few weeks from officially being in fall. This is the time of year to begin tax planning for your 2020 taxes. The mistake most people make is they do not plan for taxes until after the new year and by then there is little to no planning that can be done. Below is a helpful checklist with important deadlines to be aware of to help you with year-end tax planning:

October 1st

Establish a SIMPLE IRA for 2020 – Although not as common anymore if you are a business owner establishing a new SIMPLE IRA it must be done by October 1st.

October 15th

Establish and fund a SEP-IRA for 2019 – If you are a business owner who filed an extension for your business the deadline to establish or fund a SEP-IRA for 2019 is October 15th.

Withdraw or Recharacterize 2019 IRA Contributions Without Penalty – Any excessive contributions to an IRA or Roth IRA can be reversed by October 15th. After this deadline excess contributions have a 6% penalty charged against them. Keep in mind this deadline does not apply to Roth Conversions since they are no longer eligible for recharacterization.

Make 2019 Employer Contributions to a SIMPLE IRA – If you are a business owner who filed an extension for your business the deadline to fund the SIMPLE IRA for 2019 is October 15th.

October 31st

Provide Trust Beneficiary Documentation to Custodian or Administrator – If an IRA, Roth IRA, or employer-sponsored plan owner died in 2019 and has a trust named as the beneficiary then the deadline to get this paperwork to the custodian or administrator is October 31st.

December 30th

Utilize Coronavirus Related Distributions – The CARES Act allows for distributions up to $100,000 from IRAs or employer-sponsored plans (i.e. 401(k) or 403(b)). These distributions waive the 10% early distribution penalty and the tax implications can be spread over three years and the deadline for them is December 30th.

December 31st

Required Minimum Distributions (RMDs) are waived for 2020 – Another part of the CARES Act was that RMDs were waived for 2020. So this deadline nothing needs to be done but it does create some interesting planning opportunities so talk with us today.

Make a Qualified Charitable Distribution (QCD) – The deadline to make up to $100,000 charitable contribution from your tax-deferred account is December 31st. If you are charitably inclined you will want to speak with us or and initiate these by December 15th to ensure they are completed by year-end.

Roth Conversions for 2020 – With RMDs not being required for 2020, Roth conversions are an attractive option for many this year. Consult with us and your tax adviser before completing a conversion and they must be done by December 31st.

Complete Net Unrealized Appreciation (NUA) Transactions – NUA is when you convert employer stock in your 401k or retirement plan with your employer into a taxable account. There are potentially huge tax savings for individuals using this strategy. The transaction must be done by December 31st but should be started by November 1st to ensure plenty of time to complete the transaction by year-end. Please talk with us or your tax advisor to learn more.

Max out HSA Contributions – For 2020 the maximum amount you can contribute for self-only is $3,550 or $7,100 for families. There is an additional $1,000 catch up contribution allowed for individuals that are 55 or older.

Max Out Employer-Sponsored Plan – For 2020 if you want to maximize contributions to your employer retirement plans the maximum contribution is $19,500 for those under the age of 50. For individuals that are 50 or older can contribute up to $26,000 for 2020

Personal Gifts of $15,000 – You can gift up to $15,000 per individual annually to loved ones without tax implications.

California Proposes New Kind of Wealth Tax

California has a long history of starting trends and new fads. One trend that has been growing has been the idea of extra taxes on the wealthy and Rob Bonta (D-Oakland) and others have proposed a new tax on the wealthy that we have not seen before. The tax would be based on a taxpayer’s net worth (not income) and applied annually.

Wealth Tax Basics

The new tax rate of 0.4% would be applied to an individual or joint filer on all net worth that exceeds $30 million. A couple that files married, separate would have a threshold of $15 million. This new legislation is expected to impact about 30,400 Californians. As an example, an individual that has a net worth of $38 million would owe approximately an additional $32,000 in taxes (($38 million – $30 million) * 0.4%).

What Assets Are Included?

This calculation includes 18 categories of all assets held globally (not just in CA) including real estate, closely-held businesses, offshore assets, pension assets, business interests, and collectibles like art. Hard to value assets (i.e. businesses) will be allowed to have a deferred tax liability attached to them. This is sure to create tremendous challenges.

Do Not Think You Can Just Leave

In an unprecedented move, the bill also wants to charge individuals that leave this state this wealth tax for ten years after they leave on a phaseout schedule. For example, an individual subject to this tax leaves CA and goes to Texas, the bill proposes they would be subject to this tax at 90% the first year and each subsequent year at a diminishing rate.

Logistical Nightmare

This bill will create many challenges. First, how do you value certain illiquid assets and what discounts can be applied?  It is safe to assume individuals and the state will have different estimates.

Secondly, it would be safe to expect other states that have benefited from California’s prior missteps like Nevada, Arizona, and Texas to use this to their advantage to attract new desired residents. They probably would not play nice with California as well to help them enforce this law. This would damage California’s relationships with other states and countries as they pick fights and try to enforce this.

There would be much litigation involved on all sides and this law would be tied up in court for years delaying any potential tax revenues and draining financial resources in the process.

Will This Become Law? This is hard to answer given the supermajority in California. We have seen similar ideas like this from Senator Warren Elizabeth fail in the past. Several European countries have also tried to enforce a law like this and every time they eventually scrapped it due to clever asset management, lawsuits, and people moving abroad. This law feels ill-timed but given financial constraints in California it may become law.

What we do know is that if this does come to fruition it will fundamentally change asset and financial planning for many individuals.