2020 Year-End Tax Strategies
In 2017, the Tax Cuts and Jobs
Act (TCJA) was signed into
law. Changes included tax rate
reductions for most individuals, a
new deduction for owners of sole
proprietorships and pass-through
entities, an increased standard
deduction, increase in child credits,
an increase in the Alternative
Minimum Tax (AMT) exemption,
and limitations on or elimination of
many other tax deductions. The IRS
continues to release guidance and
update tax forms to reflect changes
enacted in the TCJA. Additional
changes in tax law came into effect
with the Coronavirus Aid, Relief
and Economic Security (CARES)
Act, signed on March 27, 2020.
Several provisions of the CARES Act
affect individual income tax returns.
The following summary outlines some of the significant
planning opportunities now available to minimize individual tax
obligations.
CAPITAL GAINS
Income from an investment held for more than one year is
generally taxed at preferential capital gains rates. For 2020,
the long-term capital gain and qualified dividend rates remain
unchanged at 0%, 15% or 20%, based on statutory income
brackets and adjusted for inflation. For example, the 20% rate
applies when taxable income exceeds $496,600 (married filing
joint), $469,050 (head of household) or $441,450 (others).
Planning Opportunities:
X Consider holding capital assets for at least 12 months,
as short-term capital gains are taxed at ordinary
income rates.
X Consider gifting appreciated stock or mutual fund shares
to relatives in a lower income tax bracket (such as
children or grandchildren), who may pay less or no tax
on the long-term capital gains when the shares are sold.
X Consider selling unrealized loss positions in your
investment portfolio to offset capital gains recognized
earlier in the year.
NET INVESTMENT INCOME TAX (NIIT)
In addition to income tax, individual taxpayers with modified
adjusted gross income (MAGI) of more than $200,000 per year
($250,000 if married filing joint; $125,000 if married filing
separately) may be subject to net investment income tax. NIIT
equals 3.8% of the lesser of (a) net investment income or (b) the
amount by which MAGI exceeds the applicable threshold. Net
investment income includes interest, dividends, capital gains,
rental income (unless derived from ordinary business activities),
and passive activities, less deductions properly allocated to net
investment income.
Planning Opportunities:
X Consider electing installment sale treatment so that gains
are spread over a number of years. By spreading the
income over multiple years, current year net investment
income and MAGI may be reduced to minimize or
eliminate the 3.8% tax for the current and future tax years.
X Consider selling unrealized loss positions in your
investment portfolio to offset capital gains recognized
earlier in the year.
X Tax exempt income is not subject to the 3.8% tax. Consider
switching investments to tax exempt investments if it
makes sense for your portfolio. State taxation of such
investments should also be considered.
MEDICAL DEDUCTIONS
For 2020, medical expenses can be deducted to the extent the
expenses exceed 7.5% of adjusted gross income (unchanged from
2019). Eligible expenses include health insurance premiums (if
not deducted elsewhere on your income tax return), long-term care
insurance premiums (subject to limitations), medical and dental
services, and prescription drugs. You may also deduct expenses
paid for medical care of a child for whom you provide more than
half of total support.
Planning Opportunities:
X Since individuals generally use cash basis accounting,
medical expenses must be paid in the year incurred
in order to be deductible. Credit card payments are
deductible in the year charged, rather than paid. Be
aware, however, that prepayment of medical services in
advance of the year services are actually rendered may not
accelerate the deduction.
X Consider bunching elective medical procedures into 2020
(for services and purchases for which timing is within your
control, without negatively impacting your or your family’s
health) if it will help you exceed the 7.5% floor and if you
have enough total itemized deductions to benefit from
itemizing. The threshold will likely be increased to 10%
of AGI for 2021.
MORTGAGE INTEREST
For tax years 2018-2025, the TCJA reduces the limit on interest
deduction pertaining to outstanding mortgage debt incurred after
December 15, 2017, from $1 million to $750,000. Interest on
debt incurred prior to December 15, 2017, but refinanced later, is
deductible to the extent the new debt does not exceed the original
debt. Furthermore, the TCJA suspends the prior provision that
allowed up to $100,000 of interest on home equity debt to be
treated as deductible qualified residence interest.
Planning Opportunities:
X Keep track of how and when you spend proceeds of a loan.
For example, if you used a portion of your mortgage debt to
acquire business assets, that portion is deductible as trade
or business interest or as investment interest expense.
X Elect out of treatment of debt secured by a qualified
residence. This election allows you to characterize interest
expense on home equity debt under the specified interest
tracing rules and to preserve an otherwise nondeductible
expense.
CHARITABLE
DONATIONS
Year-end is a great time to make
donations to qualified charities. For 2020,
the CARES Act relaxed some tax deduction
limits on charitable giving. Cash donations to
public charities other than a supporting organization or
a Donor-Advised Fund are fully deductible up to 100% of
adjusted gross income (AGI) (increased from 60% of AGI in
2019), and gifts of appreciated property or gifts for use by public
charities are deductible up to 30% of AGI (unchanged from 2019).
The above-the-line deduction for cash contributions to charities
that each taxpayer can claim is now up to $300, so taxpayers who
do not itemize can take advantage of this new deduction. This $300
deduction is not available to taxpayers who itemize deductions.
For donations made during the year, be sure to get acknowledgment
letters from the qualified charities for both cash and property
(including stock donations) donations over $250. If you are not
certain if a particular charity is qualified, you can consult the
IRS website at https://apps.irs.gov/app/eos/ and search for the
organization in question.
Planning Opportunities:
X Consider bunching donations into 2020 to take advantage
of the tax deduction limits reduced by the CARES Act. The
regular contribution deduction limits are expected to return
after 2020.
X Donate appreciated stock to charity to avoid paying capital
gains tax and get a fair market value deduction for stocks
held for more than one year.
X Sell depreciated stock and donate the cash proceeds to
charity. You will receive a charitable deduction as well as
a capital loss benefit on the sale of stock. Capital losses
offset capital gains, and any resulting net loss in future
years offsets a maximum of $3,000 in ordinary income
for a married filing joint taxpayer ($1,500 for all other
taxpayers).
401K AND SEP
CONTRIBUTIONS
Contributions to a traditional employersponsored
defined contribution plan are typically
pretax, therefore reducing taxable income. If you
are an employee and your company offers a 401K plan,
you should try to maximize your contribution to boost your
retirement savings and reduce current year taxes. The maximum
contribution to a 401K plan increased to $19,500 in 2020 (from
$19,000 in 2019). Employees age 50 or older can also make an
additional “catch-up” contribution of up to $6,500 (from $6,000
in 2019).
If you are self-employed, consider setting up a self-employed
retirement plan (SEP) or some other type of retirement plan in order
to maximize the allowable contribution each year. For SEP, you have
until the tax filing deadline, including extension, to set up a plan and
make contributions for the year. While you also have until the tax filing
deadline to make profit sharing contributions, a new plan needs to be
established no later than December 31 of the tax year.
Under the CARES Act, if an individual, spouse or dependent is
diagnosed with COVID-19, or is otherwise economically harmed
by a business closure or quarantine, the individual can draw up
to $100,000 from their IRA, pension plan, or 401(k) plan in 2020
without incurring the 10% early distribution penalty. The income
attributable to this distribution will be taxed over a period of three
years. The withdrawals may also be re-contributed back into a
qualified retirement plan at any time during the three-year period
to eliminate otherwise reportable taxable income.
FLEXIBLE SPENDING ACCOUNTS (FSA)
Amounts contributed to a healthcare Flexible Spending Account
(FSA) are not subject to federal income, Social Security or Medicare
taxes. For 2020, the maximum contribution is limited to $2,750
(increased from $2,700 in 2019).
Historically, the “use it or lose it” provision applied to amounts
contributed to a flexible spending account. However, there is
a carryover provision which allows participating employees to
carryover up to $500 of unused funds to the following year if your
employer offers this option. This carryover does not count toward
the annual contribution limit. Some employers may offer a grace
period to incur eligible medical expenses, generally two-and-a-half
months after year-end.
Check with your employer for the rules on the established FSA plan.
HEALTH SAVINGS ACCOUNTS (HSA)
If you are covered by a qualified high-deductible health plan, you
can either contribute pre-tax income to an employer-sponsored
Health Savings Account (HSA) or make deductible contributions to
an HSA you set up yourself. For 2020, the maximum contributions
are $3,550 for single taxpayers (increased from $3,500 in 2019)
and $7,100 for family coverage (increased from $7,000 in 2019).
Taxpayers aged 55 or older as of the end of the tax year can
contribute an additional $1,000. (This means HSA holders can
contribute and reduce income by $9,100 if both spouses are over
55.) There is no “use it or lose it” provision with HSAs, as you can
carry over unused balances from year to year.
QUALIFIED CHARITABLE
DISTRIBUTIONS (QCD)
Taxpayers who have reached age 70 ½ can donate up to $100,000
of traditional and Roth IRA distributions directly to qualified
charities. The donation satisfies the minimum distribution
requirement and is excluded from taxable income. A charitable
deduction cannot be claimed for the contribution. It is worth noting
that the CARES Act suspended required minimum distributions
(RMDs) for 2020.
SECTION 199A DEDUCTION FOR
SOLE PROPRIETORSHIPS AND
OWNERS OF PASS-THROUGH
ENTITIES
The TCJA introduced Section 199A (Qualified Business Income
Deduction, or QBI), which provides a deduction for sole
proprietorships and owners of pass-through entities (partnerships,
S Corporations, trusts and estates, etc.). It is intended to provide tax
relief to businesses not benefiting from the reduced top corporate
rate, lowered from 35% to 21%. The 199A deduction is generally
equal to 20% of QBI when taxable income is lower than the
applicable threshold. The taxable income thresholds for 2019 are
$326,600 for married filing joint and $163,300 for all others.
The deduction is complex and subject to various rules and
limitations based on (1) your taxable income, (2) the type
of business(es) you operate (i.e., Specified Service Trade or
Business), and
(3) your business’ W-2 wages paid and basis at
acquisition of qualified property.
Planning Opportunities:
X Consider making deductible retirement and HSA
contributions, deferring income, or accelerating expenses
to reduce taxable income.
X Review your company personnel to consider if independent
contractors should be converted to employees to increase
your company’s total W-2 wages.
X Consider acquiring qualified business property before
year-end.
X If you have multiple qualified businesses, consider
aggregating certain qualified businesses to maximize your
199A deduction. Analyze your various business revenue
streams and consult with your tax advisor to determine
which aggregated activities are more beneficial.