Time is running out to trim your 2020 tax bill. From distributions to donations, don’t miss these money-saving tips.
Now is a good time to review your investment portfolio to realize any additional capital gains and losses for the year. And if you find yourself with net realized capital losses for the year, Oscar Vives Ortiz, CPA/PFS member of the AICPA PFS Credential Committee, noted in a recent AICPA release that it’s important to know that you can only reduce your ordinary income by $3,000.
The remaining capital loss, he noted, would then be carried forward into the next year. “Remember to coordinate your capital gain/loss harvesting strategy with your tax planning,” he is quoted as saying. “If you expect to be in a higher tax bracket next year, it may be better to carry the capital loss into next year to help offset capital gains in 2021 instead of incurring capital gains in 2020.”
Brandon Opre, a certified financial planner with TrustTree Financial, recommends something called “tax-gain” harvesting. “Year-end is generally the best time for this,” he says. “If investors have taxable investment accounts, strategically selling winning investments could potentially reduce future taxes. Plus, this harvesting can help reduce concentrated positions and reset cost basis for future opportunities.”
Others agree that tax-gain harvesting can be an effective tactic. Tax gain harvesting could be a great strategy for those with income over $1 million, said Nicole Gopoian Wirick, a certified financial planner with Prosperity Wealth Strategies.
“For those high-income earners, new tax reform could increase capital gains and qualified dividends to ordinary income tax brackets -- a potential increase of almost 20%,” says Gopoian Wirick. “Additionally, there is a possibility that the step-up in cost basis at the date of death will be eliminated, potentially making this strategy all the more valuable from a legacy planning perspective.”
Donations to Qualifying Charities
Thanks to a provision in the CARES Act, taxpayers can now easily deduct up to $300 in donations to qualifying charities this year, says Evan Beach, a certified financial planner with Campbell Wealth Management.
Under this new change, individual taxpayers can claim an "above-the-line" deduction of up to $300 for cash donations made to charity during 2020, according to the IRS. This means the deduction lowers both adjusted gross income and taxable income -- translating into tax savings for those making donations to qualifying tax-exempt organizations.
The special $300 deduction is designed especially for people who choose to take the standard deduction, rather than itemizing their deductions. According to the IRS, nearly nine in 10 taxpayers now take the standard deduction and could potentially qualify for this new tax deduction.
Under the CARES Act, taxpayers can now fully deduct contributions equal to up to 100% of their adjusted gross income, or AGI.
Another opportunity: The significant run up in a narrow segment of the market (technology, in particular) makes it an especially beneficial year to gift shares of stock, says Beach.
While the SECURE Act delayed required minimum distributions (RMDs) to age 72, if you’re born after July 1, 1949, the qualified charitable distributions (QCD) age is still 70½. “And that’s a great option for those who don't itemize and are looking to reduce AGI,” says Beach.
Making a QCD from your rather than taking your RMD (though those are suspended for 2020 anyway, but still) -- for those charitably inclined who don’t need their balances, it’s a good opportunity to draw down your retirement plan accounts, reducing potential future RMDs and getting rid of an asset that is less-favorable to leave to the next generation, says Karen Van Voorhis, a certified financial planner with Daniel J. Galli & Associates.
And lastly, Leon LaBrecque, a certified financial planner with Sequoia Financial Group, recommends what he calls a tax swap: Donate highly appreciated securities to a donor-advised fund and buy it in a Roth . This, he says, gets rid of capital gain taxes, provides a deduction, and resets your basis to allow for tax-free growth.
Consider, too, what LaBrecque calls a Roth charity offset: Convert a traditional to a Roth , offset the income with a charitable gift to a donor-advised fund.
- Also from Bob Powell, don't miss Year-end Financial and Retirement Planning Tips: From Roth IRA conversions and taxes to employee benefits and your 2021 budget, here’s your checklist of easy, smart money strategies.
Avoid Penalty for Underpayment of Estimated Tax
The U.S. income tax system is a pay-as-you-go tax system, which means that you must pay income tax as you earn or receive your income during the year, according to the IRS.
You can do this either through withholding or by making estimated tax payments, according to the IRS. If you didn't pay enough tax throughout the year, either through withholding or by making estimated tax payments, you may have to pay a penalty for underpayment of estimated tax.
Generally, according to the IRS, most taxpayers will avoid this penalty if they either owe less than $1,000 in tax after subtracting their withholding and refundable credits, or if they paid withholding and estimated tax of at least 90% of the tax for the current year or 100% of the tax shown on the return for the prior year, whichever is smaller.
You can mitigate underpayment penalties by increasing the amount of taxes withheld from your paycheck, says Marianela Collado, a certified financial planner with Tobias Financial. Read Tax Withholding for Individuals.
James Guarino, a certified financial planner with Baker Newman Noyes, also recommends being aware of the potential for underreporting of tax. “This can result in penalty assessments for not having paid in enough tax during the year,” he says.
This, he says, is a distinct possibility because some folks received unemployment compensation (without any tax withholding) or more importantly, opted to not take their RMD (required minimum distribution) for 2020 (part of the CARES relief package) and therefore did not have the normal amount of taxes withheld that they would’ve had if they received their RMDs
Donate Appreciated Stock
Another to lower your tax bill is to use appreciated stock (or funds) to make a donor-advised fund contribution (DAF). “If an investor has unrealized gains of stock or mutual funds, they can typically gift appreciated shares directly to a DAF,” says Chris Giambrone, a certified financial planner with CG Capital. “There could be substantial tax savings with this strategy depending on amount of otherwise taxable gains.”
Beware Mutual Fund Capital Gain and Dividend Distributions
Mutual funds held in a taxable account will often make capital gains and dividend distributions in December and that can increase your tax bill, says Leon LaBrecque, a certified financial planner with Sequoia Financial Group.
To avoid this tax, purchase your mutual funds have the ex-dividend date.
Put that COVID-Related Distribution Back
If you took a retirement account distribution for COVID-related reasons and can pay it back now, do so year-end, says Brandon Opre, a certified financial planner with TrustTree Financial.
The reason: “If you pay it back in future years you may have to submit an amended return and the tax situation gets a little murky,” he says. “I've had clients, who had the ability to repay, do so in the past few weeks to avoid the future paperwork burden.”
The CARES Act also made some changes for net operating losses (NOL) that could be worth looking at for small businesses, says Michael Baker, a certified financial planner with Vertex Capital .
Here’s the text from the IRS:
New rules for NOL carrybacks. Section 2303 of the Coronavirus Aid, Relief Economic Security Act (CARES Act), revised the provisions of the Tax Cuts and Jobs Act (TCJA), section 13302, for tax years 2018, 2019, and 2020. Taxpayers can carry back NOLs, including farm NOLs, arising from tax years beginning in 2018, 2019, and 2020 for five years. See section 172(b)(1)(D)(i).
NOL limitation suspended. Section 2303 of the CARES Act suspends the 80% of taxable income limit on NOL carryovers for three years. The limit will not apply to tax years beginning in 2018, 2019, and 2020. See section 172(a)(1).
“Business owners may want to consider accelerating expenses from 2021 into 2020 to reduce taxable income or potentially create a NOL that can be carried forward or backward,” says Baker. “Of course, I’d advise working with a tax professional when looking at this strategy.”
If you’re a business owner and took a Paycheck Protection Program (PPP) loan, remember that (according to current law) the expense you paid with those funds would not be deductible, says Scott Bishop, a certified financial planner with STA Wealth Management. “You need to be prepared to pay taxes on that.”
Consider this example: Let’s say you had a $500,000 PPP loan and spent all of it. “If it’s forgiven (which is expected), then your $500,000 of expenses are not deductible,” says Bishop. “At the 37% tax bracket that would be $185,000 of ‘phantom income.’ You spent the money, but it is not deductible, so you will owe more than you thought in taxes.”
Own a Business?
If you own a business, Jim Shagawat, a certified financial planner with AdvicePeriod, recommends considering the following:
- If you own a pass-through business, consider the Qualified Business Income (QBI) deduction eligibility rules.
- Consider the use of a Roth versus traditional retirement plan and its potential impact on taxable income and Qualified Business Income.
- If you have business expenses, consider if it makes sense to defer or accelerate the costs to reduce overall tax liability.
- Some retirement plans, such as a solo 401(k), must be opened before year-end.
Pay Home Business Expenses Now
If you have a home business or a side gig, take this time to look at your profit and loss statement so you won’t be surprised by lower expenses and higher taxable income (and taxes) than expected come April 15, 2021, Brooke Salvini, CPA/PFS member of the AICPA PFP Executive Committee, wrote in a recent release. “Now may be the right time to squeeze in any large business expenses you have been considering,” wrote Salvini. “By paying for qualified business expenses before the calendar flips to 2021, you will lower your overall 2020 taxable income.”
Are You a Lifelong Learner?
If you need to take a class to invest in yourself and improve your prospects, develop new skills and acquire certifications, consider paying in 2020 to start in 2021, says Marguerita Cheng, a certified financial planner with Blue Ocean Global Wealth.
Why so? So, you can take advantage of the lifetime learning credit (LLC). The LLC, according to the IRS, is for qualified tuition and related expenses paid for eligible students enrolled in an eligible educational institution. This credit can help pay for undergraduate, graduate and professional degree courses — including courses to acquire or improve job skills. There is no limit on the number of years you can claim the credit. It is worth up to $2,000 per tax return.
Moving to a Tax-Friendly State?
If you are thinking of moving to a lower tax state, find out the rules of both establishing residency in the new state and relinquishing your residency in the “exiting” state before you move forward, says Bishop. “Each state has their own rules,” he says. Read Deciding Where to Retire: Finding a Tax-friendly State to Call Home and How to Establish Residency in a New State.
Speaking of state residency, Guarino says Covid-19 forced many folks to work remote from their resident state. “They may find they owe taxes to the state their employer is located as well as the state they live,” he says. “In New England, this is a significant issue for New Hampshire residents who worked remotely for Massachusetts employers.”
Do Tax-Bunching Analysis
Scott Hammel, a certified financial planner with Apeiron Planning Partners, recommends asking your CPA to run a tax-bunching analysis on your property taxes and charitable contributions. “You likely won’t get below the standard deduction amount to make this worthwhile, but it’s worth considering,” he says. “If you’ve paid off your mortgage -- or can pay it off -- this could be a viable strategy.”
Also ask your CPA what it would take to consider your second home an investment property and what investment types would work for to lower income (oil and gas, opportunity zones the like). “Depending on how much of your income is passive, there may be different investments that would help more than others,” says Hammel.
Gopoian Wirick says taxpayers whose tax brackets are above 28% should consider accelerating deductions into 2020 due the possibility of a new tax plan capping the rate at which itemized deductions can be taken at 28%.
“The higher the tax bracket, the more advantageous this strategy because the benefit is the difference between the taxpayer’s current bracket and 28%,” she says.
“While the itemized deduction for state and local taxes (SALT) is capped at $10,000, charitable giving can be a great opportunity to accelerate deductions in a year when charitable organizations are undoubtably struggling to carry out their mission. A gift to a DAF is a great way to ‘lump’ several years of charitable giving into one year and then distribute the funds from the DAF to charities over a period of time. If there was ever a year to take advantage of the lumping strategy, then this may be it.”
What Will Your Income Be Next Year?
If you expect your income to increase in the future, Shagawat recommends considering the following strategies to minimize your future tax liability:
- Make Roth IRA and Roth 401(k) contributions and Roth conversions.
- If offered by your employer plan, consider making after-tax 401(k) contributions.
- If you are age 59.5 or over, consider accelerating traditional withdrawals to fill up lower tax brackets.
- If, on the other hand, you expect your income to decrease in the future, Shagawat recommends considering strategies to minimize your tax liability now, such as traditional and 401(k) contributions instead of contributions to Roth accounts.
- And, if you're on the threshold of a tax bracket, consider strategies to defer income or accelerate deductions and strategies to manage capital gains and losses to keep you in the lower bracket. Consider the following important tax thresholds:
If taxable income is below $163,300 ($326,600 if MFJ), you are in the 24% percent marginal tax bracket. Taxable income above this bracket will be taxed at 32%.
If taxable income is above $441,450 ($496,600 if MFJ), any capital gains will be taxed at the higher 20% rate.
If your Modified Adjusted Gross Income (MAGI) is over $200,000 ($250,000 if MFJ), you may be subject to the 3.8% Net Investment Income Tax (NIIT) on the lesser of net investment income or the excess of MAGI over $200,000 ($250,000 if MFJ).
If you will be receiving any significant windfalls that could impact your tax liability (inheritance, RSUs vesting, stock options, bonus), Shagawat recommends reviewing your tax withholdings to determine if estimated payments may be required.
Multiyear planning is critical. Many experts say it's preferable to manage tax planning using a multiple year format when it comes to maximizing deductions or equalizing income recognition.
What to do?
Claim a lump-sum deduction (especially for charitable contributions) in one year. A good example of this is using a donor-advised fund (DAF) to obtain the tax benefit of two to three years of charitable contributions all in one year.
Spread out income between multiple years (i.e., using an installment sale) would keep income contained within a certain a tax bracket over multiple years; rather than a lump-sum recognition all within the same year.
Guarino also recommend being aware of what tax bracket your taxable income will be taxed. “For example, knowing that you still have another $25,000 of taxable income leeway before you move up to the next tax bracket,” he says. “Most of the clients I advise are comfortable keeping income within the 24% tax bracket without having any additional taxable income ‘spill into’ the next tax bracket tier of 32%. To the extent possible – this is where utilizing Roth conversions is terrific.”
Is Your Investment Portfolio Tax-Efficient?
Make sure your qualified investments are as tax efficient as possible, says Hammel. “Consider municipal bonds, timing when you rebalance your portfolio to limit short-term gains, and take advantage of tax-loss harvesting,” he says. “Everything you can. The holdings outside your ’s should be completely different from the holdings inside your . Tax location is almost as important as diversification.”