|2020 has been quite a challenge, to say the least. The COVID-19 crisis brought massive unemployment, business closures, and an enormous amount of uncertainty. All of this has made 2020 seem like the year that will never end but in fact, it will in less than a month. As such, it is time to discuss steps that can be taken to help reduce your 2020 tax bill.|
The past 12 months have seen several major tax law changes. In response to the COVID-19 emergency, the Coronavirus Aid, Relief, and Economic Security (CARES) Act was signed into law in March. In addition, the Taxpayer Certainty and Disaster Tax Relief Act (Disaster Act) and the Setting Every Community Up for Retirement Enhancement (SECURE) Act were passed in December 2019. The Disaster Act extended many beneficial provisions that had expired or were set to expire. Barring additional extenders, many of these will expire again at the end of the year. The SECURE Act, on the other hand, made significant changes to the retirement rules. We will highlight planning techniques stemming from these recent bills, as well as other year-end planning ideas.
Let us not forget that there is the Georgia Senate race in January. If the Republicans retain the Senate, we do not anticipate significant tax law changes. If the Democrats take both Senate seats, this will almost certainly lead to tax reform (with potentially higher tax rates). It is also possible that we will see additional COVID-19 legislation. As always, we are paying close attention to the ever-changing tax environment to discover tax planning opportunities.
Key Tax Considerations Related to COVID-19
Many tax provisions were implemented to help individuals and businesses deal with the pandemic and its ongoing economic disruptions. Here a few items to be aware of for 2020.
Economic Impact Payment (EIP). Eligible individuals received a payment of $1,200 ($2,400 for joint filers) plus $500 for each qualifying child, with payments phased out based on adjusted gross income. The payments are treated as advance refunds of a 2020 tax credit.
Charitable Deductions. Unique to 2020, individuals who do not itemize their deductions can take an above-the-line charitable deduction of up to $300. Such contributions must be made in cash and to qualified organizations.
Retirement Accounts. You can take up to $100,000 in coronavirus-related distributions from retirement plans through the end of the year without being subject to the 10% additional tax for early distributions. Additionally, required minimum distributions (RMDs) are temporarily suspended for 2020. If your retirement assets have taken a hit, not having to take an RMD may allow those assets to recover some value before you liquidate them.
Year-end Planning Moves for Individuals
Here are some strategies that may lower your individual income tax bill for 2020.
Take Advantage of Generous Standard Deduction Allowances. For 2020, the standard deduction amounts are $12,400 for singles and those who use married filing separate status, $24,800 for married joint filing couples, and $18,650 for heads of household. If your total annual itemizable deductions for 2020 will be close to your standard deduction amount, consider making additional expenditures before year-end to exceed your standard deduction. That will lower this year’s tax bill. Next year, you can claim the standard deduction, which will be increased a bit to account for inflation.
Cancellation of Debt (COD) Relief. Individuals can exclude up to $2 million ($1 million if not married filing jointly) of COD income from qualified principal residence indebtedness that is cancelled in 2020 because of their financial condition or decline in value of the residence. Debt cancelled after December 31, 2020 still qualifies, but only if discharged pursuant to a written binding agreement entered into prior to January 1, 2021.
Traditional IRA Contributions for All. The SECURE Act removed the age restriction on making traditional IRA contributions. Individuals over the age of 70½ who are still working in 2020 are no longer prohibited from contributing to a traditional IRA. However, if you’re over age 70½ and considering making a charitable donation directly from your IRA (known as a Qualified Charitable Distribution or QCD) in the future, making a deductible IRA contribution will affect your ability to exclude future QCDs from your income.
Carefully Manage Investment Gains and Losses in Taxable Accounts. If you hold investments in taxable brokerage firm accounts, consider the tax advantage of selling appreciated securities that have been held for over 12 months. The maximum federal income tax rate on long-term capital gains recognized in 2020 is only 15% for most folks, although it can reach a maximum of 20% at higher income levels. The 3.8% Net Investment Income Tax (NIIT) also can apply at higher income levels.
Take Advantage of 0% Tax Rate on Investment Income. For 2020, singles can take advantage of the 0% income tax rate on long-term capital gains and qualified dividends from securities held in taxable brokerage firm accounts if their taxable income is $40,000 or less. For heads of household and joint filers, that limit is increased to $53,600 and $80,000, respectively. While your income may be too high to benefit from the 0% rate, you may have children, grandchildren, or other loved ones who will be in the 0% bracket. If so, consider giving them appreciated stock or mutual fund shares that they can sell and pay 0% tax on the resulting long-term gains. However, if securities are given to someone who is under age 24, the Kiddie Tax rules could potentially cause some of the resulting capital gains and dividends to be taxed at the higher rates that apply to the individual’s parent.
Convert Traditional IRAs into Roth Accounts. This may be the perfect time to make that Roth conversion you’ve been thinking about. The current tax rates are still relatively low compared to a couple of years ago, and while they are scheduled to remain that way until 2026, depending on the results of the November election, they could increase much sooner. Also, your income may be lower in 2020 due to the financial fallout of COVID-19. On the bright side, that means you’re likely in a lower tax bracket than you normally find yourself. Since the CARES Act suspended Required Minimum Distributions (RMDs) for 2020, if you already budgeted to pay tax on your RMD, rolling that distribution to a Roth IRA could be a perfect move. No RMD for 2020 also means that 100% of the distribution can be classified as a rollover.
Consider Intrafamily Loans. Interest rates are at a historic low and continue to decrease. This scenario creates an attractive opportunity for those interested in assisting family members financially and transferring assets in a tax-efficient manner. Intrafamily loans, along with proper gift tax planning, may be a smart move.
Year-end Planning Moves for Small Businesses
If you own a business, consider the following strategies to minimize your tax bill for 2020.
Net Operating Losses (NOLs). The CARES Act temporarily relaxed many of the NOL limitations that were implemented under the Tax Cuts and Jobs Act (TCJA). If your small business expects a loss in 2020, know that you will be able to carry back 100% of that loss to the prior five tax years. If you had an NOL carried into 2020, you can claim a deduction equal to 100% of your 2020 taxable income.
Establish a Tax-favored Retirement Plan. If your business doesn’t already have a retirement plan, now might be the time to take the plunge. Current retirement plan rules allow for significant deductible contributions and credits. Contact us for more information on small business retirement plan alternatives, and be aware that if your business has employees, you may have to cover them too.
Take Advantage of Generous Depreciation Tax Breaks. 100% first-year bonus depreciation is available for qualified new and used property that is acquired and placed in service in calendar-year 2020. That means your business might be able to write off the entire cost of some or all of your 2020 asset additions on this year’s return. Thanks to the CARES Act, Qualified Improvement Property (QIP) is now eligible for bonus depreciation (or can be depreciated over 15 years rather than 39 years). So, consider making additional acquisitions, including QIP acquisitions, between now and year-end.
Cash in on Generous Section 179 Deduction Rules. For qualifying property placed in service in tax years beginning in 2020, the maximum Section 179 deduction is $1.04 million. The Section 179 deduction phase-out threshold amount is $2.59 million.
Time Business Income and Deductions for Tax Savings. If your business is conducted via a pass-through entity, the traditional strategy of deferring income into next year while accelerating deductible expenditures into this year makes sense if you expect to be in the same or lower tax bracket next year. On the other hand, if you expect to be in a higher tax bracket in 2021 (which could be the case due to COVID-19 and/or the results of the presidential election), take the opposite approach. Accelerate income into this year (if possible) and postpone deductible expenditures until 2021.
Watch out for Business Interest Expense Limit. The CARES Act temporarily relaxed the unfavorable TCJA limitation on a taxpayer’s deduction for business interest expense. Under the TCJA, the deduction was limited to the sum of (1) business interest income, (2) 30% of adjusted taxable income, and (3) floor plan financing interest paid by certain vehicle dealers. For 2020, the 30% limit has been increased to 50% of adjusted taxable income. Barring additional legislation, the limit will go back to 30% in 2021. Fortunately, many businesses are exempt from this limit. We can help you determine if an exemption applies.
This letter only covers some of the year-end tax planning moves that could potentially benefit you, your loved ones, and your business. Please contact us if you have questions, want more information, or would like us to help in designing a year-end planning package that delivers the best tax results for your particular circumstances.
Year-end Estate and Gift Planning
In 2020, each individual is entitled to a credit against federal estate and gift taxes which enables $11,580,000 to pass tax-free (the “exclusion amount”). However, in 2026 the exclusion amount is scheduled to revert back to the 2017 level of $5,000,000. The estate and gift tax rate is 40%. The following are some planning ideas to preserve the advantage of the currently exclusion amount and favorable gift tax rates.
Gift of Exclusion Amount. The easiest and most direct way is to make gifts before the end of 2020. The 2020 gift removes all income and appreciation generated by the gift for the donor’s taxable estate. If you have concerns over losing control of assets given away and losing the economic benefit from them, below are several attractive alternatives to outright gifts.
Spousal Limited Access Trust (SLAT). A married individual can create an irrevocable trust for the benefit of the spouse and transfer assets equal to their exclusion amount to the trust. The donor’s spouse can be the trustee, and the trust can provide that the donor’s spouse can receive distributions of income and principal for health, education, maintenance and support. By creating a SLAT for a spouse, a donor can continue to indirectly benefit from the property through the spouse without concern of estate tax inclusion.
The Wait and See Qualified Terminable Interest Property Trust (QTIP). A married individual can create a QTIP trust for the benefit of a spouse and transfer assets equal to their exclusion amount to the trust. The trust provides that all income must be paid to the donor’s spouse and can be used only for the spouse’s benefit during the spouse’s lifetime. The gift can be made using the marital deduction and will be included in the surviving spouse’s estate or it can be made using the donor’s exclusion amount and will not be included in the surviving spouse’s estate or a combination.
Irrevocable Life Insurance Trust. If a reduction in the exclusion amount will result in your estate incurring estate taxes, you could purchase life insurance to pay the expected potential estate tax. You will make all premium payments to the Trustee of the trust, who will in turn pay the premiums to the insurance company. By having the policy in an irrevocable trust, the proceeds will not be subject to estate tax.
Grantor Retained Annuity Trust (GRAT). For individuals not interested in gifting large amounts of net worth, a trust freezing the growth of assets could be attractive. Today’s low interest rates provide a great opportunity to transfer wealth with no gift or estate taxes through an irrevocable GRAT. You would transfer assets that are expected to appreciate into the irrevocable trust and choose the term of years the GRAT will last. During this period, the GRAT will repay you an amount equal to the assets initially transferred into the GRAT, plus an IRS mandated rate of return. The objective is for the assets to appreciate during the selected term at a higher rate than the IRS required rate of return. All the “excess” appreciation is a tax-free gift to the beneficiaries of the GRAT.
Please Contact Us
As we said at the beginning, this letter is to get you thinking about tax planning moves for the rest of the year. Even though the IRS continues to publish guidance on COVID-19-related developments, there are things you can do now to improve your tax situation. Please don’t hesitate to contact us if you want more details or would like to schedule a tax planning session.
theKFORDgroup team is ready to assist you with your tax questions. Give us a call at (210)340-8351.