In a year with COVID-19 relief efforts tied to the tax code, and a presidential election that will bring potential tax law changes in the future, now is the time to consider year-end tax planning opportunities. Below is our list of the top opportunities to consider as we approach the end of 2020. If you would like to implement any of the opportunities listed, or if you would like to discuss how these opportunities apply to your specific situation, please do not hesitate to contact our team or schedule a tax planning appointment by clicking the following link: www.calendly.com/ongandcompany
INDIVIDUAL YEAR-END TAX PLANNING OPPORTUNITIES
- Consider options available to accelerate income to 2020 to benefit from current low tax rates. We typically want to defer income to future years, but lower income levels brought by COVID-19, along with the potential for tax rate increases in the near future, make 2020 a year in which accelerating income could provide a tax benefit for taxpayers. Make sure you project your overall tax impact prior to executing the opportunities below as they could impact your premium tax credit, portion or social security income subject to tax, and/or Medicare IRMAA (if applicable).
- Consider converting all or a portion of your traditional IRA to Roth. With tax rates at historically low levels and incomes down in 2020 due to COVID-19, many taxpayers have the opportunity to lock in low federal tax rates in pre-tax retirement assets by executing a Roth conversion prior to December 31st. The favorable brackets to stay within while executing this conversion are the 12% bracket (taxable income up to $80,250 for married filing jointly taxpayers) and 24% bracket (taxable income up to $326,600 for married filing jointly taxpayers).
- Consider locking in long-term capital gains. If you have a large amount of unrealized long-term capital gains in your portfolio, 2020 might be the year to realize those gains and rebalance. The 0% federal long-term capital gains rate applies to taxpayers with taxable income up to $80,250 if married filing jointly and $40,125 if single. If income is over that level, the favorable 15% federal rate applies to taxpayers until they hit the top tax bracket, then the rate increases to 20%. For those considering the sale of a business or other highly appreciated assets, consider an installment sale to spread the gain over multiple years. The Biden tax plan has called for eliminating the favorable long-term capital gains rates for taxpayers with income of $1M, but it remains to be seen if any of the tax law changes proposed during the campaign will be implemented.
- Consider taking a COVID-related distributions (CRD) from your retirement account. As part of the Coronavirus Aid, Relief, and Economic Security (CARES) Act, individuals affected by COVID-19 can withdraw up to $100,000 from employee-sponsored retirement accounts like 401(k)s and 403(b)s, as well as personal retirement accounts, such as traditional individual retirement accounts, or a combination of these. The 10% early distribution penalty is waived for distributions made in 2020. The distribution can be taxed as income spread evenly over tax years 2020, 2021 and 2022, and if you can pay back the amount you took out within three years, you can claim a refund on those taxes. You must have experienced adverse financial consequences due to COVID-19 to be eligible to take a CRD. Contact our team if you have questions about your situation and whether or not you would qualify.
- Consider your economic stimulus payment and the impact of your 2020 income on your Recovery Rebate credit.
- The CARES Act directed the IRS to issue economic stimulus checks of up to $1,200 per taxpayer and $500 per qualified child dependent earlier this year. The payments were paid based on 2018 or 2019 return information, but are actually structured as advances of 2020 tax credits. These Recovery Rebate credits phase out for higher-income taxpayers, so you should consider the implications if the payment you received based on 2018 or 2019 won’t match the amount of credit calculated on your 2020 return. If the 2020 credit calculation is less than you received, there is no impact as you will not be required pay back the payment you received. If you received less than the credit calculated for 2020 due to a reduction in income versus your base period used (2018 or 2019), you can claim the credit as an additional refund or offset to taxes due with your 2020 tax return. If you did not receive an economic stimulus payment during the year, or you received a reduced payment due to your income level on previous year returns, you should consider planning your 2020 income to allow yourself to be eligible for the Recovery Rebate credit.
- Maximize the tax efficiency associated with your charitable contributions.
- Use the above-the-line charitable deduction of $300. Everyone is entitled to a charitable deduction this year. The TCJA doubled the standard deduction while repealing or limiting many itemized deductions, leaving millions fewer taxpayers claiming actual itemized deductions. Typically, there is no tax benefit for giving to charity unless you itemize deductions. However, the CARES Act created an above-the-line deduction of up to $300 for cash contributions from taxpayers who don’t itemize. If you would like to take advantage of this provision, make sure to donate before the end of the year.
- Bunch your charitable gifts. With the increase in the standard deduction implemented as part of the TCJA ($12,400 for single and $24,800 for married filing jointly in 2020), the tax benefit associated with charitable giving was eliminated for many who now take the standard deduction. Bunching your charitable gifts that you intend to make over a future period into a single year allows taxpayers to exceed the standard deduction and receive a tax benefit in the year of the bunched contribution. The standard deduction can then be used in the year(s) following the larger bunched contribution. A donor-advised fund is a great tool that allows individuals to execute this strategy, as you receive the tax deduction in the year you contribute to your fund. You can then distribute contributions out of the fund at any time, so you can keep your recurring donation schedule consistent while still receiving the benefit of bunching.
- Give directly from your retirement account to charitable organizations through a qualified charitable distribution (QCD). Although RMDs are not required for 2020, QCDs from IRAs are still available in 2020 and still offer tax benefits. QCDs allow IRA owners who are 70.5 or older to directly transfer up to $100,000 annually from an IRA to charity, tax-free. After the TCJA in 2018, QCDs became more valuable than ever. Many taxpayers now take the larger standard deduction, which eliminates the tax deduction for charitable gifts (outside of the $300 above-the-line deduction made available for 2020). QCDs add to the standard deduction by allowing the donations made from the IRA to be excluded from income. With a QCD, you get a tax break for your charitable contribution even if you are using the standard deduction.
- Consider estimated tax payments to eliminate or minimize underpayment penalties.
- Many individuals have received unemployment compensation in 2020, and many of the amounts received have been larger payment amounts due to the federal supplements. Unemployment compensation is subject to income tax, and many taxpayers will be hit with a surprise tax bill if taxes have not been withheld from payments received. Be sure to project your taxes due, and consider making estimated tax payments (the next estimated tax payment due date is 1/15/2021) to eliminate or reduce a potential underpayment penalty if you have not met the federal requirement of paying in the lower of 90% of your current year tax or 100% (or 110% at higher income levels) of prior year (2019) tax.
- Review city tax withholding and prepare documentation for refunds if you lived and worked outside of the city in 2020.
- Certain cities (e.g. Kansas City, MO) have their own income tax that they collect from people who live or work within the city. For example, if you live or work in Kansas City, MO, you are required to pay a 1% tax on all income earned while either living or working in the city. Employers based in the city will withhold this tax from employee paychecks, then remit the payments to the city on your behalf. If you do not live in the city, you are only required to pay this tax on income generated while working in the city. For many in 2020, employers have continued to withhold this tax for these employees while the employees have been working from home (outside of the city). If this situation applies to you, you can request a refund with your 2020 city income tax filings (Form RD-109 Earnings Tax Return for Kansas City, MO). As part of the return, you will need to include a nonresident schedule that includes your total days worked everywhere, actual days worked outside of the city, employer's name, employer's email address, employer's contact person, contact person's phone number, address of your primary work location, and a description of the records you maintained to support your calculation for days worked outside of the city. This can be a significant potential refund with many workers spending ~75% of the year working from home. If this situation applies to you, be sure to collect, organize, and prepare your records to claim the refund as part of your 2020 tax filings.
- Skip or reduce your Required Minimum Distributions (RMD) from retirement accounts.
- The CARES Act enabled any taxpayer with an RMD due in 2020 from a defined-contribution retirement plan, including a 401(k) or 403(b) plan, or an IRA, to skip those RMDs this year. This includes anyone who turned age 70 1/2 in 2019 and would have had to take the first RMD by April 1, 2020. The waiver does not apply to defined-benefit plans. If you already took your RMD within the last 60 days, you can use the 60-day indirect rollover to contribute the RMD back to an IRA to avoid receiving the taxable income in 2020. Consider reducing (rather than skipping in full) to fill the lower tax brackets and take advantage of the current low tax rates.
- Take advantage of the annual gift tax exclusion ($15,000 per individual) in anticipation of higher estate transfer taxes in the future.
- With the potential reduction in the estate tax exemption from $11.58M to $3.5M, along with the potential elimination of the favorable step-up in basis on inherited assets, many should consider implementing a gifting plan to transfer assets by taking advantage of the annual $15,000 exclusion on gifts.
- Consider the December 31st deadline for employee retirement plan contributions, charitable contributions, and 529 contributions.
- Remember that December 31st is the deadline for employee contributions to 401(k) and Simple IRAs, and it is also the deadline for charitable contributions and 529 contributions. Note that the TCJA expanded the use of 529 funds to include paying for K-12 private school tuition, up to $10,000 per year per student. If your children are attending private schools, consider maximizing your contributions to 529 accounts to receive a deduction on your state tax return. In addition, the Setting Every Community Up for Retirement Enhancement (SECURE) Act passed in December 2019 allows families to take tax-free 529 plan distributions for student loan repayment of up to a lifetime limit of $10,000 per beneficiary. If you are phased out of the student loan interest deduction due to your income level, consider making a contribution to a 529 account to pay off student loan debt and receive a deduction on your state tax return.
BUSINESS YEAR-END TAX PLANNING OPPORTUNITIES
- Take advantage of full expensing of qualified improvement property (QIP).
- The CARES Act included a correction to the Tax Cuts and Jobs Act (TCJA) that allows businesses to fully deduct costs associated with improvements made to the interior of a building. Previously, those costs were required to be depreciated equally over a 39-year lifespan. Note that this correction was made retroactive to 2018, so there is an opportunity to amend 2018 and 2019 tax returns to incorporate this deduction, in addition to including bonus depreciation on QIP on 2020 tax returns. If amending is not an option, businesses can file a Form 3115 Application for Change in Accounting Method with their 2020 tax returns to add the previously missed bonus depreciation onto their 2020 tax returns. Fully expending in the year placed into service, rather than depreciating over 39 year, can have a significant impact on the tax situation of the owners of the business (for passthroughs) or for the corporation.
- Use current losses for quick refunds through net operating loss (NOL) carrybacks.
- The CARES Act revised the provisions of the TCJA to allow taxpayers to carry back NOLs, including non-farm NOLs, arising from tax years beginning in 2018, 2019, and 2020 for 5 years. Previously, taxpayers were required to carry forward losses to be applied against future taxable income. The ability to carry back losses up to 5 years allows individuals (for passthroughs) and corporation to apply losses generated in 2018, 2019, or 2020 against pre-TCJA tax years that taxed income at higher rates. This opportunity should be considered to take advantage of rate arbitrage and to accelerate refunds associated with 2018-2020 losses rather than carrying forward.
- Consider the impact of PPP forgiveness on 2020 taxable income.
- As of the date of this blog post, the IRS has issued guidance that any expenses that are reasonably expected to be attributable to PPP forgiveness are nondeductible. With the vast majority of PPP covered periods ending in 2020, this means that any portion of a PPP loan that is forgiven will increase taxable income by that amount on 2020 income tax returns. The impact of forgiveness, whether or not confirmed by year end, must be considered when planning Q4 estimated tax payments and cash flow needs for Q1 of 2021.
- Deduct and/or issue reimbursements for home office expenses.
- The COVID-19 pandemic has forced a majority of workers to spend a significant amount of time working from home in 2020. Self-employed individuals should track all direct and indirect home office expenses incurred in 2020 and be sure to compare the simplified method ($5 per square foot) versus the actual expenses method (actual expenses multiplied by business use percentage).
- While self-employed individuals can apply a home office deduction on their individual tax returns, employees cannot (including S-Corporation owner employees). Employers should issue reimbursements for home office expenses to allow the company to deduct the business use of home expenses. Documentation of the calculation for this reimbursement should be retained in the form of an expense report. Contact our team if you would like assistance with the calculation of a home office reimbursement expense, or if you would like an expense report template to be completed and retained with company documents.
- Issue reimbursements for health (including Medicare), vision, and dental insurance premiums paid personally by S Corporation owners.
- Greater than 2% owners of S Corporations can deduct premiums paid for health, dental, and vision insurance as self-employed health insurance. To do so, the company must pay for the premiums directly or reimburse owners for the amount of premiums paid by December 31st. The total amount of premiums deducted for each owner must then be reported in Box 1 of their W2s to allow for proper reporting of the deduction. Self-employed health insurance can be a significant deduction, so be sure to issue reimbursements if premiums have been paid through personal accounts in 2020.
If you have any questions about the opportunities listed above, or if you would like to schedule an appointment to run a tax projection to understand the impact of potential changes on your situation, please do not hesitate to contact our team. Appointments can be scheduled online by visiting our homepage at www.ongandcompany.com.