“Last-Minute” 2020 Year-End Tax-Saving Moves for Individuals

There are only a few days left before the year ends, but here are some actions you can take before the new year to improve your situation for 2020 and beyond.

Consider President-elect Biden’s proposals. As the year comes to an end, it is hard to predict what, if anything, that the Biden Administration has proposed will become law and take effect in 2021. Most experts believe that taxes will need to be increased after the economic effects of the pandemic to help pay for the increased federal spending as a result of the pandemic. But enacting any major tax legislation is likely to be a slow process and may not affect 2021 taxes.

Here are some of the Biden Administration’s most noteworthy tax proposals:

Tax increase proposals

  • Raise the highest individual income tax rate to 39.6% from 37%.
  • Cap itemized deductions for the wealthiest Americans at 28%.
  • End favorable capital gains rates, including those rates on qualified dividends, for anyone with income over $1 million.
  • Eliminate the step-up in basis at death (taxing all appreciated investments at death)
  • Reducing the estate and gift tax exemption to its pre-Tax Cuts and Jobs Act (TCJA) level.

Tax decrease proposals.

  • $8,000 tax credit to help offset the costs of child care.
  • Exclusion from income for student loans that have been forgiven.
  • A refundable tax credit for low- and middle-income workers who contribute to IRAs and employer-provided retirement savings plans.

Solve underpayment of estimated tax/withheld tax issues.

Add an extra amount of withholding from your paycheck to solve an underpayment of estimated tax problem. Employees may discover that their prepayments of tax for 2020 have been too small because, for example, their estimate of income or deductions was off and they are underwithheld, or they failed to make estimated tax payments for unanticipated income, such as gains from sales of stock. Or they may have an underpayment of estimated tax because of the additional 0.9% Medicare tax and/or the 3.8% surtax on unearned income. To reduce an estimated tax underpayment penalty, an employee can ask their employers to increase withholding for their last paycheck or paychecks to make up or reduce the deficiency. If you are significantly underwithheld annually, you can file a new Form W-4 or simply request that the employer withhold a flat amount of additional income tax. If you are unable to add an additional withholding amount on your final paycheck, you can make a final estimated tax payment for 2020 (due on Jan. 15, 2021) to cut or eliminate the penalty for a Q4 underpayment only. It doesn’t help with underpayments for preceding quarters. By contrast, tax withheld on wages can wipe out or reduce underpayments for previous quarters because, as a general rule, an equal part of the total withholding during the year is treated as having been paid on each quarterly estimated payment date.

Charitable donations.

Use IRAs to make charitable donations. Taxpayers who have reached age 70½ by the end of 2020, own IRAs, and are thinking of making a charitable gift should consider arranging for the gift to be made by way of a qualified charitable contribution, or QCD—a direct transfer from the IRA trustee to the charitable organization. Such a transfer (up to $100,000 for 2020) will neither be included in gross income nor allowed as a deduction on the taxpayer’s return. But, since such a distribution is not includible in gross income, it will not increase Adjusted Gross Income (AGI) for purposes of the phaseout of any deduction, exclusion, or tax credit that is limited or lost completely when AGI reaches certain specified level.

Taxpayers who have reached age 72 by Dec. 31 normally must take required minimum distributions (RMDs) from their IRAs or 401(k) plans (or other employer-sponsored retired plans) by Dec. 31. As a result of the CARES Act, there is no such requirement for 2020.

A QCD before Dec. 31, 2020 can still be a good idea for retired taxpayers who don’t need their as-yet undistributed RMD for living expenses. A 2020 QCD will reduce the taxpayer’s retirement account balance and therefore reduce the amount of the RMD that must be withdrawn in future tax years.

Charitable donation by non-itemizers. Non-itemizers can deduct up to $300 of cash charitable donations that they make in 2020 ($600 for married filing joint taxpayers).

Higher limit on charitable contributions. In response to the Coronavirus (COVID-19) pandemic, the limit on charitable contributions of cash by an individual in 2020 was increased to 100% of the individual’s adjusted gross income (AGI). For previous years, the limit was 60% of a taxpayer’s AGI. While this increased limit was extended to 2021 by the CAA, 2021, taxpayers should consider increasing 2020 contributions to take advantage of the increased limit.

Retirement plans.

Establish a Keogh plan. A self-employed person who wants to contribute to a Keogh plan for 2020 must establish that plan before the end of 2020. If that is done, deductible contributions for 2020 can be made as late as the taxpayer’s extended tax return due date for 2020.

Relief with respect to withdrawal from retirement plans. A distribution from a qualified retirement plan is generally subject to a 10% additional tax unless the distribution meets an exception under Code Sec. 72(t).

2020 legislation provides that the Code Sec. 72(t) 10% additional tax does not apply to any coronavirus-related distribution, up to $100,000. A coronavirus-related distribution is any distribution made on or after January 1, 2020, and before December 31, 2020, from an eligible retirement plan, made to a qualified individual.

A qualified individual is an individual

  1. Who is diagnosed with the virus SARS-CoV-2 or with coronavirus disease 2019 (COVID-19) by a test approved by the Centers for Disease Control and Prevention (CDC),
  2. Whose spouse or dependent (as defined in Code Sec. 152) is diagnosed with such virus or disease by such a test, or
  3. Who experiences adverse financial consequences as a result of being quarantined, being furloughed or laid off or having work hours reduced due to such virus or disease, being unable to work due to lack of child care due to such virus or disease, closing or reducing hours of a business owned or operated by the individual due to such virus or disease, or other factors as determined by the Secretary of the Treasury.

Other relief also applies to coronavirus-related distributions, including the ability to recognize income over a 3-tax-year period.

Other.

Make year-end gifts. A person can give any other person up to $15,000 for 2020 without incurring any gift tax. The annual exclusion amount increases to $30,000 per donee if the donor’s spouse consents to gift-splitting. Anyone who expects eventually to have estate tax liability and who can afford to make gifts to family members should do so. Besides avoiding transfer tax, annual exclusion gifts take future appreciation in the value of the gift property out of the donor’s estate, and they shift the income tax obligation on the property’s earnings to the donee who may be in a lower tax bracket (if not subject to the kiddie tax).

Watch out for the use-it-or-lose-it rule. Unused cafeteria plan amounts left over at the end of a plan year must generally be forfeited (use-it-or-lose-it rule). A cafeteria plan can provide an optional grace period immediately following the end of each plan year, extending the period for incurring expenses for qualified benefits to the 15th day of the third month after the end of the plan year. Benefits or contributions not used as of the end of the grace period are forfeited. Under an exception to the use-it-or-lose-it rule, at the plan sponsor’s option and in lieu of any grace period, employees may be allowed to carry over up to $500 of unused amounts remaining at year-end in a health flexible spending account.

Taxpayers should make sure they understand their employer’s plan and should make last-minute purchases before year end to the extent that not doing so will result in losing benefits. In most cases, a trip to the drug store, dentist or optometrist, for goods or services that the taxpayer would otherwise have purchased in 2021, can avoid “losing it.”

Paying by credit card creates deduction on date of credit card transaction. Taxpayers should consider using a credit card to pay deductible expenses before the end of the year. Doing so will increase their 2020 deductions even if they don’t pay their credit card bill until after the end of the year.

Increase 2020 itemized deductions via a “bunching strategy.” Many taxpayers who claimed itemized deductions in prior years will no longer be able to do so. That’s because the standard deduction has been increased and many itemized deductions have been cut back or abolished. Paying some otherwise-deductible-in-2021 itemized deductions in 2020 can decrease taxable income in 2020 and will not increase 2021 taxable income if 2021 itemized deductions would otherwise have still been less than the 2021 standard deduction. For example, a taxpayer who expects to itemize deductions in 2020 but not 2021, and usually contributes a total of $1,500 to charities each year, should consider making a total of $3,000 of charitable contributions before the end of 2020 (and skipping charitable contributions in 2021).

Please contact our office for additional guidance and tax savings strategies that may be applicable to your personal situation.

CARES Act Part 2 – Individual Provisions

On Friday, the President signed into law the CARES Act. This legislation contained very significant tax law changes, the majority of which are temporary and will only be relevant for the 2020 calendar year. We’ve spent the last five days digging through this 880 page legislation to highlight the most relevant changes for you. 

Below is a summary of these provisions, as they relate to individuals:

Tax Deadline Extension

 2019 Tax Returns

As you’re probably aware, the April 15th, 2020 tax deadline has been automatically postponed to July 15th, 2020. This includes all of the following:

  • 2019 Form 1040, Individual tax returns and payments
  • 2019 Traditional or Roth IRA contributions
  • 2019 HSA contributions

2020 Estimated Payments For those of you who make estimated payments throughout the year, the Q1 2020 estimated payments deadline was also extended to July 15, 2020. However, the Q2 2020 estimated payments deadline currently remains at June 15, 2020.

Stimulus Rebate Checks

Under the CARES Act, eligible individuals are allowed an economic impact payment equal to:

  1. $1,200 ($2,400 for joint return) plus
  2. $500 for each qualifying child of the taxpayer under 17 years old

 The amount of the credit is reduced (but not below zero) by 5% of the taxpayer’s adjusted gross income (AGI) in excess of:

  1. $150,000 for a joint return,
  2. $112,500 for a head of household, and
  3. $75,000 for all other taxpayers

We’ve put together this calculator to help you estimate your stimulus rebate. Please download this sheet to edit. This calculation is based on the CARES Act as of March 27th and may change.

For taxpayers who have already filed their 2019 tax returns, the IRS will use this information to calculate the payment amount. For those who have not yet filed their return for 2019, the IRS will use information from their 2018 tax filing to calculate the payment. This economic impact payment will be deposited directly into the same banking account reflected on the return filed.

In the coming weeks, Treasury plans to develop a web-based portal for individuals to provide their banking information to the IRS online, so that individuals can receive payments immediately as opposed to checks in the mail. The IRS will also mail a notice to the taxpayer’s last known address indicating how the payment was made, the amount of the payment, and a phone number for reporting any failure to receive the payment to IRS.

If you would like more information, please see this IRS news release.

If you are due a higher rebate based on your 2020 return next Spring, then you may be able to claim the excess over the amount of rebate already received as a credit on that filing. However, if the rebate received based on 2018 or 2018 was greater than what you would have been entitled to based on your 2020 filing, you will not be required to pay back the excess.

Charitable Contribution Provision

The CARES Act adds a deduction to the calculation of gross income for up to $300 of qualified charitable contributions made during the 2020 tax year by eligible individuals. Qualified charitable contributions must be made in cash to eligible 501(c)(3) non-profits and eligible individuals are those who do not elect to itemize deductions. Prior to the Cares Act, only taxpayers who itemized deductions (rather than taking the standard deduction) were allowed a deduction for charitable contributions.

Student Loan Debt

Employer-Tax Free Reimbursements

Eligible student loan repayments up to $5,250 are excluded from the employee’s gross income. Eligible student repayments are payments made by an employer directly to the employee or lender for principal or interest on any qualified higher education loan before January 1, 2021. This payment must be for the employee – it can’t be for a spouse or a dependent. Note that certain restrictions apply to S-corporation owners and self-employed individuals.

Suspension of Payments

The CARES Act offers a few benefits in relation to federal student loan payments. Note that these provisions only apply to loans that are held through the Department of Education.

  1. Student loan payments are suspended through September 30, 2020.
  2. Interest will not accrue during this time.
  3. Involuntary collection has been suspended. In other words, there is no garnishment of wages, Social Security, and tax refunds for student loan debt collection.
  4. If you are a part of a loan forgiveness program, this period of time will still count as “payments.” For example, those that are in the public service loan forgiveness program are required to make 120 consecutive payments. Although you may not make payments, this period of time will still count as payments toward the 120 consecutive payment requirement.

Student Loan Forgiveness

The CARES Act doesn’t include any provisions for student loan forgiveness. Initial proposals from Senate and House Democrats included student loan forgiveness plans for $10K and $30K but neither proposals were included in the legislation.  

Waiver on Early Withdrawal

The CARES Act provides that the 10% early withdrawal penalty does not apply to any coronavirus-related distribution that is made in 2020, up to $100,000. Note that the requirements for a qualified individual are one:

  1. Who is diagnosed with the virus SARS-CoV-2 or with coronavirus disease 2019 (COVID-19) by a test approved by the Centers for Disease Control and Prevention (CDC),
  2. Whose spouse or dependent is diagnosed with such virus or disease by such a test, or
  3. Who experiences adverse financial consequences as a result of being quarantined, being furloughed or laid off or having work hours reduced due to such virus or disease, being unable to work due to lack of child care due to such virus or disease, closing or reducing hours of a business owned or operated by the individual due to such virus or disease, etc.

This does NOT mean you do not pay tax on the distribution. However to ease the tax burden, the Cares Act includes a provision so that the amount distributed can be included in income ratably over 3 years (unless the taxpayer elects not to). The way the CARES Act is written you can contribute the aggregate amount of the coronavirus-related distribution back to the eligible retirement plan within the 3-year timeframe and treat the contribution amount as a trustee to trustee transfer.

Final Thoughts

I know this is a challenging time and we are working around the clock to stay on top of every detail as legislation changes. We are here to work through this with you and are honored to be a resource for our community during this time. 

Sincerely,

Paul, Mohib, and Jerome 

The Smartest Way to Minimize Tax on a ROTH IRA Conversion

Considering converting your Traditional IRA into a Roth IRA? You’re not alone. Many of my clients are wondering if they should convert their IRA now and pay tax on the conversion this year, or wait till next year when tax rates may be lower.

If you are already sold on converting to a Roth IRA, you can convert this year without worrying about changes to the tax code! If tax rates turn out to be lower next year under tax reform, you can use the recharacterize-and-reconvert strategy to shift the conversion’s tax consequences from 2017 to 2018.

What are the benefits of a ROTH conversion? Roth IRAs have two major advantages over traditional IRAs:

  1. While distributions from a traditional IRAs are taxed as ordinary income (except to the extent they represent nondeductible contributions), Roth IRA distributions are tax-free if they are “qualified distributions”
  2. While Traditional IRAs are subject to the lifetime required minimum distribution (RMD) rules that generally require minimum annual distributions in the year following the year in which the IRA owner attains age 70 1/2, Roth IRAs aren’t subject to the lifetime RMD rules that apply to traditional IRAs (as well as individual account qualified plans).

There are other tax advantages. Since distributions from Roth IRAs are tax-free (if they are qualified distributions), they could keep you from being taxed in a higher tax bracket. Not only that, Qualified Distributions from Roth IRAs don’t enter into the calculation of tax owed on Social Security payments, and they have no effect on Adjusted Gross Income (AGI) based deductions!

Keep in mind that converting from a Traditional IRA to a Roth IRA, (or from another pre-tax qualified plan to Roth IRA) is not income-tax-free. Instead, it is subject to tax as if it were distributed from the traditional IRA (or qualified plan) and not rolled over into another plan of the same type, but it generally isn’t subject to the 10% premature distribution tax. A substantial conversion could move a taxpayer into a higher bracket and/or result in reduced tax breaks that have AGI-based phaseouts or “floors”.

If you convert your pre-tax retirement account to a Roth IRA during 2017, you have the ability to determine when to pay tax on the conversion—in the year of the conversion, or in the following year. This unique opportunity allows you to minimize your tax liability on the conversion, should significant changes to the tax code occur.

Here’s how it works: If congress fails to pass a tax code overhaul, or if the reform fails to lower your 2018 marginal tax rate, and you are making a Roth IRA conversion this year, simply report the transaction on your 2017 return. But if tax reform succeeds, and your marginal tax rate will be lower next year (in 2018) than this year, you can shift the conversion’s income from 2017 to 2018 through a 2-step process.

Step 1 – recharacterization. The conversion from a traditional IRA to a Roth IRA can be recharacterized (reversed or cancelled out).

The recharacterization is made via a trustee-to-trustee transfer directly between financial institutions or within the same financial institution. Any recharacterized conversion (or Roth IRA rollover from a traditional IRA) will be treated as though the conversion or rollover had not occurred. Any recharacterized contribution will be treated as having been originally contributed to the second IRA, not the first IRA. The amount transferred must include related earnings or be reduced by any loss.

Ideally, a recharacterization should be made by the due date (plus extensions) of the taxpayer’s return for the affected year, and reflected on the return for that year.

However, you can make a recharacterization even after you have filed your return for the year for which a conversion to a Roth IRA was made. Technically, you have six months from the unextended due date of the return to make a recharacterization of the amount you previously converted to a Roth IRA. For example, a conversion from a traditional IRA to a Roth IRA in 2017 may be recharacterized as a contribution to a traditional IRA as late as Oct. 15, 2018. If you want to make a recharacterization after having filed the return for the affected year, you simply file an amended return reflecting the transfer, and write “Filed pursuant to section 301.9100-2” on the amended return.

Step 2 – reconversion. After you convert an amount from a traditional IRA to a Roth IRA, not only may you transfer that amount back to a traditional IRA in a recharacterization, but may later reconvert that amount from the traditional IRA to a Roth IRA. If you take these steps, your resulting income will be fixed at the time of the reconversion.

It’s important to keep in mind that a reconversion cannot be made before the later of:

  • The beginning of the tax year following the tax year in which the amount was converted to a Roth IRA; or
  • The end of the 30-day period beginning on the day on which the IRA owner transfers the amount from the Roth IRA back to a traditional IRA by way of a recharacterization.

This timing rule applies regardless of whether the recharacterization occurs during the tax year in which the amount was converted to a Roth IRA or the following tax year.

If you have questions on ROTH conversions, feel free to contact us for assistance!