Year-end tax planning for calendar year 2020
Now, as year-end approaches, is a good time to think about planning moves that may help lower your tax bill for this year and possibly next. Year-end planning for 2020 takes place against the backdrop of a difficult year with the challenges of the pandemic. New tax rules have been enacted to help mitigate the financial impact of the pandemic, some of which should be considered as part of this years’ planning, most notably elimination of required retirement plan distributions, and liberalized charitable deduction rules.
Major tax changes from recent years generally remain in place, including lower income tax rates, larger standard deductions, limited itemized deductions, elimination of personal exemptions, an increased child tax credit, and a reduction in impact of the alternative minimum tax (AMT) for individuals; and a major corporate tax rate reduction and elimination of the corporate AMT, limits on interest deductions, and generous expensing and depreciation rules for businesses. Non-corporate taxpayers with certain income from pass-through entities may still be entitled to a valuable deduction.
Despite the lack of major year-over-year tax changes, the time-tested approach of deferring income and accelerating deductions to minimize taxes still works for many taxpayers, as does the bunching of expenses into this year or next to avoid restrictions and maximize deductions. However, with the possibility of tax reform proposed by Biden, some taxpayers may want to accelerate income into this year. As such, there isn’t a one-size-fits-all solution.
We have compiled a list of actions based on current tax rules that may help you save tax dollars if you act before year-end. Not all actions will apply in your particular situation, but you (or a family member) will likely benefit from many of them. We can narrow down the specific actions that you can take once we discuss your situation with you to tailor a particular plan. In the meantime, please review the following list and contact us at your earliest convenience so that we can advise you on which tax-saving moves to make:
Year-End Tax Planning Moves – international tax considerations
First things first… a brief comment related to international taxes.
U.S. individual and business taxpayers that have a controlling ownership interest in a non-U.S. corporation may be subject to the anti-tax deferral rules, namely the Global Intangible Low-Taxed Income (GILTI) regime which has now been in law for the past two years. Refer to our post here regarding this specific matter. It’s possible that many taxpayers owning non-U.S. corporations may be subject to U.S. tax again this year similar to the past couple of years. For this reason, it’d be advisable to get in touch with us before year-end to consider year-end planning moves to optimize your tax situation. This is even more useful than in the past, since some new regulations have been passed recently which has given us additional tools and tax election opportunities to mitigate against the impact of this GILTI regime.
In fact, we highly recommend that you contact us if you are a U.S. person that has an ownership interest in a non-U.S. corporation, even if you don’t have control of the corporation. There is the potential for onerous tax implications under different anti-tax deferral regimes, so you would be well advised to contact us before year-end to take necessary actions to mitigate against adverse tax implications.
Year-End Tax Planning Moves for Individuals
You may want to postpone income until 2021 and accelerate deductions into 2020 if doing so will enable you to claim larger deductions, credits, and other tax breaks for 2020 that are phased out over varying levels of adjusted gross income (AGI). These include deductible IRA contributions, child tax credits, higher education tax credits, and deductions for student loan interest. Postponing income also is desirable for taxpayers who anticipate being in a lower tax bracket next year due to changed financial circumstances. Note, however, that in some cases, it may pay to actually accelerate income into 2020. For example, that may be the case for a person who will have a more favorable filing status this year than next (e.g., head of household versus individual filing status), or who expects to be in a higher tax bracket next year.
If you believe a Roth IRA is more favorable in your situation compared to a traditional IRA, consider converting traditional-IRA money invested in any beaten-down stocks (or mutual funds) into a Roth IRA in 2020 if eligible to do so. Keep in mind, however, that such a conversion will increase your AGI for 2020, and possibly reduce tax breaks geared to AGI (or modified AGI).
It may be advantageous to try to arrange with your employer to defer, until early 2021, a bonus that may be coming your way. This could cut as well as defer your tax.
Many taxpayers won’t be able to itemize because of the high basic standard deduction amounts that apply for 2020 ($24,800 for joint filers, $12,400 for singles and for married persons filing separately, $18,650 for heads of household), and because many itemized deductions have been reduced or abolished. Like last year, no more than $10,000 of state and local taxes may be deducted; miscellaneous itemized deductions (e.g., tax preparation fees and unreimbursed employee expenses) are not deductible; and personal casualty and theft losses are deductible only if they’re attributable to a federally declared disaster and only to the extent they exceed the $100-per-casualty and 10%-of-AGI thresholds. You can still itemize medical expenses but only to the extent they exceed 7.5% of your adjusted gross income, state and local taxes up to $10,000, your charitable contributions, plus interest deductions on a restricted amount of qualifying residence debt, but payments of those items won’t save taxes if they don’t cumulatively exceed the standard deduction for your filing status. Two COVID-related changes for 2020 may be relevant here: (1) Individuals may claim a $300 above-the-line deduction for cash charitable contributions on top of their standard deduction; and (2) the percentage limit on cash charitable contributions has been raised from 60% of modified adjusted gross income (MAGI) to 100%.
Some taxpayers may be able to work around these deduction restrictions by applying a bunching strategy to pull or push discretionary medical expenses and charitable contributions into the year where they will do some tax good. For example, a taxpayer who will be able to itemize deductions this year but not next will benefit by making two years’ worth of charitable contributions this year, instead of spreading out donations over 2020 and 2021. The COVID-related increase for 2020 in the income-based charitable deduction limit for cash contributions from 60% to 100% of MAGI assists in this bunching strategy, especially for higher income individuals with the means and disposition to make large charitable contributions.
It’s worth putting a spotlight on this current year only tax law change related to the increase limit of cash contributions to 100% of modified adjusted gross income. This creates some incredible tax saving opportunities for persons who are charitably minded, or perhaps older in age and their estate plan involves charitable donations. Since the limits are so expanded, one could give a lot of cash to charity to eliminate or reduce their current year tax bill. This could result in dropping folks into low tax brackets to obtain 0% tax on certain long-term capital gains. Or it could mean it is a good time to rollover an IRA to a Roth IRA – having the rollover income taxed at a low rate due to the large charitable donation deduction. Or maybe it means distributing significant funds from a tax-deferred IRA/401(k) plan and then donating those funds to charity. There is a lot of opportunity with this favorable law – but it’s only a calendar year 2020 benefit. So it’s something to consider this year in advance of year-end.
You may want to consider using a credit card to pay deductible expenses before the end of the year. Doing so will increase your 2020 deductions even if you don’t pay your credit card bill until after the end of the year.
If you expect to owe state and local income taxes when you file your return next year and you will be itemizing in 2020, consider asking your employer to increase withholding of state and local taxes (or pay estimated tax payments of state and local taxes) before year-end to pull the deduction of those taxes into 2020. But remember that state and local tax deductions are limited to $10,000 per year, so this strategy is not good to the extent it causes your 2020 state and local tax payments to exceed $10,000.
Higher-income earners must be wary of the 3.8% surtax on certain unearned income. The surtax is 3.8% of the lesser of: (1) net investment income (NII), or (2) the excess of modified adjusted gross income (MAGI) over a threshold amount ($250,000 for joint filers or surviving spouses, $125,000 for a married individual filing a separate return, and $200,000 in any other case). As year-end nears, a taxpayer’s approach to minimizing or eliminating the 3.8% surtax will depend on his estimated MAGI and NII for the year. Some taxpayers should consider ways to minimize (e.g., through deferral) additional NII for the balance of the year, others should try to see if they can reduce MAGI other than NII, and other individuals will need to consider ways to minimize both NII and other types of MAGI. An important exception is that NII does not include distributions from IRAs and most other retirement plans.
Long-term capital gain from sales of assets held for over one year is taxed at 0%, 15% or 20%, depending on the taxpayer’s taxable income. If you hold long-term appreciated-in-value assets, consider selling enough of them to generate long-term capital gains that can be sheltered by the 0% rate. The 0% rate generally applies to the excess of long-term capital gain over any short-term capital loss to the extent that, when added to regular taxable income, it is not more than the maximum zero rate amount (e.g., $80,000 for a married couple). If the 0% rate applies to long-term capital gains you took earlier this year for example, you are a joint filer who made a profit of $5,000 on the sale of stock held for more than one year and your other taxable income for 2020 is $75,000 then try not to sell assets yielding a capital loss before year-end, because the first $5,000 of those losses won’t yield a benefit this year. (It will offset $5,000 of capital gain that is already tax-free).
Required minimum distributions (RMDs) that usually must be taken from an IRA or 401(k) plan (or other employer-sponsored retirement plan) have been waived for 2020. This includes RMDs that would have been required by April 1 if you hit age 70½ during 2019 (and for non-5% company owners over age 70½ who retired during 2019 after having deferred taking RMDs until April 1 following their year of retirement). So if you don’t have a financial need to take a distribution in 2020, you don’t have to. Note that because of a recent law change, plan participants who turn 70½ in 2020 or later needn’t take required distributions for any year before the year in which they reach age 72.
If you are age 70½ or older by the end of 2020, have traditional IRAs, and especially if you are unable to itemize your deductions, consider making 2020 charitable donations via qualified charitable distributions from your IRAs. These distributions are made directly to charities from your IRAs, and the amount of the contribution is neither included in your gross income nor deductible on Schedule A, Form 1040. However, you are still entitled to claim the entire standard deduction. (Previously, those who reached reach age 70½ during a year weren’t permitted to make contributions to a traditional IRA for that year or any later year. While that restriction no longer applies, the qualified charitable distribution amount must be reduced by contributions to an IRA that were deducted for any year in which the contributor was age 70½ or older, unless a previous qualified charitable distribution exclusion was reduced by that post-age 70½ contribution.)
If you are younger than age 70½ at the end of 2020, you anticipate that you will not itemize your deductions in later years when you are 70½ or older, and you don’t now have any traditional IRAs, establish and contribute as much as you can to one or more traditional IRAs in 2020. If these circumstances apply to you, except that you already have one or more traditional IRAs, make maximum contributions to one or more traditional IRAs in 2020. Then, in the year you reach age 70½, make your charitable donations by way of qualified charitable distributions from your IRA. Doing this will allow you, in effect, to convert nondeductible charitable contributions that you make in the year you turn 70½ and later years, into deductible-in-2020 IRA contributions and reductions of gross income from later year distributions from the IRAs.
Take an eligible rollover distribution from a qualified retirement plan before the end of 2020 if you are facing a penalty for underpayment of estimated tax and having your employer increase your withholding is unavailable or won’t sufficiently address the problem. Income tax will be withheld from the distribution and will be applied toward the taxes owed for 2020. You can then timely roll over the gross amount of the distribution, i.e., the net amount you received plus the amount of withheld tax, to a traditional IRA. No part of the distribution will be includible in income for 2020, but the withheld tax will be applied pro rata over the full 2020 tax year to reduce previous underpayments of estimated tax.
One new tax law change to not overlook is the opportunity to take a distribution up to $100,000 from IRAs and workplace retirement plans in 2020, if you are impacted by COVID-19, and not be subjected to the 10% early withdrawal penalty. The distribution can be included in income ratably over a 3-year period unless you elect otherwise. You can also contribute the money back to your retirement plan within three years and treat the transaction as a direct rollover.
New for this year is that individuals of any age can make contributions to a traditional IRA, assuming there is enough compensation. Prior to this rule change, taxpayers were not allowed to make an IRA contribution once they reached age 70½ by the close of the year. The rationale for the rule change is that Americans are living longer, and many are continuing to work past 70½ years old. The restriction didn’t apply to Roth IRA contributions.
Consider increasing the amount you set aside for next year in your employer’s health flexible spending account (FSA) if you set aside too little for this year and anticipate similar medical costs next year.
If you become eligible in December of 2020 to make health savings account (HSA) contributions, you can make a full year’s worth of deductible HSA contributions for 2020.
The HSA is an underutilized retirement tool. You get the benefit of: (1) a deduction (with no income phase-out) for contributions, (2) tax-free growth, and (3) there isn’t any tax on distributions if used for unreimbursed qualified medical expenses. Further, the HSA can revert to an IRA and there are no required distributions. The HSA can pay for prior year medical expenses. One could create a strategy to build up funds in the account for retirement with a better return on investment compared to traditional retirement account vehicles.
You may want to make gifts sheltered by the annual gift tax exclusion before the end of the year if doing so may save gift and estate taxes. The exclusion applies to gifts of up to $15,000 made in 2020 to each of an unlimited number of individuals. You can’t carry over unused exclusions from one year to the next. Such transfers may save family income taxes where income-earning property is given to family members in lower income tax brackets who are not subject to the kiddie tax.
If you were in federally declared disaster area, and you suffered uninsured or unreimbursed disaster-related losses, keep in mind you can choose to claim them either on the return for the year the loss occurred (in this instance, the 2020 return normally filed next year), or on the return for the prior year (2019), generating a quicker refund.
If you were in a federally declared disaster area, you may want to settle an insurance or damage claim in 2020 in order to maximize your casualty loss deduction this year.
Year-End Tax-Planning Moves for Businesses & Business Owners
The Coronavirus Aid, Relief, and Economic Security (CARES) Act accelerates the timeline allowing corporations to claim all remaining AMT credits in either 2018 or 2019. This gives companies several different options to file for quick refunds. The fastest method for many companies will be filing a tentative refund claim on Form 1139, but corporations must file by Dec. 31, 2020 to claim an AMT credit this way.
The CARES Act resurrected a provision allowing businesses to use current losses against past income for immediate refunds. Net operating losses (NOLs) arising in tax years beginning in 2018, 2019 and 2020 can be carried back five years for refunds against prior taxes. These losses can even offset income at the higher tax rates in place before 2018. Consider opportunities to accelerate deductions into a loss year to benefit from this rate differential and obtain a larger refund.
Accounting method changes are among the most powerful ways to accelerate deductions, but remember any non-automatic changes you want to make effective for the 2020 calendar year must be made by the end of the year. C corporations make NOL refund claims themselves, but pass-through businesses like partnerships and S corporations pass losses onto to owners, who will make claims. The fastest way to obtain a refund is generally by filing a tentative refund claim, but these must be filed by Dec. 31, 2020 for the 2019 calendar year. If your losses will be in 2020, start preparing to file early because you cannot claim an NOL carryback refund until you file your tax return for the year.
The CARES Act also made changes to charitable contribution deductibility for corporations. For corporations, the taxable income limit is increased from 10% to 25% on cash charitable contributions.
Taxpayers other than corporations may be entitled to a deduction of up to 20% of their qualified business income. For 2020, if taxable income exceeds $326,600 for a married couple filing jointly, $163,300 for singles, marrieds filing separately, and heads of household, the deduction may be limited based on whether the taxpayer is engaged in a service-type trade or business (such as law, accounting, health, or consulting), the amount of W-2 wages paid by the trade or business, and/or the unadjusted basis of qualified property (such as machinery and equipment) held by the trade or business. The limitations are phased in; for example, the phase-in applies to joint filers with taxable income between $326,600 and $426,600, and to all other filers with taxable income between $163,300 and $213,300.
Taxpayers may be able to achieve significant savings with respect to this deduction, by deferring income or accelerating deductions so as to come under the dollar thresholds (or be subject to a smaller phase-out of the deduction) for 2020. Depending on their business model, taxpayers also may be able increase the new deduction by increasing W-2 wages before year-end. The rules are quite complex, so don’t make a move in this area without consulting us.
More small businesses are able to use the cash (as opposed to accrual) method of accounting than were allowed to do so in earlier years. To qualify as a small business a taxpayer must, among other things, satisfy a gross receipts test. For 2020, the gross-receipts test is satisfied if, during a three-year testing period, average annual gross receipts don’t exceed $26 million (the dollar amount was $25 million for 2018, and for earlier years it was $1 million for most businesses). Cash method taxpayers may find it a lot easier to shift income, for example by holding off billings till next year or by accelerating expenses, for example, paying bills early or by making certain prepayments.
Businesses should consider making expenditures that qualify for the liberalized business property expensing under Section 179. For tax years beginning in 2020, the expensing limit is $1,040,000, and the investment ceiling limit is $2,590,000. Expensing is generally available for most depreciable property (other than buildings) and off-the-shelf computer software. It is also available for qualified improvement property (generally, any interior improvement to a building’s interior, but not for enlargement of a building, elevators or escalators, or the internal structural framework), for roofs, and for HVAC, fire protection, alarm, and security systems. The generous dollar ceilings mean that many small and medium sized businesses that make timely purchases will be able to currently deduct most if not all their outlays for machinery and equipment. What’s more, the expensing deduction is not prorated for the time that the asset is in service during the year. The fact that the expensing deduction may be claimed in full (if you are otherwise eligible to take it) regardless of how long the property is in service during the year can be a potent tool for year-end tax planning. Thus, property acquired and placed in service in the last days of 2020, rather than at the beginning of 2021, can result in a full expensing deduction for 2020.
Businesses also can claim a 100% bonus first year depreciation deduction for machinery and equipment bought used (with some exceptions) or new if purchased and placed in service this year, and for qualified improvement property, described above as related to the expensing deduction. The 100% write-off is permitted without any proration based on the length of time that an asset is in service during the tax year. As a result, the 100% bonus first-year write-off is available even if qualifying assets are in service for only a few days in 2020.
Businesses may be able to take advantage of the de minimis safe harbor election (also known as the book-tax conformity election) to expense the costs of lower-cost assets and materials and supplies, assuming the costs don’t have to be capitalized under the Code Sec. 263A uniform capitalization (UNICAP) rules. To qualify for the election, the cost of a unit of property can’t exceed $5,000 if the taxpayer has an applicable financial statement (AFS; e.g., a certified audited financial statement along with an independent CPA’s report). If there’s no AFS, the cost of a unit of property can’t exceed $2,500. Where the UNICAP rules aren’t an issue, consider purchasing such qualifying items before the end of 2020.
A corporation (other than a large corporation) that anticipates a small net operating loss (NOL) for 2020 (and substantial net income in 2021) may find it worthwhile to accelerate just enough of its 2021 income (or to defer just enough of its 2020 deductions) to create a small amount of net income for 2020. This will permit the corporation to base its 2021 estimated tax installments on the relatively small amount of income shown on its 2020 return, rather than having to pay estimated taxes based on 100% of its much larger 2021 taxable income.
To reduce 2020 taxable income, consider deferring a debt-cancellation event until 2021.
To reduce 2020 taxable income, consider disposing of a passive activity in 2020 if doing so will allow you to deduct suspended passive activity losses.
These are just some of the year-end steps that can be taken to save taxes. Again, by contacting us, we can tailor a particular plan that will work best for you.
We wish you all the best as we close out the year 2020.
The material appearing in this communication is for informational purposes only and should not be construed as legal, accounting, or tax advice or opinion provided by Lodder CPA PLLC. This information is not intended to create, and receipt does not constitute, a legal relationship, including, but not limited to, an accountant-client relationship. Although these materials have been prepared by a professional, the user should not substitute these materials for professional services, and should seek advice from an independent advisor before acting on any information presented. Lodder CPA PLLC assumes no obligation to provide notification of changes in tax laws or other factors that could affect the information provided.