December 8, 2020
To Our Valued Clients and Friends:
2020 was a year of unprecedented challenges, primarily due to the rapid spread of the COVID-19 virus. The year began with retirement enhancements enacted by the SECURE Act effective January 1, 2020, primarily known for its delay in requiring minimum distributions until age 72. This legislation paled in comparison to the flurry of legislative actions made in response to the damaging financial impact of the virus. Congress passed not only the expansive CARES Act, but authorized stimulus checks to individuals and Paycheck Protection Program forgivable loans to businesses.
Tax planning at the end of 2020 is even more important than in previous years, since so many of you have experienced a significant income decline in 2020 compared to earlier years, and are hopeful for a return to more normal operations in the future. Conventional advice has been to accelerate deductions and defer income, when it is anticipated that income will remain consistent between years and tax rates are expected to remain unchanged. This deferral of taxable income into future years is especially beneficial if it enables you to claim larger deductions, credits, and other tax breaks 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. This conventional wisdom may not hold true for 2020 yearend planning. If you experienced a significant decline in income during 2020, but forecast a higher income in 2021, it may be advisable to do the exact opposite by accelerating income and deferring expenses.
We have compiled some actions, based on current tax rules, that may help you save tax dollars if you act before year-end. Not all actions will apply to your situation, but you (or a family member) will likely benefit from many of them. Due the expansive changes in tax law in the SECURE and CARES Acts, only some highlights will be provided in this letter.
Year-End Tax Planning Moves and Changes for Individuals
Recovery Credit – During 2020 most individuals each received economic impact payments of $1,200, plus an additional $500 for each qualifying child under age 17. The 2020 credit is based on 2020 income, however the advanced payment received during 2020 was based on prior year tax returns. If you did not receive the full amount of the credit due to income limitations, but qualify for additional credit due to a lower 2020 income, the additional credit will be claimed when you file your 2020 tax return.
Retirement Related Changes – The required beginning age for taking required minimum distribution (RMDs) was changed from 70½ years to 72 years of age under the SECURE Act allowing retirement assets to grow further before withdrawals are required and reducing the complexity of the previous ½ year rule. For participants or IRA owners whose death is after 2019, the distribution to a non-spousal beneficiary is required to be withdrawn within 10 years following the death, thus eliminating the prior “stretch” over the beneficiary’s life expectancy.
Understanding that many Americans were experiencing significant financial hardship due to the impact of COVID-19, through the CARES Act many retirement rules were eased temporarily during 2020 as follows:
- RMDs have been waived for 2020 (no change to defined benefit distributions)
- While still employed and even before the age of 59½, 2020 COVID-19 related distributions up to $100,000 are permitted. The taxation of these withdrawals can be included in income ratably over 3 years and if repaid anytime over the next 3 years, will not incur any tax.
- There is no 10% early withdrawal penalty for these COVID-19 related 2020 distributions.
- Loan repayments can be delayed for one year with amortization schedules adjusted accordingly, along with a temporary Increase in the maximum loan amount from $50,000 to $100,000 up to the vested account balance.
- There is no longer an age limitation on contributing to a traditional IRA.
Safe harbor estimated tax payments – When your taxes were prepared in 2019, the need for estimated tax payments considered the amount of tax withheld from your pay and from retirement distributions. Many of you have opted to not take your 2020 RMD and others may have had changes in your employment. If either of these events occurred, you will need to compare your current year tax withholdings to those taxes withheld in 2019. If your current withholdings are less, there is a possibility that you may need to make a January estimated tax payment. We can prepare a tax projection for you to determine the amount of the January estimated payment that is needed to prevent an underpayment penalty.
If your income is lower in 2020 than you project during your retirement years or believe that tax rates will increase significantly in the future, you may want to consider converting some traditional IRA money into a Roth IRA. Keep in mind, however, that such a conversion will increase your AGI for 2020, and possibly reduce tax breaks geared to AGI.
Long-term capital gains from sales of assets held for over one year are taxed at 0%, 15% or 20%, depending on the taxpayer’s taxable income. The 0% rate generally applies to the excess of long-term capital gain over any short-term capital loss to the extent that it, when added to regular taxable income, 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, try not to sell assets yielding a capital loss because such losses may not yield a benefit this year. And if you hold long-term appreciated assets, consider selling enough of them to generate long-term capital gains sheltered by the 0% rate.
Many of you have claimed itemized deductions since you purchased your first home, and last year were surprised that you now are claiming the now higher standard deduction. ($24,800 for joint filers, $12,400 for singles and for marrieds filing separately, $18,650 for heads of household). As explained last year, itemized deductions were slashed by state and local taxes now being limited to $10,000 and miscellaneous itemized deductions being eliminated as deductions (e.g., investment fees, tax preparation fees and unreimbursed employee expenses). There is a small change for 2020. Taxpayers now can deduct up to $300 in charitable deductions in addition to the standard deduction.
If your limited itemized deductions total around the standard deduction amount, consider the “bunching strategy” to pull or push discretionary medical expenses and charitable contributions into the year where they will generate a tax benefit. For example, if you believe you will be able to itemize deductions this year but probably not next year, you will benefit by making two years’ worth of charitable contributions this year, instead of spreading out donations over 2020 and 2021.
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.
Due to the CARES Act, RMDs were not required in 2020, but must be resumed in 2021. If you opted to not take a RMD in 2020, you may have inadvertently stopped your automatic withdrawal that was previously set up. Please confirm that you are set for 2021 RMDs. Remember that in 2021 a failure to take a required withdrawal can result in a penalty of 50% of the amount of the RMD not withdrawn. Note that the SECURE Act changed the required beginning date for retirement withdrawals from 70½ to 72 years.
If you are age 70½ or older by the end of 2020, have traditional IRAs, and particularly if you cannot itemize your deductions, consider making 2020 charitable donations up to $100,000 via qualified charitable distributions from your IRAs. Such 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. By reducing your AGI, you may benefit from lower Medicare premiums and increased itemized medical deductions.
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. In addition to direct gifts, amounts exceeding the annual exclusion can be made on behalf of an individual for medical or educational expenses, if the checks are written directly to the provider. Not only higher education costs, but undergraduate tuition, even including preschool and some summer camps, can qualify. Remember that you cannot 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 (now once again taxed at the parents’ highest effective tax rate, rather than at the often higher trust tax rates).
Some actions that can be taken if it will be beneficial for you to decrease income and accelerate deductions this year are –
- If allowed, arrange with your employer to defer, until early 2021, a bonus that may be coming your way.
- 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 do not pay your credit card bill until after the end of the year.
- Consider disposing of a passive activity in 2020 if doing so will allow you to deduct suspended passive activity losses.
Year-End Tax-Planning Moves and Changes for Businesses & Business Owners
Forgivable Paycheck Protection Loans – As of the date of this letter, the amount of the loan forgiven, or projected to be forgiven, will increase your taxable business income. There is very promising current legislative action to make this forgiveness tax-free and to reduce documentation needed in applying for forgiveness if the loan proceeds were $150,000 or less.
For Net Operating Losses (NOLs) arising in years beginning before 2021, taxpayers are now allowed to carryback 100% of NOLs to the five prior tax years and claim 100% of carryforward NOLS. Prior to the enactment of the CARES Act, NOL carryforward deductions in any year were limited to 80% of taxable income and carrybacks were prohibited. In 2021, the previous rules will be resumed.
Businesses can again make expenditures that qualify for the accelerated business property expensing options (Section 179 and/or 100% bonus depreciation). For tax years beginning in 2020, the Section 179 expensing limit is $1,040,000, and the investment ceiling limit is $2,590,000. Unlike regular depreciation, these deductions are not prorated for the time that the asset is in service during the year. 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. Keep in mind, although these aggressive expensing options can certainly lower current year taxes, if the assets are debt financed, you will be paying off debt in future years without any associated tax deductions.
In order to encourage businesses to retain their workforce, some payroll tax changes were implemented –
- Refundable employee retention credit of up to $5,000 per employee of the employee’s 6.2% social security payroll tax, if the business was adversely affected by COVID-19 (determined quarterly based on comparative gross receipts to the prior year).
- Delay of payments of the 6.2% portion of employer payroll taxes (includes 50% of the social security portion of the self-employment tax) for up to 3 years
- Voluntary delay of employee payroll taxes
Again in 2020, taxpayers other than “C” 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 and $163,300 for all other filing statuses, 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. Taxpayers may be able to achieve significant savings with respect to this deduction, by deferring income or accelerating deductions in order to come under the dollar thresholds, (or be subject to a smaller phaseout of the deduction) for 2020. Depending on their business model, taxpayers also may be able to increase the new deduction by increasing W-2 wages before year-end. The rules are quite complex, so do not make a move in this area without consulting your trusted tax adviser at MPB.
Changes in Retirement Provisions – Businesses need to ensure that if changes outlined previously are operationally implemented by the Plan in 2020, that Plan documents are amended to incorporate these changes by the end of the Plan year beginning on or after January 1, 2022.
Businesses can continue to take advantage of the de minimis safe harbor election to expense the costs of lower-cost assets and materials and supplies. To qualify for the election, the cost of a unit of property cannot exceed $5,000 if the taxpayer has audited financial statements or $2,500 for all other businesses.
Keep in mind that meals remain 50% deductible, even though other entertainment expenses are now disallowed. If your entertainment has both an entertainment and meal component, make sure that you request invoices which break out the meal cost separately to ensure the 50% deduction.
These are just some of the year-end steps that can be taken to save taxes. By contacting us, we can tailor a particular plan that will work best for you.
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