2020 Year-End Tax Planning Report

2020 Year-End Tax Planning Report
by Glenn Venturino, CPA and James Lange, CPA/Attorney

With year-end approaching, let us look at some tax-planning considerations that can help lower your 2020 tax bill or reduce future taxes beyond 2020.

For 2020 year-end tax planning purposes, we highly recommend that taxpayers who have yet to implement Roth Conversions in 2020 to consider doing so.  We believe more taxpayers than ever before will be good candidates for Roth IRA conversions.  Especially, when you consider the suspension of 2020 Required Minimum Distributions (RMDS) and losses suffered by many business owners due to the COVID-19 pandemic.  Please see our book, Retirement Plan Owner’s Guide to Beating the New Death Tax, which describes Roth IRA conversions after the passing of the SECURE Act.  Please see Chapter 6.  Please also see our article that appeared in Forbes.com which received over 175,000 views. Click here.

On March 27, 2020, the Coronavirus Aid, Relief and Economic Security (CARES Act) was signed into law by President Trump in response to the economic fallout of the COVID-19 pandemic in the United States.  The CARES Act permitted the suspension of RMDs for eligible taxpayers.  It also allowed individuals who had withdrawn RMDs from certain retirement accounts the ability to roll those funds back into a retirement account until August 31, 2020.

The suspension of 2020 RMDs provided unique opportunities for many taxpayers to have greater control of their 2020 retirement distributions and the amount of corresponding 2020 taxable income.   We will explore a few of these opportunities throughout this letter.

The Tax Cuts and Jobs Act (TCJA) brought significant tax reform changes for both individuals and businesses that are relevant now.  Many of the new changes that took place in 2018 were anything but simple.  One change that affected millions of taxpayers was the elimination or drastic reduction of certain itemized deductions on Schedule A

Many taxpayers are utilizing the new higher standard deduction in lieu of itemizing their tax deductions since the law change took place.  While this change did simplify the tax return filing for many, there are still plenty of tax-savvy ideas to consider.  With many taxpayers no longer itemizing deductions, additional focus should shift to Adjusted Gross Income (AGI) tax planning.  Reducing your AGI can increase tax deductions, increase certain tax credits, and reduce exposure to other taxes.

Itemized Deductions:  We have a higher standard deduction allowance in 2020 ($12,400 for individuals, $14,050 if 65 or over, $24,800 for married filing jointly, $27,400 if 65 or over).  There are also significant limitations on what we may include for itemized deductions.  For those taxpayers who never itemized or were not close to being able to itemize, the increase in itemized deductions is favorable.  For others, particularly if you pay high real estate taxes and state and local income taxes, the change in itemized deductions generally hurt you.

Gaming the Standard Deduction Allowance Vs. Itemizing Deductions

Bunching Strategy:  Bunching your itemized deductions is a technique that involves accumulating deductions, so they are high in one year and low in the following year.  If your tax deductions normally fall short of itemizing, or even if you can marginally itemize, you can benefit from the “bunching” strategy.  It’s very typical for most taxpayers to wait until tax time to add up everything and use the higher of the standard deduction or their itemized deductions.  It should be easier for most taxpayers to project their total itemized deductions before the end of 2020 due to the elimination of certain itemized deductions and limitations on others [State and Local Tax (SALT) deduction].  By being proactive, you can time the payments of tax-deductible items to maximize your itemized deductions in one year while using the standard deduction the following year.

Bunching Charitable Donations:  Consider bunching charitable donations every other year while taking the standard deduction in the off years.  2020 is a particularly good year to consider bunching your charitable deductions because, for this year only, your deductible charitable contributions are only limited to 100% of your AGI.

Combine bunching high charitable contributions and making Roth IRA conversions before year-end.

Another popular vehicle for maximizing your charitable donations is the use of a Donor-Advised Fund (DAF).  The DAF functions as a conduit.  The taxpayer gets an immediate tax deduction when the money is directed into the fund.  The donor can decide which charities will receive the money and when they will receive the money even if it is in a future year.  In a high-income year, front-loading the fund with a larger contribution can be quite nice.  By the way, the assets within the fund also enjoy tax-free growth.  Please note that the 100% of AGI charitable contribution limit for 2020 does not apply to DAFs.

We have found that charities are very active with their solicitations during the holiday season and would be happy to receive gifts near year-end or early in the new year.  If it appears that you think you will be itemizing your deductions in 2020, but not next year, consider making last-minute cash and non-cash charity donations before year-end.  If you do not have the extra cash available today, you can use a credit card before year-end and still qualify for a 2020 tax deduction.  If the gift is appreciated stock, the tax benefits are even greater.

New for 2020:  The CARES Act created a new charitable deduction available to taxpayers who will not be itemizing their deductions in 2020.  The Universal Deduction allows for an above-the-line charitable deduction of $300 per tax return.  The payment must be in cash (or cash equivalent) to a 501(c)(3) public charity.  This above-the-line deduction will reduce your AGI.

One planning technique that may be more advantageous in 2020 and beyond is the use of Qualified Charitable Distributions (QCDs) for taxpayers who are 70 and ½ or older.  See the section titled “Charitable Giving” for details on using this strategy.

A Helpful Tip:  If you are currently using QCDs, please make sure you receive acknowledge letters from the charitable organizations for any single donation of $250 or more before filing your tax return.  The IRS requires the letter under the Substantiation and Disclosure requirements for the donation to be tax-deductible.

Alert:  This is especially important to seniors who no longer itemize their deductions.  Although 2020 RMDs have been waived, using your IRA for charitable giving using ordinary income dollars still provides tax benefits.  If all your pension income is entirely from qualified plans such as 403(b)s and 401(k)s, you should consider an IRA rollover or partial rollover before December 31, 2020.  You will not be eligible to take advantage of QCDs in 2021 unless this action is taken because QCDs only apply to IRAs and no other retirement plans.

Important Early Thought for 2021:  If you are considering using your RMDs from your IRA to make QCDs, try to be proactive.  Advanced planning with your tax advisor and investment advisor (if you have one) will ease the process while achieving your charitable giving goal and maximizing the income tax savings.

Medical Expenses:  The 2020 threshold for deducting out-of-pocket costs medical expenses on Schedule A must exceed 7.5% of your AGI.  Most taxpayers don’t typically incur significant deductible out-of-pocket medical expenses due to medical insurance coverage.

Your net medical expense deduction is linked directly to your AGI.  Eligible expenses include health insurance premiums, long-term care premiums (limits apply), prescription drugs, medical, dental, and eye care services.  If you have incurred higher medical expenses and believe that you will qualify to itemize your deductions in 2020, you should consider paying any last-minute medical expenses before December 31, 2020.  If one spouse has larger medical expenses and lower-income than the other, analyze if filing separately reduces your overall tax bill.

State and Local Tax Deductions:  The overall deductible limit for 2020 remains at $10,000.  This was a backdoor tax increase for those paying high real estate and/or state and local income taxes.  This limit applies to a combined total that will include state and local income taxes, real estate taxes, sales tax, personal property tax, etc.  There is not a lot of wiggle room in this category.  A large portion of this deduction is typically filled with a combination of income tax withholdings from employee wages and larger real estate tax costs.  If you don’t have employee wages but are expecting higher taxable income from other sources of taxable income (i.e., self-employment income, capital gain income/investment income), paying an increased 4th quarter estimate by December 31, 2020, can generate additional tax savings.  But, if your state and local deductions are more than $10,000, unlike prior years, there is no advantage of paying your estimates early.

Qualified Business Income Deduction for Business Owners:  The TCJA introduced a new complicated 20 percent tax deduction (also known as the Section 199A deduction) for eligible business owners such as sole proprietorships, LLCs, S Corporations, Partnerships, and Trusts.  The deduction is also available to certain real estate rental property owners.  The details of this deduction are beyond the scope of this letter.  In January 2019, the Department of Treasury and the IRS issued final regulations providing some additional clarity and safe harbors for taxpayers to follow.  It is a valuable tax deduction for those who qualify.  They will enjoy an extra reduction of taxable income without additional capital outlay.  Certain deduction limits are imposed when taxable income exceeds threshold amounts.  Keeping taxable income below these thresholds will preserve more of the qualifying deduction.

Defer Income and/or Accelerate Expenses:  Many taxpayers don’t have much control in choosing whether to defer or accelerate income from year to year.  However, the new tax law provides businesses and business owners (including pass-through entities), with incentives and deductions to lower their overall tax costs.  Smart timing of income and expenses can be fruitful while poor timing may result in paying a larger tax bill.  Being able to estimate income for 2021 can help with the decision of either accelerating income before the end of 2020 or deferring the income into 2021.  The same is true for deductions. Try to use this flexibility to your advantage.

Payroll Protection Loan Forgiveness:  The Treasury Department and the IRS recently issued Revenue Procedure 2020-51 and 2020-27. The procedures provide guidance on whether a Paycheck Protection Program (PPP) loan participant is permitted to deduct certain otherwise allowable expenses in the year the expenses were paid or incurred if at the end of such taxable year the taxpayer reasonably expects to receive forgiveness of the covered loan. The guidance also covers the situation where the loan participant has not applied for forgiveness by the end of the 2020 taxable year but intends to apply in the next taxable year.

In both examples, if you reasonably expect to receive forgiveness of your covered PPP loan on the basis of expenses paid or accrued during the covered period, any qualifying expenses paid with the loan proceeds will be treated as reimbursement of such expenses. This treatment essentially has the same effect as receiving taxable income. It does not matter that the forgiveness application has not been submitted by the end of the 2020 tax year.

It makes sense to consider whether you should defer or accelerate income/expenses into either 2020 or 2021. If you are still considering a Roth IRA conversion before the end of 2020 and did receive a PPP loan that can be expected to be fully forgiven, consider the effect of the Revenue Procedures on taxable income when running the numbers.

Tax Loss Harvesting:  If your capital gains are larger than your losses, you might want to consider “loss harvesting.”  This means selling certain investments that will generate a loss—converting them from unrealized losses to realized losses.  You can use an unlimited amount of capital losses to offset capital gains.  Large long-term capital gain income has often triggered Alternative Minimum Tax (AMT) in past years.  On a good note, for the most part, AMT has virtually disappeared.  For those higher-income taxpayers, lowering current year investment income by loss harvesting will generate even greater savings. These taxpayers can potentially lower the net investment income tax (the additional 3.8% tax) assessed on net investment income above certain levels.

Roth IRA Conversions:  In general, we like Roth IRA conversions for taxpayers who can make a conversion and stay in the same tax bracket they are currently in and have the funds to pay for the Roth conversion from outside of the IRA.  Unfortunately, the qualification “in general” is likely critically important.  It is best to run the numbers to determine the most appropriate conversion amount for the current year and to plan for possible future conversions in your situation.  We often develop a long-term Roth IRA conversion plan that usually involves multiple years of partial conversions.

When a conversion plan is developed, we often recommend a conversion up to certain income limits to avoid additional Medicare premium cost increases or to avoid high rates of income tax on amounts of Roth conversion income over certain amounts.

But again, in “running the numbers” we have also found that in some circumstances, it is advantageous to make a Roth conversion that will push the taxpayer into a higher tax bracket.

Likewise, it is part of the Westinghouse retiree’s religion to never make a Roth conversion that will increase their Medicare Part B premium.  More times than not, that is good thinking.  But certainly not always, especially if you are considering the very long-term implications of a Roth IRA conversion.  In God We Trust.  All Others Bring Data.  Jim was just on a webinar panel for Financial Planning magazine and one of the quantitative speakers mentioned to Jim that he himself did Roth conversions that pushed him into paying higher Medicare Part B premiums but the long-term benefits of the conversion were so powerful, it was worth well more than the short-term pain of the higher premiums.

It might make sense for a parent to gift money to their children to either make a Roth IRA contribution or to pay for a Roth IRA conversion.

Sometimes, it goes the other way too.  In certain situations, utilizing a parent’s IRA and lower tax rates to do Roth conversions can be beneficial.  The adult child (eventual beneficiary) having sufficient financial resources can make a monetary gift to the parent to pay the tax on the conversion.  Since the parent wouldn’t be receiving annual RMDs from the converted portion of the IRA, the child can make annual gifts to replace the lost income distributions to cover living expenses.  Without future IRA income, the parent’s Social Security income in future years can be received tax-free.  Friendly Caution:  Keep in mind that you are expecting your child to make those monetary gifts to you each year.

Going forward, Roth conversions under the current tax laws may present a better opportunity to do conversions at the lower tax rates. The historical benefits of Roth IRAs and Roth conversions that grow in value have not changed.  It is more important than ever to develop a Roth conversion plan considering your unique situation.  If you are interested in this strategy, please contact us.  Again, we refer you to the DVD we had mailed to you, Unintended Benefits of Trump’s New Tax Law.

Inherited IRA distributions generally must now be taken within 10 years:  If you inherit an IRA during 2020 or beyond and experience reduced income due to a job layoff or loss, review your tax situation carefully.  It is quite normal to want to delay spending down the inherited IRA but there may be an ideal amount to withdrawal by the end of 2020 for tax purposes.

Previously, if you inherited an IRA or 401(k), you could “stretch” your distributions and tax payments out over your single life expectancy.  Many people have used “stretch” IRAs and 401(k)s as reliable income sources.

For IRAs inherited from original owners who have passed away on or after January 1, 2020, the new law requires beneficiaries, subject to exception, to withdraw assets from an inherited IRA or 401(k) plan within 10 years following the death of the account holder.

Exceptions to the 10-year rule include assets left to a surviving spouse, a minor child, a disabled or chronically ill beneficiary, and beneficiaries who are less than 10 years younger than the original IRA owner or 401(k) participant.

Next step:  If you have an IRA that you planned to leave to beneficiaries based on prior rules, consider working with your tax advisor or estate planning attorney, as this change may require you to reevaluate your retirement and estate planning strategies.  If you are the beneficiary of an inherited IRA or 401(k) and the original owner died prior to January 1, 2020, you do not need to make any changes.

One of our main goals is to help clients identify specific opportunities that coordinate tax reduction with their investment portfolios.  To achieve this goal, we continually stay current about potential year-end tax strategies and keep abreast of future strategies that our clients might want to consider in helping reduce their income taxes.  We hope you are continually implementing long-term tax reduction strategies.  If you are interested in our help with year-end planning, you should know we are crushed with year-end planning work for our clients now.  The last I checked, there is some availability for year-end planning before year-end.

As a comprehensive financial services firm, Lange Financial Group, LLC is committed to helping our clients improve their long-term financial success.  Of course, since every situation is different, not all strategies outlined will be appropriate for you.  Please discuss all potential tax strategies with your tax preparer.  Remember, this is not advice for preparing your taxes.  Our goal is to identify ways to reduce your taxes!

Our entire team at Lange Financial Group, LLC is available to provide you with updated information that can help with all your financial planning needs.  If you would like us to mail a print or digital copy of this important report to any of your friends or associates, please call Alice Davis at our office at 412-521-2732.

It should be noted that our frequently recommended three best tax shelters that create income-tax-free growth are particularly appropriate in today’s tax environment.  These three tax shelters are:

  1. Roth IRA conversions, please see our book, Retirement Plan Owners’ Guide to Beating the New Death Tax, which describes Roth IRA conversion in the shadow of the SECURE Act. Please see Chapter 5, p. 36.
  1. Section 529 plans (college plans for grandchildren and children). We would recommend Joe Hurley’s book, Saving for College, or his website, savingforcollege.com.
  1. Life insurance.

As always, if you have any questions about your specific situation before our next scheduled meeting, please feel free to call your tax preparer.

James Lange
Certified Public Accountant
Attorney at Law

P.S. What follows is year-end tax planning advice that we licensed and are providing for you.  We covered what we believe are the most important points for most taxpayers, but frankly did not go into as much detail in many areas as the following reprinted materials.

Medicare Tax 

Once again in tax year 2019, many higher-income taxpayers had larger tax bills due to the 3.8% Medicare contribution tax on net investment income.  The focus must be on reducing your AGI to help mitigate the additional tax costs.  Try and manage your AGI by keeping it as close to the threshold as possible. Going well below the threshold provides no additional benefit as it relates to computing the 3.8% surtax.  With a few strategic moves, you may be able to reduce your AGI enough to mitigate the impact of these new taxes.

The Medicare contribution tax is imposed only on “net investment income” and only to the extent that total Modified Adjusted Gross Income (MAGI) exceeds $200,000 for single individuals and $250,000 for taxpayers filing joint returns.  The amount subject to the tax is the lesser of:

  1. Net investment income; or
  1. The excess of MAGI over the applicable threshold amount listed above.

In addition to the complexity of calculating “net investment income” subject to the tax, another difficulty will be determining what constitutes net investment income that is subject to the tax.  The chart below summarizes what qualifies as investment income under the new law.

Type of IncomeSubject to 3.8% Medicare Contribution Tax?
Interest and DividendsX 
Capital GainsX 
Royalties and net rental incomeX 
Installment sales proceedsX 
Gain from the sale of a personal residence in excess of the IRC 121 exclusionX 
Passive income from S corporationsX 
Passive activity incomeX 
Income from a trade or business that trades in financial instruments or commoditiesX 
Non-passive income from S corporations X
Wages X
Income from a qualified pension, profit-sharing plan, and stock bonus plans X
Social Security income X
Tax-exempt interest X
Source: The Essential Planning Guide to The Income & Estate Tax Increases, pg. 61

Let us examine ways to reduce your AGI before the end of 2020:  Many taxpayers, especially wage earners, have less control over their AGI when compared to self-employed taxpayers or even those in retirement.  The following year-end moves can be ideal if any of these situations apply.  If you have earned income from self-employment or as an employee, one of the best ways to manage AGI is through retirement plan contributions.  There are many alternatives to choose from that enable individuals to make retirement plan contributions.  Now is an ideal time to make sure you maximize your retirement plan contributions for 2020 and start thinking about your strategy for 2021.  Examine your year-to-date elective deferral contributions on your most recent pay stub.  While your intentions may have been to maximize current year contributions to your 401(k) or 403(b), you may find out that you have not hit the maximum amounts as anticipated.  There is still time to have your employer increase your contributions from your remaining paychecks to reach the maximum level of contributions allowable for 2020.

Higher 401(k)/403(b) Contribution Limits:  The elective deferral (contribution) limit for employees who participate in 401(k), 403(b), most 457 plans, and the federal government’s Thrift Savings Plan remains the same at $19,500 for 2020 and 2021.  The 2020 catch-up contribution limit for employees age 50 and over who participate in 401(k), 403(b), most 457 plans, and the federal government’s Thrift Savings Plan also remains the same at $6,500.

Planning Note:  We are big proponents of using Roth 401(k) and Roth 403(b) plans for elective deferral contributions.  Considering the current increased tax rate structure on certain investment income and the new Section 199A for business owners, an increased focus on reducing both adjusted gross and taxable income can be beneficial.  Higher-income taxpayers should consider switching back to making tax-deductible retirement plan contributions instead of funding their Roth accounts.  An ideal strategy may be to split your contributions during the year if you’re in overlapping tax brackets.  For example, consider making tax-deductible contributions to reduce your income to the bottom level of your upper tax bracket and fund the remaining portion of your current year retirement account with non-deductible Roth contributions in a lower bracket.  If you’re interested in this strategy, be sure to discuss with your professional tax preparer.  With possibly the lowest historic tax rates, we often recommend hedging against higher future tax rates by splitting your annual retirement plan contributions using both tax-deductible and non-deductible Roth contributions.

Make a Tax-Deductible IRA Contribution:  For those taxpayers who qualify, you can make a tax-deductible contribution of $6,000 with a catch-up (for taxpayers 50 or older) of an additional $1,000.  The contribution can be made until April 15, 2021, and still be a deduction on your 2020 tax return.

Planning Note:  Since the IRA contribution can be made after the end of the calendar year, calculating the actual tax savings provides a great advantage and should not be overlooked.

While it Lasts:  For those of you who don’t qualify for a regular Roth IRA contribution (because your income is too high) and who have no traditional IRAs, you can take advantage of a nice loophole in the code (back-door Roth).  Consider making a traditional IRA contribution and converting it immediately to a Roth IRA.  You will run into complications with this strategy if you have other traditional IRAs.  Once again, if this strategy fits your situation, make your 2020 contribution as soon as possible and repeat the process with your 2021 IRA contribution in early January 2021.  If you are married with adequate earned compensation, the back-door Roth IRA strategy will be applicable to your non-working spouse.

Caution:  If you are planning to do a rollover from a qualified plan to an IRA account prior to the end of the year, the above strategy will be unsuccessful, and the conversion will result in unexpected taxable income.  It will not matter if the IRA contribution and the immediate Roth conversions occurred earlier in the year before the rollover date.

For those of you who can afford it, I encourage establishing and funding a Roth IRA for your children or even grandchildren and get a tax-free retirement fund started for their benefit.  The longer period of tax-free growth provides a greater benefit.  Like any IRA, the child or grandchild must have earned income to qualify for a contribution.

Tax Loss Harvesting:  If your capital gains are larger than your losses, you might want to consider “loss harvesting.”  Loss harvesting occurs by selling securities that convert unrealized paper losses to actual realized losses.  You can use an unlimited amount of capital losses to offset capital gains.  If you recognize excess losses over your gains you are permitted to offset other income items, such as interest, dividends, and wages up to $3,000.  Any remaining unused capital losses can be carried forward into future years indefinitely.  Tax-loss harvesting will generate even greater savings for higher-income taxpayers that are subject to an additional 3.8% net investment income tax on net capital gains.  (Don’t forget to review your “Trust Investment Accounts” for loss harvesting as the higher tax rates apply at much lower levels of taxable income).  Being tax-savvy by reviewing your investment portfolio(s) for loss harvesting should be done annually prior to the end of the current tax year.

The Hidden Tax Trap:  Larger tax balances due to or smaller than expected refunds can often be traced to Capital Gain Distributions.  Quite often the bulk of these taxable distributions will not be known until late November and December.  These taxable capital gain distributions occur when the mutual fund portfolio managers recognize gains in the managed funds that get passed onto the fund investors.  Due to the mass sell-off that occurred during the early part of the COVID-19 pandemic, there is the possibility that significant capital gain distributions may be forthcoming.  It is very important that you or your investment advisor review your investment portfolio(s) for any “Loss Harvesting” opportunities.  You do have until the end of December to sell securities at a loss.

Please note that if you sell an investment with a loss and then buy it right back, the IRS disallows the deduction.  The “wash sale” rule says you must wait at least 30 days before buying back the same security to be able to claim the original loss as a deduction.  However, you can buy a similar security to immediately replace the one you sold—perhaps a stock in the same sector.  This strategy allows you to maintain your general market position while capitalizing on a tax break.

If you are planning to write-off a non-business bad debt, be sure to establish that it is bonafide debt and document unsuccessful efforts to collect.  Form over substance matters in these instances.

Utilize Installment Sales:  If appropriate, reporting taxable gains using an installment sale will allow you to spread the gain over several years rather than recognizing the entire gain in the year of sale.  In many instances, this type of gain is also subject to the 3.8% Medicare surtax on “net investment income” thus managing your AGI can save additional taxes. Keep in mind that Medicare Part B premiums are determined by looking at your tax return from two years prior to the current year.  An installment sale may enable you to spread the gain over several years while never crossing the threshold that would trigger increased Medicare premiums in any one year.  Alternatively, if you have entered into an installment sale arrangement, you may have an option to elect out of the installment sales tax treatment.  This election allows you to recognize the entire gain in the year of sale even though payments you receive will be over multiple tax years.  Consider this option if it’s the appropriate tax strategy.

Maximize your HSA Contribution:  If you are enrolled in a Health Savings Account (HSA) plan, it is not too late to maximize your 2020 tax-deductible contribution to the account.  In fact, you have until April 15, 2021, to fund your HSA account and still get a 2020 tax deduction.  Like an IRA contribution, the exact amount of tax savings can be calculated.  It is the only section in the Internal Revenue Code (the Triple Crown if you will) that allows a tax deduction on the way in, tax-free growth, and tax-free qualifying distributions.  For those who can afford it, fully funding the HSA account and never using the funds to pay for current medical expenses (using other monies to pay for medical expenses incurred) can allow for a big pot of tax-free money to accumulate over time to be used for future medical costs.  These funds can come in handy during retirement when you normally experience more medical expenses while having less annual income.  Also, once you reach age 65, you can use the money for reasons other than medical expenses.  These non-qualifying distributions will be penalty-free but subject to income taxes.  It is taxed like an extra IRA account without being subject to RMD rules.  Certainly not a bad thing to have.

Funding Self-Employed Retirement Plans:  If you are self-employed, you have other retirement savings options.  We will review these alternatives with you when you come in for your appointment.  One of my favorites for many one-person self-employed businesses is the one-person 401(k) plan.

Most self-employed retirement plans allow for contributions to be made as late as October 15th of the following year.  Having this deferred funding benefit allows you to calculate various levels of savings based on various contribution amounts.  The 2020 maximum contribution for taxpayers age 50 and older can be as high as $63,500 and $64,500 in 2021.

Increase Tax-Favored Income:  Converting taxable interest to tax-exempt interest will serve to reduce AGI and MAGI. For example, moving money from CDs or money market accounts will not create any taxable income.  Alternatively, selling corporate bonds may produce a taxable gain and reduce or offset the benefits.

Reduce Business or Rental Real Estate Income:  Make full use of depreciation including bonus depreciation and Section §179 expensing allowances for property and equipment placed in service before the end of the year.  You have more control in attaining the desired profit or loss level if properly analyzed.  The 2017 Tax Cut and Jobs Act has increased the annual limits for Section §179 expensing and bonus depreciation.  The new tax law permits full expensing of certain improvements to nonresidential rental property.  Improvements such as a full roof replacement on an existing building is eligible for full write-off under Code Section §179.  These type of expenditures have historically been subject to much longer depreciation recovery periods.  Expensing certain asset purchases under the de minimis expensing rules, while convenient, may end up reducing the new Qualified Business Income deduction.

Capital Gains and Losses:  Looking at your investment portfolio can reveal several different tax-saving opportunities.  Review your year-to-date sales of stocks, bonds and other investments.  This allows you to determine the net amount of capital gains or losses you have realized to date.  Also, review the unsold investments in your portfolio to determine whether these investments have unrealized gains or losses.  (Unrealized means you still own the investment while realized means you’ve sold the investment).

Most taxpayers can obtain the tax basis of their investments.  In most instances, the basis refers to the price that you paid to acquire the investment.  Some investments allow you to reinvest your dividends and/or capital gains to purchase additional shares.  These additional shares add to the cost basis of the original purchase.

Generally, it is best to offset short-term gains with long-term losses rather than the opposite of offsetting long-term gains with short-term losses.  If your capital gains are larger than your losses, you can begin looking for tax-loss selling candidates.  See “Tax Loss Harvesting.”  Tax-loss harvesting and portfolio rebalancing are a natural fit.

Please note that if you sell an investment with a loss and then buy it right back, the IRS disallows the deduction.  The “wash sale” rule says you must wait at least 30 days before buying back the same security in order to be able to claim the original loss as a deduction.  However, you can buy a similar security to immediately replace the one you sold—perhaps a stock in the same sector.  This strategy allows you to maintain your general market position while utilizing a tax break.

Dealing with Stock Loss Carryovers in the Year of Death for a Surviving Spouse:  From a tax point of view, it is important for the surviving spouse to consult with his/her tax advisor on strategies that would use the deceased spouse’s loss carryovers on the final joint tax return.  The surviving spouse could sell their own securities or other capital assets at a gain to use the deceased spouse’s expiring capital loss carryover.  If there is time, evaluating the sick spouse’s portfolio before the date of death may also be helpful.

Zero Percent Tax on Long-Term Capital Gains:  If you are in the 10% or 12% tax bracket, the tax rate for long-term capital gains is zero percent!  In order to qualify for the zero-tax rate, your 2020 taxable income cannot exceed $40,000 for singles and $80,000 for married joint filers. 

Please note that the 0% tax rate only applies until your taxable income reaches the end of the 12% tax bracket.  For example, let us assume that a married couple with wages of $70,000, long-term capital gains of $45,000 a standard deduction of $24,400 leaving them with $90,600 of taxable income.  The first $34,400 of long-term capital gain is tax-free, but once their taxable income passes the $80,000 limit, the remaining long-term capital gain of $10,600 is taxed at 15%.

If you are eligible for the 0% capital gains tax rate, here is a cool maneuver to take advantage of the federal tax-free rate.  Sell some appreciated stocks recognizing just enough gain to push your income to the top of the 12% tax bracket.  If you want to continue owning these investments, use the sales proceeds to purchase new shares in the same company or companies.  The newly purchased shares will now have a higher cost basis than the shares you sold.  If you eventually decide to sell the new shares, the capital gains will be smaller due to the higher cost basis.  Please also note that you do not have to wait 30 days before you can buy the stock back when there is a taxable gain.  This technique is referred to as “gains-harvesting.”  The 30-day period only applies to securities sold at a loss.

Consider this strategy:  If you’re ineligible for the 0% capital gains tax rate, but you have adult children (not subject to the Kiddie tax rules) in the 0% bracket, consider gifting appreciated stock to them.  Your adult children will pay a lot less in capital gains tax than if you sold the stock yourself and gifted the cash to them.  This is especially true if you are subject to both the Medicare surtax on net investment income, and you’re in the 37% tax bracket.  In this scenario, you are paying 23.8% on your long-term capital gains.  Modest amounts of low basis stocks can still be gifted and sold by younger children while avoiding the new Kiddie tax rules in effect.

But be careful—you cannot “go back in time” if you subsequently discover you would have fared better had you identified different shares before you made a particular sale.  If you don’t specify which shares you are selling at the time of the sale, the tax law treats the shares you acquired first as the first ones sold.  In other words, it uses a FIFO (First-In, First-Out) method.  This may not produce the optimal result that you had wished for.

Hidden Gem:  When a parent’s income is too large to claim education tax credits (the American Opportunity and Lifetime Learning), shifting income to the kid’s return can generate tax savings.  In this tax-planning strategy, the parent is eligible to claim the child as a dependent but chooses not to do so.  The child indicates that he or she can be claimed as a dependent on someone else’s tax return thus by default not claiming a personal exemption.  Due to income limitations, the parent(s) do not qualify for the education tax credit on their tax return.  Also, since the personal exemption deduction is currently suspended, no tax benefits associated with the child are lost.  The child utilizes the education credit up to $2,500 on their own tax return depending on which education credit they qualify for.  This holds true even if the parent pays for college tuition and qualified expenses.  Ideally, you would shift enough income from the parent to the child to be offset by the education tax credit.

Caution:  Take into account the changes to the Kiddie Tax rules when calculating the optimal amount of income to shift.

Step-Up-In-Basis Rules:  Another very important but often overlooked item is a step-up-in-basis which occurs when a taxpayer inherits certain assets.  The new cost basis is the fair market value as of the date of death, which is often much greater than the original basis that the decedent had in this investment. However, the step-up-in-basis rule does not apply to certain investments, such as IRAs and other tax-deferred accounts.

Remember that if someone gifts you an appreciated asset while they are alive, the tax basis of the giver becomes your tax basis.

Taxes on Social Security Income:  Social Security income may be taxable, depending on the amount of other income a taxpayer receives.  If a taxpayer only receives Social Security income, the benefits are generally not taxable, and it is possible that the taxpayer may not even need to file a federal income tax return.

If a taxpayer receives other income in addition to Social Security income, and one-half of the Social Security income plus the other income exceeds a base amount, then up to 85% of the Social Security income may be taxable.  The base amount is $25,000 for a single filer and $32,000 for married taxpayers filing a joint return.

A complicated formula is necessary to determine the amount of Social Security income that is subject to income tax.  IRS publication 915 contains a worksheet that is helpful in making this determination.

Social Security income is included in the calculation of MAGI for purposes of calculating the Medicare contribution tax, as discussed earlier.  Therefore, taxpayers having a significant net-investment income will have a reason to delay receiving Social Security benefits.

Assuming a reasonable or long-life expectancy, it is generally beneficial for an individual who is eligible to receive Social Security on or after age 62 to delay payments until full retirement age.  Assuming a full retirement age of 66, an individual who elects to receive Social Security benefits at age 62 will see benefits reduced by 25%.  However, if the same individual delays receiving Social Security benefits until after full retirement age, delayed retirement credit may be available.  The chart below shows the percentage increases when an individual delays receipt of retirement benefits.

Increase in Social Security Benefits for Delayed Retirement
Year of BirthYearly Rate of IncreaseMonthly Rate of Increase
1933-19345.5%11/24 of 1%
1935-19366.0%1/2 of 1%
1937-19386.5%13/24 of 1%
1939-19407.0%7/12 of 1%
1941-19427.5%5/8 of 1%
1943 or later8.0%2/3 of 1%
Source: The Essential Planning Guide to The Income & Estate Tax Increases, page 38

An interesting wrinkle in long-term planning related to the taxation of Social Security is the synergy of developing a good long-term Social Security maximization plan and a good long-term Roth IRA conversion plan.  We often enjoy tremendous benefits using the following combination strategy under the right circumstances.

One effective strategy is holding off on Social Security and making Roth IRA conversions in the years after you retire and you don’t have wages, but before age 70 when you will have RMDs and full Social Security.  Make those Roth IRA conversions while your marginal income tax bracket is at an all-time low.  Please note a Roth IRA conversion increases income which could increase Social Security taxes.

Take Advantage of CRDs:  Under the CARES Act, “Qualified Individuals” are eligible to take special distributions and increased loans from defined contribution plans.  In general, a person is a “Qualified Individual” if:

  • The individual or the individual’s spouse or dependent is diagnosed with COVID-19 by a CDC-approved test; or
  • The individual experiences adverse financial consequences due to COVID-19 resulting from being quarantined, furloughed, or laid off. A reduction of work hours or the closing of the business owned or operated by the individual.  Inability to work due to lack of childcare.

Distribution Amounts and Tax Treatment:  Until Dec. 31, 2020, plan sponsors of tax-qualified retirement plans, including IRAs, defined benefit, and defined contribution plans, may amend their plans to permit Qualified Individuals to take distributions of up to $100,000.  For federal tax purposes, the amount of a Qualified Individual’s distribution may be spread (to the extent taxable) equally over three years, and if made to anyone under the age of 59-1/2, distribution will not be subject to a 10% early distribution tax.  Importantly, participants should be aware that the tax treatment of these distributions may differ under state tax laws.  While a distribution to a Qualified Individual is not a loan, it may be repaid, at any time during the three-year period following the withdrawal, to any eligible plan that the individual becomes a participant or an IRA.

Estate and Gift Tax Opportunities:  The game of estate planning for most clients has changed from trying to reduce gift or estate tax to try to reduce income taxes.  For 2020, each taxpayer can pass $11,580,000 (minus past taxable gifts that he/she has made) to children or other beneficiaries without having to pay gift or estate taxes.  If you are married, you will be able to pass $23,160,000 without any federal gift or estate taxes.  There is a 35% estate tax on gifts or estates of deceased persons exceeding the limits.  This is the exemption amount for the federal estate tax, not for PA inheritance tax, which is a flat 4.5% to lineal heirs (children and grandchildren).

Many people believe that with the estate tax exemption set at over $11,000,000 per person, they don’t need to worry about shrewd, tax-wise ways to give wealth.  However, these people might want to rethink their strategy.  Congress can change the law (and has changed the law in the past), and your wealth could grow faster than expected, thereby subjecting you to estate tax.  Nevertheless, before you gift something away, you need to consider the income tax effects of making certain gifts.  Giving away the wrong asset can cost your family some unnecessary taxes.  However, if you have an estate that is worth less than $3,000,000, I would recommend focusing on long-term planning to reduce income taxes, not estate taxes.  Planning appropriately for your IRA, Roth IRA, Roth IRA conversions, and your retirement plan should be your biggest concern.

In 2020, you and your spouse can each give $15,000 per calendar year ($30,000 for couples) to as many individuals as you would like without reducing your lifetime gift tax exemptions. Depending on your circumstances, it may be smart to make a gift before the end of this year. Gifts to medical or educational providers are not included in the $15,000 limit.  In fact, there is no limit on qualified gifts if the checks are made directly to a school or medical facility.

If you are going to make a gift, it is important to determine which asset is the best one to gift.  It is usually best to gift high-basis assets or cash, especially if the taxpayer is in poor health.  In most cases, it is best not to give low-basis assets because the basis of gifted assets is the same for the recipient as it is for the donor, and the gifted assets will not usually receive a step-up-in-basis when a taxpayer passes.

Before making sizable gifts to children or other family members, keep in mind that in some cases, these gifts may unfortunately backfire.  For example, a gift might make a student ineligible for college financial aid, or the earnings from the gift might trigger tax on a senior’s Social Security benefits.

Congress has created several tax breaks over the last few years to help pay for education.  One of the most popular types of savings plans is the 529 plan. Withdrawals (including earnings) used for qualified education expenses (tuition, books, and computers) are income-tax-free.

The amount you can contribute to a Section 529 plan on behalf of a beneficiary qualifies for the annual gift-tax exclusion.  However, the tax law allows you to give the equivalent of five years’ worth of contributions upfront with no gift-tax consequences.  The gift is treated as if it were spread out over a 5-year period.  For instance, you and your spouse might together contribute the maximum of $150,000 (5 x $30,000) on behalf of a grandchild this year without paying any gift tax.

Miscellaneous Year-End and Other Tax Reduction Strategies:  Most taxpayers cannot control the timing of received income, but many of us can determine when to pay or not pay deductible expenses.  Prepare tax projections for 2020 and possibly 2021 to determine which tax bracket you are in and where you can get the most bang for your buck.  Let’s say, for example, your deductions and exemptions are greater than your income, and you will have a negative taxable income, with a tax liability of zero.  This is often the case with seniors who receive tax-free Social Security income.  In this case, it would be a good strategy to increase your income from negative taxable income to zero taxable income, because the tax on zero taxable income is still zero!  One of the best ways to do this is to do a partial Roth IRA conversion up to the amount that brings your negative taxable income up to zero.  Depending on your tax bracket, you may wish to convert even more, especially if you expect to be in a higher income tax bracket in the future.  If a Roth conversion is not appropriate or desirable, then taking additional retirement account distributions in one year while lowering the amount in the following year may save tax dollars.  This strategy is comparable to bunching itemized deductions while using income instead of expenses.

Paying taxes is bad enough.  Paying a penalty is even worse.  If you face an estimated tax shortfall for 2020, consider having the extra tax withheld from sources such as wages, non-suspended regular IRA, and pension distributions.  Withheld taxes are treated as if you paid them evenly to the IRS throughout the year.  This can make up for any previous underpayments, which could save you penalties.

SECURE ACT and RMDs:  If you turned age 70 ½ during 2020, your beginning date for RMDs is now age 72.

IRA Contributions:  Many Americans are living to older ages and an increasing number are continually working past the normal retirement age.  Under the SECURE Act, you can contribute to your traditional IRA past age 70 ½ if you are still working.  Essentially, the new rules for Traditional IRAs are lining more closely to Roth IRAs and 401(k) and 403(b) plans.

Harvesting Ordinary Income:  Harvesting ordinary income is another part of an overall successful year-end plan.  Many older taxpayers incur extra-ordinary high medical expenses.  Without proper planning, thousands of dollars of medical expenses can be incurred with no tax benefit.  Harvesting ordinary income should at least equal itemized deductions plus exemptions; and the targeted tax liability at least equals tax credits available.  Furthermore, harvesting ordinary income may be considered in order to “fill up” your marginal tax bracket.

Making Trust Distributions:  Net investment income tax also applies to trusts and estates.  With compressed tax brackets for trusts compared to individual tax brackets, making permitted discretionary distributions to beneficiaries can reduce overall taxes.  By making the proper election, trusts can distribute current year income up to 65 days into the following year and still have the income taxed to the beneficiary in the current tax year.

Pennsylvania 529 Plan Contribution Deduction:  Don’t miss out on the state tax deduction for contributions to a Section 529 College Saving Program.  A taxpayer can reduce their PA taxable income up to $15,000 per plan beneficiary (kids, grandkids, nieces, nephews, etc.).  Married couples can deduct up to $30,000 per beneficiary per year, provided each spouse has taxable income of at least $15,000.  If your child is currently in college and you are writing checks to the college for tuition or qualified expenses, you should open the 529 plan immediately.  You can deposit the college expense money into the account and immediately write the check to the college.  You have just generated an immediate 3.07% rate of return on the deposit.  Now that’s a winner.

529 Plan changes:  The 2017 TCJA provides that distributions up to $10,000 used for tuition at an elementary or secondary public, private or religious school, K-12 are permitted.  Prior law limited 529 money to be used to pay college and/or graduate school costs.  Make sure the specific State plan has been amended to allow distributions to elementary and high school tuition.

Kiddie Tax Planning:  Considering hiring your child as an employee.  It is prudent to review the child labor laws in your state and the Fair Labor Standards Act.  Maintain good records that substantiate wage payments.  A child can use their standard deduction to shelter up to $12,400 of wages from federal income tax.  There is also Social Security tax savings in certain situations.  The child becomes eligible to contribute up to $6,000 to a Roth IRA.  The wage income may enable the child to escape the kiddie tax rules that would otherwise be imposed on unearned income.

In prior years, shifting income to children was a popular strategy to reduce overall family tax costs.  The new kiddie tax rules will often create can more tax than what the parent would have paid on their own tax return.

Utilize Your Home Office:  It may be the right year to switch back to deduct the actual cost of home office expenses as opposed to using the simplified method.  If you are one of the many who will be using the standard deduction in 2020, enjoying some tax benefits of deducting a portion of your real estate and mortgage interest as a home office deduction can help ease the pain.

Dependent Care Expenses:  If you are paying out-of-pocket dependent care expenses (not enrolled in an employer plan) for two or more qualifying dependents, the annual expense is $6,000.  The expenses do not need to be prorated between the qualifying individuals.  If you incurred $5,800 for one child and $200 for the second child, the full $6,000 of expenses are eligible for the $1,200 tax credit.  Keep in mind that if one spouse is a student or disabled, earned income is deemed to be $250 per month with one child and $500 per month with two or more qualifying individuals.  In certain instances, taking online courses can be considered students. 

Modifications to Depreciation Limits on Automobiles:  The annual depreciation limits have been expanded very generously for these business assets.  Generous depreciation deductions will lower overall taxable business income and while reducing AGI.  As stated earlier, many tax benefits under the current landscape are tied to reducing your AGI. 

Employee Business Expenses:  With the elimination of deductions formerly reported on Form 2106 Employee Business Expense, encourage your employer for reimbursement of the substantiated expenses that are no longer tax-deductible.

Charitable Giving:  Under the current tax system, a focus on controlling AGI can provide tax savings.  The Path Act of 2015 made permanent the popular Qualified Charitable Distribution (QCD) rules for making charitable contributions from an IRA.  Taxpayers age 70 ½ and older can transfer up to $100,000 directly from their IRA over to a charity, satisfying all or part of the RMD with the IRA-to-charity maneuver.  Even though there is no RMD from your IRA in 2020, making use of your IRA for qualified charitable donations still makes sense.  It can be viewed as making a charitable donation with pre-tax dollars. This is especially fruitful when the alternative of using the after-tax dollars to fund the donations does not reduce your taxable income due to the higher standard deduction.

This is a great time of the year to clean out your basement and garage.  However, please remember that you can only write off these non-cash charitable donations to a charitable organization if you itemize your deductions.  Please do yourself a favor and follow the substantiation rules to tilt the scale in your direction if the deduction is questioned by the IRS.  Determining the value of non-cash donations can sometimes be challenging.  It can never hurt to have pictures of the donated items (cellphone cameras make this much easier).  The more detailed the receipt, the better.  Please send cash donations to your favorite charity no later than December 31, 2020, and be sure to hold on to your canceled check or credit card receipt as proof of your donation.  If you contribute $250 or more, you also need an acknowledgment from the charity.  Many taxpayers kindly help various charities by making non-cash donations.

Tax tip for coaches who still itemize their charity deductions:  Many taxpayers have children who participate in youth, intermediate, or even high school level sports.  If dad or mom volunteer their time as coaches, assistant coaches, timekeepers, etc., they can be eligible for an income tax deduction for various out-of-pocket expenses incurred.  For example, miles driven on their cars while performing their role as coaches are deductible charity miles.  Many teams travel out of town to compete.  You are entitled to deduct certain travel expenses as a charitable deduction.  See the IRS website Newsroom for “Tips for Taxpayers Who Travel for Charity Work” for a list of qualifying deductions.

My favorite substantial charitable gift is leaving a portion of your IRA or retirement plan to a charity of your choice after you and your spouse die.

If you want to give money to a charity and get the deduction this year, but don’t know which charity you want to benefit, you should consider donor-directed funds that could be set up by a group like The Pittsburgh Foundation.

As mentioned earlier, if you plan to make a significant gift to charity this year, consider gifting appreciated stocks that you have owned for more than one year rather than cash.  Review your tax brackets to help determine how you can maximize the deduction.  Doing so boosts the savings on your tax returns.  Your charitable contribution deduction is the fair market value of the securities on the date of the gift, not the amount you paid for the asset, and therefore, you never have to pay taxes on the profit!  In addition, if you really like the appreciated stock that you donated, use the non-donated cash to replace the securities that were donated and now you have a stepped basis in the newly acquired shares.

Do not donate stocks that have lost value.  If you do, you can’t claim a loss.  In this case, it is best to sell the stock with the loss first and then donate the proceeds, allowing you to take both the charitable contribution deduction and the capital loss.

Inherited IRAs:  Be careful if you inherit a retirement account.  In many cases, a decedent’s largest asset is his or her retirement account.  When a beneficiary receives this distribution, it is often a very large sum of money, and there is no step-up-in-basis on retirement accounts.  If you inherit a retirement account, such as an IRA or other qualified plan, the money is usually taxable upon receipt.  In addition to this immediate taxation, the extra money could push you up into a higher tax bracket, causing you to pay more taxes than you might have if this taxable income was spread over several years.

The solution to this problem is to establish an Inherited IRA, allowing you to spread out the distributions over your lifetime which should reduce and defer your income taxes significantly.  Sounds easy, right?  Unfortunately, the tax laws regarding the inheritance of retirement accounts are very complicated.  Be sure to take the necessary steps in order to avoid any unnecessary income taxes.

Helpful Tip:  Inherited IRAs for non-spouse beneficiaries can never be converted to a Roth IRA.  Inherited employer plan assets [401(k), 403(b), etc.] can be directly transferred to a properly titled, Inherited Roth IRA.  Income tax will be due on the conversion and paid by the beneficiary. Required distributions will also occur.  If the child beneficiary is in a lower tax bracket at the time of inheritance, what a wonderful way to get a Roth IRA started at a lower tax cost while enjoying future tax-free growth.  You may want to help direct mom and/or dad after they retire to keep some of their retirement plan dollars in a qualified plan rather than rolling everything into a traditional IRA.

Identity Theft Affidavit:  Consider filing IRS Form 14039 (available on the IRS website) before the 2020 tax filing season arrives.  Identity theft has been steadily on the rise.  The IRS will provide you a 6-digit PIN number to use when filing your income tax return.  The PIN will help the IRS verify a taxpayer’s identity and accept their electronic or paper tax return.  The PIN will prevent someone else from filing a tax return with your SSN as the primary or secondary taxpayer (spouse).

Final Thoughts:  When it comes to tax planning and paying income taxes, it’s usually not what you know, but rather what you don’t know that can leave you with unhappy tax results. We are here to help close that knowledge gap.  We look forward to seeing you soon.


About Glenn Venturino, CPA: Glenn has been an integral part of the Lange Accounting Group, LLC for over 33 years.  As our longest standing Lange team member, Glenn manages the tax department and oversees many of the day-to-day operational functions such as payroll, employee benefits, financial reporting, and billing. As a CPA, Glenn has built a substantial accounting practice having working relationships with hundreds of individual clients and various small businesses. 

About James Lange, CPA/Attorney:  Jim is President of Lange Financial Group, LLC, and has 30+ years of experience working with retirees and those about to retire.  Jim can be reached at (412) 521-2732.

The views expressed are not necessarily the opinion of Lange Financial Group, LLC, and should not be construed, directly or indirectly, as an offer to buy or sell any securities mentioned herein.  This article is for informational purposes only.  This information is not intended to be a substitute for specific individualized tax, legal, or investment planning advice as individual situations will vary.  For specific advice about your situation, please consult with a financial professional.

Some Content Provided by MDP, Inc. Copyright MDP, Inc.

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