Year-End Tax Planning for Individuals
As we approach the end of 2020, we hope the attached year-end tax planning information will prove helpful. As always, R&A is here to assist you.
From all of us at R&A, thank you for your business and your loyalty, and wishing you and your family a good holiday and New Year.
With a new president taking office, an ongoing pandemic, and unprecedented tax law changes over the past few years, this could be the most important tax planning year yet. This article will review 2020 legislative tax changes affecting individuals and attempt to forecast a future tax landscape to best position your financial situation.
Looking ahead, many anticipate inevitable tax increases on the horizon due to a host of moving parts. While election results confirm a new president will take office in 2021, we’re still in a state of uncertainty on who will win control of the Senate. This means that predicting future tax law remains a guessing game. Depending on the balance of power, the administration could establish another tax overhaul or institute a general tax increase due to the impact COVID-19 has had on the economy. We also know that the TCJA provisions sunset in 2025, so long-term tax planning may present opportunities to accelerate income into this year or next.
In President-elect Biden’s tax plan, he outlines a number of policies to enact tax hikes for both high-net-worth individuals and corporations. Biden plans to raise taxes on individuals with income above $400,000, as well as increase capital gains taxes, payroll taxes, and the corporate income tax rate. He also proposes lowering the exemption amount of estate and gift tax to $3.5 million and increasing the top rate for the estate tax to 45 percent. There could be concessions along the way should Republicans maintain majority control of the Senate.
Without knowing the outcome of the Senate majority or what bills will be passed in the future, we can only be certain on what changes have already happened—and there’s been a number of them this year.
Arizona Tax Updates
One change set to take effect in Arizona on January 1, 2021 is a state income tax hike for high income taxpayers and small businesses filing as pass-throughs. By a small margin of victory, voters approved Proposition 208 on the November ballot, which adds a new 3.5% surcharge to the top state income tax rate of 4.5%. This surcharge—set to infuse funds into the Invest in Education Act—will bring the top tax rate to 8% for individuals with annual income of $250,000 and joint filers with annual income of $500,000.
Please note that the following content contained in this article pertains to federal tax law, and unless otherwise specified, does not apply to state law. Arizona updated its conformity to the IRC to be amended and in effect on January 1, 2020, which addresses retroactive federal tax reform, such as the Tax Cuts and Jobs Act, but excludes changes to the IRC after January 1, 2020. Therefore, Arizona has not adopted changes made by the CARES Act as of this writing.
Required Minimum Distributions
One of the most welcomed changes in 2020 was reprieve from taking required minimum distributions (RMDs) from retirement accounts. The CARES Act waived RMDs for retirees in 2020 since calculations are based on the prior year’s account balance. This means that retirees would have been taking distributions and calculating taxes owed on accounts that may have fluctuated in a volatile market. RMDs are suspended from defined contribution plans, including 401(k) plans and IRAs, but the waiver does not apply to defined benefit plans.
The IRS also announced mid-year that taxpayers can re-contribute any RMDs that were taken in 2020 by August 31. If you opted to return your distributions, you could save a fair amount in taxes owed this year.
In addition, a bill passed late last year—the SECURE Act—also brings a number of well-received provisions that could affect your retirement plans in 2020, including:
- Increasing the age for beginning RMDs from age 70 ½ to age 72 (for taxpayers who did not turn age 70 ½ prior to Jan. 1, 2020)
- Allowing penalty-free withdrawals of up to $5,000 for the birth or adoption of a child
- Repealing the maximum age of 70 ½ for making traditional IRA contributions
- Reducing the time period for taking IRA distributions to 10 years for beneficiaries who inherit IRAs after Dec. 31, 2019 (excluding spouses)
Before you decide how to manage your distributions, consider the lost tax-deferred growth and if the following situations could be triggered:
- Your Social Security payments become taxable
- Your income-based Medicare premiums and prescription drug charges increase
- Other income-based deductions or credits are impacted
Please be advised that while distributions aren’t subject to the additional 0.9% Medicare tax or 3.8% net investment income tax (NIIT), they are integrated into your modified adjusted gross income (MAGI), so the distributions could re-position your tax threshold and trigger or increase NIIT.
Gift and Estate Tax Exemptions
There’s a small window of substantial opportunity right now with the combination of historically low interest rates and high lifetime gift and estate tax exemptions. The current lifetime exemption amount is $11.58 million per individual (more than double since 2017 and ten times the amount in 2008). Even if a taxpayer has already exhausted their lifetime limit, exemption amounts are subject to an inflationary factor each year. That means some taxpayers may continue to allocate additional funds to heirs as long as the exemption amount remains high.
With current gift and estate tax exemptions expected to sunset sooner than anticipated, now is the time to employ estate planning techniques to transfer wealth with minimal to no cost at all.
Economic Impact Payment
Many received stimulus checks earlier this year—up to $1,200 per taxpayer and $500 per qualified dependent. Line 30 on Form 1040 is where taxpayers will claim their stimulus checks, or what the IRS is calling the “recovery rebate credit.”
Since the payments were based on previous tax returns from 2018 or 2019—but are actually designed as advanced 2020 tax credits—taxpayers may see a difference between what they received and what they actually qualify for based on AGI in 2020. For example, if a nurse is experiencing higher than normal income this year based on the demands of healthcare professionals, there is no clawback if their income exceeds the threshold limits for the refund credit.
On the other hand, if a pilot takes leave this year due to the travel industry’s downturn, s/he can claim an additional or full credit on their 2020 tax return if the advanced credit was less than the actual credit. Similarly, a credit may also be granted if children were born or adopted in 2020 (2019 if the credit was based on 2018), making a taxpayer eligible for an additional $500.
To best prepare for filing season, you should have received Notice 1444 within 15 days of payment receipt. Please retain this letter, as it shows the amount of your stimulus payment and will be used in calculating your credit amount.
According to the Association for Fundraising Professionals, the year did not start out strong for charitable giving with donations in the first quarter down by almost 6% compared to 2019. However, the second quarter rebounded quickly and brought the first half of the year ahead of last year by a 7.5% increase. While many not-for-profit continue to suffer a great loss in donations, reports show that there has been a significant increase in smaller donations (less than $250) this year.
The CARES Act increased the federal deduction limitation for cash gifts to qualifying not-for-profit to 100% of AGI. The Act also allows nonitemizers to take an “above the line” deduction up to $300 of cash contributions to qualifying charities. This change allows the immediate reduction of AGI, while also taking the standard deduction.
If you are a taxpayer who gives generously to not-for-profit but finds that the Tax Cuts and Jobs Act (TCJA) standard deduction limits your ability to itemize and receive a tax benefit for your contributions, you may consider “bunching” your charitable contributions to obtain higher tax savings. For example, if you’re considering a year-end donation in 2020, but you may not exceed the standard deduction threshold, consider donating in January 2021, and then again in December 2021 to reach a higher itemized amount, resulting in greater tax savings.
Avoiding or Reducing AMT
Do you think you could be subject to the alternative minimum tax (AMT) this year or next? Timing is everything as we near year end. These next few months will allow you to strategize whether to accelerate income and short-term capital gains into this year in an effort to benefit from the lower maximum AMT rate. Does it make sense to hold off on deferring expenses that you cannot deduct for AMT purposes until next year? Or, does your financial position make you more at risk to be subject to the AMT next year, where you’ll want to take the opposite approach? Before you decide, we should review a number of factors, including whether you plan to replace private activity municipal bonds and what you will do with stock options.
This year has presented surmountable change, but the best way to overcome challenges is to seek out opportunity. Contact us at (520) 881-4900 for more detailed information pertaining to your tax situation.
About this Author
Adam specializes in international tax planning and analysis. Since 2012 he has coordinated offshore compliance submissions, international tax training relating to foreign pension plans, foreign investment in US property, and general foreign compliance. In addition, in conjunction with legal counsel, he assists international families regarding planning, entity structure, and transaction analysis.