Year end tax planning for individuals

As we head into the holiday season, here are a few things you can do before the end of the year with respect to tax planning. As with most things, it’s better to be proactive with your financial situation and plan not just for the end of the year, but well into the future.

Background

• The Tax Cut and Jobs Act (“TCJA”) was signed into law at the end of 2017 and initially applied to the 2018 tax year. The TCJA modified the income tax brackets and rates including a reduction in the top rate from 39.6% to 37%. It imposed a limitation on certain itemized deductions including a $10,000 cap on state and local taxes, eliminated personal exemptions and provided for an increased standard deduction. Several of the changes made by the TCJA have been modified by subsequent legislative changes.
• The Setting Every Community Up for Retirement Enhancement Act (“SECURE Act”) was signed on December 20, 2019. Among other changes, the SECURE Act changed the beginning age at which distributions are required to be taken from retirement plans from 70 ½ to 72 and it allowed penalty free withdrawals for birth or adoption expenses up to $5,000 per child. It did, however, eliminate a common planning technique called the “stretch” IRA. Many changes under the SECURE Act became effective in 2020.
• The Coronavirus Aid, Relief and Economic Security Act (“CARES Act”) was signed on March 27, 2020 as one of the federal government’s responses to the COVID-19 crisis. Several features of the CARES Act are discussed further herein. We would like to note that several states have not adopted all the provisions of the CARES Act.
• President-elect Biden has proposed several changes to the taxation of individuals. Some of the proposals are as follows:
  • Raising the tax rate on individuals from the current 37% to 39.6%.
  • Increasing the top tax rate on capital gains and qualified dividends from the current 20% to 39.6% for taxpayers with income in excess of $1,000,000.
  • Assessing the social security tax on the amount of wages and self-employment income earned in excess of $400,000.
  • Itemized deductions:
    • Reinstating the 3% Pease reduction on overall itemized deductions for every dollar by which income exceeds $400,000
    • Capping the benefit of itemized deductions at 28% of income for taxpayers with income over $400,000

Although the Democrats retained a majority in the House of Representatives, the controlling party in the Senate will not be known until January 5, 2021 after the two run off elections in Georgia. Even if the Democrats win control of the Senate (through a tie breaking vote by the Vice President), it remains to be seen what legislation would actually pass.

The current 2020 and 2021 income and capital gains tax brackets and rates and standard deduction amounts are as follows. Knowledge of these amounts are important when attempting to bunch expenses and defer income.

Current tax planning ideas

Tax planning ideas such as deferring income to the following tax year when your income may be lower and accelerating deductible expenses to this year or bunching expenses to a year when they will exceed the standard deduction amounts will need special consideration given the uncertainty of ordinary and capital gain tax rates and thresholds in 2021.

Capital Gains and Losses

Now is a good time to review your portfolio and consider selling assets with unrealized losses to absorb/offset realized capital gain income. If you want to keep the particular asset, consider reinvesting in it after the 30th day to avoid the wash sale rule. The wash sale rule defers the loss on the sale of an asset that is sold and repurchased shortly afterwards.

Selling Your Home

If you are thinking of selling your home and will be recognizing gain in excess of the exclusion amounts, you may want to consider accelerating the closing date to this year in light of the uncertainty on capital gains rates in 2021 and beyond.

Selling Your Business

If you have been thinking of selling your business, now may be a good time, depending on your situation, to capture the gain on the sale in this year when rates are known. This would include electing out of the installment sale method should capital gains rate rise next year.

Qualified Business Income Deduction (“QBI”)

This piece of the TCJA was not changed or modified by the CARES Act. The QBI deduction allows certain eligible taxpayers to reduce qualified income from their qualifying businesses by up to 20%.

Limitations that would affect the amount of QBI deduction include:

• Income from Specified Service Trades or Businesses (“SSTBs”)
• W2 Wages and Unadjusted Basis Immediately After Acquisition (“UBIA”)
• Taxable Income Limitation

SSTBs include trades or businesses performing services in health, law, consulting, athletics, financial or brokerage services or where the principal asset is the reputation of the employee or owner.

Taxpayers with taxable income less than $326,600 for joint filers and $163,300 for other filers (tax year 2020 levels) can take the full 20% without regard to whether the business income is derived from a SSTB.

Taxpayers that have an ownership interest in a trade or business or a SSTB with taxable income of $326,600-$426,600 for joint filers and $163,300-$213,300 for other filers (tax year 2020 levels) are subject to a limited deduction based on their taxable income and W2 wages/UBIA limits.

High-income taxpayers (married filing jointly with taxable income over $426,600 or over $213,300 for all others) are not eligible for the QBI deduction against income from a SSTB.

Mazars Insight

Under certain conditions, the law allows for aggregation between similarly owned businesses for the QBI calculation. Aggregating business can allow you to increase the QBI deduction by combining W2 wages and the unadjusted basis of qualified property of multiple businesses. Note that the aggregated business cannot be SSTBs.

High-income taxpayers can plan to defer income to 2021, accelerate expenses to 2020 or make a retirement plan contribution in order to reduce their 2020 taxable income and take advantage of the QBI deduction. Also, for those who are subject to W2 wages/UBIA limits, hiring employees instead of contractors and increasing depreciable assets would help in maximizing the QBI deduction for the current year.

Qualified Energy Improvements to Principal Residence

Now that some of us are working from home, we may want to update our windows and doors or heating and energy systems before the end of the year. In 2018, 2019 and 2020, an individual may claim a credit for 10% of the cost of qualified energy efficiency improvements and the amount of the residential energy property expenditures paid or incurred by the taxpayer during the taxable year. The overall credit limit is $500.

Charitable Contributions

Donating appreciated securities held for more than 12 months will provide you with a charitable contribution equal to the fair market value of the security without recognizing the capital gain that would have been recognized if the security was sold and the cash proceeds were donated to the charitable organization.

Bunching your charitable contributions in one year may result in your itemized deductions exceeding the allowable standard deduction. For example, if you were going to give $15,000 per year to a charity, consider giving $30,000 this year to exceed this year’s standard deduction amount.

Required Minimum Distributions (“RMD”)

The CARES Act temporarily waived the RMD requirement for certain types of retirement plans including IRAs, 401Ks, 403bs and inherited IRA plans for the 2020 tax year. The RMD is the minimum amount you must withdraw from your retirement account each year. ROTH IRAs do not require withdrawals until after the death of the owner.

Mazars Insight

ROTH IRA Conversions – this year may be an ideal time to consider converting your traditional IRA to a ROTH IRA. Although you will owe federal and state tax on the amount converted, you may be able to plan to be in a lower bracket this year if you choose not to take your RMD.

Waiver of the Early Withdrawal Penalty from Retirement Accounts

The CARES Act also allows you to access up to $100,000 of your retirement savings without penalty if you have been affected by the COVID-19 crisis. You have until December 31, 2020 to take the withdrawal. You will still owe income tax on the amount withdrawn but not the penalty amount. The income tax is due over a three-year period. Additionally, you have the option to pay back the amount withdrawn within the following three years to avoid the tax altogether.

Net Operating Losses (“NOLs”)

The CARES Act temporarily changed the rules to allow for NOLs incurred in 2018, 2019 and 2020 to be carried back 5 years to the earliest year first and allowing for 100% deductibility through 2020.  Previously, the TCJA rule had been that NOLs could only be carried forward and offset only 80% of income.  It should be noted that several states do not follow this particular change, making filing and tracking income and losses a bit more of a burden. Planning and review of the complexity of your situation should be weighed in light of the cash flow benefits.

Employer Payment of Student Loans

The CARES Act also included a provision that allows employers to provide tax free payments of up to $5,250 towards their employees’ student loans. The amount paid will be excluded from employee income.

Interest Expense

The CARES Act increased the amount of interest expense that businesses – including sole practitioners and Single Member LLCs – can deduct from 30% of adjusted taxable income to 50%.

IRA Contributions

The IRS removed the age limit for making traditional IRA contributions starting in 2020.  Previously, individuals could no longer make regular IRA contributions past the age of 70½.  Under the SECURE Act, an individual can continue to make contributions. You can contribute to a Roth IRA and make rollover contributions to a Roth or traditional IRA regardless of your age.

Qualified Charitable Distribution (“QCD”)

The SECURE Act preserved the ability to make QCDs at age 70½ even though the required minimum distribution age was changed to 72. This tax planning strategy allows individual IRA owners who are 70½, or older, to directly transfer up to $100,000 annually from an IRA to charity tax free.

Note that this strategy does not apply to 401k accounts.

For married couples, each spouse can make QCDs up to the limit for a potential total of $200,000. The benefit of this distribution is that your income is lowered as a result of not having the income included in your Adjusted Gross Income which translates to lower tax brackets and deduction thresholds. A QCD is still available in 2020 even though RMD’s are not required. It should be noted that you will not get the charitable contribution deduction either.

Relocation of residency and domicile

If you moved your residence due to COVID-19, special consideration should be given to determine the location of your tax residency. Simply moving from your home in one state to your vacation home in another state may not be enough to sever ties to your former state.

Other considerations

• Make an extra principal payment on your mortgage. The extra payment will reduce your overall interest expense over the lifetime of the loan.
• Consider refinancing your mortgage. With decreased interest rates, it may make sense to review the impact to savings and cash flow that a reduced rate would generate. Be sure to refinance the amount of principal you had outstanding at the time of refinance in order to ‘grandfather’ the interest deduction limitation to the pre-TCJA amount of $1,000,000 of principal.
• If you received a bonus, or are about to, consider increasing your 401k contribution.
• Start a college savings plan and set up regular contributions for your children, grandchild, or your favorite niece or nephew. Contributions to a 529 college savings plan in New York and Connecticut reduce state taxable income and the earnings grow tax free. Distributions are also tax free if they are used for education expenses.
• Check your credit score. In light of security breaches and identity theft, now is a good time to review your score and correct any errors on it. At the same time, consider changing your passwords. One easy way to change a password that is strong (and be able to remember it) is to use a favorite phrase and use a symbol for one or two letters.  “H@ppyCP@!” for example.

As you can see, there are several planning opportunities for you to consider before the end of this year even in light of the future’s uncertainty.

Please contact your Mazars professional if you have any questions.

Published on December 10, 2020

The information provided here is for general guidance only, and does not constitute the provision of tax advice, accounting services, investment advice, legal advice, or professional consulting of any kind. The information provided herein should not be used as a substitute for consultation with professional tax, accounting, legal or other competent advisers.