Here are some planning strategies that may lower your individual income tax bill for 2020.
Take Advantage of Generous Standard Deduction Allowances.
If your annual deductions will be close to your standard deduction, consider making additional expenditures to exceed your standard deduction. That will lower this year’s tax bill. Next year, you can claim the standard deduction, which will be increased a bit to account for inflation.
Also, consider state and local income and property taxes that are due early next year. Prepaying bills before year-end can decrease your federal income tax bill because your itemized deductions will be higher. However, the maximum amount you can deduct for state and local taxes is $10,000.
Warning while planning:
This can be a bad idea if you owe Alternative Minimum Tax (AMT) this year. Therefore, prepaying those expenses may do little or no good if you’re an AMT victim. Contact us if you’re unsure about your exposure to AMT.
Accelerating other expenditures could cause your itemized deductions to exceed your standard deduction in 2020. For example, consider making bigger charitable donations this year and smaller contributions next year to compensate. The CARES Act offers two unique opportunities for charitable minded taxpayers in 2020. The CARES Act increases the limit on charitable deductions. It is increased to 100% of the Adjusted Gross Income for cash contributions made to charities. Note there is no requirement that the contributions be related to COVID-19.
Traditional IRA Contributions for All.
The SECURE Act removed the age restriction on making traditional IRA contributions. Individuals over the age of 70½ who are still working aren’t prohibited from contributing to a traditional IRA.
Carefully Manage Investment Gains and Losses in Taxable Accounts.
If you hold investments in taxable brokerage accounts, consider the advantage of selling appreciated securities being held over 12 months. The 3.8% Net Investment Income Tax (NIIT) also can apply at higher income levels.
If you have capital losses recognized this year or capital loss carryovers, selling winners won’t result in a hit. In particular, sheltering net short-term capital gains with capital losses is a sweet deal. So, net short-term gains would otherwise be taxed at higher ordinary income rates.
Planning for loser investments.
So, what if you have some loser investments that you would like to unload? Taking the resulting capital losses this year would shelter capital gains, including high-taxed short-term gains, from other sales this year.
Selling losers would cause your capital losses to exceed your capital gains. The result would be a net capital loss for the year. No problem!
In fact, having a capital loss carryover into next year and beyond could work to your advantage. The carryover can be used to shelter both short-term and long-term gains recognized next year and beyond. This can give you extra investing flexibility in those years. You won’t have to hold appreciated securities for over a year to get a preferential tax rate. Federal rates on net short-term capital gains recognized in 2021 are higher than the 2020 rates of 35% and 37%. Having a capital loss carryover into next year to shelter short-term gains could be a very good thing.
Take Advantage of 0% Tax Rate on Investment Income.
A silver lining to a down year are the ability to harvest some long-term capital gains at very favorable rates. For heads of household and joint filers, that limit is increased to $53,600 and $80,000, respectively. Your income may be too high to benefit from the 0% rate. So, if you’re planning to have children, grandchildren, or other loved ones who’re in the 0% bracket, they would benefit. If so, consider giving them appreciated stock or mutual fund shares. They can sell these and pay 0% tax on the resulting long-term gains. Gains will be long-term.
Giving away stocks that pay dividends is another tax-smart idea. As long as the dividends fall within the gift recipient’s 0% rate bracket, they will be federal-income-tax-free.
Securities given to someone under 24 causes some of the capital gains and dividends to be taxed at higher rates. That would defeat the purpose.
Convert Traditional IRAs into Roth Accounts.
This may be the perfect time to start planning to make that Roth conversion you’ve been thinking about. The current tax rates are still relatively low compared to a couple of years ago. They are scheduled to remain that way until 2026. Also, your income may be lower in 2020 due to the financial fallout of COVID-19. On the bright side, that means you’re likely in a lower tax bracket than you normally find yourself.
It’s possible the overall value of your retirement account suffered as a result of the economic downturn. The depressed value in your IRA means a rollover distribution will contain more assets. Once in the Roth IRA, the recovery of value and ultimate withdrawal will be tax free.
Consider planning to use Interfamily Loans.
Interest rates are at a historic low and continue to decrease. This creates an attractive opportunity for those interested in assisting family members financially and transferring assets in a tax-efficient manner.
Individuals who wish to lend money to relatives may do so at interest rates lower than what commercial lenders offer. This allows the lendee to save money on interest. There’s a minimum rate that can be charged by the lender called the Applicable Federal Rate (AFR). Loans with interest rates below the AFR may be subject to gift tax rules. Individuals can use the annual and lifetime gift exclusions to maximize the benefit to the lendee.
To ensure the loan is an arm’s length transaction, follow the steps below. First, have a properly worded and signed document. Next, file the documents with the necessary authorities. Then, provide the lendee with a formal document that summarizes the amount of interest paid each year. Finally, either collect the loan payments or establish the payments will be gifted. Please contact us if you are interested in taking advantage of intrafamily loans.
MKA is here to help, give us a call if you have any tax planning questions.