Tax Planning Opportunities for 2020
The year 2020 has been full of many unexpected events. These events have led to some unique tax planning opportunities for 2020. Most people we meet with want to know how to legally pay the least amount of taxes possible. By being strategic and deliberate in your actions, you may be able to incorporate some of these planning strategies to minimize your taxes and use these opportunities to your benefit.
Planning Your Income – Bracket Management
A key to tax planning is taking full advantage of the lower tax brackets. It is also essential to know both your current and future tax rates as you want to pay tax at the lowest rate possible. By having a plan of where to save and how to take distributions from each account, you can better control your tax liability.
Required Minimum Distributions
One unique opportunity in 2020 is there is no longer a requirement to take a required minimum distribution (RMD) from IRA accounts and most retirement plans. This provision is part of the Coronavirus Aid, Relief, and Economic Security (CARES) Act that was signed into law on March 27, 2020. If you took a distribution before this law went into effect and didn’t need the money, you can return it to the retirement account by August 31st and not have it count as income for 2020.
Even though the distribution requirement isn’t in effect in 2020, it may benefit you to take the distribution this year. By prolonging taking the distribution, you may end up taking the money out when you are in a higher tax bracket.
Where to Save
It is important for individuals who are still working to make sure you are saving into the right location. Should you be saving into a tax-deferred account such as a 401(k) or 403(b), a tax-free account such as a Roth 401(k), or in a taxable account such as a savings or brokerage account? Many people may have lower earnings this year due to being laid off or earnings reduced due to COVID. This makes it especially important to look at where to save this year. Where you should save this year may be different than where you should save in future years.
Another opportunity that may be present this year for individuals with lower earnings is to do a Roth conversion. Roth IRA conversion is the process of transferring money from your pre-tax account such as a traditional IRA to a Roth IRA. This is a taxable event which means you pay tax on the conversion amount as if it is ordinary income in the year of the conversion. If you are in a lower tax bracket this year than you will be in the future, it may be wise to take advantage of the opportunity to do a Roth conversion to take full advantage of the lower bracket.
The opportunity to do Roth conversions is also present for retirees. Many people may benefit from doing a Roth conversion this year as they may have lower income since there is no requirement to take an RMD this year. In years when you have an RMD, the first money out of the retirement account is the RMD. You mus take this before you can do a Roth conversion. Since there is no other income that has to be taken out this year, you may have an excellent opportunity to do a Roth conversion to take advantage of the lower income tax rates.
Roth Conversions and Control
A Roth conversion allows you to control when you pay the tax on your retirement account income. The Roth IRA provides tax diversification during retirement allowing you to better control the amount of tax you pay. There are three main tax benefits to Roth IRAs.
First, a qualified distribution from a Roth IRA provides tax-free income. Second, there is no required minimum distribution from a Roth IRA. Third, the growth in the Roth IRA is tax-free. With the myriad of tax benefits provided by Roth conversions, it is essential to remember it is not a panacea, and it is crucial to determine the optimal conversion amount.
A Roth conversion may be even more appealing after the SECURE Act which was passed in December 2019. Under the SECURE Act, most retirement accounts will have to be distributed to non-spouse beneficiaries over ten years. This means the taxes on tax-deferred retirement accounts will be due over this short-time frame. The inherited Roth IRA will also have to be distributed by the end of these ten years, but the taxes will have already been paid. If you expect the tax rates to increase or think your beneficiaries will be in a higher tax bracket than you, a Roth conversion may be right for you.
Our Founder and CEO, Dean Barber, and I have did an episode of The Guided Retirement Show specifically on what retirees need to know about Roth Conversions. You can find links to their episode. below.
Waiver of 10% Early Withdrawal Penalty
One provision under the CARES Act is the waiver of the 10% early withdrawal penalty for up to $100,000 distribution from an IRA or qualified employer plan for those under age 59 ½. You, a spouse, or a dependent must have been diagnosed with COVID 19, experience an adverse financial consequence as a result of being laid off or work hours reduced, unable to work because of a lack of child care, own a business that closed, had hours reduced, etc. The tax can be spread over three years or is tax-free if paid back within a 3-year period.
Charitable Giving Tax Planning Opportunities in 2020
With the increase in the standard deduction that occurred under the Tax Cuts and Jobs Act of 2017, many people are not receiving a tax benefit from their charitable giving. There are a few different scenarios that should be analyzed to see if they help your tax situation. It is tax advantageous to determine what to give, how much to give, and when to give.
Qualified Charitable Distributions (QCD)
We are getting a common question of whether or not you can still do a qualified charitable distribution this year since there is no required minimum distribution. The answer is yes, and QCDs still offer tax benefits. The money taken out of the IRA via a QCD is still not subject to tax. A QCD may provide long-term tax benefits. By doing a QCD in 2020, you will reduce the RMD you are required to take in future years. One question to ask yourself is would your beneficiary prefer to inherit an IRA or money in a bank account or stock. Remember your beneficiary will be subject to income tax on the IRA distribution, but the stock will receive a basis step-up at the date of your death.
Bunching or Donor Advised Fund (DAF)
These two strategies are similar and may allow you to receive a tax benefit from your philanthropy.
Under a bunching strategy, you give twice as much to charity in one year. A DAF allows you to bunch your charitable giving, but you keep giving the same amount to charity on an annual basis.
Both of these strategies increase the amount of charitable giving in a single year with the hopes of your itemized deduction exceeding the standard deduction amount. Another consideration is whether to give charitable donations of cash or appreciated securities. Gifting of appreciated securities allows you to deduct the stock’s full fair market value without paying tax on the capital gain.
Special Charitable Giving Rules for 2020
The CARES Act has two provisions to encourage charitable giving in 2020.
100% AGI Limit
Another opportunity for this year under the CARES Act is you can get a federal income tax deduction for charitable contributions of up to 100% of your adjusted gross income (AGI). The contributions may be made to any charity, not just those related to the COVID-19 crisis. The CARES Act increased the AGI limit from 60% to 100% of your AGI. This means you can get a charitable contribution deduction for the full amount of your AGI. If your charitable contributions exceed this amount, the unused amount can be carried forward for five years subject to the 60% AGI limit in those years. This 100% AGI limit applies to cash contributions made directly to charitable organizations, not to contributions to donor advised funds, supporting organizations, or private foundations.
This increase in the allowed charitable contribution presents some unique planning opportunities for 2020. You can use this charitable deduction to offset the inclusion of the IRA in taxable income caused by a Roth conversion or taking a large IRA distribution then contributing it to charity. Remember those over age 70 ½ would still want to take advantage of a QCD. Another caution is that not all states will allow the higher adjusted gross income limit for charitable contributions.
$300 Above-the-Line Charitable Deduction
The CARES Act also has a charitable benefit for those donors who will not be itemizing. You may take an “above-the-line” deduction for charitable contributions of up to $300. The contribution must be in cash, so it cannot be property such as old clothing or household items. The contribution must also be given to a public charity. Contributions to nonoperating private foundations, support organizations, and donor-advised funds don’t qualify for the new deduction. Since it is an above-the-line deduction, you don’t have to itemize to claim the deduction. Instead, it will be listed as an adjustment to income on Schedule 1 of Form 1040 which will be deducted from your gross income.
The 2020 Election and Tax Planning Opportunities
One constant with taxes is the laws will change. We know the historically low tax rates we have now are on the schedule to sunset at the end of 2025. However, if the Democrats pull off the trifecta in November, the sunset could accelerate. The tax plan Biden has proposed is to restore the 39.6% tax rate, make other changes to individual income taxes, increase the corporate tax rate, and reduce the federal estate tax exemption.
It would be best if you didn’t wait until after the election to determine your tax plan for the year. The tax rates will increase at some point, so what do you need to do to maximize the benefit you can receive from these lower rates. The BFG Tax Service team can help you develop a forward-looking tax plan to make sure you don’t miss out on any tax planning opportunities in 2020. Reach out to us below or give us a call at (913) 393-1000.
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