It’s not yet time to pay your 2020 taxes, but it is the perfect time to get started on your year-end tax planning. By paying attention to the details of tax law changes and taking advantage of strategies to defer income, you can significantly reduce or defer your income tax bill.
If you practice tax-smart investing, this graph from Fidelity.com shows you how long-term tax smarts pay off by utilizing 4 simple strategies, and the sooner you get started, the bigger the difference it will make:
- Tax-loss harvesting
- Managing capital gains
- Managing distributions
- Tax-smart withdrawals
2020 Tax Law Changes
We’re going to talk about each of those strategies, plus many more! But let’s get started by reviewing a few of the recent changes to tax laws that you need to know before you file your 2020 returns:
Tax brackets were adjusted to keep up with inflation.
The 2020 income brackets for single filing status, according to the IRS, are:
- 37% tax rate: Applies to taxable income of more than $518,400
- 35%: More than $207,350 but not more than $518,400
- 32%: More than $163,300 but not more than $207,350
- 24%: More than $85,525 but not more than $163,300
- 22%: More than $40,125 but not more than $85,525
- 12%: More than $9,875 but not more than $40,125
- 10%: Income of $9,875 or less
For married filing jointly:
- 37% tax rate: Applies to taxable income of more than $622,050
- 35%: More than $414,700 but not more than $622,050
- 32%: More than $326,600 but not more than $414,700
- 24%: More than $171,050 but not more than $326,600
- 22%: More than $80,250– but not more than$171,050
- 12%: More than $19,750– but not more than $80,250
- 10%: Income of $19.750 or less
Standard Deduction Amounts have increased as follows:
- Married filing jointly: $24,800—up $400
- Married filing separately: $12,400—up $200
- Head of household: $18,650—up $300
- Single: $12,400 up $200
At the end of 2019, Congress passed the Setting Every Community Up for Retirement Enhancement Act of 2019, better known as the SECURE Act. One of its features was to increase contribution limits for limited workplace retirement accounts. For 2020. the base contribution limit for 401(k) plans is $19,500, up $500 from the previous tax year. The limit for catch-up contributions (for anyone 50 and over), is $6,500, up $500.
The Coronavirus Aid, Relief, and Economic Security (CARES) Act waived required minimum distributions (RMDs) for 2020 tax returns. Normally, the distributions are taxed. For retirees, that’s a bonus and may decrease your federal income taxes owed.
Even if you file using a standard deduction, this year, you can deduct as much as $300 in cash contributions made to charities during 2020 (also part of the CARES Act). Usually, you can only do this if you itemize deductions. And, if you do itemize, you can deduct cash contributions made in 2020 of up to 100% (increased from 60%) of your adjusted gross income (AGI).
You can increase your contribution limits to your Health Savings Account (HSA):
Self-only coverage: $3,550—($50 increase from the previous years’ return)
Family coverage: $7,100—($100 increase from the previous years’ return)
If you adopted a child in 2020, your maximum allowable credit for adoption expenses goes up by $220, to $14,300.
The Saver’s Credit is a tax credit for eligible contributions to your IRA or employer-sponsored retirement plan. This year, the income limits have been raised.
You’re eligible for the Saver’s Credit if your income is no more than:
Married filing jointly: $65,000—up $1,000 from the previous tax year
Head of household: $48,750—up $750
All other tax-filing statuses: $32,500—up $500
Here’s a chart of how much you can deduct:
2020 Saver’s Credit
|Credit Rate||Married Filing Jointly||Head of Household||All Other Filers*|
|50% of your contribution||AGI not more than $39,000||AGI not more than $29,250||AGI not more than $19,500|
|20% of your contribution||$39,001 – $42,500||$29,250 – $31,875||$19,501 – $21,250|
|10% of your contribution||$42,501 – $65,000||$31,876 – $48,750||$21,251 – $32,500|
|0% of your contribution||more than $65,000||more than $48,750||more than $32,500|
Income limits and maximum credit amount for the Earned Income Tax Credit (EITC) are higher.
You might be eligible for the EITC in 2020 if your AGI is not more than:
- Married filing jointly: $56,844—up from $55,952 for 2019
- All other tax-filing statuses: $50,594—up from $50,162
- The maximum amount that the EITC is worth in 2020 is $6,660—up from $6,557.
The Social Security income cap rose. The maximum amount of income subject to Social Security payroll taxes increased to $137,700 for 2020—up from $132,900 last year.
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21 Tips for Reducing your Taxes
Now that you know how tax law changes will affect your deductions and brackets, let’s look at ways that you can defer or reduce your tax bite.
Tip #1: Accounting rules require that we pay taxes on our income in the year that it is received. But, sometimes, you can defer your income—such as year-end bonuses—into the next year, especially if you think your income will be lower then. For those who are self-employed, you can ask your customers to defer payment to you until the following year.
You can also use several strategies to defer capital gains.
Tip #2: Wait at least one year before selling an asset or a property. That way, you’ll be taxed at long-term capital gains tax rates, which are 0%, 15% or 20%, depending on your taxable income and filing status. In contrast, if you sell it within one year, your gains will be taxed at short-term capital gain rates, which generally correspond to ordinary income tax brackets (10%, 12%, 22%, 24%, 32%, 35% or 37%).
Tip #3: Take advantage of the IRS’ Primary Residence Exclusion. If you’ve owned and used your property as your primary residence for two out of the five years immediately preceding the date of the sale, individuals can exclude up to $250,000 of capital gains while a married couple can exclude up to $500,000. However, you’re only eligible if you haven’t taken a capital gains exclusion for any other property sold at least two years before this current sale.
Tip #4: If you are subject to the capital gains tax for selling your property, and you know your income will be lower next year (due to retirement, changing jobs, etc.), you may want to hold off on the sale until then. And if you will need to pay capital gains, make sure you keep track of home renovation and selling expenses (like real estate commissions) you’ve made over the years. If they increase the value of your home, they can also add to your basis in the property, which means lower capital gains when you sell. See: irs.gov/taxtopics/tc701
Tip #5: Use a 1031 Exchange when you buy and sell a rental or investment property. With the exchange, you can defer paying capital gains tax by reinvesting funds from property sales back into your next real estate purchase. The rules can be quite complex, so please consult a tax advisor. You can find details at: irs.gov/businesses/small-businesses-self-employed/like-kind-exchanges-real-estate-tax-tips
Tip #6: If you have investment property, there are extensive rules and regulations about deductions. The IRS says that “you can deduct the ordinary and necessary expenses for managing, conserving, and maintaining your rental property. Ordinary expenses are those that are common and generally accepted in the business. Necessary expenses are those that are deemed appropriate, such as interest, taxes, advertising, maintenance, utilities, and insurance.
“You can deduct the costs of certain materials, supplies, repairs, and maintenance that you make to your rental property to keep your property in good operating condition.
“You can deduct the expenses paid by the tenant if they are deductible rental expenses. When you include the fair market value of the property or services in your rental income, you can deduct that same amount as a rental expense.
“You may not deduct the cost of improvements. A rental property is improved only if the amounts paid are for a betterment or restoration or adaptation to a new or different use.”
Please see: irs.gov/businesses/small-businesses-self-employed/tips-on-rental-real-estate-income-deductions-and-recordkeeping#:~:text=If%20you%20receive%20rental%20income,expenses%2C%20depreciation%2C%20and%20repairs.&text=You%20may%20not%20deduct%20the%20cost%20of%20improvements.
Tip #7: Accelerate deductions. You can lower your tax bill by increasing your charitable deductions: donating appreciated stock or property, instead of cash. And if you’ve owned the donated asset for more than a year, you can deduct the property’s market value on the date of the gift and you avoid paying capital gains tax on the built-up appreciation—sort of a 2-for-1 tactic! Just make sure you have a receipt. The old rule that you only needed receipts for a $250 or more charitable contribution is no longer valid.
Additionally, you can accelerate these expenses:
- Estimated state income tax bills due January 15
- Property taxes due early next year
- Medical bills
Tip #8: Don’t automatically assume that you don’t have enough deductions to itemize. The IRS says 75% of taxpayers take the standard deduction, but many could reduce their taxes by itemizing.
One valuable hint: if you’re close to the standard deduction limit, you might consider a ‘bunching’ year-end tactic. This means timing expenses to produce lean and fat years. One year, you take as many deductible expenses as possible, using the above strategies. And then, the next year, you’ll have a ‘lean’ deduction year, and will take the standard deduction.
Tip #9: Contribute the maximum to retirement accounts. And, if you have an employer who matches some or all of your contributions, do it now! Do not leave any ‘free’ money on the table. As I said earlier, in 2020, you can contribute up to $19,500 into a 401(k). And if you are 50 or older, that contribution goes up to $26,000.
Tip #10: Consider contributing to or maximizing your IRA. The deadline for IRA contributions is April 15, but why wait? The way the stock market has been performing of late, if you wait, you’re likely to miss out on some appreciation. The maximum contribution for 2020 is $6,000, or $7,000, if you are over 50 years of age.
Tip #11: If you are self-employed, consider a Keogh plan or a Simplified Employee Pension Plan (SEP-IRA). A Keogh plan is a tax-deferred pension plan. For 2020, you can contribute up to 100% of compensation, or $57,000. A SEP-IRA allows you to contribute 5% of your net earnings from self-employment to your employees (not including contributions for yourself), up to $57,000 for this year. The rules are a little more complicated for your own contributions. See here: irs.gov/publications/p560
Tip #12: Do a Roth IRA Conversion if you expect your future income to be taxed at a higher rate. And unlike Roth Contributions, there is no income limit to convert a Roth, nor is there a cap on the conversion amount.
Tip #13: Sell investments that have declined in value to offset gains from your winners. This is called tax loss-harvesting. You realize losses on the losers and then offset them dollar for dollar against the gains on your winners. And this goes even further than offsetting gains. If your losses are more than your gains, you can use up to $3,000 of excess loss to offset other, ordinary, income. Further, if you have more than $3,000 in excess loss, you can carry it over to the next year. You can carry over losses year after year for as long as you live.
Tip #14: Exercise Stock-Options if you expect your 2021 income to rise. You can recognize the taxable income that is generated by the difference in the current price of your stock and what you paid for it.
Tip #15: Avoid the kiddie tax. In the past, parents would often try to shift the tax bill on their investment income from their high tax bracket to a child’s low bracket. Not anymore! For 2020, the kiddie tax taxes a child’s investment income above $2,200 at the same rates as trusts and estates, which are typically higher than rates for individuals. If the child is a full-time student who provides less than half of his or her support, the tax usually applies until the year the child turns age 24. One caveat: gifting stock to pay college expenses can backfire. If the appreciation sends the child’s unearned income above $2,200, your tax bill might be a lot higher than you bargained for.
So be careful if you plan to give a child stock to sell to pay college expenses. If the gain is too large and the child’s unearned income exceeds $2,200, you could end up paying taxes at the same rates as trusts and estates.
Tip #16: Make sure you’ve spent your money in your flexible spending accounts. The money you deposited escapes both income and Social Security taxes. But if you don’t use it, you lose it. You may need to make some last-minute purchases to ensure the account is cleaned out.
Tip #17: Gifting. You can give $15,000 to each of your heirs without it counting toward the estate tax calculation. The lifetime exclusion for 2020 is $11.58 million per recipient. If you’re married, you can each give that much. Medical gifts and tuition gifts do not count against your lifetime exemption or the annual exclusion. And you can also pay the provider directly for medical and education bills for your family.
Tip #18: Home office deductions. With more than 42% of the workforce currently working at home, according to the Stanford Institute for Economic Policy Research, this question, naturally has come up. Under current law, you’re not allowed to deduct these expenses—unless you’re self-employed. However, things could change if Congress grants additional COVID-19-related tax relief.
Here’s the rule: A home office qualifies as your principal place of business if most of your income-earning activities occur there. It can also be your principal place of business if you use it to conduct administrative or management functions, such as bookkeeping and processing invoices, and you don’t conduct those functions at any other fixed location.
Self-employed expenses that are directly allocable to the home office space, such as repair and maintenance costs, are fully deductible as long as you don’t run afoul of the business income limitation. That rule limits your allowable home office deductions to the gross income from your business activity reduced by:
Other expenses for which deductions are allowed in the absence of business use (such as home mortgage interest and real estate taxes), and business deductions that aren’t allocable to the use of the home (such as advertising and supplies).
You can also deduct indirect home office expenses, including:
- Property taxes
- Casualty insurance premiums
- Homeowner association fees
- Security monitoring
- Depreciation for a residence that you own
- Rent for a rented residence
A percentage of these expenses can be allocated to the home office space based on square footage or the number of rooms in the residence (assuming all the rooms are of similar size). Indirect expenses are also subject to the business income limitation.
Please see irs.gov/credits-deductions/individuals/home-office-deduction-at-a-glance for more information.
Tip #19: Invest in Opportunity Zone Funds. Opportunity zones were designated by the U.S. government in 2017. They are distressed areas that the government wanted to revitalize by inducing investment in housing, small businesses, and infrastructure. They encourage investors with capital gains to invest in low-income and undercapitalized communities.
According to the Tax Policy Center, they offer these three primary benefits:
- Temporary deferral of taxes on previously earned capital gains. Investors can place existing assets with accumulated capital gains into Opportunity Funds. Those existing capital gains are not taxed until the end of 2026 or when the asset is disposed of.
- Basis step-up of previously earned capital gains invested. For capital gains placed in Opportunity Funds for at least 5 years, investors’ basis on the original investment increases by 10 percent. If invested for at least 7 years, investors’ basis on the original investment increases by 15 percent.
- Permanent exclusion of taxable income on new gains. For investments held for at least 10 years, investors pay no taxes on any capital gains produced through their investment in Opportunity Funds (the investment vehicle that invests in Opportunity Zones).
Rules and regulations have changed since 2017. So, please consult your tax advisor for the most recent information. Here is a link to the IRS site: irs.gov/credits-deductions/businesses/opportunity-zones
And this link will help you locate opportunity zones: irs.gov/pub/irs-drop/n-18-48.pdf
If you don’t want to be an individual owner, you can invest in Opportunity Zone Funds that buy older buildings in Opportunity Zones, renovate them at a reinvestment cost, then manage them as rental properties. This link offers information on 218 Opportunity Zone Funds: ncsha.org/resource/opportunity-zone-fund-directory/
Investing in Opportunity Zones can be advantageous for active real estate investors who buy and sell multiple properties that generate revenues, accompanied by higher tax high tax brackets.
What not to Do
Tip #20: Beware the Alternative Minimum Tax (AMT). This tax can turn your ‘hoping for a refund’ into a tax nightmare. So, you have to make sure you don’t trigger it by accelerating your tax deductions too much. The AMT is figured separately from your regular tax liability and with different rules. It was created in the 1960s to prevent high-income taxpayers from avoiding the individual income tax. Folks with high incomes have to calculate their taxes twice: once, under the regular income tax system, and once under AMT rules. They then have to pay whichever tax bill is higher. For 2020, the AMT exemption amount is $72,900 for singles and $113,400 for married couples filing jointly.
Some accelerated deductions, such as state and local income taxes, and property taxes are not deductible under the AMT. Please check with your tax advisor.
Tips #21: Avoid Purchasing Mutual Funds in late November or December. This will help you avoid ‘phantom’ costs. These are two-fold: Capital gains (for the full year) on investments in funds must be paid out prior to the end of the year. So, if the funds you are buying are in the black, you will get a capital gain, which will be taxed—even if you just bought the fund at the end of the year. You will have to report that gain to the IRS, even though you still own the fund. Secondly, when the year-end distribution is paid, the share price of the fund drops on the distribution date by the amount of the payout. So, if a fund pays a $1-per-share capital gains distribution and the share price is $10, the price will drop to $9 on the day after the distribution. The $1 difference is the payout, or taxable amount. You get a double whammy; your share price has dropped by $1 and you are being taxed on that $1.
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Do This so you aren’t a Victim
And, finally, some special considerations for 2020 and beyond.
Are Stimulus Checks Taxable?
You’ll be relieved to know that you won’t have to pay taxes if you received that $1,200 check from Uncle Sam. And it won’t reduce any future tax refunds you are owed.
What about Taxation on Paycheck Protection Program Funds (PPP)?
That’s an excellent question that is way beyond the scope of this article. It seems the rules are changing daily, so please consult your tax advisor.
What to Expect after the Election?
Well, we’ve covered the tax rule changes for 2020, as well as how to take advantage of all the legal deductions and deferments to which you are entitled. Now, let’s move onto next year and try to decipher how the rules may change as a result of the presidential election.
Let’s first look at the proposals from the candidates.
A Trump Win. During his term, Trump did manage to lower top individual tax rates, from 39.6% to 37%. The standard deduction was also increased, so a lot of folks no longer had to go through their shoe boxes, counting up all their expenses. The child tax credit was increased to $2,000, and the estate tax exemption rose to $11,580,000 for 2020.
After 2025, all of these changes are scheduled to revert back to their previous levels.
If reelected, Trump says he will do this:
- Make the changes permanent,
- Reduce the capital gains rate
- Enact a capital gains tax “holiday”
- Enact a 10% middle-class tax cut, reducing the 22% marginal tax rate to 15%.
A Biden Win. Biden says he will revert all of these changes back to the old tax rate levels. He also would like to:
- Raise the childcare credit for daycare expenses to $8,000 for one child and $16,000 for two or more, with a phase-out of the credit for couples making more than $125,000
- Enact a $5,000 credit for caregivers
- Enact a refundable, $15,000 tax credit for first-time home buyers
- Exclude forgiven student debt from taxable income
- Enact a renter’s tax credit
- Raise the top tax rate back to 39.6% for income over $400,000
- Expand the 12.4% social security tax on earnings over $400,000
- Raise the tax rate on capital gains and qualifying dividends to 39.6% for those with income over $1 million
- Limit the tax benefit from itemized deductions for those with income over $400,000
- Eliminate the stepped-up basis on transfers of appreciated property at death. Currently, instead of paying taxes on the difference between what you paid for an asset and the current value when you transfer it to an heir, the cost basis of the asset is considered the price when you transfer it, thus reducing taxes on any gains.
- Reduce the estate tax exemption to $3.5 million. It is currently $11.18 million for singles and $22.36 million for married couples.
- Eliminate the ability to exchange real estate using the tax deferred section 1031 exchange
- Increase the tax on corporate income from the flat 21% to a flat 28%
Of course, any proposals will have to be approved by the House and the Senate. If the House stays under Democratic control, and the Senate under Republican control, many of these proposals will be nixed. If, however, the Democrats manage to snag control of both Houses, we can expect more tax changes.
Whoever wins, you can count on it—there will be tax reform. And government spending will almost certainly increase. Our infrastructure needs are huge. The American Society of Civil Engineers says we would need to invest $3.6 trillion into U.S. infrastructure by 2020 just to bring our 1.6 million miles of aging water and sewer pipes to acceptable levels. And not much has been done to tackle this issue. As well, healthcare is always on the agenda, and costs are rapidly escalating as our population ages (not counting the drastic needs relating to COVID-19). Renewable energy is likely to require additional government funds, and Social Security reform is on almost every President’s wish list.
Bottom line: someone (you and me) is going to have to pay for it. That will mean certain tax reform. Stay tuned!