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We hope you’re doing well and wish you the very best for a happy and healthy Holiday Season. As the end of the year approaches, it’s a great time to think of planning moves that may help lower your tax bill for this year and possibly the next. 2020 has been a year filled with challenges and opportunities for reflection; we’re hopeful that 2021 is filled with recovery and joy and look forward to seeing you soon, whether in person or virtually.
Due to the coronavirus pandemic (COVID-19) and the enactment of legislation to offset the economic burden wrought by COVID-19, as well as a legislation passed at the end of 2019, there is a lot to consider when reviewing year-end tax planning options that may be available to reduce your 2020 tax liability.
In December of 2019, the SECURE Act was signed into law. This legislation extended several expiring deductions and tax credits and provided some taxpayer-friendly changes to retirement-related rules. In 2020, the first piece of COVID-19 tax-related legislation signed into law was the Families First Coronavirus Response Act (Families First Act), which responded to the coronavirus outbreak by providing, among other things, four types of tax credits for employers and self-employed individuals. The Families First Act was followed by the biggest piece of legislation for the year - the Coronavirus Aid, Relief, and Economic Security Act (CARES Act). The CARES Act, as well as subsequent coronavirus-related legislation, will most likely impact your tax return in some way. It seems likely that additional guidance and legislation will be passed in the coming months.
We have compiled a checklist of actions based on current tax rules that may help you reduce your taxes if you act before year-end. We’ve included three sections to consider in this letter: 2020 Coronavirus Legislation and Relief, Year-End Tax Planning Moves for Individuals, and Year-End Tax Planning Moves for Businesses & Business Owners. Not all actions will apply in your particular situation, but you (or a family member) will likely benefit from many of them. We can narrow down the specific actions that you can take if you would like to meet to tailor a particular plan. In the meantime, please review the following list and contact us if you’d like to discuss further which tax-saving moves to make.
2020 Coronavirus Legislation and Relief
...Effect of CARES Act Rebate on Your 2020 Tax Return – Under the CARES Act, individuals with income under a certain level are entitled to a recovery rebate tax credit. These are direct payments (sometimes referred to as "stimulus checks") to individuals by the government. Most, but not all, of these stimulus checks have already been sent out to eligible individuals during 2020.
Single individuals and joint filers are entitled to a payment of $1,200 or $2,400, respectively, plus $500 for each qualifying child. The term "qualifying child" has the same meaning that it does for the child tax credit. Thus, a qualifying child can be no older than 16 on the last day of the tax year (December 31, 2020). The amount of the recovery rebate phases out for income over a certain level. The rebate is reduced by 5 percent of the amount by which the taxpayer's adjusted gross income exceeds (1) $150,000 in the case of a joint return, (2) $112,500 in the case of a head of household, and (3) $75,000 in the case of a single taxpayer or a taxpayer with a filing status of married filing separately.
The government issued the rebates based on 2019 income tax returns, or 2018 returns for individuals who had not yet filed their 2019 tax return. The calculation for the correct amount of the rebate will be part of your 2020 tax return. If your 2020 tax return indicates a rebate larger than your stimulus check (because, for example, your income went down or you had another child), any additional amount can be claimed as a credit against your 2020 tax bill. On the flip side, if the 2020 rebate calculation shows an amount in excess of what you were entitled to, you do not have to repay that excess.
...Income from Repayment of Student Loan Debt – The CARES Act excludes from income certain student loan debt repaid by an individual's employer. Thus, if an employer repaid some or all of your student loan debt after March 27, 2020, and before 2021, that repayment, which would otherwise be taxable income to you, is not includible in your income.
...Several CARES Act provisions affect health care related rules. For example, under the CARES Act, a High Deductible Health Plan (HDHP) temporarily can cover telehealth and other remote care services without a deductible, or with a deductible below the minimum annual deductible otherwise required by law. The CARES Act also modified the rules that apply to various tax-advantaged health-related accounts so that additional health-related items are "qualified medical expenses" that may be reimbursed from those accounts. Under the new rules, which apply to amounts paid after 2019, over-the-counter products and medications are now reimbursable without a prescription.
...Charitable Contributions. While the tax benefits of making charitable contributions and taking an itemized deduction for such contributions were tamped down as a result of the increase in the standard deduction in the TCJA, the CARES Act modified the charitable contribution rules for 2020 tax returns. As a result, an eligible individual can claim an above-the-line deduction of up to $300 for qualified charitable contributions made during 2020. The above-the-line deduction is not available for contributions made after 2020. An eligible individual is an individual who does not elect to itemize deductions. Thus, absent this provision, anyone taking the standard deduction would be ineligible to take a charitable contribution deduction. A qualified charitable contribution is a cash contribution paid in 2020 to an eligible charitable organization. Contributions of noncash property, such as securities, are not qualified contributions.
In addition, if you are itemizing your deductions and have substantial charitable contributions, the CARES Act modified the percentage limitation rules that could otherwise limit your charitable contribution deduction. Under the provision, for charitable contributions made during 2020, any qualified contribution is allowed as a deduction to the extent that the aggregate of such contributions does not exceed the excess of your charitable contribution base over the amount of all other charitable contributions. Excess contributions are eligible for a five-year carryover.
...Expenses Incurred While Working from Home – Although more people have been working from home this year due to the pandemic, related expenses are not deductible if you are an employee. TCJA eliminated the deductibility of such expenses when it suspended the deduction for miscellaneous itemized expenses that was available before 2018. However, if you are self-employed or own a business and worked from home during the year, tax deductions may be available.
...Credit for Sick Leave for Self-Employed Individuals – Under the Families First Act, if you are considered an eligible self-employed individual, you may be eligible for an income tax credit for a qualified sick leave equivalent amount. You are an eligible self-employed individual if you regularly carry on any trade or business and would be entitled to receive paid leave during the tax year under the Emergency Paid Sick Leave Act added by the Families First Act. The calculation of the qualified sick leave equivalent amount is quite complicated but is generally equal to the number of days during the tax year that you could not perform services for which you would have been entitled to sick leave, multiplied by the lesser of two amounts: (1) $511, or (2) 100 percent of your average daily self-employment income. The number of days taken into account in determining the qualified sick leave equivalent amount may not generally exceed 10 days. Your average daily self-employment income under this provision is an amount equal to the net earnings from self-employment for the year divided by 260. In addition, if you have appropriate documentation, the credit is refundable.
...Credit for Family Leave for Certain Self-Employed Individuals – Another income tax credit that may be available to you under the Families First Act is a credit for a qualified family leave equivalent amount. The qualified family leave equivalent amount is an amount equal to the number of days (up to 50) during the tax year that you could not perform services for which you would be entitled, if you were employed by an employer, to paid leave under the Emergency Family and Medical Leave Expansion Act, which was added by the Families First Act, multiplied by the lesser of two amounts: (1) 67 percent of your average daily self-employment income for the tax year, or (2) $200. Your average daily self-employment income under the provision is an amount equal to your net earnings from self-employment for the year divided by 260. This credit is also refundable.
... CARES Act and SECURE Act Changes impacting Retirement planning. Several taxpayer-favorable changes were made in the CARES Act and the SECURE Act with respect to retirement plans and distributions from those plans including the following:
(1) The required minimum distribution rules for 2020 are waived so no one is required to take such a distribution and include it in taxable income in 2020.
(2) The age limit for making contributions to a traditional individual retirement account (IRA), previously 70 ½ years old, was repealed in 2020. Thus, anyone who is otherwise eligible may make a contribution to a traditional IRA.
(3) A new type of retirement plan distribution was added to the list of early distributions that are excepted from the 10-percent penalty for early withdrawals. You can now receive a distribution from an applicable eligible retirement plan of up to $5,000 without penalty if the distribution is either a qualified birth or adoption distribution.
(4) Taxpayers impacted by the coronavirus (which is essentially anyone) can withdraw up to $100,000 from a retirement plan without penalty and is generally includible in income over a three-year period and, to the extent the distribution is eligible for tax-free rollover treatment and is contributed to an eligible retirement plan within a three-year period, is not includible in income.
(5) The required beginning date for required minimum distributions has been increased to 72 years old from 70 ½ years old. The former rules apply to employees and IRA owners who attained age 70½ prior to January 1, 2020. The new provision is effective for distributions required to be made after December 31, 2019, with respect to individuals who attain age 70½ after December 31, 2019.
...Paycheck Protection Program (PPP) – If your business obtained funds through the PPP program, please reach out if you need assistance relating to the forgiveness application process.
Year-End Tax Planning Moves for Individuals
...If you aren’t already on track to maximize contributions to an employer’s 401(k) plan, consider increasing your contributions for the last paycheck(s) of the year. This can provide an additional tax-deferred deduction for 2020. The pre-tax and Roth 401(k) plan contribution limit for 2020 is $19,500. Employees age 50 and older can make an additional contribution of $6,500, for a total limit of $26,000. Be sure to review your contribution rate for next year as well; for 2021 the 401(k) plan contribution limits will remain the same.
...If you believe a Roth IRA is better than a traditional IRA, consider converting traditional-IRA money invested in beaten-down stocks (or mutual funds) into a Roth IRA if eligible to do so. Keep in mind, however, that such a conversion will increase your AGI for 2020. This strategy can be particularly beneficial if you are in a lower tax bracket for 2020.
...For a traditional or Roth IRA, the maximum contribution amount for 2020 is $6,000, with the ability to contribute an additional catch-up contribution of $1,000 for those age 50 or older. Please note that generally there must be earned income to contribute to an IRA and the ability to make deductible contributions to a traditional IRA or any contributions to a Roth IRA can be affected by income, filing status, and whether a taxpayer is covered by another employer retirement plan. Also bear in mind that contributions to traditional and Roth IRA’s for 2020 can be made until the April 15, 2021 tax return due date, so this is an item we may want to discuss when preparing your taxes early next year.
...If you have a child (or a grandchild) who’s going to attend college in the future, consider making contributions to a qualified tuition program, also known as a “529 Plan”. In Colorado, contributions to a Colorado CollegeInvest 529 Plan are generally deductible for state income tax purposes.
...If you become eligible in December of 2020 to make Health Savings Account (HSA) contributions, note that you can make a full year's worth of deductible HSA contributions for 2020. You may want to consider an HSA if you don't already have one. These are tax-advantaged accounts which help individuals who have high-deductible health plans (HDHPs). In brief, if you qualify for an HSA, contributions to the account are deductible (within IRS-prescribed limits), earnings on the account are tax-deferred, and distributions are tax free if used for qualifying medical, dental, and vision expenses. For those with a High Deductible Health Plan, the 2020 limit for contributions to a Health Savings Account is $7,100 if covered with a qualifying family plan, and $3,550 if covered with a single plan. For those who are 55 or older in 2020 there is also the ability to contribute an additional $1,000 catch-up contribution. Note that HSA contributions can be made for a given tax year until the tax deadline (without extensions) for that year.
...Consider increasing the amount you set aside for next year in your employer's Healthcare Flexible Spending Account (FSA) if you set aside too little for this year. If eligible, it can also be worth considering contributions to your employer’s Dependent Care FSA.
...It may be advantageous to try to arrange with your employer to defer, until early 2021, a bonus that may be coming your way.
...Consider realizing losses on stock while substantially preserving your investment position. For example, you can sell the original holding, then buy back the same securities at least 31 days later.
...Keep in mind the opportunity for tax loss “harvesting”. If you have an event in 2020 that will generate a capital gain be sure to reach out to us and also discuss with your financial advisor to look at the possibility of off-setting a portion of the gain with capital losses. Long-term capital gain from sales of assets held for over one year is taxed at 0%, 15% or 20%, depending on the taxpayer's taxable income. The 0% federal rate generally applies to the excess of long-term capital gain over any short-term capital loss to the extent that it, when added to regular taxable income, is not more than the "maximum zero rate amount" ($80,000 for married filing joint status, $53,600 for head of household status, $40,000 for single status). If the 0% rate applies to long-term capital gains you took earlier this year, try not to sell assets yielding a capital loss before year end because such losses won't (to the extent of the gain) yield a federal tax benefit this year. If you hold long-term appreciated-in-value assets, consider selling enough of them to generate long-term capital gains sheltered by the 0% rate.
...If you recently realized or plan to realize a significant capital gain in the near future, consider the possibility of reinvesting the gain into a Qualified Opportunity Fund. These funds are organized for the purpose of investing in newly designated Qualified Opportunity Zones and recent tax legislation provides special tax benefits relating to reinvestment in this type of fund. There is a 180 day period beginning on the date of sale or exchange to reinvest in this type of fund; if this is an opportunity you would like to consider please reach out to discuss with us and also your financial advisor
... Postpone income until 2021 and accelerate deductions into 2020 if doing so will enable you to claim larger deductions, credits, and other tax breaks for 2020 that are phased out over varying levels of adjusted gross income (AGI). These include deductible IRA contributions, child tax credits, higher education tax credits, and deductions for student loan interest. Postponing income also is desirable for those taxpayers who anticipate being in a lower tax bracket next year due to changed financial circumstances. Note, however, that in some cases, it may pay to actually accelerate income into 2020. For example, that may be the case where a person will have a more favorable filing status this year than next (e.g., head of household versus individual filing status), or expects to be in a higher tax bracket next year.
...If you are facing a penalty for underpayment of federal or state estimated tax for 2020 consider having your employer increase your withholding for the remainder of the year. The withheld tax will be applied pro rata over the full 2020 tax year to reduce previous underpayments of estimated tax.
...Consider making charitable donations before year-end to take the deductions in 2020. If contributing used clothing or other household goods please remember to obtain a receipt from the charity and keep a list of the items donated and their estimated fair values for tax purposes. This is a requirement to be eligible for the noncash charitable deduction. A picture of the items donated may also be helpful in an audit situation. No charitable deduction is allowed for a cash contribution of less than $250 unless you have a bank record of the contribution or a written acknowledgement from the charity. For cash (or check) contributions of $250 or more you will need to obtain a written acknowledgement from the charity in order to claim the deduction.
...Consider donating appreciated stock to a charity before year-end. If stock has been held for more than a year, you generally will be able to claim a deduction for the fair market value of the stock and avoid paying any tax on the capital gain.
...If you expect to owe state and local income taxes when you file your return next year, consider paying the estimated taxes prior to year-end (or asking your employer to increase withholding of state and local taxes, as mentioned above) to pull the deduction of those taxes into 2020. But remember that state and local tax deductions are limited to $10,000 per year, so this strategy is not a good one if to the extent it causes your 2020 state and local tax payments to exceed $10,000.
...For 2020 the basic standard deduction has been increased (to $24,800 for joint filers, $12,400 for singles, $18,650 for heads of household, and $12,400 for marrieds filing separately). Like last year, no more than $10,000 of state and local taxes may be deducted; miscellaneous itemized deductions (e.g., tax preparation fees and unreimbursed employee expenses) are not deductible; and personal casualty and theft losses are deductible only if they're attributable to a federally declared disaster and only to the extent the $100-per-casualty and 10%-of-AGI limits are met. You can still itemize medical expenses but only to the extent they exceed 7.5% of your adjusted gross income, state and local taxes up to $10,000, your charitable contributions, plus interest deductions on a restricted amount of qualifying residence debt, but payments of those items won't save taxes if they don't cumulatively exceed the standard deduction for your filing status. Two COVID-related changes for 2020 may be relevant here: (1) Individuals may claim a $300 above-the-line deduction for cash charitable contributions on top of their standard deduction; and the percentage limit on charitable contributions has been raised from 60% of modified adjusted gross income (MAGI) to 100%.
...Some taxpayers may be able to work around these changes by applying a "bunching strategy" to pull or push charitable contributions and potentially medical expenses into the year where they will do some tax good. For example, if a taxpayer knows he or she will be able to itemize deductions this year but not next year, the taxpayer may be able to make two years' worth of charitable contributions this year, instead of spreading donations over 2020 and 2021.
...Whether or not a taxpayer itemizes deductions, in Colorado contributions to certain charities qualify for the Enterprise Zone Contribution Credit or Child Care Contribution Credit; these credits can provide a significant reduction to state income taxes of up to 50% of the donation amount while supporting high impact local causes. Please note that only specific charities focused on improving economic conditions in designated “enterprise zones” or specific charities focused on promoting child care in Colorado qualify for these credits. A charity’s promotional materials should indicate if certain contributions qualify for these credits but please let us know if you’d like to discuss in advance.
...Consider paying deductible expenses before the end of the year. If you choose to use a credit card to pay an expense, doing so will increase your 2020 deductions even if you don't pay your credit card bill until after the end of the year. As a side note, we’d never recommend borrowing to fund a tax deduction, or making a purchase solely for the deduction. If you choose to put the purchases on a credit card, be sure to pay the balance in full when due to avoid carrying a balance and paying interest charges.
... Required minimum distributions (RMDs) that usually must be taken from an IRA or 401(k) plan (or other employer-sponsored retirement plan) have been waived for 2020. This includes RMDs that would have been required by April 1 if you hit age 70½ during 2019 (and for non-5% company owners over age 70½ who retired during 2019 after having deferred taking RMDs until April 1 following their year of retirement). So if you don't have a financial need to take a distribution in 2020, you don't have to. Note that because of a recent law change, plan participants who turn 70½ in 2020 or later needn't take required distributions for any year before the year in which they reach age 72.
... If you are age 70½ or older by the end of 2020, have traditional IRAs, and especially if you are unable to itemize your deductions, consider making 2020 charitable donations via qualified charitable distributions from your IRAs. These distributions are made directly to charities from your IRAs, and the amount of the contribution is neither included in your gross income nor deductible on Schedule A, Form 1040. However, you are still entitled to claim the entire standard deduction. (Previously, those who reached reach age 70½ during a year weren't permitted to make contributions to a traditional IRA for that year or any later year. While that restriction no longer applies, the qualified charitable distribution amount must be reduced by contributions to an IRA that were deducted for any year in which the contributor was age 70½ or older, unless a previous qualified charitable distribution exclusion was reduced by that post-age 70½ contribution.)
... Make gifts sheltered by the annual gift tax exclusion before the end of the year and thereby save gift and estate taxes. The exclusion applies to gifts of up to $15,000 made in 2020 to each of an unlimited number of individuals. You can't carry over unused exclusions from one year to the next. Such transfers may save family income taxes where income-earning property is given to family members in lower income tax brackets who are not subject to the kiddie tax.
...Higher-income earners must be wary of the 3.8% surtax on certain unearned income. The surtax is 3.8% of the lesser of: (1) Net Investment Income (NII), or (2) the excess of modified adjusted gross income (MAGI) over a threshold amount ($250,000 for joint filers or surviving spouses, $125,000 for a married individual filing a separate return, and $200,000 in any other case). As year-end nears, a taxpayer's approach to minimizing or eliminating the 3.8% surtax will depend on his or her estimated MAGI and NII for the year. Some taxpayers should consider ways to minimize (e.g., through deferral) additional NII for the balance of the year, others should try to see if they can reduce MAGI other than NII, and other individuals will need to consider ways to minimize both NII and other types of MAGI.
Year-End Tax-Planning Moves for Businesses & Business Owners
...Taxpayers other than C Corporations may be entitled to a deduction of up to 20% of their qualified business income. For 2020, if taxable income exceeds $326,600 for a married couple filing jointly, or approximately $163,300 for all other taxpayers, the deduction may be limited based on whether the taxpayer is engaged in a service-type trade or business (such as law, accounting, health, or consulting), the amount of W-2 wages paid by the trade or business, and/or the unadjusted basis of qualified property (such as machinery and equipment) held by the trade or business. The limitations are phased in for joint filers with taxable income between $326,600 and $426,600 and for all other taxpayers with taxable income between approximately $163,300 and $213,300.
...Taxpayers may be able to achieve significant savings by deferring income or accelerating deductions so as to come under the taxable income thresholds mentioned directly above (or be subject to a smaller phase-out of the deduction) for 2020. Depending on their business model, taxpayers also may be able to increase the new deduction by increasing W-2 wages before year-end. The rules are quite complex, so don't make a move in this area without consulting us.
…If significant changes are anticipated for your business in 2021, it can be important to review your entity structure. Please reach out if you’d like to discuss.
... More "small businesses" are able to use the cash (as opposed to accrual) method of accounting than were allowed to do so in earlier years. To qualify as a "small business" a taxpayer must, among other things, satisfy a gross receipts test. For 2020, the gross-receipts test is satisfied if, during a three-year testing period, average annual gross receipts don't exceed $26 million. Cash method taxpayers may find it a lot easier to shift income, for example by holding off billings till next year or by accelerating expenses, for example, paying bills early or by making certain prepayments.
...Consider setting up a self-employed retirement plan if you are self-employed and haven't done so already. In particular, simplified employee pension plans (better known as SEP IRAs) do not need to be established or funded until the tax return due date, including extensions if filed. Therefore, the SEP IRA offers a significant post year-end tax planning opportunity for self-employed persons. Contributions made by the due date, including extensions, are treated as made on the last day of the previous tax return year, December 31, 2020 in this case. Solo 401(k) plans, Safe Harbor 401(k) plans and SIMPLE IRA plans can also be worth considering depending on your business and goals. Please reach out if you’d like to further discuss these options.
... Businesses should consider making expenditures that qualify for the liberalized business property expensing option. For tax years beginning in 2020, the expensing limit is $1,040,000, and the investment ceiling limit is $2,590,000. Expensing is generally available for most depreciable property (other than buildings) and off-the-shelf computer software. It is also available for qualified improvement property (generally, any interior improvement to a building's interior, but not for enlargement of a building, elevators or escalators, or the internal structural framework), for roofs, and for HVAC, fire protection, alarm, and security systems. The generous dollar ceilings that apply this year mean that many small and medium sized businesses that make timely purchases will be able to currently deduct most if not all their outlays for machinery and equipment. What's more, the expensing deduction is not prorated for the time that the asset is in service during the year. The fact that the expensing deduction may be claimed in full (if you are otherwise eligible to take it) regardless of how long the property is held during the year can be a powerful tool for year-end tax planning. Thus, property acquired and placed in service in the last days of 2020, rather than at the beginning of 2021, can result in a full expensing deduction for 2020.
...Businesses also can claim a 100% bonus first year depreciation deduction for machinery and equipment purchased either used (with some exceptions) or new, if purchased and placed in service this year. The 100% write-off is permitted without any proration based on the length of time that an asset is in service during the tax year. As a result, the 100% bonus first-year write-off is available even if qualifying assets are in service for only a few days in 2020.
...Businesses may be able to take advantage of the "de minimis safe harbor election" (also known as the book-tax conformity election) to expense the costs of lower-cost assets and materials and supplies, assuming the costs don't have to be capitalized under the Code Sec. 263A uniform capitalization (UNICAP) rules. To qualify for the election, the cost of a unit of property can't exceed $2,500. If the taxpayer has an applicable financial statement (AFS; e.g., a certified audited financial statement along with an independent CPA's report) the limit for the cost of a unit of property increases to $5,000. Where the UNICAP rules aren't an issue, consider purchasing such qualifying items before the end of 2020.
...A corporation (other than a "large" corporation) that anticipates a small net operating loss (NOL) for 2020 (and substantial net income in 2021) may find it worthwhile to accelerate just enough of its 2021 income (or to defer just enough of its 2020 deductions) to create a small amount of net income for 2020. This will permit the corporation to base its 2021 estimated tax installments on the relatively small amount of income shown on its 2020 return, rather than having to pay estimated taxes based on 100% of its much larger 2021 taxable income.
...To reduce 2020 taxable income, consider deferring a debt-cancellation event until 2021.
...To reduce 2020 taxable income, consider disposing of a passive activity in 2020 if doing so will allow you to deduct suspended passive activity losses.
...Increase your basis in a partnership or S corporation ownership interest, if doing so will enable you to deduct a loss from it for this year. A partner's share of partnership losses is deductible only to the extent of the basis in the partnership interest as of the end of the partnership year in which the loss occurs. An S corporation shareholder can deduct their pro-rata share of an S corporation's losses only to the extent of the total of their basis in S corporation stock and debt owed to them by the S corporation.
These are just some of the year-end steps that can be taken to save taxes. Again, please contact us if you’d like to meet for a consultation so we can tailor a plan that will work best for you.
We look forward to seeing you soon and wish you a very Happy and Healthy Holiday Season!
The Staff of Frank Rim, CPA, P.C.