Key Points

• Recent legislation changes that the government enacted to ease the hardships faced by individuals and businesses have added some complexity to year-end tax planning and provided some tax planning opportunities.

• Although a divided Congress may limit President-Elect Biden’s proposals to increase both income and estate taxes, the chance of a future tax increase at some point in the near future is likely.

• We outline some opportunities to consider due to the recently passed legislation modifications and some strategies to consider ahead of potential future tax changes.

As the end of the year approaches, it is always a good time to think about ways to help lower your April tax bill next year and in years to come. Prior to this year, taxpayers were still digesting changes made due to the landmark Tax Cuts and Jobs Act (TCJA). This year, a global pandemic brought not only health threats and social turmoil, but also tax modifications that the government enacted to ease the hardships faced by individuals and businesses.

More recent legislation changes, such as those in the Coronavirus Aid, Relief, and Economic Security Act (CARES Act), provided some relief; however, they also added some complexity to year-end tax planning. These changes, coupled with a change in administration, have significantly impacted year-end tax planning.

The CARES Act has provided some tax planning opportunities. Below are several key tax provisions to consider:

Eligibility for Individual Recovery Rebate or Tax Credit

Under the CARES Act, an eligible individual is allowed an income tax credit for 2020 equal to the sum of: 1) $1,200 ($2,400 for eligible individuals filing a joint return) plus 2) $500 for each qualifying child of the taxpayer. Since April, the IRS had issued the advance payments of the credit (stimulus checks) based on a taxpayer’s 2019 income tax return (or tax year 2018, if no 2019 return has yet been filed).

However, if an individual did not qualify for the credit due to their 2019 income level or dependency status, they may be entitled to the credit on their 2020 tax return (based on their 2020 income level and dependency status). No repayments of the credit are required.

Penalty-Free Retirement Plan Distributions

The CARES Act allows up to a $100,000 coronavirus-related distribution made on or after January 1, 2020, and before December 31, 2020, from an eligible retirement plan to a qualified individual without incurring the 10% additional tax on early distributions (those taken before 59-½ years old).

The distribution may also be contributed back to the retirement plan at any time during the three years after the date on which such distribution was received. As usual, the distribution must be included in one’s income on the tax return; however, the distributions can be spread over a three-year period to ease the tax burden.

Required Minimum Distribution Waiver

The CARES Act allows any taxpayer who would normally need to take a 2020 Required Minimum Distribution (RMD) to skip their RMD. This includes anyone who turned age 70-½ in 2019 and would have had to take the first RMD by April 1, 2020.

The 2020 RMD waiver provides flexibility to taxpayers who otherwise may not need the RMD for spending purposes to defer paying taxes on their 401(k) RMD or IRA RMD until April 2022. In addition to the tax benefit, it allows investments (that otherwise would have been sold to fund the RMD) to grow as financial markets continue to recover.

Opportunity for Higher Charitable Deductions

For any individual who does not elect to itemize deductions, the CARES Act added an “above-the-line” deduction of up to $300 for cash contributions to a qualified charity. However, the contribution cannot be used for the establishment or maintenance of a donor-advised fund.

The CARES Act also increased the limit on cash contributions from 60% of modified adjusted-gross-income to 100%, with certain limitations.

New Tax Proposals

Along with changes in legislation, this year also brought an election filled with uncertainty. While President-Elect Biden has many proposals to increase both income and estate taxes, what promises to be a divided Congress may limit his ability to enact some modifications.

Below are the major provisions included in President-Elect Biden’s tax proposal:

Raise income taxes on individuals with income above $400,000 and restore the top personal marginal income tax rate back to 39.6% from 37%.

• Impose a 12.4% payroll tax on income earned above $400,000.

• Phase-out of the favorable Qualified Business Income Deduction (Section 199A).

• Raise the tax rate on capital gains to 39.6% (up from 20%) for taxpayers with income in excess of $1,000,000.

• Restore the estate and gift tax rate and exemption back to 2009 levels (from the current exemption of $11.58 million to $3.5 million indexed for inflation, and a 45% estate tax rate).

• End the step-up in basis at death for inherited assets.

Planning Ahead of Potential Tax Changes

Although getting the above proposals enacted may be a challenge, the chance of a future tax increase at some point in the near future is likely. Below are some strategies to consider ahead of potential tax changes.

Accelerating Income

Because we are in a fairly low tax environment in 2020, accelerating income in 2020 may provide some longer-term tax benefits to some. A couple of ways to accelerate income is to exercise stock options or sell appreciated property or investments before year-end to recognize built-in capital gains.

Deferring Deductions

Additionally, deferring deductions to future years to offset income being taxed at these higher rates may provide another source of savings. Some ways to defer deductions include delaying (until next year) payments for items like real estate taxes, interest expenses, charitable contributions, and medical and dental expenses.

Harvesting Losses to Offset Future Capital Gains

Although stock markets have broadly rebounded from declines earlier-in-the-year, there are many sectors and industries (as of this writing) that are still significantly underwater, including energy, real estate, financial services, and travel and leisure stocks.

It may be possible to harvest some investment portfolio capital losses from this year to offset your capital gains through tax-loss harvesting (that is, selling securities at a loss to offset current or future capital gains). A capital loss in excess of the current year’s capital gains can offset up to $3,000 of ordinary income in the current year. Any unused capital losses can be carried forward to use in future years.

Even though year-end planning can seem especially overwhelming this year with the pandemic, new tax legislation, and the uncertainty of our political environment, we are here to help. If you have any questions regarding your tax planning, please contact one of our Wealth Advisors.