Year-End Planning Strategies

Presented by STEPHEN LAFRANCE, CFP®, MBA

The window of opportunity for many tax-saving moves closes on December 31, so it is important to evaluate your tax situation now, while there is still time to affect your bottom line for the 2020 tax year.

Timing is everything
Consider any income opportunities you may be able to defer until 2021. For example, you may consider deferring a year-end bonus, or delaying the collection of business debts, rents, and payments for services. Doing so may allow you to postpone paying tax on the income until next year. If there’s a chance that you’ll be in a lower income tax bracket next year, deferring income could mean paying less tax on the income as well.

Similarly, consider ways to accelerate deductions into 2020. If you itemize deductions, you might accelerate some deductible expenses like medical expenses, qualifying interest, or state and local taxes by making payments before year-end. Or you might consider making next year’s charitable contribution this year instead.

Sometimes, however, it may make sense to take the opposite approach — accelerating income into 2020 and postponing deductible expenses to 2021. That might be the case, for example, if you can project that you’ll be in a higher tax bracket in 2021; paying taxes this year instead of next might be outweighed by the fact that the income would be taxed at a higher rate next year.

Special concerns for higher-income individuals
The top marginal tax rate (37%) applies if your taxable income exceeds $518,400 in 2020 ($622,050 if married filing jointly, $311,025 if married filing separately). Your long-term capital gains and qualifying dividends could be taxed at a maximum 20% tax rate if your taxable income exceeds $441,450 in 2020 ($496,600 if married filing jointly, $248,300 if married filing separately, $469,050 if head of household).

Additionally, a 3.8% net investment income tax (unearned income Medicare contribution tax) may apply to some or all of your net investment income if your modified AGI exceeds $200,000 ($250,000 if married filing jointly, $125,000 if married filing separately).

The 2017 Tax Cuts and Jobs Act (TCJA) substantially reduced the number of households affected by the alternative minimum tax (AMT). If you’re subject to the AMT, traditional year-end maneuvers, like deferring income and accelerating deductions, can have a negative effect. That’s because the AMT — essentially a separate, parallel income tax with its own rates and rules — effectively disallows a number of itemized deductions. For example, if you’re subject to the AMT in 2020, prepaying 2021 state and local taxes won’t help your 2020 tax situation, but could hurt your 2021 bottom line.

High-income individuals are subject to an additional 0.9% Medicare (hospital insurance) payroll tax on wages exceeding $200,000 ($250,000 if married filing jointly or $125,000 if married filing separately).

IRAs and retirement plans
Take full advantage of tax-advantaged retirement savings vehicles. Traditional IRAs and employer-sponsored retirement plans such as 401(k) plans allow you to contribute funds on a deductible (if you qualify) or pre-tax basis, reducing your 2020 taxable income. Contributions to a Roth IRA (assuming you meet the income requirements) or a Roth 401(k) aren’t deductible or made with pre-tax dollars, so there’s no tax benefit for 2020, but qualified Roth distributions are completely free from federal income tax, which can make these retirement savings vehicles appealing.

For 2020, you can contribute up to $19,500 to a 401(k) plan ($26,000 if you’re age 50 or older) and up to $6,000 to a traditional IRA or Roth IRA ($7,000 if you’re age 50 or older). The window to make 2020 contributions to an employer plan typically closes at the end of the year, while you generally have until the April tax return filing deadline to make 2020 IRA contributions.

Roth conversions
Year-end is a good time to evaluate whether it makes sense to convert a tax-deferred savings vehicle like a traditional IRA or a 401(k) account to a Roth account. When you convert a traditional IRA to a Roth IRA, or a traditional 401(k) account to a Roth 401(k) account, the converted funds are generally subject to federal income tax in the year that you make the conversion (except to the extent that the funds represent nondeductible after-tax contributions). If a Roth conversion does make sense, you’ll want to give some thought to the timing of the conversion. For example, if you believe that you’ll be in a better tax situation this year than next (e.g., you would pay tax on the converted funds at a lower rate this year), you might think about acting now rather than waiting. (Whether a Roth conversion is appropriate for you depends on many factors, including your current and projected future income tax rates.)

Previously, if you converted a traditional IRA to a Roth IRA and it turned out to be the wrong decision (things didn’t go the way you planned and you realized that you would have been better off waiting to convert), you could recharacterize (i.e., “undo”) the conversion. Recent legislation has eliminated the option to recharacterize a Roth IRA conversion.

Charitable Giving
Charitable giving can play an important role in many estate plans. Philanthropy cannot only give you great personal satisfaction, it can also give you a current income tax deduction, let you avoid capital gains tax, and reduce the amount of taxes your estate may owe when you die.

There are many ways to give to charity. You can make gifts during your lifetime or at your death. You can make gifts outright or use a trust. You can name a charity as a beneficiary in your will, or designate a charity as a beneficiary of your retirement plan or life insurance policy. Or, if your gift is substantial, you can establish a private foundation, community foundation, or donor-advised fund.

Making outright gifts
An outright gift is one that benefits the charity immediately and exclusively. With an outright gift, you get an immediate income and gift tax deduction.

Make sure the charity is a qualified charity according to the IRS. Get a written receipt or keep a bank record for any cash donations, and get a written receipt for any property other than money.

Will or trust bequests and beneficiary designations
These gifts are made by including a provision in your will or trust document, or by using a beneficiary designation form. The charity receives the gift at your death, at which time your estate can take the income and estate tax deductions.

Charitable trusts
Another way for you to make charitable gifts is to create a charitable trust. You can name the charity as the sole beneficiary, or you can name a non-charitable beneficiary as well, splitting the beneficial interest (this is referred to as making a partial charitable gift). The most common types of trusts used to make partial gifts to charity are the charitable lead trust (CLT) and the charitable remainder trust (CRT).

Charitable trusts generally make sense when your total estate value is near or exceeds the federal estate tax exemption amount of $11.58 million for individuals and $23.16 million for married couples.

Private family foundation
A private family foundation is a separate legal entity that can endure for many generations after your death. You create the foundation, then transfer assets to the foundation, which in turn makes grants to public charities. You and your descendants have complete control over which charities receive grants. But, unless you can contribute enough capital to generate funds for grants, the costs and complexities of a private foundation may not be worth it.

A general guideline is that you should be able to donate enough assets to generate at least $25,000 a year for grants.

Community foundation
If you want your dollars to be spent on improving the quality of life in a particular community, consider giving to a community foundation. Similar to a private foundation, a community foundation accepts donations from many sources, and is overseen by individuals familiar with the community’s particular needs, and professionals skilled at running a charitable organization.

Donor-advised fund
Similar in some respects to a private foundation, a donor-advised fund offers an easier way for you to make a significant gift to charity over a long period of time. A donor-advised fund actually refers to an account that is held within a charitable organization. The charitable organization is a separate legal entity, but your account is not — it is merely a component of the charitable organization that holds the account. Once you transfer assets to the account, the charitable organization becomes the legal owner of the assets and has ultimate control over them. You can only advise — not direct — the charitable organization on how your contributions will be distributed to other charities.

Changes to note
The 2017 TCJA also modified many provisions, generally for 2018 to 2025.

  • Personal exemptions were eliminated.
  • Standard deductions have been substantially increased to $12,400 in 2020 ($24,800 if married filing jointly, $18,650 if head of household).
  • The overall limitation on itemized deductions based on the amount of adjusted gross income (AGI) was eliminated.
    The AGI threshold for deducting unreimbursed medical expenses is 7.5% in 2020, it returns to 10% in 2021.
  • The deduction for state and local taxes has been limited to $10,000 ($5,000 if married filing separately).
  • Individuals can deduct mortgage interest on no more than $750,000 ($375,000 for married filing separately) of qualifying mortgage debt. For mortgage debt incurred before December 16, 2017, the prior $1,000,000 ($500,000 for married filing separately) limit will continue to apply. A deduction is no longer allowed for interest on home equity indebtedness. Home equity used to substantially improve your home is not treated as home equity indebtedness and can still qualify for the interest deduction.
  • The top percentage limit for deducting charitable contributions was increased from 60% of AGI to 100% of AGI for certain direct cash gifts to public charities for 2020.
  • The deduction for personal casualty and theft losses was eliminated, except for casualty losses attributable to a federally declared disaster.
  • Previously deductible miscellaneous expenses subject to the 2% floor, including tax-preparation expenses and unreimbursed employee business expenses, are no longer deductible.

Extended provisions
A number of provisions are extended periodically. The following provisions have been extended through 2020 and are not available for 2021 unless extended by Congress.

  • Above-the-line deduction for qualified higher-education expenses.
  • Ability to deduct qualified mortgage insurance premiums as deductible interest on Schedule A of IRS Form 1040.
  • Ability to exclude from income amounts resulting from the forgiveness of debt on a qualified principal residence.
  • Nonbusiness energy property credit, which allowed individuals to offset some of the cost of energy-efficient qualified home improvements (subject to a $500 lifetime cap).

Talk to a professional for guidance
When it comes to year-end tax planning, there’s always a lot to think about. A tax professional or financial planning professional can help you evaluate your situation, keep you apprised of any legislative changes, and determine whether any year-end moves make sense for you.

Engage with the entire Blakely Financial team at www.blakelyfinancial.com to see what other financial tips we can provide towards your financial well-being.

STEPHEN LAFRANCE, CFP®, MBA is a financial advisor with BLAKELY FINANCIAL, INC. located at 1022 Hutton Ln., Suite 109, High Point, NC 27262. 336-885-2530.

Blakely Financial, Inc. is an independent financial planning and investment management firm that provides clarity, insight, and guidance to help our clients attain their financial goals.

Securities and advisory services offered through Commonwealth Financial Network, Member FINRA/SIPC, a Registered Investment Adviser.

Prepared by Broadridge Advisor Solutions