2020 Year-End Tax Strategies: How to Keep More of Your Money
Submitted by Reby Advisors | Certified Financial Planners | Danbury, CT on November 6th, 2020By George Koeltl, CFP®, November 6, 2020
Vanguard Research reports that tax strategies add up to 1.85% to annual investor returns. Simply put, taxes erode wealth. Money that goes on a one-way trip to Washington D.C. can no longer fund your lifestyle, generate compound returns, or get passed on as a legacy to loved ones.
This article outlines 12 tax reduction strategies to consider before the end of the year. Remember, not all of these strategies will be appropriate for your situation, so please consult your tax advisor or financial planner prior to making a final decision.
2020 End-of-Year Tax Planning
1. Take Advantage of Incentives for Charitable Giving in The CARES Act
Passed earlier in 2020 in response to economic hardships caused by the coronavirus pandemic, the law encourages increased charitable giving in three primary ways:
- Creating an above-the-line $300 deduction for qualified contributions.
- Eliminating the 60% deduction limit. Donors can offset 100% of 2020 adjusted gross income, a massive opportunity for those with big philanthropic aspirations.
- Increasing in the deduction limit for corporations, from 10% of taxable income to 25%.
These incentives expire at the end of the year. For additional details, read my blog article How The CARES Act Impacts Charitable Deductions.
2. Open a Donor Advised Fund
A donor advised fund account is a planning tool that may be used to reduce your income taxes and help fulfill philanthropic goals. It’s an investment account specifically for charitable giving. Donors get an immediate tax benefit for contributions that can be distributed to a qualified non-profit organization over time, on your schedule, even as a legacy.
This tactic generally works best for individuals who already give generously and either had a high income year or own highly appreciated assets that will be subject to capital gains taxes when sold. Learn more about whether this tool is right for you by reading our previous blog article.
3. Turn Investment Losses Into Tax Savings
Tax-loss harvesting involves selling an investment at a loss for the purpose of offsetting taxable capital gains and up to $3,000 of ordinary income for a married couple (or $1,500 for an individual). Net losses exceeding the annual limit can be carried over to future years, so it's a gift that keeps on giving.
Generally speaking, when we harvest a loss for a client, we use the cash from the sale to purchase a similar asset. This maintains the overall portfolio strategy so that we're not locking in an investment loss simply to reduce taxes.
4. Convert a Traditional IRA to a Roth IRA
Once you reach age 59 ½, and have had the account open for at least five years, a Roth IRA generates tax-free income. As my colleague Patrick Doherty wrote in July, converting all or a portion of a Traditional IRA to a Roth may reduce your income taxes for years to come.
The downside is that you will owe income taxes based on the value of the assets at the time of conversion. Still, a Roth Conversion may be worthwhile if you expect to be in a higher tax bracket in the future. Please do not hesitate to call us if you need help deciding whether this is a good option for you.
5. Maximize Your Retirement Plan
If possible, contribute the maximum annual amount to an IRA, 401k, or other tax-deferred retirement plan. Additional contributions not only increase savings towards retirement, but also reduce your taxable income in the current year. It's better to pay yourself than send money to the government.
6. Fund or Spend the Money in Your Health Care Accounts
Similar to funding a tax-deferred retirement account, pre-tax contributions to a Health Savings Account (HSA) or a Flexible Spending Account (FSA) can reduce your taxable income. These accounts can only be used to pay for qualified heath care expenses.
Typically, money in an FSA must be spent before December 31st. So, make sure to use it before you lose it.
7. Business Owner or Independent Contractor? Consider Deferring Income.
If you can pay taxes next year instead of this year, why not? Depending on your business and cashflow, it may make sense to delay billings until the end of December, for example, to ensure you get paid in January of 2021. You could also take capital gains in 2021 instead of 2020.
Deferring business income is generally only advisable if you expect to be in a lower (or at least the same) tax bracket next year. If the opposite is true, you can try to accelerate income into 2020.
8. Accelerate Other Deductions
Additional deductions you may be able to increase before year’s end include:
- Property tax bill due at the beginning of the following year
- Hospital or doctor’s bill
- Estimated state income tax bill due in January
IMPORTANT: Households that take the standard deduction probably will not benefit from accelerating these deductions.
9. Consider the Alternative Minimum Tax
Increasing deductions leading up to 2021 could be a mistake if you’re already paying the alternative minimum tax (AMT). The AMT is separate from your standard tax liability and has different rules; property taxes and state and local income taxes, for example, aren’t deductible under AMT.
Tax Planning Strategies for Retirees
10. Review IRA Distributions
The CARES Act suspended required minimum distributions (RMD) from retirement accounts in 2020. So, if you don't need the money from an IRA account and don't want to pay the taxes, you don't have to.
It's still worthwhile, however, to compare your current tax bracket with the tax rates you expect to pay in the future. In the long run, it may be advantageous to get money out of the account and reduce your RMD in the future by making a qualified charitable distribution or converting a portion of the account to a Roth.
11. Charitable Giving with Qualified Charitable Distribution (QCD)
Even without RMD requirements in 2020, you can still use a QCD to direct IRA distributions to charities if you are above the RMD age. A QCD adjusts your gross income and reduces your taxes.
From a tax standpoint, a QCD is most beneficial when it makes your total itemized tax deductions higher than the standard deduction. Oftentimes, this is achieved by contributing an amount that would have been donated over the course of several years.
12. Strategize Healthcare Deductions
Retirees might be able to combine healthcare expenses into a single year to receive a maximum deduction. Qualified healthcare expenses in excess of 10% of adjusted gross income are deductible for 2020.
In other words, if your medical bills will be 10% of your income this year and 10% next year, you don't get a deduction. However, if you can combine those expenses into one year so that it's 20% this year and 0% next year, you get a deduction on the expenses exceeding 10%.
Get Personal Tax Planning Advice
When it comes to income planning, our financial planning team believes that it doesn't matter how much you earn—it's what you keep that counts. It's better to earn $100,000 and keep it all than to earn $125,000 and pay $50,000 in taxes.
If you would like advice on how to maximize your cashflow, please do not hesitate to give us a call at (203) 790-4949.
