There are many opportunities that should be addressed sooner rather than later to cut your 2020 and 2021 taxes.
This most recent tax season was unlike any we have ever experienced. If you completed or properly extended your tax returns by July 15, the revised individual tax filing deadline this year, the last thing you likely want to think about now is taxes. However, keep an open mind, as there are many opportunities that should be addressed sooner rather than later to cut your 2020 and 2021 taxes.
In response to the COVID-19 emergency, President Trump signed into law on March 27 the Coronavirus Aid, Relief and Economic Security (CARES) Act. The CARES Act is a massive piece of legislation aimed at providing much needed relief during an uncertain time in our country. Among its many provisions, the CARES Act offers some immediate tax-saving opportunities, which are detailed in a previous Alert. Many of these provisions have been enhanced and expanded since our last writing and are largely to the favor of individuals and businesses.
In addition to the CARES Act, the Taxpayer Certainty and Disaster Tax Relief Act (Disaster Act) and the Setting Every Community Up for Retirement Enhancement (SECURE) Act, discussed in another Alert, both passed in December 2019 and provide tax planning opportunities for this year. The Disaster Act extended (retroactively to 2018, in some instances) many beneficial provisions in the tax law that had expired or were set to expire. The SECURE Act, on the other hand, made significant changes to the retirement rules.
We highlight below planning techniques stemming from recent legislation and include other easy-to-execute midyear planning ideas.
As of this writing, Republicans have announced an additional relief package, the Health, Economic Assistance, Liability Protection and Schools Act (the HEALS Act), an additional $1 trillion relief package. If Congress can compromise in providing aid to state and local governments, additional COVID-19-related tax changes could be passed and implemented as the year progresses.
In addition, who can forget that 2020 is an election year? While we do not anticipate significant tax law changes if President Trump is reelected, a new occupant of the Oval Office would almost certainly lead to tax reform (with likely higher taxes for many). As always, we are paying close attention to the ever-changing tax environment to discover tax planning opportunities that could further lower your tax obligations. Meanwhile, here are some ideas to evaluate your taxes while there is ample time to plan.
Ensure Accurate Tax Withholding and Estimated Payments
No one likes to be surprised with a large tax bill (or a smaller-than-anticipated refund) come tax filing season. In many cases, this occurs because the individual did not adjust his or her tax withholding or estimated payments to account for changes in income and deductions. For those accustomed to receiving refunds every year or owing consistent balances due, an unexpected tax bill can be an unwelcome surprise. Fortunately, there is still time to make sure the right amount of federal income tax is being withheld from your paycheck and/or being remitted quarterly for 2020.
Update Your W-4
IRS Form W-4 is used to notify your employer how much tax to withhold from each paycheck. When the Tax Cuts and Jobs Act (TCJA) (a major tax reform bill passed in December 2017, which we wrote about in this Alert) limited certain itemized deductions and reduced the personal exemption to zero, many taxpayers simply were not having the correct amount of tax withheld. An updated version of Form W-4, which takes the TCJA changes into account, was released near the end of 2019. Although the revised form is more complicated than prior versions, it should increase the accuracy of your withholding amounts.
If you have not reviewed your withholding recently, you should consider a 2020 tax projection. We often perform tax projections on a quarterly basis for our clients.
Also, summer is traditionally wedding season, though that is certainly one of the many things that has changed this year. Many couples have replaced traditional weddings with a legal ceremony and a party to follow at a later, indeterminate date. Remember, if your marital status changes, your tax situation changes, so your W-4 needs to be updated with your employer. Often, additional tax, estate and financial planning makes sense at this time as well.
Adjust Your Estimates
If you remit estimated tax payments throughout the year (if you are self-employed, for example, or have large investment portfolios), you should take a closer look at your tax situation for 2020 to make sure you are not underpaying or overpaying. Periodic tax projections are quick and easy ways to manage your tax obligations without underpaying your taxes and being hit with costly underpayment of tax penalties, or overpaying and providing the IRS with an interest-free loan.
Amend Prior Year Returns to Take Advantage of New Provisions
Ordinarily, an amended tax return is only filed when an error or omission is discovered after a return has been filed. Even then, you might decide not to amend in situations where the resulting tax reduction would not be significant enough to justify the cost of preparing and filing the amending return. That said, with the current COVID-19 situation, any opportunity for a refund may be worth pursuing. All three of the major tax laws passed within the last six months contain retroactive provisions that could make amending your 2018 and/or your 2019 return (if already filed) worth the cost. Additionally, there may be opportunities for refunds based on a future Supreme Court ruling on a challenge to the Affordable Care Act, which we wrote about in this Alert. Here are some examples:
The SECURE Act repealed the changes to the “kiddie tax” brought about by the TCJA. Under the TCJA, if your child was subject to the kiddie tax in 2018, his or her net unearned income in excess of $2,100 was taxed using estate and trust brackets instead of your marginal rate. Since higher tax rates are reached at much lower income levels for estates and trusts than for individuals, it’s quite possible that your child paid more tax than necessary in 2018 (if you weren’t in the higher brackets). Since the change is retroactive (at the taxpayer’s election), it might make sense to review your child’s 2018 return to see if it would be beneficial to amend.
Debt Forgiveness and PMI
The Disaster Act also made several retroactive changes that could lead to a situation where amending a prior-year return makes sense. If you had any debt forgiven on your principal residence and included that amount in income in 2018, you can amend your return to exclude that cancellation of debt income. If you paid mortgage insurance premiums (PMI) in 2018 and itemized your deductions for that year, those payments can be included with other mortgage interest expense and deducted on an amended return.
Other Tax Deductions and Credits
The Disaster Act also brought back, among other things, the deduction for eligible tuition and fees and the credit for qualified energy saving improvements made to your home. Thus, for example, you may be able to amend a 2018 return to claim tax credits for the windows you installed in 2018, which you were previously unable to claim. However, due to the often small amounts at issue for these deductions and credits, the tax impact may not be worth the cost associated with amending.
The CARES Act also contains multiple retroactive tax law changes that may have a significant effect on small business owners, including revised net operating loss (NOL) rules, accelerated depreciation options and other provisions that may allow a larger deduction than would have been available prior to the CARES Act. Whether you are a direct owner of a sole proprietorship or own a business through a pass-through entity (such as a partnership or an LLC), you may be able to take advantage of one or more of these retroactive changes. For more information on opportunities to amend your personal return for small business-related issues, please refer to the “Planning for Businesses” section later in this Alert.
While not every taxpayer will be able to take advantage of all these changes, there is a good chance that at least one may apply to you. If so, filing an amended return can provide some sorely needed cash flow in these uncertain times.
Coordinate Your Investment Strategy with Your Tax Plan
Income from an investment held for more than one year is generally taxed at preferential capital gains rates. Those rates are zero percent, 15 percent and 20 percent for most investments. (Higher-income individuals may also be subject to an additional 3.8 percent net investment income tax.) The rate that applies is determined by your taxable income. For example, the zero percent rate applies if your 2020 taxable income does not exceed $80,000 (for joint filers), $53,600 (for heads of household) or $40,000 (for other individuals). The 20 percent rate does not kick in until your taxable income exceeds $496,600 (for joint filers), $469,050 (for heads of household) or $441,450 (for other individuals).
If your taxable income hovers around these threshold amounts, there are ways to reduce your income to take advantage of a lower capital gains rate. For example, you could make deductible IRA contributions or reduce taxable wages by deferring bonuses or contributing to employer retirement plans. If you are over the age of 70½, contributing to a qualified charity with a direct distribution from your IRA also is a good way to lower income. If you own a business and use the cash method of accounting, you can wait until the end of the year to send out some client invoices. That way, you will not receive payments until early 2021. In addition, you can postpone taxable income by accelerating some deductible expenses this year. If possible, strive to get your income low enough to qualify for the zero percent rate.
If your income is too high to benefit from the zero percent rate, consider gifting investments (like appreciated stock or mutual fund shares) to children, grandchildren or other loved ones. Chances are these individuals will be in the zero percent or 15 percent capital gains tax bracket. If they later sell the investments, any gain will be taxed at the lower rates, as long as you and your loved one owned the investments for more than one year. This strategy has two risks, however. First, there are gift tax consequences if you transfer assets worth over $15,000 during 2020 to a single recipient. Second, all children under age 18 and most children age 18 or ages 19 to 23 who are full-time students are subject to the kiddie tax rules. Fortunately, kiddie tax rates are once again tied to the parent’s tax bracket rather than the brackets for estates and trusts. The kiddie tax limits the opportunity for parents to take advantage of the zero percent capital gain rate by gifting appreciated property to their children, including college age children.
With the recent volatility in the markets, now may also be the time to evaluate the “losers” in your portfolio, and harvest losses to reduce any capital gains. Keep in mind that in addition to capital gains, you can offset up to $3,000 of income from other sources with capital losses.
Consider Strategic Gifting Plans
Exemptions Potentially Decreasing
With a major election less than 75 days away, it is quite possible that the gift and estate tax could be targeted for changes in 2021. Currently, the unified exemption amount for 2020 is $11,580,000, which is scheduled to be reduced by more than half to an inflation-indexed $5,000,000 in 2026. Should Democrats gain control of the Senate and presidency in November, this exemption would likely be targeted for an immediate reduction. Thus, planning for gifts in 2020 to utilize this high current exemption may present a unique planning opportunity. Certain wealth transfer instruments, or “vehicles,” can help utilize the exemption in 2020 while retaining access to the assets. One of many vehicles, for example, a spousal lifetime access trust (SLAT), which is an irrevocable family trust, allows a grantor to use the exemption currently and exclude the assets from his or her taxable estate while allowing their spouse to access the trust’s assets and appreciation during the spouse’s lifetime. By planning now rather than waiting until year-end, donors can carefully structure their gifts in a way to maximize tax savings while also achieving their long-term wealth transfer goals.
Other Advanced Wealth Transfer Vehicles
Certain wealth transfer vehicles can be set up to avoid utilization of the gift/estate tax exemption at all―such as intrafamily loans and grantor retained annuity trusts (GRATs). These vehicles operate similarly, in that both effectively transfer a principal amount to a donee with the donee paying back the principal along with, presently, a nominal interest. Any investment gains earned by the donee during the period of the repayment in excess of the interest paid represent the wealth transferred, with no gift tax implications. Due to the historically low interest rates in 2020, this year is a particularly good time to utilize intrafamily loans and GRATs to transfer wealth.
New Rules for Retirement Plans
If you, your spouse or dependent have been affected by COVID-19 and find yourself in need of additional cash flow, the CARES Act contains several taxpayer-friendly provisions for retirement plan distributions taken prior to the end of 2020. For taxpayers under age 59½, COVID-19-related withdrawals up to $100,000 from a qualified retirement account (i.e., IRA, 401(k), 403(b), etc.) are not subject to the normal 10 percent early withdrawal penalty. While all 2020 withdrawals are still subject to income tax, you have a couple of options to limit the tax burden. First, you may elect to spread the income tax payments over three years rather than pay all of the tax in 2020. Second, you also may move the amount withdrawn into another qualified account within the next three years rather than the standard 60-day rollover timeframe. (No tax is due if you make the contribution within the three-year window.) Even if you do not need the cash, this is an opportunity to move funds out of an employer-sponsored plan and into an IRA that you can control.
To qualify for these special rules, you (or your spouse or dependent) must have been diagnosed with COVID-19 or have been affected financially as the result of a layoff, reduction in hours or another inability to work due to COVID-19.
If you have funds in a traditional IRA and have been considering converting the account to a Roth IRA, 2020 might be a great year to execute that plan. Current tax rates are relatively low. Given the current economic situation and the possibility of leadership changes following the November elections, it’s unlikely tax rates will decrease anytime soon. It’s also possible that your income from other sources is down, driving you into a lower tax bracket.
Convert Your RMD to a Roth IRA
Since the CARES Act suspended required minimum distributions (RMDs) for 2020, if you already budgeted to pay tax on your RMD, rolling that distribution to a Roth IRA could be a perfect move. No RMD for 2020 also means that 100 percent of the distribution can be classified as a rollover.
No one likes to see the value of their retirement account plummet like many of us experienced earlier this year, but perhaps there’s a silver lining to that decrease in your traditional IRA’s value. The depressed value in your IRA means a rollover distribution in a market downturn will contain more assets. Once in the Roth IRA, the recovery of value and ultimate withdrawal will be tax-free. Of course, there are possible disadvantages. For instance, increasing your 2020 income could mean more of your Social Security payments will be subject to income tax or result in increased Medicare premiums. Also, unlike a few years ago, the ability to “undo” this conversion no longer exists. Once you convert, it’s permanent. All factors should be considered along with your overall retirement plan.
Return Your RMD
As a result of recent IRS guidance, taxpayers also have until August 31, 2020, to return any RMDs withdrawn in 2020, tax and penalty-free. Thus, if you are looking to reduce your 2020 taxable income or you simply don’t need the money and want the money to grow in your retirement account, be sure to take advantage of this opportunity by August 31.
Contribute to an IRA
The SECURE Act removed the age limitation for deductible contributions to a traditional IRA. Therefore, if you’re over the age of 70½ and have earned income, you may want to consider making a deductible IRA contribution in 2020.
Take a Loan from Your 401(k)
Though borrowing from retirement savings is not generally recommended, the CARES Act has made it easier for taxpayers to raid their 401(k) accounts to access cash during these difficult times. For qualified plan loans originated between March 27, 2020, and September 23, 2020, the maximum loan amount is increased from $50,000 to $100,000, the loan can include 100 percent of vested funds rather than 50 percent, and allows borrowers to begin repayment in 2021 rather than immediately.
Reevaluate Your Charitable Contributions
The CARES Act temporarily increased the limit on cash contributions to public charities and certain private foundations from 60 percent to 100 percent of adjusted gross income for contributions made in 2020. Note that the donation does not have to go to a COVID-19-related cause. However, with the increased standard deduction and limits on itemized deductions, it’s likely that fewer taxpayers will be able to deduct charitable contributions for 2020.
For those in that predicament, consider bunching or increasing charitable contributions in alternating years. This may be accomplished by donating to donor-advised funds. Also known as charitable gift funds or philanthropic funds, donor-advised funds allow donors to make a charitable contribution to a specific public charity or community foundation that uses the assets to establish a separate fund. Taxpayers can claim the charitable tax deduction in the year they fund the donor-advised fund and schedule grants over the next two years or other multiyear periods. This strategy provides a tax deduction when the donor is at a higher marginal tax rate while actual payouts from the account can be deferred until later.
Separate Charitable Deduction for Those Claiming the Standard Deduction
For those who won’t itemize in 2020, the CARES Act allows a new “above the line” deduction for cash charitable contributions up to $300. For older taxpayers (over age 70½) who won’t be able to itemize but still want to make contributions, a qualified charitable distribution from an IRA is a great way to give to charity.
Planning for Businesses
If you own a business, consider the following strategies to minimize your tax bill for 2020. Thanks to the retroactive nature of many portions of the CARES Act, an opportunity to file amended returns also may be available in certain circumstances. Consider engaging an experienced CPA or tax lawyer to evaluate these strategies, as the rules are complex.
The TCJA eliminated the ability to carry back NOLs arising after 2017 and limited the benefit of NOLs carried forward to subsequent years to 80 percent of taxable income. To assist small business owners who may have incurred losses as a result of the COVID-19 crisis, the CARES Act temporarily removed the TCJA limitation. Because the new law is retroactive, you can now carry losses that originated in 2018 through 2020 back five years. This means you could carry a 2018 NOL back as far as 2013. Since tax rates were higher in 2017 and earlier years, carrying back an NOL should be much more beneficial than carrying that loss forward. If you had a loss in 2018 or 2019 or expect a loss in 2020, it is imperative that you review your options with professional guidance. Carrying back a loss could be a great way to increase cash flow.
Excess Business Losses
To further ease the burden on small business owners, the CARES Act also retroactively removed the limitation on excess business losses (EBLs) that the TCJA implemented for 2018 through 2020. Under the TCJA, beginning in 2018, taxpayers were unable to deduct business losses from sole proprietorships or pass-through entities, such as partnerships and S corporations, if the combined loss exceeded $250,000 ($500,000 for married joint fliers). (Those amounts were adjusted annually for inflation after 2018.) The excess loss was converted to an NOL and carried forward, subject to the NOL limitations discussed earlier. Since this is a retroactive law change, if your losses were limited in either 2018 or 2019 (if that return has already been filed), you should strongly consider filing an amended return to generate a refund.
Business Interest Expense
On July 28, the IRS issued final regulations on the business interest deduction limitation. For tax years beginning after December 31, 2017, business interest expense deductions are generally limited to the sum of:
- the taxpayer's business interest income;
- 30 percent (or 50 percent, as applicable) of the taxpayer's adjusted taxable income; and
- the taxpayer's floor plan financing interest expense.
The business interest expense deduction limitation does not apply to certain small businesses whose gross receipts are $26 million or less, electing real property trades or businesses, electing farming businesses and certain regulated public utilities. The $26 million gross receipts threshold applies for the 2020 tax year and will be adjusted annually for inflation. The regulations are complex, so be sure to seek professional guidance.
Better Depreciation Rules for Real Estate Qualified Improvement Property (QIP)
The CARES Act includes a technical correction to the TCJA that is retroactive to 2018. The new rule allows much faster depreciation for real estate QIP that is placed in service after 2017. QIP is an improvement to an interior portion of a nonresidential building that is placed in service after the date the building was first placed in service. However, QIP does not include any improvement for which the expenditure is attributable to the enlargement of the building, any elevator or escalator, or the internal structural framework of the building.
The retroactive correction allows you to claim 100 percent first-year bonus depreciation for QIP expenditures placed in service in 2018–2022. Alternatively, you can depreciate QIP placed in service in 2018 and beyond over 15 years using the straight-line method.
Amending a 2018 or 2019 return to claim 100 percent first-year bonus depreciation for QIP placed in service in those years could result in an NOL that can be carried back to a prior tax year to recover taxes paid in that year, as explained earlier. There also is an option to file for a change in accounting method for the business in lieu of amending returns. Evaluate whether it’s better to claim 100 percent bonus depreciation or deduct the cost of QIP over 15 years.
Qualified Small Business Corporations
Investing in a qualified small business corporation (QSBC) can generate significant tax savings. Under the TCJA, C corporations, including QSBCs, received a huge tax cut―from a top rate of 35 percent to a flat 21 percent tax rate. QSBCs are domestic corporations in specific industries with assets of less than $50 million. In addition, 80 percent or more of the corporation’s assets must be used in the active conduct of a qualified business. To reap the greatest tax benefit from an investment in a QSBC, one must hold the investment for five years or more. After this period, when the QSBC stock is sold, up to $10 million of gain, or 10 times the shareholder’s basis, whichever is greater, can be excluded from tax. If the investment is held for less than five years, it will be subject to either long or short-term capital gain treatment, depending on the length of time the investment was held.
Another benefit of investing in a QSBC is the rollover provision. The rollover provision allows an investor who held QSBC stock for at least six months to sell their interest and reinvest in the stock of another QSBC within 60 days without paying tax on the gain from the original sale. This allows a taxpayer to sell their original QSBC stock and defer gain on the sale until the five-year holding period requirement has been met. Once five years has elapsed from the purchase of the original QSBC stock, the gain on the initial sale will be ultimately excluded from tax. When combined with the new 21 percent tax rate, these benefits can make operating a business as a QSBC more tax-efficient than operating it as a pass-through entity such as a sole proprietorship, partnership, LLC or S corporation.
Challenges continue during this COVID-19 environment, including safety, health and ongoing federal economic stimulus activities, not the least of which is a forthcoming presidential election, which may have a material impact on the tax landscape going forward. Tax planning ideas and potential tax saving moves, despite the current challenges, should never take a back seat. Prompt action is recommended, as planning opportunities abound despite the economic and political environment. As major legislative developments and opportunities emerge, we are always available to discuss the impact of new or pending tax law on your personal or business situation.
For Further Information
If you would like more information about this topic or your own unique situation, please contact Michael A. Gillen, Steven M. Packer, John I. Frederick, any of the practitioners in the Tax Accounting Group or the practitioner with whom you are regularly in contact. For information about other pertinent tax topics, please visit our publications page.
Disclaimer: This Alert has been prepared and published for informational purposes only and is not offered, nor should be construed, as legal advice. For more information, please see the firm's full disclaimer.