As we anticipate the final quarter of 2020, this has certainly been an unusual year in many, many respects. Two substantial laws were signed into law that impacted the taxes of nearly every American: The SECURE Act and the CARES Act.
Between the implementation of these two laws and existing rules already in place, there are several tax-saving strategies that come to mind which families should consider taking advantage of before the end of the year.
1. Consider “bunching” your charitable contributions
The Tax Cuts and Jobs Act in 2017 doubled the standard deduction for individuals and families. By doing so, itemizing deductions became less valuable. Most families don’t often have itemized expenses that exceed the standard deduction.
Families that are charitably inclined (such as those who pay a tithe to their church or regularly contribute to one or several charitable causes) felt the sting in particular. But there is a smart way to boost the tax-saving potential of your charitable contributions. It’s called bunching.
By combining charitable contributions into certain years, some donors can increase the tax-impact of those donated dollars by ensuring the donations exceed the standard deduction ($24,800 in 2020 for all married filing jointly families) at least every other year. Any time your itemized deductions exceed your standard deduction, then you save more tax dollars.
Example 1
Jack and Jill Smith make regular donations to their church of 10% of their $120,000 income in 2020 ($12,000 per year). The Smiths have another $10,000 of itemizable deductions between health-related expenses, property tax, and state income or sales taxes, making $22,000 in total itemizable deductions.
For the Smiths, this means their itemized deduction will NEVER exceed their standard deduction! In a sense, those deductible expenses are lost.
However, if the Smiths “bunch” their charitable contributions for both 2020 and 2021 into the 2020 tax year, their itemized deductions will now EXCEED their standard deduction ($12,000 + $12,000 + $10,000 = $34,000) for 2020. Every deductible dollar ABOVE the standard deduction of $24,800 in 2020 will reduce their taxable income.
2. Sell losing investments
Everyone wants their investments to perform well, but sometimes it makes sense to part with the losers. The IRS provides an incentive to do so.
Up to $3,000 of investment losses can offset ordinary or investment income for 2020, if those losses occur before the end of 2020. Any losses exceeding $3,000 can be carried over to future years for as long as you live.
Example 1
Mike Jones has a brokerage account with a stock that has performed very poorly. Mike’s income in 2020 is $75,000. If Mike sells the stock today, he will generate a $5,000 loss.
Mike can use up to $3,000 of that loss to offset his income, lowering it to $72,000, and lowering his taxes overall. The remaining loss of $2,000 can be carried over indefinitely to offset income earned in future years.
Example 2
Mike Jones has a brokerage account with two stocks, one winner and one loser. He would like to sell his stocks to diversify his portfolio across a variety of mutual funds. Selling the winner stock will result in a $2,000 capital gain, selling the loser stock will result in a $3,000 capital loss.
By selling both investments, Mike will have net capital loss of $1,000 (-$3,000 + $2,000). The capital gain is not taxable due to Mike’s capital loss, and the remaining $1,000 loss can offset his earned income.
3. Increase business-related expenses
The majority of US small businesses follow cash-based accounting rules. This means income and expenses are recognized when earned money is received or spent money is delivered.
In this light, business owners looking to lower their 2020 taxes are incentivized to rack up as many reasonable expenses as they can before the end of the year.
This doesn’t mean you should just spend money frivolously to lower your tax bill, but if the decision to make an important business-related purchase is between buying in December 2020 or January 2021, buy it in December.
There are other recurring expenses that can be “accelerated” to 2020. 4th quarter estimated income tax payments (typically due January 15th) can be made in December. Property tax bills typically due in 2021 can be accelerated as well.
Of course, this could DECREASE your business expenses in 2021, so you’ll want to be thoughtful about when it makes the most sense to accelerate business expenses. The best case for doing so? You reasonably expect to earn more business income in 2020 compared to 2021.
4. Skip your 2020 RMDs
The CARES Act allows required minimum distributions (RMDs) in 2020 to be skipped, which typically need to occur before December 31st. This means seniors over age 70 ½ with Traditional IRAs, 401ks and other tax-deferred retirement accounts can pass on these required distributions, resulting in lower earned income in 2020 and less taxes paid.
In addition, skipping RMDs for 2020 gives your investments a little extra time to grow tax-deferred until your 2021 RMDs roll around. This RMD skipping rule for 2020 applies to Inherited IRAs as well.
(Note: Speaking of retirement accounts, remember that most retirement account contributions for 2020 can occur as late as April 15 2021. In this case, you shouldn’t feel rushed to get those dollars into your retirement accounts before the end of the year.)
5. Work with a financial advisor
Tax planning is one of the most complicated aspects of financial planning, and one of the biggest opportunities to realize real dollars saved year after year. Hiring a fee-only financial advisor to explore tax-saving options can provide a lot of value, as long as tax reduction strategies are within the confines of the law (Remember, tax avoidance is good; tax evasion means jail time.)
Good financial advisors will take tax planning a step further by coordinating with your tax accountant and possibly your attorney as well. In this way, they can fill the role of your “financial quarterback” where they know your whole financial picture--the strong and weak points--and can help coordinate the effort.
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I hope this article has been helpful. The final months of the year present an excellent time to consider tax-saving strategies you may want to take. In our experience, the best tax planning occurs much earlier in the year, but the next best time is now.