Clearly, 2020 has been a year unlike any other. The coronavirus pandemic and its impact on health and the economy has forced a lot of people to reassess their priorities and the financial life decisions tied to them. For some that means establishing or replenishing an emergency fund. For others it may mean a closer review of their estate plan. For many, though, the end of 2020 presents an opportunity to consider what may be done from an income tax perspective to make the best of a difficult year.
My hope is that a broad discussion of planning considerations will provide a roadmap for discussions with your advisor as we move into the fourth quarter of 2020. Of course another important event – the presidential election – will occur in early November, so the end of 2020 will only come with more uncertainty as to what tax rules will look like in 2021.
Is this the year to jump on low tax brackets?
At this point, we don’t yet know who the president will be for the next four years and what party will control the House and Senate for at least the next two years. We do know that we currently have some of the lowest federal income tax brackets we have seen for some time, and perhaps will see for the foreseeable future. Traditional tax planning has always focused on deferring income as long as possible. This may be the year to end such deferrals and take advantage of the low 2020 tax rates to recognize income. This can take many forms. Maybe the best example is a Roth conversion. Realizing capital gains is another consideration. For those over age 70½ or age 72, and with no required minimum distributions (RMDs) in 2020, income may be lower than normal this year. Don’t miss the chance to pay tax on income at lower rates. For those who suffered a decline in wages or earnings, the same may hold true; recognizing more taxable income now may better allow you to take advantage of today’s low tax brackets. Those who received unemployment benefits, which were enhanced under the March 2020 CARES Act, may not have had any income tax withheld, but the benefits are 100% taxable regardless. Check to see if making an estimated tax payment will help to reduce or eliminate tax penalties.
Creating more taxable income in 2020 is not a one-size-fits-all recommendation. There are so many ripple effects to consider when increasing income. However, it would still be disappointing for your tax preparer to tell you in April 2021 that it’s a shame you didn’t have more income to make the most of low tax brackets in a year with numerous one-off planning opportunities. Start talking to your financial advisor and tax preparer today to model your 2020 tax return and compare it to what you expect your tax rates to be in the future.
The giving side of things
A substantial amount of charitable giving occurs in the fourth quarter of every year. The CARES Act changed rules for charitable deductions for 2020. Cash contributions were previously limited to 60% of Adjusted Gross Income (AGI), but this year that cap was raised to 100%. Even so, someone with strong charitable intent and financial means may still not want to give 100% of their AGI because some of their charitable gift would only provide a tax benefit at the lowest tax rates and the standard deduction would be wasted. It’s probably better to work with your financial advisor to develop a long-term charitable giving strategy that will satisfy your charitable goals while maximizing the income tax benefit. Should those over age 70½ and allowed to make Qualified Charitable Distributions (QCDs) from IRAs continue to do so in 2020? Any QCDs made in 2020 will not reduce taxable RMDs, because there are none this year. If some or all of what would typically be given to charity in 2020 using a QCD is postponed and given in 2021, then 2021 taxable RMDs will be lowered and 2021 AGI and taxable income will be lower as a result. This may help reduce future Medicare Part B & D premiums, as well as allow those 2021 QCDs to offset higher taxed income.
Looking ahead to future estate taxes
Federal estate taxes are something many people do not have to worry about. The current estate tax exclusion is $11,580,000 per person. That means a couple can shelter just over $23 million of transfers during their lifetime or at death. The question is what the estate tax exclusion will be in the future. Under current law, the exclusion will decrease by 50% on Jan. 1, 2026. Reducing the exclusion more than 50% and sooner than 2026 has come up on the presidential campaign trail. This year presents an opportunity to review your estate plan with your advisor and estate attorney to determine if your circumstances warrant implementing strategies to take advantage of the law we know exists through the end of 2020 but whose future is uncertain.
The best tax planning is not a once-a-year event, because occasions may arise at any time to reduce the impact of taxes, not just for the current year but longer term as well. The temptation, of course, is to always minimize this year’s taxes when doing so may result in an even higher tax burden in the future. So, when you next sit down to look at your year-end tax picture, keep in mind that the right way to view tax planning decisions is in terms of your lifetime and legacy beyond that.