December 8, 2020
Tax Issues to Be Aware of as Year-end Approaches
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Take Full Advantage of Your Deductions – Individuals can itemize their deductions or take the standard deduction, which is $12,400 for singles and married couples filing separate returns, $24,800 for married couples filing jointly, and $18,650 for those filing as heads of household. Because of the COVID-19 pandemic, some people have seen substantial reductions in their income, possibly so much so that their income may be less than their deductions, meaning they will not be taking full advantage of their deductions.
If you fall into that category, you should review your resources to determine if you have opportunities to increase your 2020 income to take full advantage of your deductions and cash in some income tax-free states. For example, you might be able to sell profitable stocks, withdraw funds from taxable retirement accounts (but only after age 59½ to avoid a penalty), or even exercise a stock option.
Traditional IRA Contributions at Any Age – The SECURE Act passed by Congress a little over a year ago removed the age restriction on making traditional IRA contributions beginning in 2020. Thus, taxpayers who are 70½ or older and still working are no longer prohibited from contributing to a traditional IRA. However, the contribution is still limited to earned income (income from working). Traditional IRAs are tax deductible, so consider whether you would gain any benefit from making a contribution for 2020. Plus, if you are not sure, you can defer the decision up to April 15, 2021 and still qualify for a 2020 tax deduction.
Make Charitable Contributions with IRA Funds – If you are age 70½ or over and have an IRA, you can have your IRA trustee transfer IRA funds (up to $100,000) directly to a charity or charities of your choosing. Although the donation will not be tax deductible, the distribution will not be taxable either, giving you an opportunity to help your favorite charity or charities with untaxed funds in this time of need. Caution—the donation must be transferred directly from the IRA account to the charity; it cannot pass through your hands or it will be taxable.
Larger-Than-Normal Charitable Contributions Are Possible – For those of substantial means, be aware that for 2020 donations, the income (AGI) limit on cash charitable contributions has been increased from the normal amount of 60% to 100% as a way to stimulate more contributions in light of the needs brought about by COVID. Donations of property (used furniture and clothing, for example) are not eligible for this enhanced deduction.
Deducting Charitable Contributions Without Itemizing – Charitable contributions are allowed as a tax deduction if you itemize your deductions. However, for 2020 only, taxpayers can deduct up to $300 of cash charitable contributions even when they are claiming the standard deduction.
If you usually claim the standard deduction, you may not be familiar with the documentation rules for charitable contributions, so here’s a brief rundown. Donations to qualified organizations need to be made by December 31 to be deductible on your 2020 return. For cash contributions (gifts paid by cash, check, electronic funds transfer, or credit card), you cannot claim a tax deduction, regardless of the amount, unless you have a bank record (canceled check, bank or credit union statement, or a credit card statement) showing the name of the qualified organization, the contribution date, and the amount of the contribution. A receipt (or a letter or other written communication) from the qualified organization showing the name of the organization, the date of the contribution, and the amount of the contribution can be substituted for a bank record.
To claim a deduction for a contribution of $250 or more, you must have a written acknowledgment of the contribution from the qualified organization that includes the following details:
If you are in the process of divorcing but the divorce isn’t final by December 31, the options for 2020 are for you and your spouse to file jointly or for you each to submit a return using the married filing separate status. There is an exception to this rule if a couple has been separated for all of the last 6 months of the year and one spouse has paid more than half the cost of maintaining a household for a qualified child. In that situation, that spouse can use the more favorable head of household filing status. If each spouse meets the criteria for that exception, they can both file using the head of household status; otherwise, the spouse who doesn’t qualify will need to use the status of married filing separately.
Filing a joint return often results in less tax overall than filing two married separate returns, but when a joint return is filed, each spouse assumes liability for the full amount of the tax. This factor needs to be taken into account when determining the filing status of a married couple, especially when a divorce is in process or being contemplated.
If your divorce has been finalized and you haven’t remarried, your filing status will be single or, if you meet the requirements, head of household.
Maximize 2020 Education Tax Credits – Both the lifetime learning education credit and the American opportunity credit allow qualified taxpayers to prepay 2021 college tuition bills for an academic period that begins by the end of March 2021. That means that if you are eligible to take the credit and you have not yet reached the 2020 maximum for qualified tuition and related expenses paid, you can bump up your 2020 credits by paying for 2021 now. This may not apply to you if you’ve been paying tuition expenses for the entire 2020 tax year, but if your child just started college this fall, it will probably provide you with some additional tax credit for 2020.
If you are a grandparent, you may be paying all or part of the tuition for a grandchild, and if the child’s parents are claiming the child as a dependent, then the parents receive the education credit if not phased out by the high-income limitation. If the payment is made directly to the college, there are no gift tax issues. So, the grandparent makes two gifts—tuition for the student and the tax credit to the student’s parents.
Convert Your Traditional IRA into a Roth IRA - By converting a traditional IRA into a Roth IRA, taxpayers whose incomes have been very low in 2020 may be able to move the assets currently in their traditional IRA into a Roth IRA at a much lower tax rate. Any amount can be converted, and with a little planning, the conversion tax can be low or even zero. To take advantage of this opportunity, the conversion must be made before year end, and it is irrevocable.
Remember the Annual Gift Tax Exemption – One of the best ways to reduce your taxes while giving to those you love is to take advantage of the annual gift tax exemption. Though the gifts are not tax deductible, for tax year 2020, you are able to give $15,000 each to as many people as you want without having to pay any gift tax. If you want to do this, make sure that you do so by the end of the year, as you are not able to carry the $15,000 over into 2021.
Medical Expenses – If you itemize your deductions, you are able to deduct unreimbursed medical expenses in excess of 7½ percent of your income (AGI). If you have reached that threshold or are close, it may make sense for you to pay off medical bills that are still outstanding rather than paying them over time.
If you are near or above the deduction limit, it may also make sense to look at what your expenses will be for the next year and move those that you can into 2020 to increase the deduction. These expenses could include dental work or eyeglasses. Beware—if you are thinking of paying for those expenses using a credit card and you’re not going to pay the balance immediately, make sure that you’re not paying more in interest than you’re saving with the increased deduction. Medical expenses charged to a credit card are counted toward your medical deduction for the year the expense was charged to the card, not as the balance on the card is paid off.
Property Taxes – If you itemize your deductions, certain taxes are included as deductions on your federal return. Although it used to make sense to maximize your tax deduction by prepaying part of your real property taxes for the subsequent year, be aware that the total itemized deductions for state and local taxes in a year are now limited to $10,000. That limit includes state income tax, if your state has an income tax, or if not, then state sales tax. So, depending on the amount of state income or sales tax you’ve already paid during the year, it may not be beneficial to prepay property taxes.
Manage Your Stock Portfolio – In a normal tax year, if you have stocks that have declined in value, you may wish to sell them before the end of the year and use the loss to offset other capital gains for the year or to produce a deductible loss. The net capital loss on a tax return that can be used to offset other types of income is limited to $3,000 for the year, but any excess loss carries over to future years. You can repurchase the stocks you sold at a loss after 30 days have passed and avoid the wash sale rules that prohibit a loss from being claimed when you repurchase the same or similar stock right away. However, for 2020 (and depending on your overall situation), you may find yourself in a lower-than-normal tax bracket, and it actually may be beneficial to take stock gains rather than losses.
Also, be aware of the 0% income tax rate on long-term capital gains and qualified dividends from securities held other than retirement accounts. Yes, you could pay zero tax on long-term capital gains and qualified dividends if your taxable income is $40,000 or less. The upper limit for a married couple filing a joint return is $80,000, while it is $53,600 for those filing as head of household.
Every taxpayer’s situation is unique, and the suggestions offered here may not apply to you. The best way to ensure that you are putting yourself into an advantageous position is to contact this office for advice related to any of the issues discussed in this article.
- Take Full Advantage of Your Deductions
- Traditional IRA Contributions at Any Age
- Make Charitable Contributions with IRA Funds
- Larger-than-Normal Charitable Contributions May Be Possible
- Deducting Charitable Contributions Without Itemizing
- Marital Status
- Maximize 2020 Education Tax Credits
- Convert Your Traditional IRA into a Roth IRA
- Remember the Annual Gift Tax Exemption
- Medical Expenses
- Property Taxes
- Manage Your Stock Portfolio
Take Full Advantage of Your Deductions – Individuals can itemize their deductions or take the standard deduction, which is $12,400 for singles and married couples filing separate returns, $24,800 for married couples filing jointly, and $18,650 for those filing as heads of household. Because of the COVID-19 pandemic, some people have seen substantial reductions in their income, possibly so much so that their income may be less than their deductions, meaning they will not be taking full advantage of their deductions.
If you fall into that category, you should review your resources to determine if you have opportunities to increase your 2020 income to take full advantage of your deductions and cash in some income tax-free states. For example, you might be able to sell profitable stocks, withdraw funds from taxable retirement accounts (but only after age 59½ to avoid a penalty), or even exercise a stock option.
Traditional IRA Contributions at Any Age – The SECURE Act passed by Congress a little over a year ago removed the age restriction on making traditional IRA contributions beginning in 2020. Thus, taxpayers who are 70½ or older and still working are no longer prohibited from contributing to a traditional IRA. However, the contribution is still limited to earned income (income from working). Traditional IRAs are tax deductible, so consider whether you would gain any benefit from making a contribution for 2020. Plus, if you are not sure, you can defer the decision up to April 15, 2021 and still qualify for a 2020 tax deduction.
Make Charitable Contributions with IRA Funds – If you are age 70½ or over and have an IRA, you can have your IRA trustee transfer IRA funds (up to $100,000) directly to a charity or charities of your choosing. Although the donation will not be tax deductible, the distribution will not be taxable either, giving you an opportunity to help your favorite charity or charities with untaxed funds in this time of need. Caution—the donation must be transferred directly from the IRA account to the charity; it cannot pass through your hands or it will be taxable.
Larger-Than-Normal Charitable Contributions Are Possible – For those of substantial means, be aware that for 2020 donations, the income (AGI) limit on cash charitable contributions has been increased from the normal amount of 60% to 100% as a way to stimulate more contributions in light of the needs brought about by COVID. Donations of property (used furniture and clothing, for example) are not eligible for this enhanced deduction.
Deducting Charitable Contributions Without Itemizing – Charitable contributions are allowed as a tax deduction if you itemize your deductions. However, for 2020 only, taxpayers can deduct up to $300 of cash charitable contributions even when they are claiming the standard deduction.
If you usually claim the standard deduction, you may not be familiar with the documentation rules for charitable contributions, so here’s a brief rundown. Donations to qualified organizations need to be made by December 31 to be deductible on your 2020 return. For cash contributions (gifts paid by cash, check, electronic funds transfer, or credit card), you cannot claim a tax deduction, regardless of the amount, unless you have a bank record (canceled check, bank or credit union statement, or a credit card statement) showing the name of the qualified organization, the contribution date, and the amount of the contribution. A receipt (or a letter or other written communication) from the qualified organization showing the name of the organization, the date of the contribution, and the amount of the contribution can be substituted for a bank record.
To claim a deduction for a contribution of $250 or more, you must have a written acknowledgment of the contribution from the qualified organization that includes the following details:
- The amount of cash contributed;
- Whether the qualified organization gave you goods or services (other than certain token items and membership benefits) as a result of the contribution and a description and good-faith estimate of the value of any goods or services that were provided (other than intangible religious benefits); and
- A statement that the only benefit received was an intangible religious benefit, if that was the case.
If you are in the process of divorcing but the divorce isn’t final by December 31, the options for 2020 are for you and your spouse to file jointly or for you each to submit a return using the married filing separate status. There is an exception to this rule if a couple has been separated for all of the last 6 months of the year and one spouse has paid more than half the cost of maintaining a household for a qualified child. In that situation, that spouse can use the more favorable head of household filing status. If each spouse meets the criteria for that exception, they can both file using the head of household status; otherwise, the spouse who doesn’t qualify will need to use the status of married filing separately.
Filing a joint return often results in less tax overall than filing two married separate returns, but when a joint return is filed, each spouse assumes liability for the full amount of the tax. This factor needs to be taken into account when determining the filing status of a married couple, especially when a divorce is in process or being contemplated.
If your divorce has been finalized and you haven’t remarried, your filing status will be single or, if you meet the requirements, head of household.
Maximize 2020 Education Tax Credits – Both the lifetime learning education credit and the American opportunity credit allow qualified taxpayers to prepay 2021 college tuition bills for an academic period that begins by the end of March 2021. That means that if you are eligible to take the credit and you have not yet reached the 2020 maximum for qualified tuition and related expenses paid, you can bump up your 2020 credits by paying for 2021 now. This may not apply to you if you’ve been paying tuition expenses for the entire 2020 tax year, but if your child just started college this fall, it will probably provide you with some additional tax credit for 2020.
If you are a grandparent, you may be paying all or part of the tuition for a grandchild, and if the child’s parents are claiming the child as a dependent, then the parents receive the education credit if not phased out by the high-income limitation. If the payment is made directly to the college, there are no gift tax issues. So, the grandparent makes two gifts—tuition for the student and the tax credit to the student’s parents.
Convert Your Traditional IRA into a Roth IRA - By converting a traditional IRA into a Roth IRA, taxpayers whose incomes have been very low in 2020 may be able to move the assets currently in their traditional IRA into a Roth IRA at a much lower tax rate. Any amount can be converted, and with a little planning, the conversion tax can be low or even zero. To take advantage of this opportunity, the conversion must be made before year end, and it is irrevocable.
Remember the Annual Gift Tax Exemption – One of the best ways to reduce your taxes while giving to those you love is to take advantage of the annual gift tax exemption. Though the gifts are not tax deductible, for tax year 2020, you are able to give $15,000 each to as many people as you want without having to pay any gift tax. If you want to do this, make sure that you do so by the end of the year, as you are not able to carry the $15,000 over into 2021.
Medical Expenses – If you itemize your deductions, you are able to deduct unreimbursed medical expenses in excess of 7½ percent of your income (AGI). If you have reached that threshold or are close, it may make sense for you to pay off medical bills that are still outstanding rather than paying them over time.
If you are near or above the deduction limit, it may also make sense to look at what your expenses will be for the next year and move those that you can into 2020 to increase the deduction. These expenses could include dental work or eyeglasses. Beware—if you are thinking of paying for those expenses using a credit card and you’re not going to pay the balance immediately, make sure that you’re not paying more in interest than you’re saving with the increased deduction. Medical expenses charged to a credit card are counted toward your medical deduction for the year the expense was charged to the card, not as the balance on the card is paid off.
Property Taxes – If you itemize your deductions, certain taxes are included as deductions on your federal return. Although it used to make sense to maximize your tax deduction by prepaying part of your real property taxes for the subsequent year, be aware that the total itemized deductions for state and local taxes in a year are now limited to $10,000. That limit includes state income tax, if your state has an income tax, or if not, then state sales tax. So, depending on the amount of state income or sales tax you’ve already paid during the year, it may not be beneficial to prepay property taxes.
Manage Your Stock Portfolio – In a normal tax year, if you have stocks that have declined in value, you may wish to sell them before the end of the year and use the loss to offset other capital gains for the year or to produce a deductible loss. The net capital loss on a tax return that can be used to offset other types of income is limited to $3,000 for the year, but any excess loss carries over to future years. You can repurchase the stocks you sold at a loss after 30 days have passed and avoid the wash sale rules that prohibit a loss from being claimed when you repurchase the same or similar stock right away. However, for 2020 (and depending on your overall situation), you may find yourself in a lower-than-normal tax bracket, and it actually may be beneficial to take stock gains rather than losses.
Also, be aware of the 0% income tax rate on long-term capital gains and qualified dividends from securities held other than retirement accounts. Yes, you could pay zero tax on long-term capital gains and qualified dividends if your taxable income is $40,000 or less. The upper limit for a married couple filing a joint return is $80,000, while it is $53,600 for those filing as head of household.
Every taxpayer’s situation is unique, and the suggestions offered here may not apply to you. The best way to ensure that you are putting yourself into an advantageous position is to contact this office for advice related to any of the issues discussed in this article.
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