Amid a great deal of uncertainty in 2020 due to the ongoing coronavirus pandemic, we find ourselves once again navigating uncertain waters as it relates to tax planning for tax year 2021.
As this challenging and unprecedented year comes to a close, there is still a small window of time to take stock of your tax situation and make some tax-advantageous moves for tax year 2020 and beyond.
Given the magnitude of coronavirus-related legislation enacted in 2020, there are several provisions still available that may apply to your unique tax situation:
Waiver of 2020 Required Minimum Distributions
Under the Coronavirus Aid, Relief and Economic Security Act (CARES Act), required minimum distributions (RMDs) have been waived for tax year 2020 for both IRAs and qualified plans. This provision has been a welcome relief for taxpayers who would have been required to take RMDs based on inflated December 2019 values.
Planning Pointer » While you are not required to take a 2020 RMD, you may still wish to take a taxable distribution to fund living expenses or take advantage of tax planning opportunities, such as maximizing the amount of income taxed in the lower tax brackets. Any distributions skipped in 2020 could potentially increase future RMDs and the related tax liability. Converting tax-deferred funds from an IRA or qualified plan to a Roth IRA is also a worthy consideration.
Planning Pointer » Qualified Charitable Distributions (QCDs) are still allowed for 2020 if an account owner wishes to satisfy their charitable giving with IRA money in a tax-free manner. The $100,000 limit per year, per taxpayer still applies for funds donated directly to charity from an IRA.
Under the CARES Act, distributions up to $100,000 can be taken from IRAs and/or qualified plans during 2020, so long as the individual account holder has been impacted by the coronavirus, either financially or in a health-related event. Several key benefits should be considered when taking a coronavirus-related distribution:
- 10% early withdrawal penalty has been waived for taxpayers who are under age 59 ½.
- Taxable income generated from the distribution can be spread over 3 tax years in 2020, 2021, and 2022; however, a taxpayer can elect to include all of the income on his or her 2020 tax return.
- Funds can be repaid to the IRA or qualified plan within 3 years. Any or full or partial repayments would require amending previously-filed tax returns to claim back any tax previously paid on the distributions.
- Under the CARES Act, employer-sponsored retirement plans also have the ability to relax plan rules relating to loans taken by plan participants against their vested plan balance.
Planning Pointer » Consideration should be given to your 2020 tax bracket versus possible future tax brackets as it may be wise to tax the entire coronavirus-related distribution in tax year 2020 rather than spreading over -three tax years, if you expect your tax rate to rise in the future.
Charitable Giving Relief
In order to spur charitable giving in 2020, the CARES Act included several charitable-related tax incentives. Additionally, the newly-passed “Consolidated Appropriations Act, 2021” has provided further relief:
- New $300 “above-the-line” charitable deduction for cash donations made during 2020 ($600 for married couples in tax year 2021 only). This provision is only available to taxpayers who do not itemize deductions. The donations must be made in cash to a public charity during 2020 or 2021 and cannot be made to a donor-advised fund or “supporting organization”.
- The 60% AGI limit for deducting cash charitable contributions during 2020 and 2021 has been temporarily suspended. A taxpayer can therefore give up to 100% of his or her adjusted gross income, with any excess carrying forward for up to 5 years. Similar to the new $300 charitable deduction, the donations must be made in cash and cannot be made to a donor-advised fund or supporting organization.
Planning Pointer » Due to the suspension of the 60% AGI limit on cash donations, it is an opportune time to consider making large charitable gifts of cash out of IRAs for charitably-inclined taxpayers. Generally, the 60% AGI limit creates a tax barrier to donating cash from IRAs (for those not using the QCD rules) because it does not provide a complete offset deduction to the taxable income created by the IRA distribution. However, under the temporary suspension of the 60% AGI limit, unlimited amounts of IRA money can be cashed out, then donated to charity and taken as an itemized deduction to fully offset taxable income. Any excess unused charitable deduction would be carried forward for up to 5 years.
Planning Pointer » Donors with securities that have declined in market value (below cost basis) may wish to harvest capital losses by selling off the securities and then donating the cash, rather than donating the security to charity “in kind”.
As we look towards the upcoming 2021 tax season, there are several important reminders that you should consider:
“Economic Impact” Stimulus Payments
During the initial round of stimulus funding, you may have received a full or partial $1,200 stimulus payment, per person, during 2020 due to the ongoing coronavirus pandemic, in an effort for the Federal government to stimulate the economy and support its’ citizens financially. You may also have received an additional $500 per qualifying child.
These stimulus payments are not taxable income and should not be reported as such on your 2020 income tax return (due April 15, 2021). You should retain Notice 1444 that you received in the mail to aid in the preparation of your 2020 tax return and to help calculate any “Recovery Rebate Credit” that you may be owed, if you did not receive the full amount of stimulus payment due to you.
Additionally, under the newly-passed “Consolidated Appropriations Act, 2021”, a second round of stimulus payments in the amount of $600 per person ($1,200 per married couple) will be forthcoming, subject to income phase-outs. Each qualifying dependent child will also receive $600. These additional stimulus funds will be rectified, if needed, on 2020 individual income tax returns.
Taxpayers who received a refund in 2020 from their 2019 Federal income tax return may have also received an interest payment from the IRS. Unlike the stimulus payments, any interest you received is taxable and should be reported on your 2020 tax return. Most interest payments were received separately from tax refunds sent by the IRS. In January 2021, the IRS will send a 2020 Form 1099-INT to anyone who received interest income totaling more than $10.
Withholding & Estimated Tax Payments
As we near year-end, you should always double-check that the amount of tax being withheld from wages or retirement income is sufficient to meet your year-end tax liability. Withholding a sufficient amount of tax throughout the year will help avoid a large balance due at tax time, as well as avoid underpayment penalties and interest.
Additionally, if you earn income that is not subject to withholding – such as income from self-employment or rental properties – you should ensure that your quarterly estimated tax payments for both Federal and state have met the “safe harbor” requirements for avoiding underpayment penalties and interest. The deadline for making 4th quarter estimated tax payments is January 15, 2021.
If you recently moved, confirm your new address with your employer, bank, and financial institutions to avoid delays in receiving year-end statements and tax documents.
Year-End Tax Planning Moves
There are several tried-and-true income tax planning moves that tax advisors and financial planners generally recommend as we near year-end. Given the uncertain outcome of future tax increases or tax reform under President-elect Joe Biden, the path for year-end tax planning for 2020 is not as clear cut. It is important to discuss these planning ideas with your team of advisors to find the solution that works best for your unique tax situation. A few favorite tax planning ideas to consider are listed below:
Accelerate Income and Defer Deductions. Maybe.
Generally, it is recommended to accelerate income and delay deductions if you believe that your tax rate will increase in the future. As mentioned above, the future of tax rate increases is unclear; however, it is likely that they will not be reduced below the current rates. It may make sense to intentionally trigger taxable income in 2020 in order to pay lower income taxes now versus potentially higher rates in the future. One way this can be accomplished is by performing Roth IRA conversions from tax-deferred IRAs or qualified retirement plans – but keep in mind that “re-characterizations” are no longer allowed, and these transactions cannot be undone if you change your mind.
Potential 28% Cap on Itemized Deductions
If you do decide to delay deductions, please keep in mind that President-elect Biden has mentioned imposing a 28% cap on itemized deductions for higher income taxpayers. This could affect your ability to take full advantage of your itemized deductions in the future. However, it is still a smart move to defer any deductions that would NOT be usable in 2020, such as state and local income taxes that fall above the $10,000 limit.
An Eye on the Future
With the hope of a fresh year upon us, it is important to keep an eye towards the future. Several newer tax-related provisions will take effect soon:
- Life expectancy tables for calculating RMDs have been updated to reflect longer life expectancies, which results in (slightly) smaller RMD amounts. These changes do not take effect until 2022.
- RMD beginning date has been increased from age 70 ½ to age 72, starting with tax year 2020.
- The beloved “stretch” IRA has been severely diminished under the SECURE Act, particularly for those IRA owners who have named a trust as their IRA beneficiary. We urge you to revisit your beneficiary designations to ensure that you have taken the SECURE Act implications into account.
- New Form 1099-NEC will replace the use of Form 1099-MISC for non-employee compensation for tax year 2020 and beyond. If you are an independent contractor, keep an eye out for this new tax form in order to prepare your 2020 tax return.
- With the uncertain political climate hanging in the balance, now is a great time to review your estate, trust and gift plans with your team of advisors. Future potential income and estate tax increases, coupled with a potential decrease in the lifetime estate tax exemption, could create complicated estate planning issues for high net worth individuals.
Tax Season 2021 – Will the IRS be ready?
As we approach the upcoming tax season, many taxpayers are wary of dealing with the IRS. According to the IRS website, which provides updates on their “mission critical” status, it is evident that they are unfortunately still playing catch-up due to COVID understaffing and service center closures. Most recently, the IRS issued an update stating that close to 10 million tax returns (and related refunds) remain unprocessed. If there is anything that 2020 has taught us, especially as it relates to the IRS, it is this:
- Be patient. Unfortunately in many cases a “wait and see” approach is the best (and only!) option.
- File early. If you are anxious to file your 2020 tax return and receive your refund, it is wise to gather your tax documents early and submit your tax return quickly after all of your tax documents are available. As a reminder, many 1099 tax forms are not available until mid-to-late February or early March due to mutual fund “factoring” that must take place before the forms can be issued by financial institutions.
- Don’t fret if you receive a tax notice or two. Because of the numerous changes the IRS systems have endured due to CARES Act and SECURE Act legislation in 2020, we have seen many more tax notices than is typical. In many cases, they are incorrect or have crossed in the mail with unprocessed tax payments. Before you take action or make payment, have your tax advisor review the tax notice and provide guidance. In most cases, a written response or phone call to the IRS will resolve the issue.
- Extended tax season? Many taxpayers and their tax advisors are curious about whether the upcoming tax season will be extended due to the ongoing coronavirus pandemic, similar to the July 15th extension for the 2020 tax season. At this point, no word of an extension has been announced and the deadline stands at Thursday, April 15, 2021.
THE BOTTOM LINE
Spending some time planning for the end of 2020 and upcoming 2021 tax year is time well spent, especially given the magnitude of new tax-related provisions handed down in the SECURE Act and CARES Act.
The Central Trust Company team is ready to assist you with any questions that you may have.
We wish you safe, happy holiday and a prosperous New Year!