It’s Time to Get Started on Your 2020 Taxes
Even though your 2020 tax return will not be due until April 15, 2021, if you wait until after the new year to start thinking about your taxes, it may be too late to take some actions that could reduce your tax bill. This is the time of year to do some serious tax planning.
Tax planning begins with estimating your 2020 taxable income. Your tax advisor should be able to help you, or, if you’re so inclined, there are tax bracket charts and tax estimators available on the internet. The easiest way to start is to dig out your 2019 tax return and run through the figures to see how they have changed in 2020. Some suggestions:
- For investment income and capital gains, you can look at the year-to-date figures on your latest statements (taxable accounts only) and adjust them upwards for the final month or two. If you own any stock mutual funds in your taxable accounts, check your December 2019 statement or your 2019 Form 1099 to see what they paid out in capital gains distributions in 2019 for an idea of what to they might be this year.
- Refer to your latest IRA statement, which reports your total distributions to date, and adjust as needed for the full year.
- If you used the standard deduction last year, you will probably do so again in 2020, unless, for example, you increased your charitable giving or had higher medical expenses.
Once you have estimated your taxable income, you can determine your marginal tax bracket and see how close you are to the top or the bottom of that bracket. If you are near the top, you may want to look for ways to keep from rising into the next bracket; if you are near the bottom, you may look for ways to push your income down into the lower bracket. Also, if you are on Medicare and close to the next premium surcharge bracket, you can look for ways to ways to avoid reaching into it.
If you are in the middle of one of the lower tax brackets, you may want to add some income by converting some Traditional IRA money to a Roth IRA. Remember that current tax rates are historically low and are scheduled to revert back to pre-2018 levels in 2026, so if you can withdraw from your Traditional IRA at a lower tax rate now, you may save future taxation. While some of us have perhaps been conditioned to wait until we have to make minimum required distributions at age 72 (previously, age 70½), that runs the risk of the withdrawals pushing our taxable income into higher tax brackets in the future. If you are already taking RMDs, even though the Cares Act lets you skip your RMD in 2020, it may be a good tax strategy to take money out anyway, and convert it to a Roth IRA, if you do not need the money.
Recent Retirees
People who have recently retired may find that they pay little or no taxes. Although that is an enviable status on the surface, it may not be optimal. If you have sizeable retirement account balances, that means that when you reach age 72, your required minimum distributions (RMDs) could generate a large tax liability, not only because your retirement account balances will be higher and the distributions could push you into a higher tax bracket, but also because tax rates will probably be higher than they are now. It may be better to spread your retirement plan distributions over time so that you stay in the lower tax brackets. Before the end of the year, you could withdraw just enough money from your (non-Roth) retirement accounts to reach the top of the 12% bracket, or even the 22% bracket, depending on your tax situation, and either use that money for living expenses or convert it to a Roth IRA.
Charitable Contributions
Starting in 2020, taxpayers can take a $300 (single)/$600 (joint) charitable deduction even if they use the standard deduction. Also, if you have reached age 70½, you can make a Qualified Charitable Distribution (QCD) of up to $100,000 from your Traditional IRA to a qualified charity. This reduces federal taxable income, like a tax deduction, even if you use the standard deduction. You must move the money directly to the charity from the IRA. If you are already taking RMDs, in place of your 2020 RMD, which you do not need to take, you can withdraw from your IRA anyway, and offset the increase in your taxable income by making a QCD.
Another tax-saving strategy is to bunch charitable deductions in alternate years if it causes your itemized deductions to exceed the standard deduction in those years. For example, if you regularly contribute $10,000 each year, and your total deductions, including your state and local taxes, medical expense deduction, and mortgage interest, fall just short of the standard deduction amount ($12,400 (single)/$24,800 (joint) for 2020; higher if you are over age 65), you can make your 2021 contributions now to bring your itemized deductions above the standard deduction. Then in 2021, you would take the standard deduction.
Retirement Plan Contributions
You have until April 15 to make most IRA and other retirement plan contributions, but if you are self-employed and use a Solo 401(k) or a SIMPLE IRA, any salary reduction contributions must be made no later than 30 days after the end of the salary period, which would fall in January 2021. The employer contribution portion can be delayed until April 15.
Capital Gains and Losses
It is often a good idea to reduce your capital gains for the year by selling securities with capital losses, which can offset the gains or even reduce ordinary income by up to $3,000 in any one year. If you still want to own that security, you can buy it back after 30 days to avoid the wash sale rule, which can disallow the tax loss. But if all of your taxable income falls in the 12% tax bracket and the loss would only offset gains and not ordinary income, your capital gains tax is 0%, so the loss won’t reduce your taxes. However, if your taxable income is in the 12% bracket, you can harvest some gains at a 0% tax, as long as the additional income keeps you in that bracket. And you don’t have to wait 30 days to buy back the security.
Medical Expenses
If you already have substantial medical expenses this year that will bring your itemized deductions close to or above the standard deduction, schedule appointments and procedures or purchase items that will increase your deduction for 2020. Deductible medical expenses are more inclusive than you may think, and include not only premiums, deductibles, co-pays, and prescriptions, but also dental, vision, and even transportation costs. In 2020, you are allowed to deduct total medical expenses in excess of 7.5% of your adjusted gross income.
529 College-Savings Plans
Many states, including Massachusetts, allow a deduction on state tax returns for at least a portion of 529 plans contributions that are made by the end of the calendar year.
Annual Gifts
If your assets are substantial enough to potentially be subject to federal or state estate taxes, consider annual gifting. You can give up to $15,000 per person each year without filing a gift tax return or using any of your lifetime estate tax exemption. Even though the estate tax exemption is over $11 million per person now, after 2025 the exemption will fall back to the $5 million level, unless Congress takes action. Also, some states impose estate taxes, including Massachusetts, where estate tax is applied to assets above $1 million.
About The Author
Anne Christopulos
Anne is a Managing Director and Financial Planner with over twenty years of experience in the financial services industry. After holding corporate management positions in finance and strategic planning in New York City, she moved to Boston to become the Product Manager for the IRA business at Fidelity Investments. Following that, she was Vice President, Retirement Investments, at Fleet Financial Services. A native of Cape Cod, she returned to the Cape in 2001 and made the transition to personal financial planning with Secure Future Financial Services in Dennis and Davis Financial Services in Orleans before joining West Branch Capital. Anne holds a B.A. in music and economics from Wellesley College and an MBA from Harvard Business School.
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