2020 Year-End Tax Planning Letter
To Our Clients and Friends:
2020 has been quite a challenge, to say the least. The COVID-19 crisis brought massive unemployment, business closures, and an enormous amount of uncertainty. All of this has made 2020 seem like the year that never ends, while most of us can’t wait for it to be over. As we approach the end of the year, it’s time to discuss steps that can be taken to help reduce your 2020 tax bill.
The past 12 months have seen several major tax law changes. In response to the COVID-19 emergency, the Coronavirus Aid, Relief, and Economic Security (CARES) Act was signed into law in March. In addition, the Taxpayer Certainty and Disaster Tax Relief Act (Disaster Act) and the Setting Every Community Up for Retirement Enhancement (SECURE) Act were passed in December 2019. The Disaster Act extended many beneficial provisions that had expired or were set to expire. Barring additional extenders, many of these will expire again at the end of the year. The SECURE Act, on the other hand, made significant changes to the retirement rules. We’ll highlight planning techniques stemming from these recent bills, as well as other year-end planning ideas.
Under a Joe Biden presidency, some version of tax reform is possible in the future depending on which party controls the Senate. It’s also possible that we’ll see additional COVID-19 legislation in the weeks ahead. As always, we’re paying close attention to the ever-changing tax environment to discover tax planning opportunities.
Year-end Planning Moves for Individuals
Take Advantage of Generous Standard Deduction Allowances. For 2020, the standard deduction amounts are $12,400 for singles and those who use married filing separate status, $24,800 for married joint filing couples, and $18,650 for heads of household. As discussed in our 2019 year-end tax planning letter, due to the increased standard deduction and the $10K limit on itemized deductions for taxes (property/income tax, etc.), less people are able to itemize their deductions.
If your total annual itemizable deductions for 2020 will be close to your standard deduction amount, consider making additional, deductible expenditures before year-end to exceed your standard deduction. That will lower this year’s tax bill. Next year, you can claim the standard deduction, which will be increased a bit to account for inflation. To do this, consider the following:
NEW: The CARES Act offers two unique opportunities for charitable minded taxpayers in 2020. Individuals who don’t itemize will be allowed an “above the line” deduction of up to $300 in 2020. For those who do itemize, the CARES Act increases the limit on charitable deductions to 100% of the individual’s Adjusted Gross Income (AGI) for cash contributions made to public charities in 2020. (Note there is no requirement that the contributions be related to COVID-19).
If your standard deduction is still greater than your total itemized deductions, and you are over 70 ½, you may still make a direct contribution to a charity from their IRA of up to $100,000 in 2020 and thereby reduce your adjusted gross income for both federal and state.
Cancellation of Debt (COD) Relief. Individuals can exclude up to $2 million ($1 million if not married filing jointly) of COD income from qualified principal residence indebtedness that is cancelled in 2020 because of their financial condition or decline in value of the residence. Debt cancelled after 12/31/20 still qualifies for exclusion, but only if discharged pursuant to a written binding agreement entered into prior to 1/1/21.
Traditional IRA Contributions over Age 70 1/2. The SECURE Act removed the age restriction on making traditional IRA contributions. Individuals over the age of 70½ who are still working in 2020 are no longer prohibited from contributing to a traditional IRA. However, if you’re over age 70½ and considering making a charitable donation directly from your IRA (known as a Qualified Charitable Distribution or QCD) in the future, making a deductible IRA contribution after age 70 ½ will affect the amount of future QCDs that will be excludable from your income. Please contact us for further explanations of QCDs and how they can be an effective way to give to charity and reduce your income.
Waiver of Required Minimum Distributions for 2020. If you have not yet taken your required minimum distribution (RMD) from your IRA, you do not have to do so in 2020 under the CARES Act. If you have already taken your RMD, you can repay it (along with any taxes withheld) within 60 days of the distribution. By not taking the RMD, you can leave the funds in your IRA for another year to grow tax-free.
Manage Investment Gains and Losses in Taxable Accounts. If you hold investments in taxable brokerage firm accounts, consider the tax advantage of selling appreciated securities that have been held for over 12 months. The maximum federal income tax rate on long-term capital gains recognized in 2020 is only 15% for most folks, although it can reach a maximum of 20% at higher income levels. The 3.8% Net Investment Income Tax (NIIT) also can apply at higher income levels.
To the extent you have capital losses that were recognized earlier this year or capital loss carryovers from pre-2020 years, selling winners this year will not result in taxable gain to the extent of these losses. A reminder that net short-term capital gains are taxed at ordinary tax rates.
If selling a bunch of losers would cause your capital losses to exceed your capital gains, the result would be a net capital loss for the year. No problem! That net capital loss can be used to shelter up to $3,000 of 2020 ordinary income from salaries, bonuses, self-employment income, interest income, royalties, and whatever else ($1,500 if you use married filing separate status). Any excess net capital loss from this year is carried forward to next year and beyond (doesn’t expire).
Donating Appreciated Investments to Charity. If you are charitable-minded, consider donating long-term investments that have appreciated in value. By donating these investments, rather than selling, you avoid being taxed on the gain and you may be able to deduct the fair market value of the assets donated.
This tax advantage doesn’t apply to donations of investments that have decreased in value. In that circumstance, you should sell the stock first to recognize the loss and then donate the cash. The loss would then be deductible and so might the donation.
Take Advantage of 0% Tax Rate on Investment Income. A potential silver lining to a down year may be the ability to harvest some long-term capital gains at very favorable rates. For 2020, singles can take advantage of the 0% income tax rate on long-term capital gains and qualified dividends from securities held in taxable brokerage firm accounts if their taxable income is $40,000 or less. For heads of household and joint filers, that limit is increased to $53,600 and $80,000, respectively.
Convert Traditional IRAs into Roth Accounts. This may be the perfect time to make that Roth conversion you’ve been thinking about. The current tax rates are still relatively low compared to a couple of years ago, but there is no guarantee they won’t increase in the future. Also, your income may be lower in 2020 due to the financial fallout of COVID-19. On the bright side, that could mean you are in a lower tax bracket than you normally find yourself. Since the CARES Act suspended Required Minimum Distributions (RMDs) for 2020, if you already budgeted to pay tax on your RMD, rolling that distribution to a Roth IRA could be good tax planning. No RMD for 2020 also means that 100% of the distribution can be classified as a rollover.
Year-end Planning Moves for Small Businesses
Net Operating Losses (NOLs). The CARES Act temporarily relaxed many of the NOL limitations that were implemented under the Tax Cuts and Jobs Act (TCJA). If your small business expects a loss in 2020, know that you will be able to carry back 100% of that loss to the prior five tax years. If you had an NOL carried into 2020, you can claim a deduction equal to 100% of your 2020 taxable income. This is something we monitor when we prepare your 2020 tax return.
Establish a Tax-favored Retirement Plan. If your business doesn’t already have a retirement plan, now might be the time to set it up. Current retirement plan rules allow for significant deductible contributions. For example, if you’re self-employed and set up a SEP-IRA, you can contribute up to 20% of your self-employment earnings, with a maximum contribution of $57,000 for 2020. If you’re employed by your own corporation, up to 25% of your salary can be contributed with a maximum contribution of $57,000.
Other small business retirement plan options include the 401(k) plan (which can be set up for just one person), the defined benefit pension plan, and the SIMPLE-IRA. Depending on your circumstances, these other types of plans may allow bigger deductible contributions.
The SECURE Act offers an additional incentive for establishing a retirement plan in 2020. The tax credit available for costs incurred by an employer to adopt a new eligible plan has increased from a maximum of $500 to a maximum of $5,000, and a $500 credit has been added for new small employer plans with an auto-enrollment feature.
Contact us for more information on small business retirement plan alternatives, and be aware that if your business has employees, you may have to cover them too. Deadlines for establishing a plan in its initial year varies, so check with us to make sure it is established in time for 2020 funding.
Take Advantage of Generous Depreciation Tax Breaks. 100% first-year bonus depreciation is available for qualified new and used property that is acquired and placed in service in calendar-year 2020. That means your business might be able to write off the entire cost of some or all of your 2020 asset additions on this year’s return. So, consider accelerating additional acquisitions between now and year-end.
Also, the CARES Act made a technical correction to the TCJA that retroactively treats a wide variety of interior, non-load-bearing building improvements [known as Qualified Improvement Property (QIP)] as eligible for bonus deprecation (and hence a 100% write-off). Alternatively, if you elect out of bonus depreciation, you can depreciate QIP over 15 years (rather than the 39 years provided by the TCJA). Small businesses can take advantage of this provision by filing for a change in accounting method or by amending the applicable return. Contact us for more details.
Claim 100% Bonus Depreciation for Heavy SUVs, Pickups, or Vans. The 100% bonus depreciation provision can have a hugely beneficial impact on first-year depreciation deductions for new and used heavy vehicles used over 50% for business (excludes commuting). That’s because heavy SUVs, pickups, and vans are treated for tax purposes as transportation equipment that qualifies for 100% bonus depreciation. However, 100% bonus depreciation is only available when the SUV, pickup, or van has a manufacturer’s Gross Vehicle Weight Rating (GVWR) above 6,000 pounds. The GVWR of a vehicle can be verified by looking at the manufacturer’s label, which is usually found on the inside edge of the driver’s side door where the door hinges meet the frame. If you are considering buying an eligible vehicle, doing so and placing it in service before the end of this tax year could deliver a significant write-off for the current year.
Cash in on Generous Section 179 Deduction Rules. For qualifying property placed in service in tax years beginning in 2020, the maximum Section 179 deduction is $1.04 million. The Section 179 deduction phase-out threshold amount is $2.59 million of capital asset additions.
Time Business Income and Deductions for Tax Savings. If you conduct your business using a pass-through entity (sole proprietorship, S corporation, LLC, or partnership), your share of the business’s income and deductions are passed through to you and taxed at your personal rates. If you assume next year’s individual federal income tax rate brackets will be roughly the same as this year’s, the traditional strategy of deferring income into next year while accelerating deductible expenditures into this year makes sense if you expect to be in the same or lower tax bracket next year. Deferring income and accelerating deductions will, at a minimum, postpone part of your tax bill until 2021.
However, if 2020 was a comparatively sub-par year and you expect to be in a higher tax bracket in 2021, you may want to take the opposite approach. Accelerate income into this year (if possible) and postpone deductible expenditures until 2021. That way, more income will be taxed at this year’s lower rate instead of next year’s higher rate. Contact us for more information on timing strategies.
Watch out for Business Interest Expense Limit. The CARES Act temporarily relaxed the unfavorable TCJA limitation on a taxpayer’s deduction for business interest expense. Under the TCJA, the deduction was limited to the sum of (1) business interest income, (2) 30% of adjusted taxable income, and (3) floor plan financing interest paid by certain vehicle dealers. For 2020, the 30% limit has been increased to 50% of adjusted taxable income. Barring additional legislation, the limit will go back to 30% in 2021. The rules for businesses conducted as partnerships, LLCs treated as partnerships for tax purposes, and S corporations are especially complicated.
Fortunately, many businesses are exempt from the interest expense limit rules under the small business exception. Under this exception, a taxpayer is generally exempt from the limit if average annual gross receipts are under $26 million (the inflation-adjusted amount for 2020) for the three-tax-year period ending with the preceding tax year.
Forms 1099-MISC and 1099-NEC (new)
In the past, non-employee compensation was reported in Box 7 of Form 1099-MISC. Beginning in 2020, nonemployee compensation will now need to be reported on the newly reintroduced Form 1099-NEC. Other types of miscellaneous income such as rents will still be reported on 1099-MISC.
For 2020, Form 1099-NEC must be filed with the IRS by February 1, 2021, while 1099-MISC must be filed with the IRS by March 1, 2021, if filing on paper (March 31st if filing electronically). Both Forms must be furnished to the recipient by February 1st. (Note: Make sure you obtain vendor and other 1099 recipient information well ahead of year-end by having them fill out Form W-9 to avoid delays in 1099 preparation).
Paycheck Protection Loan Forgiveness
The U.S. Small Business Administration (SBA) released a simplified application for forgiveness of PPP loan amounts of $50,000 or less. Under the simplified application, PPP borrowers are exempted from any reductions in forgiveness based on reductions in full-time-equivalent employees or reductions in employee salary or wages.
According to IRS guidance, the business expenses related to forgivable PPP loans are not deductible (essentially making the PPP loan forgiveness taxable in an indirect manner). Although lawmakers state that this was not their intent, Congress will need to address the deductibility of these expenses in future legislation to clearly make these expenses deductible. At this point, a proposed bill is stalled in the Senate and we recommend you consider the forgiveness of the PPP loans as additional taxable income for 2020 planning purposes.
SBA Debt Relief
As part of the coronavirus debt relief efforts, the SBA may have paid 6 months of principal, interest and associated fees for borrowers owed for 7(a), 504 and Microloans during 2020. If you received this debt relief, be aware that the total paid will be considered taxable income to you.
Families First Coronavirus Response Act
We provided information to you on this Act back in March of 2020 (https://www.houlihan.biz/COVID-19-Update.php). However, it is worth mentioning again with the increase in COVID cases that is currently impacting our area. The FFCRA requires certain employers to provide employees paid sick leave or expanded family and medical lease for specified reasons related to COVID-19 through December 31, 2020. If you have employees who you are required to pay under this act, remember that there is a payroll tax credit available to reimburse employers for these costs. Please contact our office or your payroll provider for more information.
This letter only covers the most common year-end tax planning moves that could potentially benefit you, or your business. Of course, individual circumstances can vary by uniqueness and complexity. Please contact us if you have questions, want more information, or would like us to provide more tailored tax planning that delivers the best tax results for your particular circumstances.