Year-End Tax Planning for Individuals

We recognize the impact this unimaginable year has had on all of us. There have been immeasurable shifts in our society, but our unwavering commitment to help guide you through these uncharted waters with our resources and expertise remains steadfast. Here are some planning tips to help you untangle the complex tax laws affecting high-income taxpayers this year.

Required Minimum Distributions

One of the most welcomed changes in 2020 was reprieve from taking required minimum distributions (RMDs) from retirement accounts. The CARES Act waived RMDs for retirees in 2020 since calculations are based on the prior year’s account balance. This means that retirees would have been taking distributions and calculating taxes owed on accounts that may have fluctuated in a volatile market. RMDs are suspended from defined contribution plans, including 401(k) plans and IRAs, but the waiver does not apply to defined benefit plans.

The IRS also announced mid-year that taxpayers can re-contribute any RMDs that were taken in 2020 by August 31. If you opted to return your distributions, you could save a fair amount in taxes owed this year.

In addition, a bill passed late last year—the SECURE Act—also brings a number of well-received provisions that could affect your retirement plans in 2020, including: 

• Increasing the age for beginning RMDs from age 70 ½ to age 72 (for taxpayers who did not turn age 70 ½ prior to Jan. 1, 2020)
• Allowing penalty-free withdrawals of up to $5,000 for the birth or adoption of a child
• Repealing the maximum age of 70 ½ for making traditional IRA contributions
• Reducing the time period for taking IRA distributions to 10 years for beneficiaries who inherit IRAs after Dec. 31, 2019 (excluding spouses)

If you’d like to avoid the RMD requirement, you can roll your funds into a Roth IRA. We recommend that you work closely with your tax professional to understand the current income tax effect of doing so.

Before you decide how to manage your distributions, consider the lost tax-deferred growth and if the following situations could be triggered:

1. Your Social Security payments become taxable
2. Your income-based Medicare premiums and prescription drug charges increase
3. Other income-based deductions or credits are impacted

Please be advised that while distributions aren’t subject to the additional 0.9% Medicare tax or 3.8% net investment income tax (NIIT), they are integrated into your modified adjusted gross income (MAGI), so the distributions could re-position your tax threshold and trigger or increase NIIT.

Economic Impact Payment

Many received stimulus checks earlier this year—up to $1,200 per taxpayer and $500 per qualified dependent. Line 30 on Form 1040 is where taxpayers will claim their stimulus checks, or what the IRS is calling the “recovery rebate credit.”

Since the payments were based on previous tax returns from 2018 or 2019—but are actually designed as advanced 2020 tax credits—taxpayers may see a difference between what they received and what they actually qualify for based on AGI in 2020. For example, if a nurse is experiencing higher than normal income this year based on the demands of healthcare professionals, there is no clawback if their income exceeds the threshold limits for the refund credit.

On the other hand, if a pilot takes leave this year due to the travel industry’s downturn, s/he can claim an additional or full credit on their 2020 tax return if the advanced credit was less than the actual credit. Similarly, a credit may also be granted if children were born or adopted in 2020 (2019 if the credit was based on 2018), making a taxpayer eligible for an additional $500.

To best prepare for filing season, you should have received Notice 1444 within 15 days of payment receipt. Please retain this letter, as it shows the amount of your stimulus payment and will be used in calculating your credit amount.

Charitable Contributions

According to the Association for Fundraising Professionals, the year did not start out strong for charitable giving with donations in the first quarter down by almost 6% compared to 2019. However, the second quarter rebounded quickly and brought the first half of the year ahead of last year by a 7.5% increase. While many nonprofits continue to suffer a great loss in donations, reports show that there has been a significant increase in smaller donations (less than $250) this year.

The CARES Act increased the federal deduction limitation for cash gifts to qualifying nonprofits to 100% of AGI. The Act also allows nonitemizers to take an “above the line” deduction up to $300 of cash contributions to qualifying charities. This change allows the immediate reduction of AGI, while also taking the standard deduction.

If you are a taxpayer who gives generously to nonprofits but finds that the Tax Cuts and Jobs Act (TCJA) standard deduction limits your ability to itemize and receive a tax benefit for your contributions, you may consider “bunching” your charitable contributions to obtain higher tax savings. For example, if you’re considering a year-end donation in 2020, but you may not exceed the standard deduction threshold, consider donating in January 2021, and then again in December 2021 to reach a higher itemized amount, resulting in greater tax savings.

Gift and Estate Tax Exemptions

There’s a small window of substantial opportunity right now with the combination of historically low interest rates and high lifetime gift and estate tax exemptions. The current lifetime exemption amount is $11.58 million per individual (more than double since 2017 and ten times the amount in 2008). Even if a taxpayer has already exhausted their lifetime limit, exemption amounts are subject to an inflationary factor each year. That means some taxpayers may continue to allocate additional funds to heirs as long as the exemption amount remains high.

With current gift and estate tax exemptions sunsetting in a few years, now is the time to employ estate planning techniques to transfer wealth with minimal to no cost at all.

Avoiding or Reducing AMT

Do you think you could be subject to the alternative minimum tax (AMT) this year or next? Timing is everything as we near year end. These next few months will allow you to strategize whether to accelerate income and short-term capital gains into this year in an effort to benefit from the lower maximum AMT rate. Does it make sense to hold off on deferring expenses that you cannot deduct for AMT purposes until next year? Or, does your financial position make you more at risk to be subject to the AMT next year, where you’ll want to take the opposite approach? Before you decide, we should review a number of factors, including whether you plan to replace private activity municipal bonds and what you will do with stock options.

California Proposals

A proposed tax bill, Assembly Bill 1253, is in the works and intends to impose higher taxes on wealthy income earners in California. If the bill is passed, it will add an additional 1% on income over $1M, 3% on income over $2M, and 3.5% on income over $5M, plus adjustments for inflation. The proposal also intends to make the rate retroactive to January 1, 2020 and move California’s highest tax rate from 13.3% to 16.8%.

Unfortunately, that’s not the only bill making its way through legislation with intent to increase tax rates for high net worth individuals. Assembly Bill 2088 initiates the first net worth tax around the country, setting a 0.4% tax rate on all net worth above $30M. If passed, this tax would be applied to all assets and liabilities (excluding directly owned real estate) held globally by a taxpayer.

Combined, this means the state and federal tax rate for the top income earners in California would climb to 53.8%.

With these proposed changes and the variables of the upcoming election, tax planning is imperative this year, as we all prepare for a potential shift in tax rates.

Start Planning Now

To best position you for the future, we invite you to visit our online tax guide at www.bpw.com/resources/client-tools/ and schedule a meeting to discuss proactive tax strategies that can favorably impact your bottom line and reduce your tax burden. Our goal is not only to preserve your wealth but also define new opportunities for growth.

Please contact me at (805) 963-7811 or bforeman@bpw.com to review your financial situation and year-end planning opportunities.