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End of Year Tax Planning - Daviman Financial - Fiduciary Advisors Serving Indianapolis & Indiana
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317.207.0175 [email protected]

Who’s ready for 2020 to be over? It would be nice to put elections and quarantines behind us for a change and discuss something more enjoyable…like taxes. Ok, we can appreciate that with the end of the year and more holidays approaching this might not be top of your list either. However, unlike many personal finance topics, this one has an expiration date. Many useful tax planning strategies must be completed prior to the end of the year, so we thought we’d review a few you may want to consider before 2021 arrives. Let the fun begin!

1. Make pre-tax contributions to your 401(k) plan: If you are looking for a great way to reduce your taxable income while planning for your future this is a no brainer. It’s especially true for those with variable income who may not know they have moved into a higher tax bracket until later in the year. The maximum contribution for 2020 is $19,500 (or $26,000 if you are over 50). Some 401(k) plans only allow contribution changes a few times a year, so check with your HR department to see if this is an option for you.

2. Contribute to your HSA plan: Since HAS contributions are an above the line deduction on your taxes, they also reduce your taxable income. In addition, it comes with the kicker that it can be withdrawn and spent tax free if used to pay for qualifying medical expenses. We’re cheating a little with this one since technically you have until tax filing to make additional contributions, but we’ve found most people prefer to make current year, rather than prior year, deposits because it is easier to keep track of that way.

3. Make a charitable contribution (Part I): As part of the CARES Act that passed this year you can now claim a deduction of up to $300 for cash contributions to qualifying organizations even if you don’t itemize your taxes.

4. Make a charitable contribution (Part II): If you make significant charitable contributions each year, but not quite enough to justify itemizing your deductions, consider a bunching strategy by making your planned 2021 donation this year instead. Having both in the same tax year might allow you to itemize and receive a tax deduction for your contribution. Many organizations typical fundraising events have been cancelled due to COVID concerns so accelerating gifts will be greatly appreciated. The CARES Act also increased the deduction limit on cash contributions for 2020 to 100% of AGI (Adjusted Gross Income).

5. Make a charitable contribution (Part III): If you are over 701/2 you can make a qualified charitable distribution from your IRA – up to $100,000 – directly to an eligible charity. While RMDs are not required this year due to the CARES Act, donors who prefer to tap their retirement accounts allows them to benefit removing this distribution from their income without having to itemize deductions.

6. Complete a Roth conversion: Converting a portion of your Traditional IRA to a Roth IRA may be a useful tax strategy for several reasons. For example, if you believe you will be in a higher tax bracket in the future, due to tax rate increases or just higher income, want more flexibility to control your tax bracket in retirement, or just want to leave a more valuable legacy to beneficiaries also in a high tax bracket. In addition, retirees who were not required to take a RMD this year, and didn’t need the income, might complete an equivalent conversion in its place so their taxable income is the same as what was expected but now have a larger Roth IRA balance and reduced future RMDS.

7. Sell Investments for a loss: This strategy is typically referred to as tax-loss harvesting. This means intentionally selling an investment (commonly a stock, ETF, or mutual fund) with unrealized (unrealized just means that you haven’t sold it yet) losses to reduce taxable gains from other investments. For a married couple filing jointly, up to $3,000 per year in realized capital losses can be used to offset capital gains or ordinary income. If you would like to reinvest in the same thing make sure you don’t get tripped up by wash sale rules, which prohibit deducting losses if within 30 days you buy identical or substantially identical securities.

8. Sell Investments for a gain: If you have investments in a taxable account with unrealized long-term capital gains, selling those investments to realize the gain may be a good plan if your income is below $40,000 for a single individual or $80,000 for a couple married, filing jointly. That is because long-term capital gains are taxed at 0% below those income thresholds for 2020.

9. Take a Coronavirus Related Distribution from your retirement account: To be clear, taking money away from your retirement savings early is rarely a good idea, but if you must, doing so in 2020 could be helpful. Another provision of the CARES Act passed this year “provides for expanded distribution options and favorable tax treatment for up to $100,000 of coronavirus-related distributions from eligible retirement plans.” Simply put, you can remove up to $100,000 without paying the 10% early withdrawal penalty, spread the taxes due over a three year period, and can even return the funds to your retirement account if completed within a three year period. To qualify there are specific guidelines such as testing positive or losing your job or income because of COVID-19 that you should review before considering taking action.

10. Fund a 529 college savings plan: Many states offer tax deductions or credits for saving. Although the tax incentives are usually capped it can be worth your while even if you have older children or grandchildren. For example, the state of Indiana offers a tax credit worth 20% of your contribution up to a $1,000 max credit.

Before the end of the year take a moment to understand where your income falls in relation to various tax brackets and phase outs. You might find that a small reduction in your Adjusted Gross Income can save you money in more than one place. Since many of these simple tax planning ideas are a matter of trade-offs (like reducing spending so you can increase retirement savings), they may make more sense in some years than others. Knowing when to pull or push income, expenses, and deductions into different tax years can be the difference in significant tax savings over time.