Year-End Tax Planning Tips for 2020
It may be hard to believe, but 2020 is almost over. If you want to maximize your tax savings, now is the time to get your ducks in a row. Let’s take a look at five year-end tax planning tips for 2020 that will help you start 2021 on the right foot.
1. Collect Important Tax Documents
It’s always a good idea to gather the paperwork you’ll need come tax time. Be sure that you know where all your household’s key documents are, such as:
W-2s and 1099 forms (once they arrive in 2021)
Charitable giving receipts
Medical expense receipts
Statements for retirement plans and other investment accounts
Tuition statements
Your previous year’s tax return
If you begin gathering these documents early, it gives you time to notice a misplaced document or incorrect form, like a tuition statement buried in your email or a donation receipt with a misspelled name.
2. Contribute the Maximum to Your Retirement Accounts
If you’re still working, check that you’ve paid as much as you can to retirement accounts such as your IRA or 401(k). The maximum IRA contribution for 2020 is $6,000 for individuals, or $7,000 for those age 50 or older. You can make 401(k) contributions totaling $19,500 in 2020, plus a $6,500 catchup contribution if you are 50 or older.
Remember: Your retirement contributions can help give you a bigger tax break for 2020. You’ll need to make contributions to your 401(k) plan by December 31, 2020, to help reduce your taxable income for the year.
You’ll have more time to contribute to your IRA—the deadline is April 15, 2021. Make sure to review how the IRA income phase-out rules affect potential tax deductions.
3. Decide If You Need Your RMD
The coronavirus pandemic changed the rules for required minimum distributions (RMDs) in 2020. Thanks to the CARES Act, you do not need to take your RMD this year. If you forgo a distribution, you can reduce your taxable income and give your retirement account more opportunity to recover from this year’s market volatility.
You might also consider whether a qualified charitable distribution (QCD) will benefit you. With a QCD, you donate up to $100,000 of your IRA to a qualified charitable organization and have it count as your RMD. Not only do you help a cause you are passionate about, but you avoid being taxed on the distribution as long as your IRA custodian makes the payment directly to the charity.
Although the federal government has waived RMDs for 2020, a qualified charitable distribution still has tax benefits that make it attractive. The donation helps reduce your taxable income and can reduce future RMDs by trimming your IRA balance.
If you’re unsure whether an RMD or QCD is a good move for you, consider talking with a fiduciary financial advisor with expertise in retirement planning.
4. Make a Plan for Tax Deductions
Decide now whether you want to itemize your deductions or take the standard deduction in 2020. The standard deduction this year is $12,400 for individuals, $18,650 for heads of household, and $24,800 for married filing jointly. If you are 65 or older, you receive an additional deduction of:
$1,650 for individuals
$1,300 for married filing jointly when one of you is 65 or older
$2,600 for married filing jointly if you are both 65-plus
If your deductible expenses total more than the standard deduction, it’s usually best to itemize.
If you’re on the cusp, you can spend a bit more now to maximize your deductions. Possibilities include:
Pay your medical bills: Medical expenses that exceed 7.5% of your adjusted gross income (AGI) can count toward your itemized deductions.
Make charitable contributions: For 2020, you can claim a deduction up to 100% of your AGI for cash contributions to qualified charities.
Pay property taxes for 2021: Paying property taxes early could benefit you—just be aware that the IRS allows a combined $10,000 annual limit ($5,000 if you are married filing separately) on state and local property/income taxes for itemized deductions.
Pay estimated state income tax due next year: The same note for property taxes above applies here. Plus, be aware that the deduction allows you to deduct state and local income taxes, or state and local sales taxes—not both.
Even if you don’t plan to itemize this year, the CARES Act authorized an above-the-line charitable deduction of up to $300 in cash contributions from taxpayers who take the standard deduction.
5. Defer or Accelerate Your Income
As part of your year-end tax planning, take a look at your tax bracket and decide if you’d be better off deferring or accelerating income.
If you expect to be in a higher tax bracket next year, you may want more income to be taxed in 2020 to help reduce 2021’s tax burden. In that case, try accelerating income (without pushing yourself into the next tax bracket) or deferring deductions:
Ask clients or customers to pay now and follow up with late client payments.
Ask for higher up-front payments for client work due early next year.
Wait to pay deductible expenses until January.
Alternatively, if you expect to be in a lower tax bracket next year, you may want to defer income and accelerate deductions:
Wait to collect on delinquent client accounts until January.
Ask for lower payments up-front for projects due next year.
Buy business equipment or office supplies this year.
Pay medical bills due in January.
Prepay deductible interest.
While you are assessing your tax needs, consider whether you have paid enough taxes through either withholding or payments for estimated taxes. If you are going to be short, now is the time to take steps, such as increasing your withholding for 2020.
6. Harvest Your Investment Losses
If you’re set to pay capital gains taxes in 2020, double-check your portfolio for investment losses. You can use those losses to offset the capital gains through a strategy called tax-loss harvesting. You can use tax-loss harvesting for taxable investment accounts, like your brokerage account, not a tax-deferred plan, such as your IRA or 401(k)
You can also use tax-loss harvesting to offset up to $3,000 in ordinary taxable income while carrying forward any unused balance into subsequent years.
If you plan to repurchase investments, make sure you don’t run afoul of the wash-sale rule. This rule bars you from selling an investment at a loss, then buying an identical or “substantially identical” equity within 30 days before or after the sale.
7. Don’t Forget Your FSA
As the year winds down, it’s critical to check the balance of your FSA and reimburse yourself for any qualified medical expenses you incurred between January 1 and December 31, 2020.
Generally, you have to use your health care FSA funds by year-end or forfeit them. But first check with your Human Resources department or FSA documentation. Some flexible spending accounts have a grace period that extends the period to spend your account balance, and others have a provision for carrying over funds—up to $550 for 2020.
If you need to spend down your FSA, here are a few strategies to use up the rest:
Schedule that dental procedure you’ve been putting off.
Get an eye exam.
Buy new glasses or contacts.
Stock up on first-aid supplies.
Year-End Tax Planning 2020: It Never Hurts to Think Ahead
As the year winds down, now is the time to get your tax plan organized. Collect your important paperwork, contribute to your retirement plans, make any last-minute deductions (or decide if you’d be better off deferring them to next year), and don’t forget to put your flexible savings account to use.
This is also a perfect time to reach out to your tax professional and financial advisor to ensure everyone in your support system is on the same page. Your tax preparer will have more time to focus on your needs if you get ahead of the tax-season rush—and now is a good time to check in with your financial advisor to discuss potential tax strategies for the year ahead.
Our Greenwood Village, Colorado fee-only financial planning firm believes year-long tax planning is the most effective kind of planning. Now that you are wrapping up your end-of-the-year tax strategies, consider starting your 2021 tax plan in January. It can help reduce tax surprises and last-minute stress.
Discuss your situation with a fee-only financial advisor. Schedule a complimentary discovery call.
This material was prepared by Kaleido Inc. from information derived from sources believed to be accurate. This information should not be construed as investment, tax or legal advice.
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